What To Watch This Week

March 13, 2010 — Mitul Kotecha

A “crisis over” mode is being adopted across markets as worries about Greece wane and economic data provides support to recovery hopes, whilst importantly allaying fears of a “double-dip”. Equities, bonds and currencies are reacting accordingly; equities are close to year highs, bond yields have risen and spreads have narrowed, whilst the USD and JPY are weaker, and conversely risk currencies are stronger. Even EUR/USD pushed higher on its way to 1.3800 as a number of stops were cleared and shorts were squeezed.

The coming weeks will be important to determine whether there is any staying power in the upward move in risk assets. A lot of the February data in the US will likely be obscured by bad weather however, including industrial production figures this week, leaving markets with little to go on. In Europe, the key release is the March German ZEW investor confidence survey, and better news in Greece, will likely prevent a sharper decline in confidence.

After both the Swish National Bank (SNB) and Reserve Bank of New Zealand (RBNZ) unsurprisingly left policy unchanged last week this week sees the turn of the US Federal Reserve and Bank of Japan (BoJ). Neither central bank is likely to shift policy but the Fed statement will be looked upon for guidance on the timing of rate hikes. The comment in the FOMC statement that the Fed Funds rate is expected to remain low for an “extended period” is set to be retained, even if some FOMC members are itching to remove it soon.

The BoJ meeting will be particularly interesting. I have just returned from a week long trip in Japan and on the ground there is plenty of speculation that the BoJ will take extra action to combat deflation and weaken the JPY. Additionally comments by Japan’s Prime Minister and Deputy PM have highlighted the potential for action to weaken the JPY although the usual market hesitation to sell JPY into fiscal year end and repatriation talk may mean a weaker JPY path is not straightforward.

Greece will not move too far from the spotlight, with EU officials likely to give the official stamp of approval on Greece’s deficit cutting measures and plenty of discussion at the Eurogroup Finance Minister’s meeting and Ecofin meeting early in the week. Moreover, weekend press reports suggest that a bailout up to EUR 25 billion is close to being agreed. Other topics of conversation will include the possible formation of a European Monetary Fund, though this looks like it will be a non-starter given the many objections to it.

Overall, risk appetite is set to continue its upward trajectory, likely keeping the USD on the back foot. Some deterioration in USD sentiment was reflected in the fact that net long aggregate USD speculation positioning has turned negative again according to the latest CFTC Commitment of Traders (IMM) report. Much in terms of FX direction will depend on what the FOMC says rather than does tomorrow.

EUR/USD may take a crack at resistance around 1.3840 on improving Greek news but it is difficult to see much upside from current levels. The one to watch will be the JPY, especially if the BoJ embarks on aggressive actions at this week’s meeting, leaving USD/JPY plenty of scope to test resistance around 92.16.

Posted in Bond markets, central banks, Currencies, Economics, Economy, equity markets, Europe, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Germany, Greece, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

GBP bulls brave or crazy?

March 10, 2010 — Mitul Kotecha

The UK Pound’s (GBP) performance over recent months has been dismal. The currency has failed to show any real sign of recovery, having fallen to and below the psychologically important level of 1.50 against the USD. A number of factors including fiscal/debt concerns, political worries, and uncertainties about whether the Bank of England will step up asset purchases, have accumulated to turn even the most ardent GBP bulls into bears.

The outcome of the upcoming UK general election widely expected on May 6, remains a major weight on GBP sentiment. Until the outcome is clear or unless one or other party develops a clear lead in the polls, it is difficult o see GBP sustain any durable recovery. In the near term GBP/USD is vulnerable to a test of its 2010 low around 1.4780 and then towards 1.44. The risk to this is that the market is very short GBP which could result in a sharp bounce in GBP in the wake of any good news. However, a rally in GBP will only result in fresh sellers.

Ahead of the elections will be the budget and this will be closely scrutinized for steps to reduce the size of the burgeoning fiscal deficit. Whichever party comes into power will need to convince markets that a credible and timely plan exists to reduce the size of the deficit and prevent a sovereign ratings downgrade. If not, GBP could see itself under much more pressure. In this respect it’s worth noting the Fitch ratings warning that the UK sovereign credit profile has deteriorated.

It’s not all bad for GBP, however. By some measures it’s now the most undervalued major currency, opening up the possibility of a sharper bounce back over the medium term. Moreover, UK debt markets are already trading as if a ratings downgrade has taken place, whilst arguably GBP has also priced in a lot of negative news already, as reflected in the very negative speculative positioning in the currency.

The economic news is also not as bad as the headlines might suggest and although recent housing data has been a bit mixed, both consumer spending and the housing market have held up reasonably well. Bearing all this in mind GBP is set to recover over the medium term, but it would be very brave to buy the currency any time soon, at least until UK elections are out of the way.

Posted in Bond markets, central banks, Currencies, Economics, Economy, Financial crisis, Fiscal/Budget, FX, Interest rates, Monetary Policy, Politics, UK. Tags: , , , , , , , , , , , , , . 1 Comment »

The Ball Is In the EU’s Court

March 4, 2010 — Mitul Kotecha

A run of data and events have continued this week’s theme of improving risk appetite. Greece lived up to expectations, with the government announcing a EUR 4.8 billion package of austerity measures amounting to around 2% of GDP. The US ADP jobs data was in line with expectations, with employment dropping by 20k in February, whilst ISM non-manufacturing index delivered an upside surprise to 53.0 in February, contrasting with a weaker eurozone Purchasing Managers Index (PMI).

Greece now believes it has lived up to its part of the bargain and the ball is now in the court of EU countries. However the issue of aid from the EU remains highly sensitive with little sign of any aid forthcoming from EU partners. Moreover, Germany dealt a blow to Greek hopes by stating that financial aid would not be discussed when the Greek Prime Minister visits tomorrow. Failure to provide such assistance could see Greece turn to the IMF. The key test will be the roll over of around EUR 22 billion of debt in April/May.

Markets have reacted positively to recent events, with Greek debt rallying and the EUR strengthening to a high of 1.3727 overnight amidst reports that regulators are investigating hedge fund trades shorting the EUR. The 17 February high of 1.3789 will provide strong resistance to further EUR/USD upside but the currency looks vulnerable to selling on rallies above its 20-day moving average around 1.3631. The EUR will be driven by news about any aid to Greece rather than data whilst the medium term outlook remains bearish.

In the US the steady but gradual recovery in the economy is continuing to take shape. The Fed’s Beige Book revealed that economic activity “continued to expand” but severe snowstorms restrained activity in several districts. Overall, the report revealed little new information following so soon after Fed Chairman Bernanke’s testimony. Today’s US releases are second tier, with a likely upward revision to Q4 non-farm productivity to around 6.5% and a 1.5% increase in January factory orders.

As has been the case recently the weekly jobless claims data will garner more attention than usual given that it has recently signaled deterioration in job conditions. One factor that could have distorted the claims as well as the payrolls data is harsh weather conditions in parts of the US. Indeed, this has led us to cuts in forecasts for February non-farm payrolls scheduled to be released tomorrow, with the real consensus likely to be much weaker than the -65k shown in the Bloomberg survey.

There are four central bank decisions of interest today no change is likely from all of them. Indonesia and Malaysia are both edging towards raising interest rates but are likely to wait until Q2 2010 before hiking. There will be no surprises if the Bank of England (BoE) and European Central Bank (ECB) leave policy unchanged too, but there will be particular interest in the ECB’s announcement on changes in liquidity provision and the BoE’s signals on the potential for further expansion in quantitative easing. A dovish signal from the BoE will deliver GBP a blow, leaving GBP/USD vulnerable to a drop back below 1.50.

Posted in central banks, Currencies, Economics, Economy, Europe, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Germany, Greece, Interest rates, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , . Leave a Comment »

All Eyes On Greece

March 3, 2010 — Mitul Kotecha

I remain a skeptic but market sentiment continues to improve, helped by firmer data and expectations that Greece’s woes are on the path to being resolved. Greece is expected to announce further austerity measures including further spending cuts and tax hikes, which will be aimed at appeasing EU concerns and passing the March 16th test set by the EU. This could pave the way for some form of debt guarantee scheme and a better reception to a likely sale of up to EUR 5 billion in 10 year Greek bonds.

These measures will allow the EUR to recover some of its recent losses in the short term after dropping to new 2010 lows against the USD around 1.3435, but gains are likely to be limited given the many uncertainties remaining including fiscal problems in other European countries and weak growth ahead. If EUR/USD can sustain a break above the 20-day moving average level around EUR/USD 1.3630 it will put the next resistance level of 1.3747 into target, which given record short EUR speculative positioning may happen quite quickly. I suggest rebuilding short EUR positions on a move to this level.

Commodity currencies continue to be favoured and despite only a brief spike following the RBA’s decision to hike interest rates yesterday AUD/USD has managed to traverse the 0.90 level and looks well placed to build on its gains helped by a firm 0.9% QoQ reading for Australian GDP in Q4. Nonetheless, AUD/USD 0.9147 looks like a near term cap on the currency. For bullish commodity currency trades the NZD may offer a little better value and short AUD/NZD may be the way to go from here. Note that NZD positioning is below the 3-month average according to positioning data. In contrast to the RBA, the Bank of Canada left interest rates unchanged, but its statement highlighted that the prospect of quantitative easing had receded, which has effectively lifted a weight off the shoulders of the CAD.

All of this leaves the USD on the back foot, with further direction coming from the US February ADP jobs report, ISM non-manufacturing survey and Fed’s Beige Book. The ADP data and ISM employment component will give further clues to Friday’s February US jobs report for a 50k drop in payrolls is expected. Service sector Purchasing Managers’ Indices (PMIs) will also be released across the eurozone and the UK and both are likely to sustain moves into expansion territory.

The rebound in EUR/USD was a trigger for further selling in USD/Asian currencies. Asian currencies remain highly correlated with local equity market performance and have benefited from a strong return of equity portfolio inflows over recent days. Only Vietnam has registered outflows this week, with South Korea and Taiwan registering the biggest inflows. Indeed, South Korea has seen the biggest inflows of portfolio capital compared to other Asian countries so far this year, with inflows of around $933 million.

There is not much data in the region to provide direction for Asian currencies today though the South Korean industrial production report will be closely watched. Despite a small monthly drop expected, output likely expanded at very healthy 40%+ pace annually. Overall, USD/Asians are likely to remain under downward pressure in line with the general pressure on the USD, but direction will continue to come from equity markets.

Posted in Asia, Australia, central banks, Commodities, Currencies, Economics, Economy, emerging markets, Europe, Financial crisis, Fiscal/Budget, FX, Greece, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , . Leave a Comment »

Is EUR/USD Parity Inevitable?

February 26, 2010 — Mitul Kotecha

Reading this article in the WSJ “Hedge Funds Try ‘Career Trade’ Against Euro“, it would seem that there is an increasing amount of investors, especially hedge funds, looking for the EUR to fall to parity against the USD.  It is hard to believe that only a few months ago it looked as though the EUR was heading back towards its previous highs around 1.60 hit in April 2008. 

Following the surge in the USD during the financial crisis EUR/USD dropped to below 1.25 in November 2008 and then managed to eek out some gains as risk appetite improved and the USD came under pressure during most of 2009.

The picture towards the end of 2009 reversed as initially investors covered short USD positions and then bought USDs on rising risk aversion and growing problems in Greece.  The trend looks well set now and a move even lower beckons for EUR/USD.  

So how low will it go?  It is tempting to say that record short speculative positioning in EUR/USD means that the market is already stretched and like an elastic band pulled too far the EUR could rebound sharply.  On the other hand the band could also snap and in the case of EUR/USD this would imply a collapse in the currency as other investors join the bandwagon of selling EUR.

It is difficult to see any quick resolution to the problems in Europe at present.  Growing social/ labour unrest in the wake of austerity measures to cut burgeoning fiscal deficits highlight that implementing budget cuts mean tough political choices.   Greece has borne the brunt of this unrest but it appears to be spreading across Europe.   

In the past countries could devalue their way out of their debt problems but this solution is not available to individual countries in the eurozone.  Another option is to inflate your way out of the debt but again this is something that the European Central Bank (ECB) will not tolerate and could do much greater long term damage.  

So the only viable solution is to cut spending, raise taxes, implement reforms and raise retirement ages, all of which will fuel plenty of tensions in the countries concerned.  The difficulty of raising taxes was highlighted by the fact that even Greek tax inspectors have gone on strike, a fact which makes a mockery out of the government’s plans.  

Assuming that austerity measures are actually carried out it will mean that growth in Greece and many of the other bigger countries in Europe that carry out these measures will weaken further, making a “double-dip” scenario for the eurozone economy more likely.  

The bottom line is that it is extremely difficult to see the EUR make a sustainable recovery against this background.  Yes, the market is positioned short but so what? We may see short positioning increase further before any stability in the EUR is achieved.   

The last time EUR/USD was at parity was in December 2002.  Given the lack of alternatives in Europe at present another test of parity does not look as inconceivable as it did only a few months ago.

Posted in central banks, Currencies, Economics, Economy, Europe, Financial crisis, Fiscal/Budget, FX, Germany, Greece, Monetary Policy. Tags: , , , , , , , . 1 Comment »
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