Euro slippage, sterling under pressure

November 13, 2012 — Mitul Kotecha

A US holiday (bond market closed) and positive data in China over the weekend helped to result in an easing in risk aversion overnight although this was probably more due to relatively limited market action in thin trading conditions. Consequently the VIX ‘fear gauge’ fell sharply. Holidays in Asia today will similarly keep activity limited. The improvement in risk appetite did little to undermine the USD (index) which remained at its highest level since early September and shows little sign of reversing.

The Eurogroup meeting yesterday did not as result in an agreement to deliver Greece its next loan tranche but this came as no surprise. In the US there appeared to be some traction towards resolving the fiscal cliff, with a Senior Republican economist indicating that Congress should agree on higher taxes for the wealthy ahead of formal discussions on averting the fiscal beginning on Friday.

EUR/USD’s slide has continued unabated and looks set to test its 100 day moving average level around 1.2639. Its weakness can be attributed to the usual suspects, namely uncertainty surrounding Greece and Spain. The currency may gain a little respite today in the form of a small rise in the German ZEW investor confidence expectations index but it will be insufficient to turn the EUR around in the short term.

At a time when the US fiscal cliff is rapidly overtaking peripheral Eurozone issues as a cause for concern, the inability of the EUR to capitalize on this is a bit disconcerting. Some clues to the timing of the next Greek loan disbursement will undoubtedly help the currency assuming that it is not too far into the future. The EUR will also need today’s Greek treasury bill auction to go well to give it some support. Unfortunately for the currency the risks are still skewed to the downside.

UK data flow has been poor to say the least and includes a series of disappointments through November including manufacturing confidence, construction confidence, industrial production and retail sales (BRC). The Bank of England did not deliver on any further policy easing at its meeting last week and clues to further policy moves as well as GBP direction will emerge from a slate of data over coming days. Unfortunately the releases will not bode well for GBP.

October CPI Inflation today is set to reveal an increase while retail sales are likely to have fallen over the same month. The main event will be the quarterly inflation report (QIR) tomorrow and this will see upward revisions to short term inflation forecasts although we still see scope for more QE early in the new year. GBP will find little support from the data or the QIR leaving the currency exposed to further declines against a relatively firm USD and a resumption of weakness against the EUR. I look for a test of EUR/GBP 0.8081 in the short term.

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JPY, GBP and CHF outlook

October 18, 2012 — Mitul Kotecha

USD/JPY blipped above 79.00 in the wake of a report in the Japanese press that states that the Bank of Japan (BoJ) is considering more easing measures at its board meeting on October 30 in order to achieve their 1% inflation goal. Higher US bond yields in the wake of the better than expected US data releases this week are also acting to support USD/JPY.

Given that Japan has effectively been less aggressive than other central bank yet has a fairly ambitious inflation goal, pressure for more aggressive BoJ action should not be surprising. However, in the past the BoJ has underwhelmed and unless US yields continue to push higher, USD/JPY may end up back in its recent ranges. USDJPY 79.23 is a strong initial barrier for the currency pair to cross to establish any move higher.

GBP/USD has edged higher since hitting a low just under 1.60 late last week benefitting in large part from general USD weakness. This is unsurprising given the strong correlation between GBP/USD and the index. However, the true reading of GBP is evident on the crosses and here the picture is far less positive. GBP has lost ground against the EUR and looks set to weaken further.

GBP losses may be limited to around 0.8198 given that interest rate differentials have turned more GBP positive recently. UK retail sales and public finances data today will give further direction and although a bounce back is likely in September sales any positive impact on GBP is likely to be short lived as the currency continues to be restrained by expectations of more BoE QE.

The expectations of a request for Spanish aid and ensuing European Central Bank (ECB) action has managed to alleviate inflows into CHF assets, helping the SNB’s task of protecting its 1.2000 line in the sand for EUR/CHF. Consequently FX reserves growth is likely to slow which in turn will reduce diversification flows from the SNB into other currencies. My forecasts continue to show both EUR/CHF and USD/CHF moving higher by year end.

However, in the short term USD/CHF will edge lower amid general pressure on the USD. Upcoming data releases including trade data today will help give some indication as to whether the SNB’s policy stance is having a positive economic impact. The sharp drop in the CHF nominal effective exchange rate since the implementation of the CHF ceiling will help but there are still many domestic companies calling for a weaker currency.

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Euro capped ahead of ECB meeting

September 6, 2012 — Mitul Kotecha

Having failed to get above the 1.2650 barrier EUR/USD looks restrained going into today’s European Central Bank (ECB) meeting. Reports overnight of a great ‘plan’ to buy bonds up to 3 years in unlimited size in sterilised fashion, helped provide some support to the currency but further gains will be limited. The ECB has already let the cat out of the bag and FX markets are quite correct to go into the ECB meeting with a dose of caution.

How will the EUR react? Given that much of what the ECB will do today has already been leaked the scope for positive surprises is limited, suggesting any upside for EUR will be capped although comments on yield targets (if any), conditionality, and the seniority issue will be important.

Profit taking, lowered expectations over recent days and uncertainty ahead of the US jobs report tomorrow will limit the damage to the currency, however. A drop to support around 1.2431 is the most that can be expected in the short term.

Unlike a likely rate cut from the ECB the Bank of England (BoE) is set to stay pat having embarked on further asset purchases in July. Weaker growth and upside inflation risk do not make for an enviable concoction. Although I anticipate further asset purchases later in the year, further action today is unlikely. This will mean that EUR/GBP in particular will lack independent direction and continue to track moves in EUR/USD (very strong sensitivity over the last 3-months). Given the potential for some further short term slippage in EUR/USD, EUR/GBP will likely follow suit.

As for GBP/USD it will struggle to sustain a break above this week’s high of 1.5935 unless US payrolls data tomorrow disappoints. Long speculative positioning means that GBP is vulnerable to profit taking especially having strengthened by over 3% since the beginning of June. The 28 August low around 1.5754 will provide near term support.

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JPY, SEK and GBP view

August 30, 2012 — Mitul Kotecha

USD/JPY remains stuck within a tight range having reversed its recent break higher towards the 80.00 level, once again settling back below 79.00. Once again the main determinant of the exchange rate appears to be yield differentials and notably the JPY has had a very low sensitivity to gyrations in risk over recent months.

For JPY bears it it’s worth noting that US 2-year bond yields have began to edge higher this week, suggesting some upward pressure on USD/JPY. The speculative market remains net long JPY suggesting scope for a drop in JPY speculative appetite too, but any upside is set to be gradual, with a technical hurdle at around 79.37 likely to be tough level to break above.

EUR/SEK has edged higher over recent days following its dramatic multi month drop. Why has the currency pair turned now? One of the key factors appears to be an increased sensitivity to risk which is playing negatively now that risk aversion is rising again. Indeed my risk barometer has been moving higher since around the middle of the month, in turn dragging SEK lower.

My quantitative model estimate based on interest rate differentials, relative equity performance and risk aversion, suggests that the SEK has further to weaken especially against the EUR. Based on the results of the model I suggest playing for such a move, targeting 8.7252, with a stop loss at 8.1616.

Another currency for which I am bearish on versus EUR is GBP. Although the move higher in EUR/GBP has been a slow grind, I continue to see value in this trade. Indeed, my models show that there is still much upside potential left for EUR/GBP based on the current levels of yield differentials and risk aversion.

As for cable (GBP/USD) it appears to be stuck to the coattails of EUR/USD but I expect it to lag any move higher in EUR/USD going forward. Moreover, if as I expect EUR/USD loses momentum into next week, this will leave GBP/USD rather exposed to downside risks.

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Fed passes the baton to the ECB. EUR and GBP downside risks

August 2, 2012 — Mitul Kotecha

Although the Fed’s inaction overnight was perhaps a little disappointing for markets the FOMC did note that it “will” provide further stimulus to the economy if needed. The USD rallied but risk currencies came under pressure. However, any sell off in risk assets will be limited as markets look to the FOMC meeting on September 13 for more action. This will also coincide with updates of the Fed’s economic forecasts. The below consensus reading for the ISM manufacturing index in July which came in at 49.8 added to the slight disappointment, with the data consistent with flat growth in manufacturing.

Attention now turns to the European Central Bank (ECB). Warnings by the Bundesbank President Weidmann for the ECB not to overstep its remit sets the scene for a stressful policy meeting today. Although markets have pared back their overly bullish expectations from the end of last week a lack of action by the ECB to reduce peripheral bond yields will disappoint and lead to a sell of in risk assets and EUR/USD but support around 1.2150 is likely to hold. Even a restart of Securities Market Purchases on its own would not be a game changer.

The Bank of England also decides on policy today but unlike the ECB there is little expectation of any action from the MPC. Inaction by the BoE today will highlight that after a GBP 375 billion in asset purchases there is limited room in the tool kit aside from lowering interest rates further. A weaker than expected reading for UK July manufacturing confidence weighed on GBP, with the data following a rash of disappointing data releases over recent weeks. I continue to see downside risks to GBP both against the EUR and USD, however. Indeed, my quantitative models reveal that GBP/USD should be trading around 1.5144 while EUR/GBP should be around 0.8242.

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