Euro edging towards year highs, GBP lagging

January 20, 2012 — Mitul Kotecha

Contrary to most expectations at the beginning of this week EUR has managed to claw back its losses and more, with the currency edging towards its year-to-date highs around 1.3069. The resilience of the currency to bad news in Europe has been impressive and its gains have reflected a speculative market that has been extremely short. The end of the week sees no key data of note so markets will have to contend with digesting the outcome of the relatively positive Spanish and French debt auctions while keeping one eye on Greek debt talks with private investors.

Unless there is yet another breakdown of talks in Greece the EUR will end the week on a positive note. I suspect it won’t last further out especially given the pitfalls ahead but at a time when investors have become increasingly bearish on the EUR it may just extend its bounce over the short term. One country to watch is Portugal whose bonds have underperformed recently as markets speculate that it could be the next contender for any debt writedown.

Retail sales data in the UK will capture local market attention today. Sales are set to have bounced back in December but the improvement is likely to be short-lived, suggesting any support to GBP will be fleeting. GBP has underperformed even against the firmer EUR recently but this is providing better levels for investors to take long positions versus EUR. In part this reflects the move in relative European/US interest rate differentials, which has been correlated with the move in EUR/GBP.

I expect GBP to outperform EUR over coming months to around 0.80, with the former continuing to benefit from the simple fact that it is not in the Eurozone and has therefore acquired a quasi safe haven status. Nonetheless, as reflected in the drop in Nationwide consumer confidence in December, this year will be particularly difficult for the UK economy. GBP will be restrained by the prospects of more quantitative easing by the Bank of England as inflation eases further

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IMF Hopes For Italy

November 28, 2011 — Mitul Kotecha

Following a week in which risk aversion increased further and equity markets fell sharply the start of this week looks a little steadier. Reports in the Italian press that the International Monetary Fund (IMF) is readying a EUR 600 billion loan for Italy in the event of a worsening in the debt crisis may help to support markets as the week kicks off.

Moreover a report in the German press that German Chancellor Merkel and French President Sarkozy are preparing a fast track “Stability Pact” for euro countries similar to the Schengen agreement, that may be announced this week, will also help to steady market nerves. However, neither report has been confirmed suggesting that as usual the scope for disappointment is high. The sell on risk on rallies environment is likely to persist for a while longer despite such reports.

Liquidity is likely to thin further this week and scope for volatility is high given that there are plenty of events and data on tap. Included among these are debt auctions in Belgium and Italy today and France and Spain later in the week against the background where Germany’s failed bond auction last week has fuelled even more nervousness in bond markets. A European Finance Ministers meeting beginning tomorrow will also come under scrutiny, especially given the lack of progress so far on many issues including the issue of Eurobonds.

The key data of the week will arrive from the US, with the November jobs report, ISM manufacturing survey, Beige Book and consumer confidence reports scheduled for release. Following what appears to be strong Thanksgiving holiday weekend spending the US data will continue to show improvement although this may not be enough to stem speculation that the Fed is verging on buying of mortgage backed securities in a third round of quantitative easing.

Risk currencies have commenced the week in strong firm, with the EUR and AUD rallying. Any gain in the EUR will prove limited and unsustainable unless the weekend press reports are confirmed. EUR/USD will find upside resistance around the 1.3412 level, while the risk of a downside test of support around its October 4 low at 1.3146 remains high over coming days.

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Extreme Uncertainty

November 20, 2011 — Mitul Kotecha

The level of uncertainty enveloping global markets has reached an extreme level. Who would have thought that close to 13 years after its introduction at a time when it has become the second largest reserve currency globally (26.7% of global reserves) as well as the second most traded currency in the world, European leaders would be openly talking about allowing countries to exit the EUR? No less an issue for currency markets is the sustainability of the USD’s role as the foremost reserve currency (60.2% of global reserves). The US debt ceiling debacle and the dramatic expansion of the Fed’s balance sheet have led to many official reserve holders to question their use of the USD. Perhaps unsurprisingly the JPY has been the main beneficiary of such concerns especially as global risk aversion has increased but to the Japanese much of this attention is unwanted and unwelcome.

The immediate focus is the travails of the eurozone periphery. Against the background of severe debt tensions and political uncertainties it is perhaps surprising that the EUR has held up reasonably well. However, this resilience is related more to concerns about the long term viability of the USD rather than a positive view of the EUR, as many official investors continue to diversify away from the USD. I question whether the EUR’s resilience can be sustained given that it may be a long while before the situation in the eurozone stabilises. Moreover, given the now not insignificant risk of one or more countries leaving the eurozone the long term viability of the EUR may also come into question. I believe a break up of the eurozone remains unlikely but such speculation will not be quelled until markets are satisfied that a safety net / firewall for the eurozone periphery is safely in place.

In this environment fundamentals count for little and risk counts for all. If anything, market tensions have intensified and worries about the eurozone have increased since last month. Politics remain at the forefront of market turmoil, and arguably this has led to the worsening in the crisis as lack of agreement between eurozone leaders has led to watered down solutions. Recent changes in leadership in Italy and Greece follow on from government changes in Portugal and Ireland while Spain is widely expected to emerge with a new government following elections. Meanwhile Chancellor Merkel has had to tread a fine line given opposition from within her own coalition in Germany while in France President Sarkozy is expected to have a tough time in elections in April next year. The likelihood of persistent political tensions for months ahead suggests that the EUR and risk currencies will suffer for a while longer.

Posted in Bond markets, Currencies, ECB, Economics, Economy, Europe, eurozone, Financial crisis, Fiscal/Budget, France, FX, Germany, Greece, Italy, UK, US, US administration. Tags: , , , , , , , , , , , , . Leave a Comment »

Eurozone contagion spreading quickly

November 17, 2011 — Mitul Kotecha

Contagion from the eurozone debt crisis is spreading quickly, threatening to turn a regional crisis into a global crisis. As highlighted by Fitch ratings further contagion would pose a risk to US banks. Consequently risk assets continue to be sold but interestingly oil prices are climbing. Taken together with comments earlier in the day from the Bank of England that failure to resolve the crisis will lead to “significant adverse effects” on the global economy, it highlights the risks of both economic and financial contagion.

Predominately for some countries this is becoming a crisis of confidence and failure of officials to get to grips with the situation is resulting in an ever worsening spiral of negativity. Although Monti was sworn in as Italian Prime Minister and Papademos won a confidence motion in the Greek parliament the hard work begins now for both leaders in convincing markets of their reform credentials. Given that there is no agreement from eurozone officials forthcoming, sentiment is set to worsen further, with safe haven assets the main beneficiaries.

EUR/USD dropped sharply in yesterday’s session hitting a low around 1.3429. Attempts to rally were sold into, with sellers noted just below 1.3560. Even an intensification of bond purchases by the European Central Bank (ECB) failed to prevent eurozone bond yields moving higher and the EUR from falling.

Against this background and in the absence of key data releases EUR will find direction from the Spanish 10 year bond auction while a French BTAN auction will also be watched carefully given the recent increase in pressure on French bonds. Having broken below 1.3500, EUR/USD will aim for a test of the 10 October low around 1.3346 where some technical support can be expected.

US data releases have been coming in better than expected over recent weeks, acting to dampen expectations of more Fed quantitative easing and in turn helping to remove an impediment to USD appreciation. While the jury is still out on QE, the USD is enjoying some relief from receding expectations that the Fed will forced to purchase more assets. Further USD gains are likely, with data today including October housing starts and the November Philly Fed manufacturing confidence survey unlikely to derail the currency despite a likely drop in starts.

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

Contagion spreading like wildfire

November 16, 2011 — Mitul Kotecha

EUR continues to head lower and is is destined to test support around 1.3484 versus USD where it came close overnight. Contagion in eurozone debt markets is spreading quickly, with various countries’ sovereign spreads widening to record levels against German bunds including Italy, Spain, France, Belgium and Austria. Poor T-bill auctions in Spain and Belgium, speculation of downgrades to French, Italian and Austrian debt, and a weak reading for the November German ZEW investor confidence index added to the pressure.

A bill auction in Portugal today will provide further direction but the precedent so far this week is not good. The fact that markets have settled back into the now usual scepticism over the ability of authorities in Europe to get their act together highlights the continued downside risks to EUR/USD. Although there is likely to be significant buying around the 1.3500 level, one has to question how long the EUR will continue to skate on thin ice.

The Bank of Japan is widely expected to leave policy unchanged today but the bigger focus is on the Japanese authorities’ stance on the JPY. Finance Minister Azumi noted yesterday that there was no change in his stance on fighting JPY speculators. To some extent the fight against speculators is being won given that IMM speculative positions and TFX margin positioning in JPY has dropped back sharply since the last FX intervention to weaken the JPY.

However, this has done little to prevent further JPY appreciation, with USD/JPY continuing to drift lower over recent days having already covered around half the ground lost in the wake of the October 31 intervention. Markets are likely therefore to take Azumi’s threats with a pinch of salt and will only balk at driving the JPY higher if further intervention takes place. Meanwhile, USD/JPY looks set to grind lower.

GBP will take its direction from the Bank of England Quarterly Inflation Report and October jobs data today. There will be particular attention on the willingness of the BoE to implement further quantitative easing. A likely dovish report should by rights play negatively for GBP but the reaction is not so obvious. Since the announcement of GBP 75 billion in asset purchases a month ago GBP has fared well especially against the EUR, with the currency perhaps being rewarded for the proactive stance of the BoE.

Moreover, the simple fact that GBP is not the EUR has given it a quasi safe haven quality, which has helped it to remain relatively resilient. Nonetheless, GBP will find it difficult to avoid detaching from the coat tails of a weaker EUR and in this respect looks set to test strong support around GBP/USD 1.5630 over the short term.

Posted in Bond markets, central banks, Currencies, ECB, Economics, Economy, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, France, FX, Germany, Greece, Italy, Japan, Monetary Policy, Portugal, Spain, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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