The Week Ahead

June 27, 2010 — Mitul Kotecha

As last week progressed there was a clear deterioration in sentiment as growth worries crept back into the market psyche. It all started well enough, with a positive reaction to China’s de-pegging of the CNY but the euphoria faded as it became evident that there was still plenty of two-way risk on the CNY. A change in Prime Minister in Australia, which fuelled hopes of a resolution to a controversial mining tax, and an austere budget in the UK, were also key events. However, sentiment took a hit as the Fed sounded more cautious on the US economy in its FOMC statement.

The US Congress finalised a major regulatory reform bill towards the end of the week and markets, especially financial stocks, reacted positively as the bill appeared to give some concessions to banks and was not as severe as feared. However, equity market momentum has clearly faded against the background of renewed growth concerns including sprouting evidence of a double-dip in the US housing market as well as fresh worries about the European banking sector. As if to demonstrate this US Q1 GDP was duly revised lower once again, to a 2.7% annualised rate of growth.

The US Independence Day holiday and World Cup football tournament will likely keep liquidity thin in the run up to month and half year end. However, there is still plenty to digest this week including the all important employment report and consumer confidence data in the US. In Europe economic sentiment gauges, purchasing managers indices and the flash CPI estimate will be in focus. Elsewhere, Japan’s Tankan survey and usual slate of month end Japanese releases, Switzerland’s KoF leading indicator and Australian retail sales will be of interest.

On balance, economic data this week is unlikely to relieve growth concerns, with Eurozone, US and UK consumer and manufacturing confidence indicators likely to post broad based declines due to a host of factors. The data will further indicate a slowing in growth momentum following Q2 2010, with forward looking surveys turning lower, albeit gradually. Whilst a double-dip scenario still seems unlikely there can be no doubt that austerity measures and the waning of fiscal stimulus measures are beginning to weigh on growth prospects even if there is still plenty of optimism for emerging market and particularly Asian growth prospects.

This suggests that Q3 could turn into a period of heightened uncertainty in which equity markets and risk assets will struggle to gain traction. In addition to growth worries, some tensions in money markets remain in place whilst banking sector concerns seem to be coming back to the fore, especially in Europe and these factors will prevent a sustained improvement in risk appetite from taking place over the coming quarter. Some more clarity may come from the results of European stress tests but much will depend on just how stressful the tests are.

In the near term, the main focus of attention will be on the US June jobs report released at the end of the week. Non-farm payrolls are set to record a decline over the month due to a reversal in census hiring, with a consensus expectation of a 110k fall. Private sector hiring is likely to record a positive reading, however, suggesting some improvement in the underlying trend in jobs growth, albeit a very gradual one. Downside risks to consensus suggest plenty of scope for disappointment.

Interestingly, weaker US data of late, has managed to restrain the USD, suggesting that cyclical factors and not just risk aversion are beginning to play into FX movements. Notably the USD was on the back foot against a number of currencies as last week progressed. Even the beleaguered EUR managed to end the week well off its weekly low and close to where it closed the previous week whilst risk currencies such as the AUD and NZD as well as GBP also posted firm performances.

Perhaps some reversal of the optimism towards US recovery prospects give USD bulls some cause for concern, but pressure is likely to prove temporary, especially given that the US economy is still on course to outperform many other major economies. Over the short-term, especially ahead of the US jobs report markets are set to remain cautious with range trading likely to dominate in the week ahead, suggesting that EUR/USD is unlikely to breach the key level of 1.2500. GBP performance has been robust but even this currency is likely to make much headway above GBP/USD 1.5000, where there are likely to be plenty of sellers.

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Euro Rally To Fade

June 17, 2010 — Mitul Kotecha

It is not an easy time to forecast currencies. Just as many forecasters fought for the accolade of being the most bearish on the EUR and many others were forced to capitulate or risk falling behind the curve, EUR/USD has started to perk up. Similarly, commodity currencies and many emerging market currencies have bounced.

Perhaps the explanation of these moves is merely position adjustments as traders and investors square positions as they keep one eye on the World Cup or maybe its just fatigue after weeks of selling pressure. Either way, the fact that speculative USD market positioning is at a very high level, suggests there is plenty of scope to take profits on long USD positions.

There are various reasons to expect the calm to give way to renewed tensions, however. Public opposition to austerity plans in Europe, added to the prospects for slowing growth as the plans are implemented, in addition to banking sector concerns, suggest that the outlook for the EUR remains downbeat. These factors also point to the prospects of risk aversion rising over the coming weeks, reversing the recent rally in risk currencies.

Further out, the EUR’s travails will not be over quickly and in the wake of the implementation of austerity plans the EUR will struggle from the impact of relatively slower growth in the eurozone compared to the US and other countries. The EUR will continue to remain under pressure even as risk appetite improves and many risk currencies appreciate.

The interruption of risk as an FX determinant is likely to fade towards the end of the year and investors will then go back to differentiating on the basis of relative growth and interest rate dynamics, which will play well for the USD as US growth strengthens.

Relative growth differentials will also bode well for commodity currencies and there will be scope for plenty of upside in the AUD and NZD as growth strengthens. Both countries have benefited from firm demand in Asia and China in particular and this source of support will likely continue to be beneficial.

Funding currencies including JPY and CHF will likely weaken this year against the USD based on the likely improvement in risk appetite later this year. The outlook for the JPY will be particularly interesting in the wake of the change in Prime Minister in Japan, especially given the new PM’s preference for a weaker JPY and reflationary policies. USD/JPY will likely reach 100 by the end of the year.

GBP should not be seen in the same context as the EUR. Although the UK has got its own share of fiscal problems the new government appears to be moving quickly to mollify both investor and ratings agency concerns. The test will come with the reaction of the emergency budget on June 22nd but I suspect that the downside risk to GBP will be limited.

Unlike the EUR which is trading around “fair value”, GBP is highly undervalued. Arguably past GBP weakness puts the UK economy on a stronger recovery footing. Moreover, problems that Europe will face in implementing multi country austerity plans and widening growth divergence, will not be repeated in the UK. Overall, there is likely to be significant outperformance of GBP versus EUR over coming months

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World Cup FX Positioning/Data Highlights

June 14, 2010 — Mitul Kotecha

The market tone felt decidedly better over the course of the last week although it was difficult to tell if this was due to position squaring ahead of the World Cup football or a genuine improvement in sentiment. There was no particular event or data release that acted as a catalyst either, with the European Central Bank (ECB) and Bank of England (BoE) meetings passing with little fanfare.

US data ended the week mixed, with retail sales disappointing in May but in contrast June consumer confidence beating expectations. Although questions about the pace of recovery remain, other data such as the Fed’s Beige Book suggest that recovery remains on track, sentiment echoed, albeit cautiously by Fed Chairman Bernanke last week.

Attention this week will centre on inflation data. Expected benign CPI readings will support the view that the Fed will take its time to raise interest rates. Speeches by the Fed’s Bullard, Plosser and Bernanke this week will be eyed for further clues on Fed thinking.

Central banks in Brazil and New Zealand hiked rates last week but this is not likely to be echoed this week. No change is likely from both the Bank of Japan and Swiss National Bank although there will be plenty of attention on the SNB’s comments on the CHF following recent data showing a surge in FX reserves due to currency intervention. The BoJ is unlikely to announce anything new but perhaps some further detail on the loan support plan could be forthcoming.

Manufacturing data will also garner some attention, with the US June Empire and Philly Fed surveys and May industrial production on tap. All three reports will confirm the improving trend in manufacturing activity in the US. Housing data will look weaker, with starts set to pull back in starts in May following the expiry of government tax incentive programmes though permits are set to rise.

In Europe, the June German ZEW (econ sentiment) investor sentiment survey will likely slip slightly due to ongoing fiscal/debt worries but this will be countered by stronger domestic data. In any case the index remains at a high level and a slight drop is unlikely to derail markets.

GBP may find some support form upgrade of UK growth forecasts by the CBI to 1.3% for 2010 and relatively hawkish comments from the BoE’s Sentance in the weekend press warning that inflation is higher than expected, indicating that the Bank may need to hike rates sooner than expected.

Further GBP/USD direction will come from CPI and retail sales data this week as well as public borrowing figures and a report by the new Office of Budget Responsibility on the UK’s fiscal position ahead of the June 22 budget. A break above GBP/USD resistance around 1.4760 is unlikely to materialise.

Despite the many data releases this week, the overall tone is likely to be one of consolidation and reduced volatility in the days ahead. This may allow EUR/USD to gain some ground due to short covering, with the CFTC commitment of traders (IMM) report revealing a further increase in net short speculative positions last week, close to the record set a few weeks back, though we suspect that there will be strong resistance around 1.2227.

The fact that the IMM data revealed that net aggregate net USD long positions reached an all time high last week, highlights the potential for profit taking this week. USD/JPY will look to take out resistance around 92.55 but this looks unlikely unless the BoJ dishes up anything particularly dovish from its meeting.

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Euro Has That Sinking Feeling

June 7, 2010 — Mitul Kotecha

The reaction to the US May jobs report shows that markets are particularly susceptible to negative US news at a time when growth fragilities in Europe are becoming increasingly apparent. Coupled with worries about Hungary, risk aversion has jumped.

Unsurprisingly the EUR took the brunt of pressure. Rhetoric over the weekend may help to assuage some fears but I suspect it is too late now that the cat is out of the bag. Hungary’s government maintained that it will meet this year’s budget deficit target of 3.8% of GDP. European Union officials also attempted to calm market concerns, downplaying any comparison of Hungary to Greece.

The overall EUR/USD downtrend remains intact. Renewed doubts about German participation in the EU/IMF rescue package, with the German constitutional court potentially blocking its contribution, will add to pressure as well as a UK press report titled EUR ‘will be dead in five years’ . The January 1999 EUR/USD introduction level around 1.1830 has now moved squarely into sight.

It is unlikely that data and events this week will do much to reverse the market’s bearish tone. Highlights include the ECB, BoE and RBNZ meetings in Europe, UK and New Zealand, respectively. The ECB (Thursday) is highly unlikely to shift its monetary policy stance. Given some opposition to bond purchases from within the ECB council the comments in the accompanying statement will be closely monitored. The BoE will also leave policy unchanged on the same day but the RBNZ is set to begin its hiking cycle with a 25bps move.

On the data front the US slate includes the Fed’s Beige Book, April trade data, May retail sales and June Michigan confidence. The Beige Book is likely to reveal some improvement in activity with little sign of inflation, whilst the trade deficit is set to widen further due to a higher oil import bill. Retail sales will reveal an autos led increase in the headline reading but more subdued core sales, whilst consumer confidence is set to rise for a second straight month.

There will be more attention on rhetoric from EU officials rather than eurozone data, with the Eurogroup of Finance Minister’s and Ecofin meetings garnering more interest. In Japan, politics will take centre stage, with the new cabinet line up in focus following the confirmation of Naoto Kan as Prime Minister. Comments by the new PM himself will be of interest, especially with regard to combating deflation and in particular any elaboration on his penchant for a weaker JPY.

All-in-all, the week is unlikely to see a let up in pressure on risk trades and will start much as the last week ended. Although the market’s attention is on the EUR, it should be noted that the AUD has lost even more ground so far this month although the EUR remains the biggest loser in terms of major currencies so far this year (vs USD). In the case of the AUD the move reflects a massive unwinding of long positioning (as reflected in the latest CFTC IMM data which shows that speculative AUD positioning has dropped to its lowest since March 2009).

In contrast in the case of the EUR where positioning is already very negative, the move simply reflects deteriorating fundamentals. The fact that European officials are showing little concern about the decline in the EUR (why should they given that the currency is now trading around fair value) and in some cases encouraging it, suggests that there is little to stop EUR/USD from dropping much further and parity is looming a lot closer.

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Wait And See

June 4, 2010 — Mitul Kotecha

It’s difficult to be too conclusive in my blog post today given that markets are in waiting mode for a number of events to pass. First and foremost is the US May jobs report. The consensus forecast is for a gain of 536k in nonfarm payrolls and a slight drop in the unemployment rate to 9.8%. Payrolls estimates range from a high of 750k to a low of 220k, the wide margin likely reflecting the uncertainty of the amount of census hiring.

On the face of it a 500k+ gain in payrolls looks strong, but the bulk of this, probably about three-quarters, will made up of census hiring which by its nature is transitory. Therefore, only about 100k in payrolls will be due to private sector jobs growth, which is still not bad. Most of the clues leading up to the jobs data are consistent with the consensus, including the 55k increase in the May ADP.

The second event is the change in Prime Minister in Japan. Naoto Kan, the previous Finance Minister is set to take over the helm. His job is going to tough, with all eyes on how and when the government begins to get to grips with Japan’s burgeoning debt burden which is approaching 200% of GDP. Most of this, around 96% is held by domestic investors, so Japan is less exposed to foreign investor sentiment.

Nonetheless, even domestic investors including many large life insurance companies are increasing their overseas investments at the expense of Japanese debt. Kan is also a supporter of weaker JPY so at the least the rhetoric from Japanese officials to weaken the JPY will step up, especially given the very painful move in EUR/JPY over recent months.

Finally, the G20 meeting beginning today in South Korea will garner attention. Topics will include bank regulation and capital requirements, the European debt crisis, and policy tools such as the recent suggestion by South Korea to make permanent the currency swap agreements between central banks. Aside from a commitment to keep policy supportive, and likely talking up the efforts to combat the crisis in Europe, it is difficult to see anything particularly market moving emerge from the meeting.

Posted in central banks, Currencies, Economics, Economy, Europe, eurozone, Financial crisis, Fiscal/Budget, FX, Interest rates, Japan, Politics, South Korea, US. Tags: , , , , , , , , , , , , . 1 Comment »
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