Risk appetite firms

October 16, 2012 — Mitul Kotecha

More encouraging news in the US in the form of a bigger than forecast increase in September retail sales and stronger than expected earnings from Citigroup Inc. helped to boost equity markets and risk assets in general. The US data follows on from recent positive consumer confidence and housing data.

Meanwhile, the VIX ‘fear gauge’ dropped while the Baltic Dry Index continued its ascent. The latter is particularly encouraging in terms of its positive implications for global growth. This is corroborated by my own risk barometer which continues to move lower. In contrast, commodity prices dropped, with gold prices losing more ground as better US data acts to dampen expectations of the magnitude of Fed QE that will need to be carried out.

I expect the constructive risk tone to be maintained with data releases both in the US (industrial production) and Europe (German ZEW investor confidence) to be supportive of risk assets. A reports in the FT today that Spain is verging on requesting a bailout will also come as welcome news for markets although there has yet to be confirmation of such a request.

Despite the better market tone I do not see major breaks out of recent ranges, with attention on the 84 S&P 500 companies set to release earnings this week and developments at the upcoming EU Council meeting. Hesitation ahead of a slate of Chinese data tomorrow will also cap market movements today.

Firmer risk appetite is usually negative for the USD but it is notable that my risk barometer has had a positive and significant correlation with the USD over recent months. In other words, lower risk aversion has actually been associated with a firmer USD. I see the USD remaining supported especially if expectations of the magnitude of Fed QE are pared back although the USD will likely lose some momentum given growing hopes of an imminent Spanish bailout request.

Asian currencies look relatively firm against the backdrop noted above. The most sensitive Asian currency to risk is the KRW and notably USD/KRW has finally broken below 1110, which opens the door for a test of 1100. TWD, THB, MYR and INR are also major Asian FX beneficiaries in an environment of better risk appetite. I expect Asian currencies to continue to trade with a firmer tone in the short term helped by strengthening capital inflows. Firmer Chinese CNY fixings are also aiding Asian currencies.

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Spain downgraded

October 11, 2012 — Mitul Kotecha

Pressure on Spain has intensified in the wake of a two notch downgrade to the country’s debt to just one notch above junk at BBB-. S&P cited “the significant risks to Spain’s economic growth and budgetary performance, and the lack of a clear direction in euro-zone policy”. The slow progress towards a sovereign bailout for Spain will have likely played a role in the decision, a factor that is also weighing on general market sentiment. The debt downgrade may on the margin increase the pressure on the Spanish government to request a formal bailout.

Nonetheless, risk assets including peripheral Eurozone bonds do not appear particularly stressed although it may only be a matter of time before pressure escalates. Italian bond supply today may give some further direction on this front. US Q3 earnings will have some bearing on sentiment too as concerns have grown that they will disappoint. With little on the data front (highlights include Eurozone country September inflation and US trade data) attention will focus on comments from the IMF meetings against the background of growing global growth worries.

Against this background the EUR is likely to continue to drift lower, with the currency set to test support just under the 1.2800 level AUD will have got a boost from the relatively positive September jobs report released this morning, which revealed a 14.5k increase in employment. The positive impact may slightly be mitigated by a rise in the unemployment rate to 5.4% from 5.3%, which also gives further evidence supporting the RBA’s recent rate cut. The data will at least help to alleviate some of the concerns about the jobs market following last month’s surprise drop in employment. My preference is to play AUD via going long positions versus EUR.

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Asian currencies running into resistance

October 10, 2012 — Mitul Kotecha

As the US Q3 earnings season gets underway caution is prevailing as reflected in the losses in US and European equity markets overnight. The VIX jumped as risk aversion increased in the wake of lower revised growth estimates from the IMF and worries that earnings will be far less flattering than in previous quarters. Nonetheless, stronger than forecast earnings from Alcoa helped to kick of the earnings season in positive mode.

In Europe the visit by Chancellor Merkel to Athens was accompanied by reassuring statements from the German leader but this was to little avail as demonstrations in the Greek capital continued. Reports that lenders are discussing extending Greece’s bailout program by two years may provide some relief, however.

Spain remains the major focal point and in this regard there is no progress in the country moving forward with a bailout request much to the chagrin of peripheral debt markets and the EUR. There are few data releases of interest today of which the Fed’s Beige Book will be the main highlight. The market tone will continue to remain cautious but we don’t expect a major relapse in risk appetite.

The USD continues to make good headway in an environment of higher risk aversion, as the USD index continues to maintain a strong correlation with risk. We see little reason for this to reverse although EUR/USD may run into some support around the 1.2824 area. Our preferred crosses include playing short EUR/AUD given that our model indicators show that AUD is oversold at current levels.

Asian currencies will run into some resistance against the background of a firmer USD and the ADXY index is struggling to break higher. The PHP and THB have been the major outperformers so far this month, with most other Asian currencies have weakening.

India has been the biggest beneficiary of renewed portfolio flows to the region, unsurprising in the wake of recent reform announcements registering around $1.3 billion of equity flows month to date. USD/KRW looks like it will struggle to break below 1110 having failed on its attempts to break through this level. Equity capital inflows to Asia are on par with the inflows registered in 2009 and 2010.

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USD buffeted, JPY firming, AUD risks receding

October 9, 2012 — Mitul Kotecha

A lacklustre day for equity markets yesterday saw many indices close lower and risk aversion edge higher, with the VIX ‘fear gauge’ being a prime mover, Some encouraging signs for global activity continue to emerge from the rise in the Baltic Dry Index but market growth fears remain high. Attention remains firmly focussed on events in Europe, with the Ecofin meeting today likely to see further discussions on a wide range of issues. As yet there is no breakthrough regarding a Spanish bailout or next tranche of Greek loan disbursement, with the latter only likely to be confirmed in November. A visit by German Chancellor Merkel to Athens today is unlikely to result in any breakthroughs. US corporate earnings will also garner greater attention as the week goes on, with Alcoa set to begin the earnings season tomorrow.

The USD is being buffeted by conflicting factors at present. QE3 is likely to cap any gains in the currency but the expansion of balance sheets by other central banks suggests that a weaker USD outlook is by no means a foregone conclusion. Moreover, from a growth perspective the USD comes out on top. Even though US recovery is a weak one by historical standards the economic outlook still looks better than in Europe, notwithstanding the looming US fiscal cliff. Further evidence of recovery will be gauged from the release of the September small business optimism survey today. A likely third straight gain will provide encouraging news although the survey still remains lower than levels it was at earlier in the year. Over coming days I expect the USD to edge higher as it capitalizes on the various strands of uncertainty in the Eurozone.

As Japan returns from an extended weekend USD/JPY has reversed its recent break higher and is verging on another test of 78.00. There seems little in terms of directional influences to give any major impetus to the currency pair especially as many JPY correlations have broken down lately. JPY speculative long positions remain relatively high suggesting scope for some reduction and JPY selling but I suspect that USD/JPY will remain stuck in its current 77.77 – 79.00 range for some time to come. Nonetheless, JPY bears may be encouraged by recent signs of strong bond outflows adding to data showing equity outflows over recent weeks. Indeed, in the week to 28 September 2012 Japan registered its biggest net equity and bond outflows since early May.

AUD has been a major underperformer this month, with pressure intensifying following last week’s surprise RBA rate cut. Although a further sharp drop appears unlikely hefty long speculative positioning suggests that upside traction will be limited. Nonetheless, my quantitative models show that the AUD is looking increasingly oversold against the USD. The market is already pricing in another RBA rate cut by the end of the year suggesting that the reaction to upcoming data will be asymmetric. In other words the AUD will rally more in the wake of positive data than it will weaken in the wake of soft data. Business and consumer confidence indicators will provide further direction over coming days, but the main driver will come from the September jobs report on Thursday where a further drop in employment is expected. I continue to look for strong support for AUD/USD around the 1.0100 level, with 1.0285 a barrier to any upside break.

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Euro slipping ahead of Eurogroup meeting

October 8, 2012 — Mitul Kotecha

The US September jobs report released last Friday will provide some encouraging news for markets to digest this week but holidays in the US and Japan today will keep trading relatively subdued. The jobs report itself was in any case somewhat mixed, and while the unemployment rate dropped to 7.8%, the actual increase in payrolls was relatively soft at 114k although there were revisions higher to past months.

The US jobs report does not necessarily change the picture regarding US quantitative easing. The Fed and subsequently markets will not change their expectations based on one month’s data. In this respect, any benefit to the USD will be limited although the increase in US 2-year bond yields has already exhibited itself in a firmer USD/JPY exchange rate. Nonetheless, this week’s US data will help maintain the assessment of gradual US recovery, with the Beige Book, trade data and Michigan confidence in the spotlight. US data will continue to look relatively better than in Europe.

Most attention will remain on Europe and the Eurogroup meeting beginning today. The reluctance of Spain to request a formal bailout will be a negative factor for European markets, although Portuguese austerity measures likely to be approved today, negotiations between Greece and the Troika (EU, IMF and ECB) on the next tranche of loan disbursements for the country, as well as potential for Cyprus and Slovenia to request a bailout will also come under scrutiny at the meeting.

Currencies are generally range bound, although EUR/USD is verging on another drop below 1.3000. Spain’s refusal to request for a formal bailout holds risks to the EUR especially if peripheral including Spanish bond yields move higher again. While ECB President Draghi’s commitment to OMT (Outright Monetary Purchases) reinforced last week, will provide some solace to the EUR, it will prove meaningless unless moves ahead with a bailout.

Two of the biggest FX losers so far into October have been the NZD and AUD. The AUD in particular has been struck by the surprise RBA rate cut and faltering commodity prices. AUD/USD looks set for a test of 1.0100 technical support, but direction this week business and consumer confidence data over the next couple of days ands the September jobs report on Thursday.

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