JPY pullback risks, GBP to slip versus USD

March 27, 2012 — Mitul Kotecha

A combination of market friendly comments by Fed Chairman Bernanke, a better than expected outcome for the German IFO business confidence survey in March and hopes of a bolstering of the Eurozone bailout fund, have managed to lift risk assets while pressuring the USD. Markets appear to have shaken off, at least for now, growth worries emanating from weaker manufacturing confidence surveys in China and Europe last week.

Nonetheless, while Bernanke maintained that accommodative monetary policy is still required especially given concerns about the jobs market, he did not hint at more quantitative easing, suggesting that market optimism may be tempered in the days ahead. Data and events today include US and French consumer confidence as well as bill auctions in Spain and Italy. US consumer confidence is likely to slip slightly while the bill auctions are likely to be well received.

While I remain bearish on the JPY in the medium term (beyond 1 month), over the near term I believe there is scope for a pull back. The move in USD/JPY has gone beyond what would be expected by the shift in relative yields. This is corroborated by my short term quantitative model which shows that USD/JPY should be trading around 80.

The speculative market is positioned for JPY weakness but also points to some scope for short covering; both CFTC IMM data and Japanese TFX data (a gauge of local margin trading positioning) reveal significant short JPY positions. If as I expect, USD/JPY does pull back it will offer better levels for investors to initiate medium term JPY bearish trades.

Ultimately the JPY will regain its attraction as a funding currency for carry trades and the bigger the shift in relative yield with the US, the more the potential for capital outflows from Japan into higher yielding assets.

GBP has failed to sustain gains above 1.59 against the USD over recent weeks let alone manage to test the psychologically important 1.60 level. The current bounce above 1.59 is unlikely to last. It will require a renewed downtrend in the USD in general provoked by a sharp improvement in risk appetite and/or a drop in US bond yields for GBP to move much higher. Neither seems likely.

Indeed, GBP will be vulnerable to a general firmer USD over the remainder of the year. While I would not suggest playing a bullish call on GBP versus the USD I think there is much more juice in holding GBP versus EUR, with downside risks to this currency pair likely to open up. Indeed, my quantitative models reveal that GBP is mispriced against both EUR and AUD.

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JPY retracement, CHF pressure

March 20, 2012 — Mitul Kotecha

Risk assets rallied overnight, the USD weakened and US Treasury yields rose. There was little new in terms of economic news, with only NAHB March homebuilders confidence of note, which came in slightly weaker than expected. The bigger driver for markets was the news that Apple Inc. will pay around USD 45 billion in dividends and share buybacks over the next 3-years.

Today sees a crop of second tier releases including housing starts and building permits in the US and inflation data in the UK while there will also be attention on a speech by Fed Chairman Bernanke. Risk assets will remain supported but I continue to see consolidation for markets in the near term.

USD/JPY has retraced lower as warned last week. My quantitative models suggest scope for even more of a correction lower, with a drop below 83.00 on the cards in the short term. While the upward move in the currency pair was built on a widening in the US yield advantage over Japan, the move looks overdone. Nonetheless, any pullback will offer better levels to initiate long USD/JPY medium term positions.

Clearly the market believes that the JPY will weaken further given the build up in JPY short positions over recent weeks, with shorts at their highest since April 2011. February trade data to be released on Thursday will provide further fuel for JPY bears given the persistence of a trade deficit and weakness in exports.

Following the bounce in EUR/CHF last week the currency pair has dropped back into its recent tight range around the 1.2050-1.2070 area. Strong warnings by the Swiss National Bank at its policy meeting did not lead to any follow through on the CHF. I expect a gradual drift higher in EUR/CHF over coming weeks in line with the incremental change in sentiment for the Eurozone as Greece slips from the radar.

Official pressure for CHF weakness will remain intense given the deterioration in economic data as likely to be revealed in today’s release of Q4 industrial production. Nonetheless, the SNB will be wary of confronting the market in terms of FX intervention to weaken the CHF despite its verbal warnings. Meanwhile USD/CHF remains highly sensitive to gyrations in the USD index given its strong correlation, suggesting some consolidation in the short term as the USD pulls back.

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Limbo ahead of Fed FOMC meeting

March 13, 2012 — Mitul Kotecha

A mixed session overnight leaves markets with little direction ahead of the Bank of Japan and Federal Reserve FOMC meetings today. There was no stimulus for markets from the meeting of European officials yesterday while Greece’s debt swap has failed to boost confidence.

Overall there is a real hesitancy for investors to take positions, with both volumes and volatility remaining very low. For instance the VIX volatility gauge has dropped to its lowest level since May 2011 while my measure of composite FX volatility continues to languish at relatively low levels compared to last year.

The USD has little to fear from the Fed FOMC meeting tonight. If anything it may even benefit from a less downbeat statement from Fed Chairman Bernanke following the meeting. Growing speculation that the Fed will embark on some form of sterilised quantitative easing, i.e. not printing any more money, bodes well for the USD too.

Ahead of the FOMC decision a firm February retail sales report will help add to the plethora of evidence revealing stronger signs of US recovery. A key indicator to watch in this respect is the (National Federation of Independent Business (NFIB) report of small business confidence which should also strengthen. Importantly for the USD the data should also help to maintain pressure on US bonds, keeping yields elevated and in turn the USD supported.

The BoJ meeting today will not deliver any surprises, an outcome that will likely leave the JPY largely unmoved. Speculative sentiment for the JPY has shifted negatively as reflected in the latest CFTC IMM report which reveals the biggest short position in the currency since April last year.

Crucial in pushing the JPY weaker has been the widening in bond yield differentials with the US, thanks largely to a rise in US bond yields. The 2-year yield gap is now around 20 basis points, the highest gap since August 2011. This will help to keep USD/JPY supported but my quantitative models suggest that the upmove may be overdone in the short term, with a correction lower in prospect to technical support around 81.44.

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US dollar on a firm footing

March 12, 2012 — Mitul Kotecha

The stronger than expected US February jobs report (227k versus 210k consensus) and the Greek debt swap should by rights have set a positive tone to markets this week. Unfortunately this is not the case and cautious is set to prevail, with sentiment dampened in part by China’s wider than expected $31.5 billion trade deficit posted in February.

Officials in Europe are set to finalise Greece’s second bailout today but sentiment is unlikely to be boosted as various concerns creep into the market. Growing scepticism about the fact that the Greek bailout fails to correct the country’s underlying problems, worries about whether Portugal will follow in Greece’s wake, fiscal slippage in Spain and the Irish referendum, all point to ongoing tensions in the weeks ahead.

The Federal Reserve FOMC meeting takes centre stage over coming days while data releases including retail sales, industrial production and manufacturing surveys will also prove important for USD direction. The USD reacted positively to the lack of quantitative easing (QE) hints by Fed Chairman Bernanke recently and the stronger than expected February jobs report has reinforced this view.

The USD starts the week on a firm footing but could face renewed pressure if the FOMC statement proves to be more ambiguous on the issue of QE. US data releases will reinforce signs of economic recovery and if they play into a ‘risk on’ tone the USD could suffer. We believe this is unlikely however, with risk assets set to correct lower over coming weeks, playing positively for the USD.

Having rallied following the growing optimism over the Greek PSI debt swap the EUR will find limited support in the days ahead. News of 85.8% participation will have come as relief but the use of collection action clauses (CAC) is not so positive. At least finalisation of the second Greek bailout will now move ahead, with officials set to rubber stamp the deal today.

Data releases such as the March German ZEW survey tomorrow will highlight the sharp turnaround in investor confidence following the ECB’s LTRO and progress on Greece. This would usually bode well for the EUR. However, it is already proving to be a case of buy on rumour, sell on fact outcome for the currency. Potential for a drop below support around EUR/USD 1.3055 is growing as the USD builds momentum.

Following February’s surprise decision by the Bank of Japan to expand its asset purchases and set an inflation goal, the outcome of the policy meeting on Tuesday will deliver few punches. Having weakened in the wake of the last BoJ meeting, partly as a result of higher US bond yields relative to Japan, the JPY threatens to pull back against the USD to support around 80.50.

Improved risk appetite has helped to maintain some pressure on the JPY but this impact ought to prove limited unless yield differentials continue to widen. While the BoJ’s actions will likely keep Japanese government yields supressed, JPY direction will continue to be dictated by the gyrations in US bond yields.

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Anxious wait for Greek PSI

March 7, 2012 — Mitul Kotecha

An anxious wait for the outcome of the Greek private sector involvement in a debt swap taken together with a bout of risk aversion and confirmation of weak growth in the Eurozone (Q4 GDP dropped by 0.3%) have set the scene for nervous trading in EUR/USD. Confirmation of the Greek debt swap deadline on Thursday has done little to stead nerves.

The EUR has lost plenty of ground over recent days but will likely consolidate ahead of the outcome of the PSI. Direction will then depend on whether there has been sufficient voluntary participation by bond holders to avoid forcing private sector involvement. In the event of strong participation the EUR will rally but I suggest selling into any such rally.

Another factor that is playing a role in dampening EUR demand is the fact that the European Central Bank (ECB) balance sheet continues to expand at a rapid rate, to a record EUR 3.02 trillion last week following the second ECB long term refinancing operation (LTRO). Overall, expect little respite for the EUR. Effectively the ECB is undertaking quantitative easing via the back door, which is weighing on the EUR in the process.

USD/JPY has pulled back from its highs in the wake of an increase in risk aversion. As I have been noting over recent days the move in USD/JPY had overshot its short term ‘fair value’ estimate according to my quantitative models. The drop in USD/JPY fits into line with this view. The fact that US bond yields have pulled back from recent highs has also played into the drop in USD/JPY.

While I remain bearish on the JPY over the medium term, there is scope for a further move to technical support the 80.00 level in the short term. Further out, much will depend on the ability of Japanese officials to follow through on more aggressive policy to reflate the economy.

The Bank of Japan’s inflation goal will need a determined effort in terms of more aggressive monetary policy to enable it to succeed. This will ensure that Japanese government bond yields remain suppressed at a time when I expect US bond yields to move higher. Consequently USD/JPY will likely move higher too, with my year end target remaining at 85.00.

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