Peripheral debt concerns intensify

November 10, 2010 — Mitul Kotecha

European peripheral debt concerns have allowed the USD a semblance of support as the EUR/USD pullback appears to have gathered momentum following its post FOMC meeting peak of around 1.4282. The blow out in peripheral bond spreads has intensified, with Greek, Portuguese and Irish 10 year debt spreads against bonds widening by around 290bps, 136bps and 200bps, respectively from around mid October.

The EUR appears to have taken over from the USD, at least for now, as the weakest link in terms of currencies. EUR/USD looks vulnerable to a break below technical support around 1.3732. Aside from peripheral debt concerns US bonds yields have increased over recent days, with the spread between 10-year US and German bonds widening by around 17 basis points in favour of the USD since the beginning of the month.

The correlation between the bond spread and EUR/USD is significant at around 0.76 over the past 3-months, highlighting the importance of yield spreads in the recent move in the USD against some currencies. Similarly high correlations exist for AUD/USD, USD/JPY and USD/CHF.

Data today will offer little direction for markets suggesting that the risk off mood may continue. US data includes the September trade deficit. The data will be scrutinized for the balance with China, especially following the ongoing widening in the bilateral deficit over recent months, hitting a new record of $28 billion in August. Similarly an expected increase in China’s trade surplus will add to the currency tensions between the two countries. FX tensions will be highlighted at the Seoul G20 meeting beginning tomorrow, with criticism of US QE2 gathering steam.

Commodity and Asian currencies are looking somewhat precariously perched in the near term, with AUD/USD verging on a renewed decline through parity despite robust September home loan approvals data released this morning, which revealed a 1.3% gain, the third straight monthly increase.

However, the NZD looks even more vulnerable following comments by RBNZ governor Bollard that the strength of the Kiwi may reduce the need for higher interest rates. As a result, AUD/NZD has spiked and could see a renewed break above 1.3000 today. Asian currencies are also likely to remain on the backfoot today due both to a firmer USD in general but also nervousness ahead of the G20 meeting.

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All eyes on G20

November 8, 2010 — Mitul Kotecha

Although we move from feast to famine this week in terms of data there are still a few events that are noteworthy. In the US the September trade balance (Wed) will be of interest with a narrowing expected. Net exports negatively impacted GDP in Q3 but this is likely to reverse in Q4. Michigan confidence at the end of week is also likely to reveal better news with a rebound expected in October in the wake of firming equities, whilst the October budget statement is likely to reveal a sharp narrowing compared to October last year. Several Fed speakers over the week will be also be in focus as markets try to gauge the level of support within the FOMC for the QE2 announced last week.

There are a few data releases of interest in the eurozone including the preliminary estimate of Q3 GDP. Worryingly the divergence across the eurozone between healthier northern Europe and weaker performing in Southern Europe is becoming increasingly stark, a big headache for the Eurozone Central Bank with its one size fits all policy. Elsewhere, in the UK the Bank of England Quarterly Inflation Report will be scrutinized to determine whether recently firmer data and sticky inflation has pushed the BoE away from following the Fed into QE2. Japan’s volatile machinery orders data marks the highlight of its calendar, with a sharp drop expected in September following two strong months.

The main event of the week is the G20 leaders meeting in Seoul at the tail end of the week. Rhetoric going into the meeting suggests little support for the US plan to limit current account surpluses to 4% of GDP and even US officials appear to have cooled on the idea. Moreover the G20 meeting will probably elicit further reaction to the Fed’s QE2 announcement. Reaction was highly critical initially but seems to have softened lately. Currencies will nonetheless, remain the major topic of discussion although expectations of a global agreement are likely to be disappointed.

The Fed’s QE2 announcement helped provide a prop to risk assets and weighed on the USD last week despite the amount of asset purchases being within expectations. The USD will remain a sell on rallies this week and once again the best way to play USD weakness is likely via the higher yielding commodity currencies, especially AUD and NZD. Scandinavian currencies also offer a good way to capitalize on USD weakness.

The EUR may also struggle this week given worries about peripheral Europe and widening in peripheral bond spreads. Ireland’s budget cuts announced last week have so far failed to shore up confidence whilst political uncertainties are also rising. Greece’s regional elections revealed that the ruling socialist party narrowly retained control allowing the government to continue with reforms suggesting a modicum of support for its debt. Nonetheless, with Irish and Portuguese sovereign worries continuing, the EUR will continue to lag. Notably the CFTC IMM data revealed that speculative EUR sentiment deteriorated in the latest week to its lowest in over a month. EUR/USD is likely to target 1.3864 after dropping swiftly below the 1.4000 level.

Perhaps best way to play EUR vulnerability is versus the AUD, with a further decline through 1.3800 likely to pave the way for a drop below the 13 September low around 1.3660. AUD/JPY may also be another cross worth exploring especially as Japan’s new fund begins buying JGBs today, which could limit JPY upside. A test of AUD/JPY 83.65 is on the cards shortly. If Australia’s October employment report on Thursday reveals another strong reading it will likely give the currency further support into the end of the week.

Posted in Asia, Australia, Bond markets, central banks, Commodities, Currencies, Economics, Economy, equity markets, Europe, eurozone, Fiscal/Budget, FX, Greece, Interest rates, Ireland, Monetary Policy, Portugal, South Korea, UK, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . 2 Comments »

Speculators bail out of USDs

October 4, 2010 — Mitul Kotecha

Risk appetite held up reasonably well last week, with markets failing to be derailed by concerns over Ireland’s banking sector and growing opposition to austerity measures across Europe. The main loser remained the USD, with the USD index hitting a low marginally above 78.00 and speculative positioning as reflected in the CFTC IMM data revealing a further sharp drop in sentiment to its lowest since Dec 2007.

This week is an important one for central bank meetings, with four major central banks deliberating on monetary policy including Bank of Japan (BoJ), Reserve Bank of Australia (RBA), European Central Bank (ECB) and Bank of England (BoE). The major event of the week however, is Friday’s release of the September US employment report. The RBA is set to hike its cash rate by 25bps, the BoJ may announced more easing measures whilst in contrast both the ECB and BoE are unlikely to alter their policy settings.

Whilst the BoJ is widely expected to leave its policy rate unchanged at 0.1%, it may announce further measures against the background of persistent JPY strength, a worsening economic outlook as reflected in last week’s Tankan survey and decline in exports. Japanese press indicate that the BoJ may increase lending of fixed rate 3 to 6 month loans to financial institutions as well as buy more short-term government debt.

The measures alongside risks of further JPY intervention may prevent USD/JPY slipping further but as reflected in the increase in speculative net long JPY positions last week, the market is increasingly testing the resolve of the Japanese authorities. Strong support is seen around USD/JPY 82.80, with the authorities unlikely to allow a break below this technical level in the short-term.

Although we will only see details of the voting in two weeks in the release of the UK BoE Monetary Policy Commitee (MPC) minutes it is likely that there was a three-way split within the MPC as reflected in recent comments, with MPC member Posen appearing to favour more quantitative easing whilst the MPC’s Sentance is set to retain his preference for higher rates. As has been the case over recent months the majority of the MPC are likely to have opted for the status quo.

GBP was a laggard over September as markets continued to fret over potential QE from the BoE. This uncertainty is unlikely to fade quickly suggesting limited gains against the USD and potentially more downside against the EUR. GBP speculative sentiment has improved but notably positioning remains short. EUR/GBP will likely target resistance around 0.8810.

In contrast to GBP the EUR has taken full advantage of USD weakness and looks set to extend its gains. Although there is a risk that speculative positioning will soon become overly stretched it is worth noting that positioning is well below its past highs according to the IMM data. EUR may have received some support from Chinese Premier Wen’s pledge to support Greece, and a stable EUR. Whilst there continues to be risks to the EUR from ongoing peripheral debt concerns such comments likely to be repeated at the EU-Asia summit today and tomorrow, will keep the EUR underpinned for a test of 1.3840.

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USD pressure, EUR resilience, GBP whipsawed

September 29, 2010 — Mitul Kotecha

Speculation the Fed will begin a new program of asset purchases or QE2 as soon as November is intensifying. The weaker than expected reading for US consumer confidence in September released on Tuesday has only added to this expectation as sentiment continues to be hit by job market concerns. Against this background the USD remains under strong downward pressure, with little sign of any turnaround.

The prospects of further USD debasing as well as intervention in many countries to prevent their currencies from strengthening against the USD continues to power gold prices which hit a new record high having breezed through the $1300 per troy ounce mark. In the current environment it is hard to see gold prices turning much lower although there may be some risk of profit taking in the weeks ahead.

The EUR remains a key beneficiary of USD weakness but this currency has problems of its own to contend with. Indeed, peripheral debt concerns, especially with regard to Ireland and to a lesser extent Portugal have increased, with borrowing costs rising as the yield on their debt widens against core eurozone debt. The stronger EUR will only make it harder for these countries to achieve any sort of recovery and could also damage the stronger exporting countries of Northern Europe led by Germany.

So far however, the EUR has managed to show some impressive resilience to renewed peripheral country sovereign debt concerns including comments by S&P about the high costs of rescuing an Irish Bank. Perhaps the knowledge that there is a still a huge bailout fund from the EU and IMF available if needed and also the prospect that the ECB will increase its buying of eurozone debt, has provided a buffer for the EUR.

At some point the ECB may be forced to join the battle in at least attempting to talk its currency lower but at this stage the central bank is showing no inclination to either talk down the currency or physically intervene to weaken the EUR. In the meantime, EUR/USD is likely to strengthen further despite the likely negative impact on European growth, with the currency likely to set its sights on an eventual break above 1.40.

One currency that may struggle in the wake of expectations of Fed QE2 is GBP. Uncertainty over whether the Bank of England will follow the Fed in implementing further quantitative easing could see GBP lag the gains in other currencies against the USD. Conflicting comments from MPC members Posen who noted that there may be a need for further QE in the UK to support the faltering economy were countered by Sentance who noted that there was no need for more QE. GBP/USD is likely be whipsawed as the debate continues and is set to lose further ground against the EUR.

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