Dollar firm, but beware of a short covering euro bounce

May 21, 2012 — Mitul Kotecha

The USD has risen sharply since the end of April, benefiting from the ongoing turmoil in the Eurozone and rise in US Treasury yields (2-year). Markets have managed to brush US fiscal and political concerns under the carpet as focus centres on Europe. The USD also managed to shrug off a soft April retail sales report and a slightly more cautious set of FOMC minutes.

A recovery in April durable goods orders, new homes sales and a relatively stable reading for Michigan confidence should ensure that the USD’s upward trajectory remains unimpeded this week. Given the potential for continued uncertainty ahead of Greek elections in mid June, risk aversion and the USD are set to remain elevated.

In Europe, it’s all about Greece and the machinations ahead of fresh elections in mid June. The EUR shows little sign of stabilising ahead of these elections. Data releases will take a back seat although the calendar will be heavy. FX markets will have one eye on the May German IFO survey and the flash readings in purchasing managers indices. The PMI data will give no relief to the EUR, with the data consistent with growth contraction for the most part while the IFO is set to register a decline too.

Meanwhile, pressure on German Chancellor Merkel to accept measures that were previously vetoed at an informal EU summit on Wednesday has also heightened. Such measures include direct recapitalisation of banks and/or unlimited purchases of peripheral country debt by the ECB and through the Eurozone rescue fund.

Admittedly the large extent of short market positioning (the latest CFTC IMM report revealed an all time low for EUR positioning) means that the risk of a bounce is high in the event of any good news or perhaps in the wake of any renewed securities markets purchases by the ECB or fresh hints of a third LTRO. Whether there will actually be any good news is another question entirely.

USD/JPY has been relatively stable despite a rise in US bond yields compared to Japanese JGB yields, with rising risk aversion helping to keep the JPY firm. The Bank of Japan meeting this week has the potential to change the currency pair’s trajectory but is unlikely to do so. No action is expected at the policy meeting on Wednesday, leaving the JPY with a firm bias.

Trade data will provide some justification for a more bearish stance on the JPY, with another deficit set to be registered in April as export conditions remain weak. However, as usual the JPY will continue to ignore domestic economic data and focus more on relative yields and risk.

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Calm ahead of US payrolls and ECB meeting

April 30, 2012 — Mitul Kotecha

It’s non-farm payrolls week in the US, with currencies treading water until Friday when the report is released. Ahead of the data there are several other releases on tap which will give clues to the outcome of the April jobs report, including the ISM manufacturing survey and ADP jobs report. The USD has taken a softer tone as risk appetite improved and US bond yields dropped further.

Given the Fed kept open the door to more easing it will act as a restraint on the USD unless markets become convinced that there will no further Fed balance sheet expansion over coming months. In the meantime unless risk aversion spikes again the USD is set to find it difficult to sustain any gains.

It’s always the same story with the EUR, a tale of ongoing resistance to bad news. Weaker Eurozone confidence surveys as well as a downgrade to Spain’s credit ratings did little to weaken the EUR. The key event is the European Central Bank (ECB) meeting on Thursday but despite growing growth worries, a policy rate cut is unlikely as the ECB remains in wait-and-see mode.

Data releases will not be too damaging for the EUR, with monetary and credit aggregate set to rise and German retail sales set to rebound in March. The EUR looks poised to edge higher against this background in the short term, but will be constrained by uncertainty ahead of the US jobs report. Technical resistance to the upside will be found around the 1.3265 area.

The JPY barely flinched when the Bank of Japan announced an expansion of its asset purchase fund by JPY 10 trillion in its aim to reach a 1% inflation goal. Unfortunately for the BoJ the ongoing narrowing in the US Treasury yield premium over Japan JGB yields overwhelmed the negative impact of its action on the JPY.

Overall, my quantitative models continue to show USD/JPY lower over the short term, with a move below 80.00 on the cards. If as I expect, risk aversion also creeps higher, it will imply more short term upside JPY pressure. Trading will be relatively quiet, with no major data on the calendar due to Golden Week holidays in Japan.

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Dollar still in a stupor

April 23, 2012 — Mitul Kotecha

The increase in the International Monetary Fund’s (IMF) funding by $430 adds another layer of firepower to provide help to the Eurozone periphery should it be required. Nonetheless, many other worries continue to afflict markets suggesting that any positive boost will be short lived. There are plenty of data and events this week including central banks in the US, Japan and New Zealand. Additionally US corporate earnings will remain in focus while bond auctions in the Eurozone will also provide direction. I continue to see risk aversion creeping higher against this background.

It is unlikely that the FOMC meeting tomorrow and Wednesday will provoke any change in the currently low FX volatility environment given that policy settings will remain unchanged, with the majority of FOMC members likely to look for the first tightening at the earliest in 2014. The Fed is therefore unlikely to wake the USD out of its stupor and if anything a softening in durable goods orders, little change in new home sales and a pull back in consumer confidence will play in favour of USD bears over coming days. Even a relatively firm reading for Q1 GDP will be seen as backward looking given the slowing expected in Q2.

The EUR will have to contend with political events as it digests the aftermath of the first round of the French presidential elections. The fact that the political process will continue to a second round on 6 May could act as a constraint on the EUR. Various ‘flash’ purchasing managers indices (PMI) readings and economic sentiment gauges will offer some fundamental direction for the EUR but largely stable to softer readings suggest little excitement. Consequently EUR/USD will largely remain within its recent range although developments in Spain and Italy and their debt markets will have the potential to invoke larger moves in EUR.

The JPY is usually quite insensitive to Japanese data releases and this is unlikely to change this week. Key releases include March jobs data, CPI inflation, industrial production and retail trade. Although inflation has moved into barely positive territory the BoJ is still set to increase the size of its asset purchase programme. This will act as a negative factor for the JPY but unless US Treasury yield differentials renew their widening trend against Japanese JGB yields and drop in the JPY will be limited.

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Yuan band widening, Euro still under pressure, Yen firm

April 16, 2012 — Mitul Kotecha

The big news over the weekend was the widening in China’s CNY trading band to 1% from 0.5% previously. It is unlikely to have much of an impact on global markets, with the move not particularly surprising.

China clearly wants to add more two-way risk to the market and in this way the it allows the CNY to better reflect daily market conditions. Nonetheless, CNY is currently seen around equilibrium and appreciation pressure is limited , suggesting that intra day volatility will remain limited.

The USD index is trading around the middle of its range for the year and FX volatility has declined. Recent data disappointments have taken the shine off the USD and revitalized the debate on more Fed quantitative easing. Bouts of risk aversion have given some support to the USD but this has to be balanced against weaker US data.

It will require a renewed rise in US bond yields and an increase in risk aversion before the USD can strengthen anew. Data over coming days may offer some support but whether releases including retail sales, manufacturing surveys and industrial production prove sufficiently strong to boost US bond yields is debatable, suggesting another week of benign USD action.

EUR/USD remains close to its recent lows and is showing little inclination to move back up towards the top of its 1.30-1.35 range. Renewed worries about Spain’s fiscal/debt position as well as opposition to reforms in Italy threaten to keep the EUR restrained.

Data releases may actually regain some attention over coming days however, with the key April German ZEW and IFO surveys scheduled for release. The former is expected to fall slightly while the latter is expected to remain close to the March level.

Given that both surveys have been rising over recent months the outcomes will not prove particularly worrying. However, little change expected in both surveys suggests that the EUR will find little support either. EUR/USD technical support is seen around 1.2974.

Another trade deficit expected in March in Japan will support a JPY bearish view but in reality much of the reason for the deficit is not related to the strength of the JPY but rather external demand weakness and strong energy imports.

Nonetheless, the rise in the JPY over recent days will have fuelled renewed concerns among Japanese policy makers while piling on the pressure on the Bank of Japan to be more aggressive on its policy stance.

I suspect USD/JPY may have further to fall in the short term as its move corresponds with the narrowing in the US yield advantage over Japan. A drop below USD/JPY 80 looks increasingly on the cards.

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Euro and Yen capitalise on weaker Dollar

April 13, 2012 — Mitul Kotecha

Equities continued their bounce back overnight helped by a reiteration from Fed officials that US monetary policy will remain highly accommodative through late 2014. Risk assets overcame a weaker than expected report on US jobless claims, with a smaller than expected trade deficit in February ($46 billion) helping sentiment. The launch of a North Korean missile which apparently failed did little to dent sentiment. Nonetheless, Spanish concerns continue to weigh on its markets, bucking the trend of improvement elsewhere.

Today’s data slate has little in terms of first tier data on tap, with inflation releases in Europe and the US in focus. The bigger influence will be a slate of Chinese data including Q1 GDP. The market has already priced in a good number (around 9% YOY) and therefore there is a risk of disappointment, which could hit risk assets. Also watch out for earnings from US financials including JP Morgan and Wells Fargo. So far US earnings have been positive, although admittedly its early days yet.

Downward pressure on EUR/USD has lessened for the time being and any further decline will be limited in the short term. While it is evident that the boost to markets provided by the European Central Bank’s Long Term Refinancing Operation (LTRO) has faded, EUR bears have been dealt a blow from renewed prospects of securities market purchases.

Italy’s debt auction yesterday provided little help to the EUR but at least it was not cause of further selling pressure. Concerns about Spain continue but any further downside pressure on EUR/USD will be restricted to technical support around the 1.3004 level (March 15 low), with EUR/USD set to remain in a 1.30-1.32 range.

JPY has pulled back sharply against the USD over the past month as I repeatedly warned. But before I blow my own trumpet any further I would note that further downside risks to USD/JPY remain in place although the room is now more limited than in previous weeks. According to my quantitative model a drop to around 79.00 is likely to mark a low in USD/JPY.

Warnings by the Bank of Japan of more “powerful” monetary easing have helped to prevent further JPY strengthening over recent sessions. However, a renewed narrowing in the US 2-year bond yield advantage over Japan will likely limit any upside for USD/JPY as reflected in the extremely strong correlation between USD/JPY and yield differentials over the past 3-months.

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