Key events for FX markets this week

September 21, 2009 — Mitul Kotecha

Key events this week include the Fed FOMC and G20 meetings .  The G20 meeting is likely to be a non-event as far as markets are concerned.  There will be plenty of discussion about co-ordinating exit strategies but officials are set to repeat the commitment to maintain stimulus policies until recovery proves sustainable.  

There is likely to be little emphasis on currencies despite the fact that the dollar is trading around its lowest level in a year, except perhaps at the fringes of the meeting, with focus in particular on Japan’s new government’s pro yen policy.  

Regulation will also figure high amongst the topics debated but this will have little impact on markets over the short term.  Another topic that could be debated is protectionism, especially in light of the US decision to impose tariffs on Chinese tyres.

Ahead of the G20 meeting the Fed FOMC meeting is unlikely to result in any change in interest rates but the statement is likely to be cautiously upbeat in line with Fed Chairman Bernanke’s recent comments that the recession is “very likely over”.  The statement will be scrutinised for clues to the timing of policy reversal, especially given recent speculation that a couple of FOMC members were advocating an early exit.  Given that the dollar has suffered due to its funding currency appeal, any hint that some Fed officials are turning more hawkish could give the currency some much needed relief but we doubt this will last long. 

In contrast to speculation of a hawkish shift in thinking by some Fed members the Bank of England appears to be moving in the opposite direction.  The MPC minutes on Wednesday will be viewed to determine just how close the BoE was to extending quantitative easing and reducing interest rates on bank reserves at its last meeting. 

Sterling (GBP) has been a clear underperformer over recent weeks and a dovish tint to the minutes will act as another factor weighing on the currency as speculation over further action intensifies ahead of the next meeting.  

Sterling is also struggling against the euro having hit a five month low.  A combination of factors have hit the currency including concerns about quantitative easing expansion, the health of the banking system, and the latest blow coming from a the Bank of England in its Quarterly Bulletin where it states that GBP’s long run sustainable exchange rate may have fallen due to the financial crisis.   

Against this background it is not surprising that sterling was the only major currency against in which speculative positioning actually deteriorated versus the dollar last week (according to the latest CFTC Commitment of Traders report).   It is difficult to see any sterling recovery over the short term against this background, with a re-test of the 9 July low just under GBP/USD 1.60 in focus.

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Japanese yen and FX sensitivity to interest rates

September 16, 2009 — Mitul Kotecha

Interest rates have some way to go before they take over from risk aversion as the key driver of currency markets but as noted in my previous post, low US interest rates have played negatively for the dollar. As markets have continued to pare back US tightening expectations and US interest rate futures have rallied, interest rate differentials have moved against the dollar. 

The most sensitive currency pair in this respect has been USD/JPY which has been the most highly correlated G10 currency pair with relative interest rate differentials over the past month. It has had a high 0.93 correlation with US/Japan interest rate differentials and a narrowing in the rate differential (mainly due to a rally in US rate futures) has resulted in USD/JPY moving lower and the yen becoming one of the best performing currencies over recent weeks.

Going forward the strong FX / interest rate correlation will leave USD/JPY largely at the whim of US interest rate markets (as Japanese rate futures have hardly moved). Fed officials if anything, are adding to the pressure on the dollar as they continue to highlight that US interest rates will not go up quickly. San Francisco Fed President Yellen was the latest official to do so, warning that the prospects for a “tepid” recovery could fuel inflation risks on the downside.

This echoes the sentiments of other Fed officials over recent weeks and suggests that the Fed wants to prevent the market pricing in a premature reversal in US monetary policy.   It looks increasingly likely that the Fed will maintain interest rates at current levels throughout 2010 given the massive amount of excess capacity and benign inflation outlook, suggesting that interest rate differentials will play negatively for the dollar for several months to come.

As for the yen its path will not only depend on relative interest rates but also on the policies of the new DPJ led government. If Japanese press speculation proves correct the new Finance Minister may favour a stronger yen which will benefit domestic consumers rather than a weaker yen that would benefit exporters. Against this background, markets will largely ignore comments by outgoing Finance Minister Yosano who said that further yen strength would be detrimental for exporters.

The market certainly believes that the yen will strengthen further as reflected by the sharp increase in speculative positioning over recent weeks; net CFTC IMM long yen positions have reached their highest since 10 February 2009. Although USD/JPY has pushed higher since it’s low around 90.21 the upside is likely to be limited against this background and a re-test and likely break back below the key 90.00 psychological level is likely soon.

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Contrasting messages from bonds, gold and equities

September 8, 2009 — Mitul Kotecha

There is an interesting divergence developing between bond yields, gold prices and the trend in equity markets.  Whilst equities continue to go up, bond yields are falling and gold prices are rising.  Indeed the usually strong relationship between the S&P 500 and US 10 year yields has collapsed to an insignificant correlation around -0.09 over the past month compared to a high correlation of 0.84 in the month to 8 August.  

Rising equities appear to signify an improvement in risk appetite whilst bonds (US 10-year yield around 3.4%) and gold (around $1000 per troy ounce) are giving the opposite message.  So which indicator is correct and why the breakdown in the usually solid relationship?  

Growing optimism about economic recovery and the run of better than forecast data releases suggest that equities are correct but there is growing risk that so much good news is now priced in that we should pay attention to what bond yields and gold prices are telling us.  

Some of the move lower in bond yields can probably be attributed to the wall of liquidity sloshing around due to central banks’ unconventional policy measures.  However, it is still remarkable that despite the plethora of better than expected data releases, bond yields have actually declined.  This may reflect the success of quantitative easing but could also be associated with sustained economic and market fears.    

The commitment by G20 officials last weekend not to reverse stimulus policies prematurely may also have given more confidence in the view that interest rates will not be raised quickly.  Reflecting this 2 year German bund yields dropped to a record low level at the beginning of the week although longer term bond yield have pushed higher in the 30 year area.  The G20 commitment could turn out to be a double edged sword, however.  If there is no commitment to reduce burgeoning deficits, bonds could ultimately take fright.  

If bonds and gold prices are really reflecting safe haven demand then it will pose a risk to the sustainability of any equity rally over coming months.  As equity valuations begin to look increasingly stretched – the P/E ratio on the S&P 500 has reached 18.76 (according to Bloomberg calculations) compared to a low of around 10.00 at the beginning of March 2009 – it will need more to keep the rally going and high amongst the factors needed is some clarity about the pace and shape of growth once stimulus is reversed. 

For currency markets I think it will be difficult to see a trend until there is more clarity about the economic outlook and in the meantime currency markets will continue to stock watch for direction even if the influence of risk appetite is declining.  Even so, the dollar appears to be reacting more to equities than bond movements and is coming under growing pressure as equities rise.  

Many currencies are poised to break out of recent ranges to the topside versus the dollar led by risk currencies such as the AUD, NZD and CAD.  If it turns out that the equity story rather than the bond message is the correct one then the real message is a bullish one for risk appetite and given the dollar’s usually negative reaction to improved risk appetite, it could face further pressure over coming weeks.

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Risk gyrations and FX positioning

August 24, 2009 — Mitul Kotecha

I must admit it has been quite tough to get a handle on the sharp moves in markets over recent days. Market sentiment shifted from positive to negative and back again in a matter of hours, meaning that anyone wanting to put on a long term trading position has had to have had a significant risk tolerance to hold onto their positions.

Attention was focused squarely on Chinese stocks last week but market fears over tighter regulation eased as the week progressed. Market sentiment was helped by strong existing home sales data in the US, continuing the run of better than forecast US economic data releases. Globally data releases mirrored this tone.

A cautiously upbeat tone from central bankers at the Jackson Hole symposium sets up a positive backdrop for markets. Although Fed Chairman Bernanke noted that the rebound in growth was likely to be slow and ECB President Trichet talked about a “bumpy road ahead” the overall tone was positive.

Importantly there was no indication that a reversal in monetary policy was in sight, with the Fed’s Kohn even indicating that there was no inconsistency between the Fed maintaining low rates for an “extended period” and keeping inflation low. The comments should help to ensure that markets do not misinterpret the signs of recovery as a cue to begin hiking interest rates.

This week’s data slate will maintain the run of good news. However, there are a few risks. Consensus forecasts look for US consumer confidence to improve in August but the weak labour market situation may hold some downside risks for the Conference Board measure of confidence just as it did for the Michigan reading.

US durable goods orders are set to bounce back and new home sales are likely to echo at least some of the gains in existing home sales last week. In the eurozone, attention will focus on the August German IFO survey and this release is likely to mirror the gains in the PMI, with a healthy gain in the headline reading expected.

Risk trades continue will be favoured after overcoming last week’s setbacks keeping the USD under downward pressure but within ranges and risk currencies including AUD, NZD, CAD and NOK under upward pressure. The USD index is verging on testing its 5th August low of 77.428, whist the JPY is also weaker though its moves may be more limited ahead of upcoming elections.

The IMM report shows that speculative investors have cut pared back USD short positions further, but the shift in positioning was relatively small from the previous week, with net aggregate USD short positions at -94.8k contracts compared to -96.1 in the previous week. Notable shifts in positioning over the week include a cut back in net EUR long positions to their lowest level since the week of 5th May 2009.

Commodity currencies suffered some pullback in net long positioning too with speculative AUD and NZD contracts being cut although net CAD long positions did increase slightly. Given the resumption in risk appetite into this week it seems highly likely that positioning will reverse and net USD short positions will increase.

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Risk appetite dented

August 17, 2009 — Mitul Kotecha

The surprise decline in the Michigan reading of US consumer confidence which dropped to 63.2 in August put a dampener on risk appetite at the end of last week helping to fuel a sea of red for most US and European equity markets at the close of play on Friday.   Nonetheless, FX markets remained range-bound, albeit with the dollar taking a firmer bias at the end of the week.

The impact of the drop in confidence is likely to prove short lived as risk appetite continues to improve this week although don’t look for big market moves as summer trading conditions continue to dominate.  For the most part the data releases should not throw any spanners in the works over coming days as a positive tone to data is set to be retained.  

The highlights this week include more GDP data from Japan and Norway following surprise increases in growth from Germany and France in Q2 last week.  Japan’s release showed a marginally softer than expected 0.9% QoQ increase in GDP with growth led by external demand and government stimulus measures.  In contrast, capital spending continued to remain weak.  

US numbers are set to show further improvement as likely reflected in manufacturing surveys including the August Empire survey and the Philly Fed.  Similarly housing data including housing starts and existing homes sales will point to more stabilisation whilst Fed Chairman Bernanke is set to deliver a similar tone to the recent FOMC statement. 

The highlight of the European calendar is the German ZEW survey and flash August PMIs.  Firmer equities point to a higher ZEW whilst manufacturing indices are likely to reveal a slower pace of contraction.  In the UK the minutes of the BoE MPC meeting are likely to reveal a unanimous vote for extending QE policy. 

On balance, the beginning of the week is likely to see a bit of a risk aversion led sell off in risk currencies including commodity currencies such as the Australian and NZ dollars as well as weaker Asian currencies led by the likes of the Korean won but the pressure is unlikely to last for long.  Nonetheless, Commodity currencies will face another layer of pressure from the sharp drop in commodity prices at the end of last week as reflected in the drop in the CRB index.

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