Asian FX on the back foot

July 19, 2013 — Mitul Kotecha

Sentiment remains upbeat, if not a little subdued as thin summer conditions kicked in. US and European equities rose overnight while 10 year US Treasury yields moved back above 2.5% and the USD continued its grind higher, especially versus JPY ahead of looming Japanese Upper House elections this weekend. A combination of the ongoing impact of Fed Chairman Bernanke’s testimonies to Congress (note he added a little more to his dovish spin in the Q&A session to the Senate Banking Committee yesterday calling tighter financial conditions “unwelcome”), firmer US Q2 earning and positive economic data surprises, have shored up confidence.

This was reinforced by the decision by Moody’s ratings agency to raise the outlook on the US AAA rating from negative to stable. On the earnings front US banks in particular have beaten forecasts while in contrast tech heavyweights disappointed after the close last night, suggesting that sentiment may weaken in today’s session. Additionally news that the US city of Detroit filed for bankruptcy will act to partly counterbalance the positive ratings news. In Europe, firmer UK retail sales and a strong Spanish debt auction boosted sentiment. There is little on the data front today, suggesting a generally flat end to the week.

Against the background of a move higher in US yields and a firmer USD especially versus JPY, Asian currencies generally remain on the back foot, with losses registered overnight. India’s attempts to stem the drop in the INR are having a diminishing impact on the currency, with USD/INR edging back towards the key 60 level. The good news is that capital outflows from the region have been stemmed, with month to date equity inflows of $311 registered. However, this belies the fact that India, Indonesia and to a lesser extent South Korea continue to register outflows.

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Bernanke awaited, RBI stays on hold

June 17, 2013 — Mitul Kotecha

Central banks are very much in the spotlight. Whether it’s poor communication or disappointment over the lack of fresh stimulus measures in Japan or opposition to the European Central Banks’ (ECB) OMT policy being debated in the German constitutional court there is much to focus on. Against the background of heightened volatility and elevated risk aversion the Fed FOMC meeting on Wednesday will garner even more attention than usual.

Although no change in policy settings is expected the ability of Fed Chairman Bernanke to communicate effectively the Fed’s strategy over ‘tapering’ will be crucial to determine whether market volatility persists or lessens. Ultimately markets are likely to successfully transition to a world of reduced Fed asset purchases but this may take a while. In the meantime market stress is set to remain elevated.

Aside from the Fed FOMC meeting US data releases are likely to continue to show encouraging signs of housing market recovery, with US May housing starts and April existing home set to reveal gains. Meanwhile, CPI inflation will remain benign in May while the June Empire manufacturing survey today will reveal a slight improvement.

In Europe, there will be attention on a Eurogroup meeting on Wednesday where banking union will be discussed while data releases include the June German ZEW investor confidence survey (slight drop likely) and the flash estimates of June purchasing managers’ indices. These are likely to look less negative although they are set to remain in contraction territory. In Japan, May trade data will likely show a widening in deficit as weaker external demand outweighs the impact of a weaker JPY.

In FX markets USD selling against major currencies is likely to slow. The 4.4% drop in the USD index from its highs in late May has been rapid but it has led to a major shift in positioning. Speculative USD long positions have been cut back significantly, while EUR positioning is almost back to flat after being extremely short in previous weeks. Similarly JPY short positions are beginning to be pared back. I suspect that the EUR in particular will struggle to make much more headway.

Weakness of the USD against major currencies has contrasted sharply with USD strength against emerging market currencies. The sell off in Asian currencies has been particularly sharp although there was some tentative recovery towards the end of last week. The INR followed by the most risk sensitive currencies including PHP and THB have suffered the most over recent weeks.

The INR’s vulnerability has been particular high due to its external funding requirements although it may show some tentative signs of recovery over coming days as its sell off has looked overdone. The Reserve Bank of India policy meeting today offered no help for the INR. Although it was a close call there was a significant minority looking for a rate cut to boost growth. The lack of action will weigh on the INR in the short term.

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Bullish INR but other Asian currencies held back

December 7, 2012 — Mitul Kotecha

Although the European Central Bank (ECB) left policy rates unchanged the post meeting press conference effectively opened the door to a rate cut in Q1 next year following sharp downward revisions to growth projections and well below target inflation projected over the medium term. A major casualty of the shift in ECB tone was the EUR which dropped over one big figure from a high of around 1.3089. Technical support for EUR/USD is now seen around 1.2885.

The Baltic Dry Index has continued to decline over recent days sending an ominous signal for growth ahead. Meanwhile, once again politics cast a shadow over European markets as Italy’s government overcame a confidence motion, with ex Prime Minister Berlusconi’s PDL party threatening to withdraw support and bring down the government.

Trading is likely to remain thin today as markets await the US November jobs report. The report will undoubtedly be soft (consensus is for an 85k increase in November payrolls) but as much of the weakness in jobs growth will be due to Hurricane Sandy the market impact is likely to be muted leaving a likely constructive tone to risk appetite going into next week.

Asian currencies continue to take direction from the CNY, with the lack of upside traction in this currency leaving most Asian currencies within ranges despite the fact that equity flows to Asia have been very strong over recent days, with inflows of over $2 billion registered this week alone. The implication is that central banks in the region have become increasingly active in preventing Asian currency strength.

One currency that has a limited influence from the CNY is the INR and this currency continues to outperform on reform hopes. The passage through India’s lower house of parliament allowing foreign investment into retailers was encouraging and hopes have grown that it will be followed by passage in the upper house. Further gains in the INR are seen over coming sessions, with a short term break below USD/INR 54.00 looming.

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USD pressured, limited gains for Asian currencies

November 26, 2012 — Mitul Kotecha

Risk assets registered a positive performance over the past week despite the plethora of events / issues that remain unresolved. However, it’s back to business today with talks over Greek’s debt sustainability and resolution towards distribution of its next loan tranche set to resume.

Meanwhile, markets will digest the results of elections in the Spanish region of Catalonia which have fuelled greater uncertainty in the wake of the gains in seats for pro-referendum parties who won 87 of the Catalan parliament’s 135 seats. However, the results did not provide the strength of support for pro independence parties as had initially been feared, suggesting some relief for the EUR.

Together with the failure to make any progress on the EU budget it is clear that there are still many layers of uncertainty lying ahead for European markets. Nonetheless, optimism appears to be winning the day as the EUR and peripheral bonds shake off such concerns. The risk going forward is that the market is hoping for too much, with the risk / reward dynamic skewed asymmetrically in the wake of any failure to reach agreement especially regarding Greece.

News of healthy US Thanksgiving spending will be followed by data releases this week that are set to provide further signs of improvement although markets will remain focussed on any progress towards resolving the fiscal cliff. An upward revision to US Q3 GDP, gains in durable goods orders, and new home sales in October will provide encouraging news contributing to a tone of firmer risk appetite. This will be echoed by the Fed’s Beige Book.

Economic news in Europe (expected lower economic sentiment index) and in Japan (fourth consecutive decline in industrial production) will highlight the comparative outperformance of the US economy while adding pressure for more aggressive policy measures elsewhere.

The net FX impact of the market’s optimism is to sell USDs leaving it vulnerable in an environment of improving risk appetite. Nonetheless, given that the market is now pricing in a resolution to several of the issues noted above, USD weakness may prove limited from current levels. EUR/USD is set to face resistance around the 1.3023 level while USD/JPY will face strong resistance around 83.20.

Asian currencies have benefitted from the firmer tone to risk appetite (most except IDR and INR are strongly correlated to risk) but gains have been limited over the past week as central banks in the region increasingly resist further strength. The lack of upward trajectory in the CNY has been a key driver for the slower pace of appreciation of Asian currencies over recent days and I expect this trend to continue.

China may even countenance some softening in the CNY into year end suggests limited upside for Asian currencies into year end despite a firmer risk tone. The INR remains the major underperformer, with the currency continuing to suffer from domestic considerations, and benefitting the least from any improvement in risk appetite.

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CNY influence on Asian FX continues to grow

October 31, 2012 — Mitul Kotecha

Asian currencies remain generally well supported both by a softer tone to the USD in general as well as a stronger Chinese currency, CNY. Since the USD/RMB high of 6.3964 on 25 July the RMB has appreciated by around 2.4% vs. USD. This equates to an annualized pace of appreciation of around 6.2%. The RMB is unlikely to continue to strengthen at such a rapid pace and could even be prone to a softer tone into year end.

Potential renewed weakness in the CNY could presage downside risks to Asian currencies. Also worth noting is the fact that equity portfolio capital inflows to Asian have slackened over recent weeks (Indonesia, Philippines and Taiwan registered outflows over October), a factor that could also pose risks to Asian currencies.

The influence of the RMB on Asian FX has continued to grow. Correlations or sensitivities between Asian currencies and the CNY remain are stronger than Asian FX sensitivities to USD movements. The implication is that USD index gyrations are having less influence on Asian currencies.

The most correlated currencies with the CNY are KRW, SGD and TWD although all Asian currencies with the exception of the INR register statistically significant correlations with the movements of USD/CNY. Notably our quantitative models show that the KRW, SGD and TWD are overbought relative to their short term fair value estimates.

While the USD is still influential in driving some Asian currencies several currencies including KRW, CNY and IDR do not possess a statistically significant sensitivity to the USD over the past 3-months. Should the CNY undergo renewed weakness it will mean that the currencies noted above namely KRW, SGD and TWD will be the most vulnerable to weakness given their high sensitivity to CNY.

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