Economic reality check supports dollar

October 2, 2009 — Mitul Kotecha

The US dollar appears to be making a tentative recovery of sorts at least when taking a look at the performance of the US dollar index.  Much of this can be attributable to a softer tone to equities. The S&P 500 registered its biggest back to back quarterly rally since 1975 over Q3 and either through profit taking or renewed economic doubts, stocks may be in for shakier ground into Q4. 

This increase in equity pressure/risk aversion is being triggered by weaker data. Since the Fed FOMC on 24th September the run of US data has generally disappointed expectations; in addition to the ISM survey, existing and new home sales, durable goods orders, consumer confidence and ADP jobs data all failed to match forecasts.   This list was joined by the September jobs data which revealed a bigger than expected 263k drop in payrolls.  Consequently doubts about the pace of recovery have intensified as markets face up to a reality check.

The dollar’s firmer tone is not just being helped by weaker stocks but also by plenty of official speakers discussing currency moves. Although this is potentially a dangerous game considering the recent turnaround in Japanese official comments on the Japanese yen the net effect is to support the dollar.  In particular, Treasury Secretary Geithner stressed the importance of a strong dollar, whilst European officials including Trichet, Almunia and Junker appear to have become more concerned with the strength of the euro. 

In the current environment such comments will contribute to putting further pressure on the euro which in any case has lagged the strengthening in other currencies against the dollar over recent months.   Although ECB President Trichet highlighted “excess volatility” in his comments about currencies overnight implied FX volatility is actually relatively low having dropped significantly over recent months.  The real reason for European official FX concerns is quite simply the fact that the eurozone remains highly export dependent and that recovery will be slower the stronger the euro becomes.  

It’s not just G10 officials that are becoming concerned about currency strength against the dollar as Asian central banks have not only been jawboning but also intervening to prevent their currencies from strengthening against the dollar.   A firmer dollar tone is likely to put Asian currencies on the back foot helping to alleviate some of the upward pressure over the short term but the overall direction for Asian FX is still upwards.

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Contrasting fortunes for GBP and JPY

September 28, 2009 — Mitul Kotecha

The main FX movers over recent days have been JPY and GBP. Japan’s non interventionist FX stance and the approach of fiscal half year end on September 30 have given markets plenty of appetite to push the JPY higher.  In particular a change in Japanese tax rules which waives taxes on repatriated profits suggests there will be more repatriation flows than usual ahead of fiscal half year end.  Such repatriation flows have played a role in the appreciation of the JPY.    

Even if such flows do not actually materialise the mere speculation that they exist will be sufficient to keep the JPY supported.  Helping the JPY on its way is the view that Japanese officials are not particularly concerned about a strengthening JPY although it is worth noting that Japan’s new finance minister Fujii did note that he was carefully watching the JPY’s rise.  Nonetheless, it appears that the new government’s policy in Japan is in sharp contrast to the previous government’s FX policy which favoured a weaker JPY.  

The positive shift in JPY sentiment over recent weeks has been particularly evident in speculative positioning data which reveals that net JPY speculative positions have hit their highest since 3 February 2009, a sharp turnaround from negative net positioning just three months ago.  Further JPY gains are likely over the short term as speculative appetite for the currency continues to improve. 

In contrast to Japan, UK officials appear to be more comfortable with a weaker currency. Recent comments by Bank of England (BoE) Governor King that a weaker GBP would help exporters has weighed on GBP.  Consequently, speculative sentiment for GBP deteriorated particularly sharply last week, with CFTC IMM data revealing the biggest short GBP positioning since early April 2009.  Even though the latest UK Monetary Policy Committee minutes revealed no sign that the BoE is contemplating expanding quantitative easing, GBP continues to be a much unloved currency.  

Some likely improvements in economic data this week may provide relief to GBP but it will prove limited against the weight of negative GBP sentiment.  The Hometrack housing survey revealed a further increase in UK house prices in September and data this week will likely reveal an upside revision to Q2 GDP, and an improvement in manufacturing confidence.  Overall, despite the encouraging data GBP/USD looks vulnerable to a further downside push.

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Key events for FX markets this week

September 21, 2009 — Mitul Kotecha

Key events this week include the Fed FOMC and G20 meetings .  The G20 meeting is likely to be a non-event as far as markets are concerned.  There will be plenty of discussion about co-ordinating exit strategies but officials are set to repeat the commitment to maintain stimulus policies until recovery proves sustainable.  

There is likely to be little emphasis on currencies despite the fact that the dollar is trading around its lowest level in a year, except perhaps at the fringes of the meeting, with focus in particular on Japan’s new government’s pro yen policy.  

Regulation will also figure high amongst the topics debated but this will have little impact on markets over the short term.  Another topic that could be debated is protectionism, especially in light of the US decision to impose tariffs on Chinese tyres.

Ahead of the G20 meeting the Fed FOMC meeting is unlikely to result in any change in interest rates but the statement is likely to be cautiously upbeat in line with Fed Chairman Bernanke’s recent comments that the recession is “very likely over”.  The statement will be scrutinised for clues to the timing of policy reversal, especially given recent speculation that a couple of FOMC members were advocating an early exit.  Given that the dollar has suffered due to its funding currency appeal, any hint that some Fed officials are turning more hawkish could give the currency some much needed relief but we doubt this will last long. 

In contrast to speculation of a hawkish shift in thinking by some Fed members the Bank of England appears to be moving in the opposite direction.  The MPC minutes on Wednesday will be viewed to determine just how close the BoE was to extending quantitative easing and reducing interest rates on bank reserves at its last meeting. 

Sterling (GBP) has been a clear underperformer over recent weeks and a dovish tint to the minutes will act as another factor weighing on the currency as speculation over further action intensifies ahead of the next meeting.  

Sterling is also struggling against the euro having hit a five month low.  A combination of factors have hit the currency including concerns about quantitative easing expansion, the health of the banking system, and the latest blow coming from a the Bank of England in its Quarterly Bulletin where it states that GBP’s long run sustainable exchange rate may have fallen due to the financial crisis.   

Against this background it is not surprising that sterling was the only major currency against in which speculative positioning actually deteriorated versus the dollar last week (according to the latest CFTC Commitment of Traders report).   It is difficult to see any sterling recovery over the short term against this background, with a re-test of the 9 July low just under GBP/USD 1.60 in focus.

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Japanese yen and FX sensitivity to interest rates

September 16, 2009 — Mitul Kotecha

Interest rates have some way to go before they take over from risk aversion as the key driver of currency markets but as noted in my previous post, low US interest rates have played negatively for the dollar. As markets have continued to pare back US tightening expectations and US interest rate futures have rallied, interest rate differentials have moved against the dollar. 

The most sensitive currency pair in this respect has been USD/JPY which has been the most highly correlated G10 currency pair with relative interest rate differentials over the past month. It has had a high 0.93 correlation with US/Japan interest rate differentials and a narrowing in the rate differential (mainly due to a rally in US rate futures) has resulted in USD/JPY moving lower and the yen becoming one of the best performing currencies over recent weeks.

Going forward the strong FX / interest rate correlation will leave USD/JPY largely at the whim of US interest rate markets (as Japanese rate futures have hardly moved). Fed officials if anything, are adding to the pressure on the dollar as they continue to highlight that US interest rates will not go up quickly. San Francisco Fed President Yellen was the latest official to do so, warning that the prospects for a “tepid” recovery could fuel inflation risks on the downside.

This echoes the sentiments of other Fed officials over recent weeks and suggests that the Fed wants to prevent the market pricing in a premature reversal in US monetary policy.   It looks increasingly likely that the Fed will maintain interest rates at current levels throughout 2010 given the massive amount of excess capacity and benign inflation outlook, suggesting that interest rate differentials will play negatively for the dollar for several months to come.

As for the yen its path will not only depend on relative interest rates but also on the policies of the new DPJ led government. If Japanese press speculation proves correct the new Finance Minister may favour a stronger yen which will benefit domestic consumers rather than a weaker yen that would benefit exporters. Against this background, markets will largely ignore comments by outgoing Finance Minister Yosano who said that further yen strength would be detrimental for exporters.

The market certainly believes that the yen will strengthen further as reflected by the sharp increase in speculative positioning over recent weeks; net CFTC IMM long yen positions have reached their highest since 10 February 2009. Although USD/JPY has pushed higher since it’s low around 90.21 the upside is likely to be limited against this background and a re-test and likely break back below the key 90.00 psychological level is likely soon.

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