US Ratings Under Threat

June 3, 2011 — Mitul Kotecha

The USD succumbed to further pressure overnight as Moody’s Investor Service threatened to place the US Aaa rating on review for downgrade if there is no agreement reached on raising the US debt ceiling. Although the news prompted a rise in US Treasury yields it did little for the USD.

News that the Federal Reserve’s balance sheet expanded to a record $2.772 trillion in the week ending June 1 highlights the ongoing headwinds to the USD from Fed asset purchases. The fact that there is even talk of QE3 in the wake of weak US data suggests that the headwinds will not dissipate quickly.

Direction today will come from the US May jobs report though this is unlikely to deliver any good news for the USD. Forecasts for non-farm payrolls have likely been revised lower to sub 100k compared to the published consensus forecast of 165k following the weaker indications from the May ADP jobs report and ISM data this week. A weak payrolls outcome will only intensify worries about the depth and length of the US ‘soft patch’.

Although market expectations are also likely to have been downwardly revised, something that may cushion the blow to the USD, it will be difficult to get away from the fact that growth in Q2 is weaker than many had thought.

EUR was well supported overnight, boosted by a relatively successful Spanish bond auction yesterday and reports that officials have agreed in principle to a 3-year adjustment plan for Greece covering funding needs to 2013 although there was no confirmation of such an agreement.

As a result, EUR/USD tested 1.45 and looks supported ahead of today’s US payrolls data. EUR’s recovery in general has been impressive but gains above 1.45 are likely to prove more difficult even if an agreement on Greece is close to being achieved.

As usual Japan’s political gyrations are having little impact on the JPY as the currency is instead buffeted by risk aversion swings and yield differentials. In fact USD/JPY has been rather well behaved over recent weeks as indicated by implied options volatility.

Prime Minister Kan’s success in winning a no-confidence motion came at a cost and may provide very little political stability. Kan said will resign as soon as post-earthquake recovery efforts are completed and once he is gone there is likely to be some realignment of existing political parties.

As for the JPY it will remain unscathed by political events. Over the near term USD/JPY is likely to cling to the 81 handle but we maintain our bearish view on the JPY in the medium term under the assumption that there is a sharp widening in US – Japan bond yield differentials.

Posted in Bond markets, central banks, Currencies, ECB, Economics, Economy, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Greece, IMF, Interest rates, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , . Leave a Comment »

Data and earnings focus

January 17, 2011 — Mitul Kotecha

Friday’s round of US data were generally upbeat, highlighting that consumer spending is coming back to life. Inflation pressures however, remain benign at least on the core reading highlighting the Fed’s concern that inflation is running below the level consistent with its mandate. In other words it will be a long time, probably late into 2012 before policy rates increase.

While the Fed is no hurry to raise rates despite a few hawkish rumblings within the FOMC the European Central Bank (ECB) in contrast appears to have become more eager to pull the trigger for higher rates. ECB President Trichet’s hawkish press conference last week set the cat amongst the pigeons and marked a clear shift in ECB rhetoric towards a more hawkish stance.

A very big problem for the ECB is that the eurozone economy is not performing along the lines that its hawkish rhetoric would suggest, especially in the periphery. Growth momentum in the core in contrast, as likely reflected in the January ZEW investor confidence and IFO business confidence survey data this week in Germany, remains positive. Both surveys are likely to stabilize at healthy levels but how long can the likes of Germany drag along the eurozone periphery?

There will be relatively more attention on the meeting of Eurogroup/Ecofin officials, with focus on issues such as enlarging the size of the European Financial Stability Facility (EFSF) bailout fund and development of a “comprehensive plan” to contain the eurozone crisis. Don’t look for any conclusive agreements as this may have to wait until the European Union (EU) Council meeting on 4 February assuming (optimistically given ongoing German resistance) some agreement can even be reached.

Following the success (albeit at relatively high yields) of the eurozone debt auctions last week, sentiment for peripheral debt will face further tests this week in the form of debt sales in Spain, Belgium and Portugal.

The US Martin Luther King Jr. holiday will result in a quiet start to the week for markets but there will be plenty to chew on. This week’s key earnings reports include several banks scheduled to release Q4 earnings. Financials are a leading sector in the rally in equities at present and these earnings will be critical to determine whether the rally has legs.

The US data slate includes January manufacturing surveys in the form of the Empire and Philly Fed, both of which are likely to post healthy gains whilst existing home sales are also likely to rise. This will not change the generally weak picture of the US housing market, with high inventories and elevated foreclosures characterizing conditions. As if to prove this, housing starts are set to drop in December. On the rates front, the Bank of Canada is likely to keep its policy rates on hold this week.

After coming under pressure last week much for the USD will depend on the eurozone’s travails to determine further direction. Concrete evidence of progress at the Ecofin may bolster the EUR further, with resistance seen around 1.3500 but don’t bank on it. The ability of eurozone officials to let down often lofty expectations should not be ignored. In any case following sharp gains last week progress over coming days for the EUR will be harder to achieve.

Posted in Bond markets, central banks, Currencies, ECB, Economics, Economy, equity markets, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Germany, IMF, Interest rates, Ireland, Monetary Policy, Portugal, Spain, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Irish bailout leaves EUR unimpressed

November 29, 2010 — Mitul Kotecha

As has been the case since the beginning of the global financial crisis policy makers have found themselves under pressure to deliver a solution to a potentially destabilising or even systemic risk before the markets open for a new week in order to prevent wider contagion. Last night was no different and following urgent discussions a EUR 85 billion bailout for Ireland to be drawn down over a period of 7 ½ years was agreed whilst moves towards a permanent crisis mechanism were brought forward. As was evident over a week ago a bailout was inevitable but the terms were the main imponderable.

Importantly the financing rate for the package is lower than feared (speculation centered on a rate of 6.7%) but still relatively high at 5.8%. Moreover, no haircuts are required for holders of senior debt of Irish banks and Germany’s call for bondholders to bear the brunt of losses in future crises was watered down. The package will be composed of EUR 45 bn from European governments, EUR 22.5 bn from the IMF and EUR 17.5 bn from Ireland’s cash reserve and national pension fund.

The impact on the EUR was stark, with the currency swinging in a 120 point range and failing to hold its initial rally following the announcement. A break below the 200-day moving average for EUR/USD around 1.3131 will trigger a drop to around 1.3020 technical support. Officials will hope that the bailout offers the currency some deeper support but this already seems to be wishful thinking. The EUR reaction following the Greek bailout in early May does not offer an encouraging comparison; after an initial rally the EUR lost close to 10% of its value over the following few weeks.

Although it should be noted that the bailout appears more generous than initially expected clearly the lack of follow through in terms of EUR upside will come as a blow. The aid package has bought Ireland some breathing space but this could be short lived if Ireland’s budget on December 7 is not passed. Moreover, the bailout will not quell expectations that Portugal and perhaps even Spain will require assistance. Indeed, Portugal is the next focus and the reaction to an auction of 12-month bills on 1 December will be of particular interest.

Taken together with continued tensions on the Korean peninsular, position closing towards year end ongoing Eurozone concerns will likely see a further withdrawal from risk trades over coming weeks. For Asian currencies this spells more weakness and similarly commodity currencies such as AUD and NZD also are likely to face more pressure. The USD remains a net beneficiary even as the Fed continues to print more USDs in the form of QE2.

Data and events this week have the potential to change the markets perspective, especially the US November jobs report at the end of the week. There is no doubt that payrolls are on an improving trend (145k consensus) in line with the declining trend in jobless claims but unfortunately the unemployment rate is set to remain stubbornly high at 9.6% and this will be the bigger focus for the Fed and markets as it implies not let up in QE. As usual further clues to the payrolls will be garnered from the ADP jobs report and ISM data on Wednesday.

Posted in Bond markets, central banks, Currencies, Economics, Economy, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Germany, Greece, IMF, Interest rates, Ireland, Spain, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Edging Towards A Bailout

November 18, 2010 — Mitul Kotecha

A confluence of factors have come together to sour market sentiment although there appeared to be some relief, with a soft US inflation reading (core CPI now at 0.6% YoY) and plunge in US October housing starts reinforcing the view that the Fed will remain committed to carry out its full QE2 program, if not more.

However any market relief looks tenuous. Commodity prices remain weak, with the CRB commodities index down 7.4% in just over a week whilst the Baltic Dry Index (a pretty good forward indicator of activity and sentiment) continues to drop, down around 21% since its recent high on 27 October. Moreover, oil prices are also sharply lower. Increasingly the drop in risk assets is taking on the form of a rout and many who were looking for the rally to be sustained into year end are getting their fingers burnt.

Worries about eurozone peripheral countries debt problems remains the main cause of market angst, with plenty of attention on whether Ireland accepts a bailout rumoured to be up EUR 100 billion. Unfortunately Ireland’s reluctance to accept assistance has turned into a wider problem across the eurozone with debt in Portugal, Greece and also Spain suffering. An Irish bailout increasingly has the sense of inevitability about it. When it happens it may offer some short term relief to eurozone markets but Ireland will hardly be inspired by the fact that Greece’s bailout has had little sustainable impact on its debt markets.

Ireland remains the primary focus with discussions being enlarged to include the IMF a well as ECB and EU. What appears to be becoming clearer is that any agreement is likely to involve some form of bank restructuring, with the IMF likely to go over bank’s books during its visit. Irish banks have increasingly relied on ECB funding and a bailout would help reduce this reliance. Notably the UK which didn’t contribute to Greece’s aid package has said that it will back support for Ireland, a likely reaction to potential spillover to UK banks should the Irish situation spiral out of control. Any bailout will likely arrive quite quickly once agreed.

Although accepting a bailout may give Ireland some breathing room its and other peripheral county problems will be far from over. Uncertainties about the cost of recapitalising Ireland’s bank will remain whilst there remains no guarantee that the country’s budget on December 7 (or earlier if speculation proves correct) will be passed. Should Ireland agree to a bailout if may provide the EUR will some temporary relief but FX markets are likely to battle between attention on Fed QE2 and renewed concerns about the eurozone periphery, suggesting some volatile price action in the days and weeks ahead.

Reports of food price controls of and other measures to limit hot money inflows into China as well as prospects for further Chinese monetary tightening, are attacking sentiment from another angle. China’s markets have been hit hard over against the background of such worries, with the Shanghai Composite down around 10% over the past week whilst the impact is also being felt in many China sensitive markets across Asia as well as Australia. For instance the Hang Seng index is down around 7% since its 8 November high.

Posted in Asia, bank rescue, Bond markets, central banks, China, Commodities, Currencies, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Greece, IMF, Ireland, Monetary Policy, Singapore, South Korea, Spain, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

Caught In The Headlights

November 15, 2010 — Mitul Kotecha

For a prolonged period of time market attention had firmly focused on the Fed and prospects for quantitative easing (QE2). Now that QE has been delivered with little surprise, as the Federal Reserve arguably did a good job of living up to market expectations, it is Europe that is back in the limelight. Until recently the major surprise about Europe was how well the economy and the EUR were doing and how quickly the European Central Bank (ECB) would diverge from the Fed in its policy path.

This all looks premature and as if to confirm the shift in outlook the slowing in eurozone growth in Q4 (0.4% QoQ) revealed last week is likely to mark the beginning of a sharp and diverging deceleration in growth over coming quarters. The EUR may still have some life left in it given the ongoing purchases via recycled intervention flows from Asian central banks but weaker growth and peripheral worries are undermining this vestige of support.

Unfortunately for Europe the region is now not being caste in a good light and the peripheral trio of Ireland, Greece and Portugal are all staring into the headlights with nowhere to run. A crash of sorts seems inevitable but will there be any casualties? Markets are being whipsawed as they determine what will happen next in this slow motion saga.

Irish officials have maintained they do not need any aid package following discussions held over the weekend. Any bailout would likely come from a EUR 60 billion fund from the European Commission meaning a quick distribution but Ireland’s refusal will likely see pressure resume on peripheral debt markets in Europe as well as the EUR.

Portugal is also in the spotlight following comments by its foreign minister that the country may be forced to abandon the EUR if there is a failure to adopt a broad coalition government to deal with the crisis. This sounds like scaremongering but nonetheless highlights the political tensions in the country.

In Greece the second round of regional elections reveals the ruling Pasok party candidates are in the lead, reducing the prospect of early general elections. Nonetheless, this will do little to alleviate pressure as the EU is set to revise higher Greece’s 2009 deficit and debt estimates implying even more difficulty in meeting this year’s targets.

An EU/IMF team will visit Greece to assess progress as well as decide on whether the country should receive its 3rd instalment of a EUR 110 billion loan. Suggestions from PM Papandreou that he does not rule out having to extend the repayment of the loan will not auger well for sentiment. Finally, the government is set to present its 2011 final budget on Thursday, suggesting plenty of event risk this week.

A meeting of EU finance ministers tomorrow and Wednesday will also garner attention. Germany’s stance that investors will only have to take the brunt of losses from debt rescheduling only from 2013 still remains a contentious issue amongst officials even though it is a slightly softer stance than previously stated. Agreement on this as well as pressure on Ireland to accept funding will be key points of discussion.

Event wise, an auction of T-bills in Greece tomorrow as well as a Spanish debt auction on Thursday will be watched to determine how far the contagion of Irish woes have spread. The news is unlikely to be good, with higher yields likely. Unfortunately tomorrow’s German November ZEW investor confidence survey will provide further signs of retreating investor sentiment in the wake of renewed peripheral debt concerns.

Posted in Currencies, Economics, Economy, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Germany, Greece, IMF, Interest rates, Ireland, Monetary Policy, Portugal, Spain, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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