US dollar pull back to prove short lived

January 13, 2014 — Mitul Kotecha

Having spent the tail end of last week in Singapore and Phnom Penh presenting the Global outlook for 2014 to clients as part of our Asian roadshow it struck me that there is a strong consensus view about a number of market movements this year. In particular, most expect the USD to strengthen over 2014. Indeed just as it looked as though the USD was going to surge into the new year, along comes the US jobs report to spoil the party. Clearly, it’s not going to be a one way bet in 2014.

The surprisingly weak US December payrolls data in which only 74k jobs were added compared to consensus expectations of close to 200k helped to support expectations that Fed tapering would take place only gradually, lending a helping hand to risk assets at the turn of this week.

I don’t believe the jobs data materially changes the picture for the Fed. Adverse weather may have played a role in the weakness in jobs while complicating matters was the drop in the unemployment rate to 6.7% largely due to around 350,000 people leaving the labour force. The data resulted in a drop in US bond yields and a weaker USD although equity market reaction was more mixed. Meanwhile gold and other commodity prices rose.

While risk assets may find some support in the wake of the jobs report this week much of the US data slate will if anything highlight that economic growth is strengthening, suggesting a reversal of some of the price action in US Treasuries, USD and gold. Data releases include a likely healthy increase in core US retail sales in December together with gains in manufacturing confidence surveys (Empire and Philly Fed) and industrial output as well as a further increase in consumer confidence (Michigan sentiment survey).

Additionally several Fed speakers are on tap over coming days, which may give more colour on Fed thinking in the wake of the jobs report. However, it is doubtful that they will indicate that the Fed will not taper as expected in January.

Clearly markets were caught overly long USDs last week as reflected in CFTC IMM speculative positioning data as of 7th January which showed that net USD long positions had reached their highest since September 2013. The pull back in the USD is set to be short lived, however, especially if US data over coming days reveals further improvement as expected.

USD/JPY in particular bore the brunt of the pull back in US yields, as long positions were unwound. A Japanese holiday today may limit activity but much will depend on the propensity for US yields to bounce back, with 10 year US Treasury yields currently around 2.85% compared to around 2.97% on Friday.

Asian currencies have been the most sensitive to US Treasury yields gyrations over the past three months. In order of sensitivity to US 10 year Treasury yields the highest is the JPY, followed by MYR, THB, PHP and SGD. These currencies would be expected to benefit the most in the wake of the drop in yields at the end of last week although as noted any pull back in US yields is likely to prove temporary. While the THB may suffer from political concerns in the near term the other currencies are likely to see some short term gains.

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USD/JPY pulls back, AUD range bound

January 3, 2014 — Mitul Kotecha

USD/JPY pulled back sharply overnight dropping swiftly below 105 as weaker global equities / higher risk aversion together with a pull back in US yields weighed on the currency pair. Nonetheless, its pull back is set to prove temporary and if anything provides better levels to initiate long positions. A Japanese holiday today will limit the scope for much movement in the currency.

Japan clearly has a lot of policy challenges in the months ahead (consumption tax hike, Prime Minister Abe’s third arrow, and hitting the 2% inflation target) which could prompt some volatility in the JPY but the risks remain skewed for more downside in the currency, especially given the potential for more aggressive BoJ policy action and of course the likelihood that the real yield differential between the US and Japan widens further.

AUD was undermined somewhat by the release of weaker than expected Chinese manufacturing and non manufacturing confidence data and softer commodity prices but overall the currency looks like it has found a new range around 0.8820- 0.8980 against the USD over the short term. This relative stability even in the wake of disappointing news in China marks a major shift compared to the selling pressure registered over much of Nov/Dec 13.

I am more constructive on AUD going forward and expect much more limited downside potential in the week ahead. Direction next week will come from trade data, building approvals and retail sales, but movement ahead of this will be limited.

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On track for a positive end to the year

December 23, 2013 — Mitul Kotecha

A solid revision higher to US Q3 GDP at the end of last week sets up a positive tone for risk assets into year end even as they digest the imminent onset of Fed tapering. The data revealed a revision higher to a 4.1% QoQ annualised pace of growth and if anything lent credence to the Fed’s decision to begin tapering. The GDP data will be followed by a series of positive data releases in the US this week including November personal income and spending and a likely upward revision to December Michigan consumer confidence both on tap today.

Tomorrow, November durable goods orders and next week December Conference Board consumer confidence will also paint a picture of broadening improvement in economic conditions, providing further validation to Fed tapering. Against this background US yields should be well supported along with the USD. Into next year US economic outperformance will continue, leading to both higher US yields and a firmer USD.

A Japanese holiday (Emperor’s birthday) today will dampen market action although Japanese data releases over the rest of the week will highlight further progress on the economic front, with November inflation pushing higher and industrial output expanding at a healthy clip. USD/JPY retained a foot hold above 104 but the large extent of short JPY positioning highlights scope for profit taking. Even so, the rise in US Treasury yields suggest limited downside risks for USD/JPY.

There is on little on tap on the data front in the Eurozone allowing markets to digest the steps towards banking union announced last week. Consequently EUR/USD is set to remain rangebound around 1.3650-1.3750.

There may be more interest in events in China as money market conditions and confidence surveys garner interest. Tight money market conditions will weigh on regional sentiment. A likely decline in both the manufacturing and service sector purchasing managers’ indices will also act to dampen Asian currencies reinforcing the pressure already in place from a broadly stronger USD. News in Thailand that the opposition Democratic Party has decided to boycott the Feb 2 elections will add to political uncertainty and pile more pressure on the THB although the regional underperform remain the IDR.

Overall, a thinning in market conditions as both liquidity and market participants disappear for the holidays imply limited activity over coming days. The fact is that the end of the year will market a solid year for equities and a poorer year for bonds but at least the debate over Fed tapering timing has finally been put to the rest. More of the same is likely next year but notably the growth gap between developed and developing economies will narrow, which at a time of heightened competition for capital amid Fed tapering, suggests that capital flows will increasingly be steered towards developed economies.

Dear readers, this is my last post for 2013. Thank you for taking the time to read my blog posts. I wish all Econometer readers happy holidays, success, prosperity and good health in the year ahead.

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USD firms, JPY bears in the ascendency, RBA weighs on AUD

December 3, 2013 — Mitul Kotecha

Despite some encouraging economic news from manufacturing surveys globally equity markets and risk assets in general failed to benefit overnight, with stocks showing a little fatigue following recent gains. The US ISM manufacturing confidence survey beat expectations rising to its highest level since April 2011 while its components looked upbeat, especially the employment component.

This was echoed in the UK and even in the Eurozone the final manufacturing purchasing managers index was slightly higher than forecast. Consequently core bond yields and the USD continued to push higher while gold came under further pressure. The US data also has put the spectre of a December tapering on the table although the November employment report will be scrutinised for further clues.

While JPY bears have been encouraged by the rise in Japanese inflation revealed last week (which was not only energy price led) there’s a long way to go before claiming success in hitting the BoJ’s 2% inflation target. The good news is that the higher real yield differential between the US and Japan is consistent with USD/JPY upside.

The bad news is that more BoJ policy easing is likely to sustain the move and we suspect the central bank will oblige early next year. Indeed, BoJ Governor Kuroda alluded to this yesterday, and his comments were taken at face value by markets, pushing the JPY even lower, with USD/JPY breaching 103 overnight. We keep open our trade idea to buy USD/JPY initiated on 28 October at 97.64 targeting 103.74.

AUD/USD has lost close to 6% since its high around 0.9759 on 23rd October but has found some respite recently from short covering over recent days. The Reserve Bank of Australia however, continues to do its best to weaken the currency. Unsurprisingly left policy rates unchanged today but the accompanying statement noted that the currency remained “uncomfortably high”.

The AUD has been particularly sensitive to a renewed rise in US Treasury yields, being one of the most correlated currencies over recent months and in this respect remains vulnerable to any increase in US yield. Given that we expect US yields to continue to push higher into next year this suggest only a limited AUD recovery over the coming months. In the near term AUD/USD has found some solid technical support around 0.9038.

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JPY, AUD and Asian FX

November 12, 2013 — Mitul Kotecha

Risk appetite remains relatively well supported, with US and Asian equities edging higher and the VIX ‘fear gauge’ moving lower. There is a lack of first tier data releases today, with only German and UK CPI inflation data on tap as well as the US NFIB small business optimism index. Attention will instead centre on various Fed and ECB speakers for further policy clues.

Indeed, markets will look for any hints of reinforced forward guidance by ECB speakers and further insight into the timing of tapering from Fed officials. ECB speakers include Angeloni, Weidmann, Nowotny and Asmussen while Kocherlakota and Lockhart are scheduled to speak from the Fed. There will also be plenty of interest in speeches by the Fed’s Yellen and Bernanke on Thursday.

The JPY appears to be finally succumbing to the pressure of a generally firmer USD and higher US yields although the currency has yet to break out of its recent ranges and correlations suggest that the JPY has not been as sensitive as other currencies to either factor. I remain bearish on the JPY.

While the JPY has not been as sensitive as other currencies to yield lately it has still faced some pressure and will continue to do so if we are correct in our view that US yields will push even higher against Japanese JGBs. Firmer US data has helped to shift expectations of Fed tapering to around December or January. In contrast the BoJ is showing no sign of pulling back from its balance sheet expansion and in our view could even extend asset purchases next year in order to sustain its inflation around its 2% inflation target. This remains a recipe for more USD/JPY upside.

Having rallied by around 9% since its end August low AUD has been unable to hold onto gains. Fortunately for AUD the recent rise in Australian bond yields has acted to mitigate against some of the potential pressure from rising US bond yields; since the USD began its recent rally around 28 October Australia’s yield advantage has narrowed by only 3 basis points. However, the strengthening in the USD has wreaked havoc on many currencies and the AUD has not escaped.

While AUD may face headwinds from a firmer USD, Australia’s relative yield attraction will give it some scope for recovery into year end. Indeed, if yield appetite continues to strengthen in an environment of improving risk appetite and low volatility AUD should prove to be a key beneficiary. In the near term AUD/USD will find some technical support around 0.9280.

Asian currencies have gained a little respite from general USD strength but remain vulnerable to a stronger USD over the coming weeks. Deficit currencies have renewed their position as the biggest underperformers over recent weeks, with the IDR and INR under most pressure followed by MYR. The least vulnerable to USD strength and higher US yields are North East Asian currencies especially TWD and KRW.

Reflecting renewed tapering fears most Asian countries have experienced renewed equity portfolio outflows month to date. The RMB continues to buck the trend although its relative strength may reflect the timing of China’s 3rd plenum which ends today.

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