Euro Rally To Fade

June 17, 2010 — Mitul Kotecha

It is not an easy time to forecast currencies. Just as many forecasters fought for the accolade of being the most bearish on the EUR and many others were forced to capitulate or risk falling behind the curve, EUR/USD has started to perk up. Similarly, commodity currencies and many emerging market currencies have bounced.

Perhaps the explanation of these moves is merely position adjustments as traders and investors square positions as they keep one eye on the World Cup or maybe its just fatigue after weeks of selling pressure. Either way, the fact that speculative USD market positioning is at a very high level, suggests there is plenty of scope to take profits on long USD positions.

There are various reasons to expect the calm to give way to renewed tensions, however. Public opposition to austerity plans in Europe, added to the prospects for slowing growth as the plans are implemented, in addition to banking sector concerns, suggest that the outlook for the EUR remains downbeat. These factors also point to the prospects of risk aversion rising over the coming weeks, reversing the recent rally in risk currencies.

Further out, the EUR’s travails will not be over quickly and in the wake of the implementation of austerity plans the EUR will struggle from the impact of relatively slower growth in the eurozone compared to the US and other countries. The EUR will continue to remain under pressure even as risk appetite improves and many risk currencies appreciate.

The interruption of risk as an FX determinant is likely to fade towards the end of the year and investors will then go back to differentiating on the basis of relative growth and interest rate dynamics, which will play well for the USD as US growth strengthens.

Relative growth differentials will also bode well for commodity currencies and there will be scope for plenty of upside in the AUD and NZD as growth strengthens. Both countries have benefited from firm demand in Asia and China in particular and this source of support will likely continue to be beneficial.

Funding currencies including JPY and CHF will likely weaken this year against the USD based on the likely improvement in risk appetite later this year. The outlook for the JPY will be particularly interesting in the wake of the change in Prime Minister in Japan, especially given the new PM’s preference for a weaker JPY and reflationary policies. USD/JPY will likely reach 100 by the end of the year.

GBP should not be seen in the same context as the EUR. Although the UK has got its own share of fiscal problems the new government appears to be moving quickly to mollify both investor and ratings agency concerns. The test will come with the reaction of the emergency budget on June 22nd but I suspect that the downside risk to GBP will be limited.

Unlike the EUR which is trading around “fair value”, GBP is highly undervalued. Arguably past GBP weakness puts the UK economy on a stronger recovery footing. Moreover, problems that Europe will face in implementing multi country austerity plans and widening growth divergence, will not be repeated in the UK. Overall, there is likely to be significant outperformance of GBP versus EUR over coming months

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World Cup FX Positioning/Data Highlights

June 14, 2010 — Mitul Kotecha

The market tone felt decidedly better over the course of the last week although it was difficult to tell if this was due to position squaring ahead of the World Cup football or a genuine improvement in sentiment. There was no particular event or data release that acted as a catalyst either, with the European Central Bank (ECB) and Bank of England (BoE) meetings passing with little fanfare.

US data ended the week mixed, with retail sales disappointing in May but in contrast June consumer confidence beating expectations. Although questions about the pace of recovery remain, other data such as the Fed’s Beige Book suggest that recovery remains on track, sentiment echoed, albeit cautiously by Fed Chairman Bernanke last week.

Attention this week will centre on inflation data. Expected benign CPI readings will support the view that the Fed will take its time to raise interest rates. Speeches by the Fed’s Bullard, Plosser and Bernanke this week will be eyed for further clues on Fed thinking.

Central banks in Brazil and New Zealand hiked rates last week but this is not likely to be echoed this week. No change is likely from both the Bank of Japan and Swiss National Bank although there will be plenty of attention on the SNB’s comments on the CHF following recent data showing a surge in FX reserves due to currency intervention. The BoJ is unlikely to announce anything new but perhaps some further detail on the loan support plan could be forthcoming.

Manufacturing data will also garner some attention, with the US June Empire and Philly Fed surveys and May industrial production on tap. All three reports will confirm the improving trend in manufacturing activity in the US. Housing data will look weaker, with starts set to pull back in starts in May following the expiry of government tax incentive programmes though permits are set to rise.

In Europe, the June German ZEW (econ sentiment) investor sentiment survey will likely slip slightly due to ongoing fiscal/debt worries but this will be countered by stronger domestic data. In any case the index remains at a high level and a slight drop is unlikely to derail markets.

GBP may find some support form upgrade of UK growth forecasts by the CBI to 1.3% for 2010 and relatively hawkish comments from the BoE’s Sentance in the weekend press warning that inflation is higher than expected, indicating that the Bank may need to hike rates sooner than expected.

Further GBP/USD direction will come from CPI and retail sales data this week as well as public borrowing figures and a report by the new Office of Budget Responsibility on the UK’s fiscal position ahead of the June 22 budget. A break above GBP/USD resistance around 1.4760 is unlikely to materialise.

Despite the many data releases this week, the overall tone is likely to be one of consolidation and reduced volatility in the days ahead. This may allow EUR/USD to gain some ground due to short covering, with the CFTC commitment of traders (IMM) report revealing a further increase in net short speculative positions last week, close to the record set a few weeks back, though we suspect that there will be strong resistance around 1.2227.

The fact that the IMM data revealed that net aggregate net USD long positions reached an all time high last week, highlights the potential for profit taking this week. USD/JPY will look to take out resistance around 92.55 but this looks unlikely unless the BoJ dishes up anything particularly dovish from its meeting.

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The Pain Of A Stronger Swiss Franc

June 9, 2010 — Mitul Kotecha

Volatility and increasingly large market swings are characterizing current market conditions. A warning by Fitch on the UK’s “formidable” fiscal challenge, concerns about Bulgaria’s public finance statistics and a massive public sector strike in Spain, combined to fuel another bout of risk aversion.

Hungary’s government attempted to diffuse worries about its finances, with the country’s Prime Minister listing measures including cutting public pay and prohibiting mortgages denominated in foreign currencies, in order to hit the 3.8% of GDP budget deficit target. There was also some good news in the US, with small business confidence (NFIB) rising to its highest level since September 2008 whilst ABC consumer confidence edged higher.

The US Beige Book and Fed Chairman Bernanke’s testimony on the US economy to Congress, mark the highlights today. The Beige Book is set to reveal further signs of economic recovery but with limited inflation pressures. Bernanke is likely to maintain a similar tone to comments he made yesterday, highlighting a “moderate” economic recovery, with unemployment likely to stay “high for a while”. His testimony will be scrutinized for the timing of rate hikes, and any elaboration on his comments about rates rising before the economy is at full employment.

Against the background of the many and varied uncertainties still afflicting markets maintain a sell on rallies view on risk trades is still the best option. EUR/USD will struggle to breach resistance around 1.2010 and remains susceptible to test support around 1.1826. GBP/USD could target fresh lows in a “negative reversal”, with potential to head back down to 1.3996.

Confidence has plummeted to extreme lows and it will be several months before appetite for risk trades returns. The AUD and NZD as well as many Asian currencies will struggle over the interim period before their appreciation trend finally resumes.

In contrast to the weakening of risk currencies, CHF strength is showing little sign of letting up. Switzerland recorded a massive 50% jump in FX reserves in May to CHF 232 billion from CHF 153 billion in April. This is not usually market moving data but the scale of the jump in reserves is huge and it is not just due to valuation changes. The Swiss National Bank (SNB’s) effective abandonment of defending a particular level in EUR/CHF turned into more a smoothing operation but this did not stop the bank from massive FX interventions. Despite the interventions EUR/CHF dropped by 0.8% over the month.

Aside from alleviating upward pressure on the CHF the interventions had an indirect effect of reducing the pain of holders of CHF mortgages. E.g. around 30% of Hungary’s bank loans and 60% of mortgages are denominated in CHF but countries across Europe have plenty of CHF denominated loans, especially Austria. Although Hungary announced steps to meet its deficit targets its woes are far from over.

The CHF has appreciated by around 3% since the beginning of May versus HUF, exacerbating the pain for CHF borrowers in the country. The fact that CHF strength shows no sign of letting up on the back of strong data and safe haven flows, the pain for these borrowers will only add to the problems for banks and borrowers alike in Europe.

Posted in Australia, bank rescue, central banks, Currencies, Economics, Economy, equity markets, Europe, eurozone, Fiscal/Budget, FX, Hungary, Monetary Policy, UK. Tags: , , , , , , , , , , , , , , , , , , . 2 Comments »

Volatility Within Ranges

May 31, 2010 — Mitul Kotecha

Most investors will likely be happy to see the tail end of May given the sharp losses in many asset classes over the month. At least over the last few days there was a sense of some healing, particularly in risk assets though it is questionable how long this can continue given the still many and varied uncertainties afflicting markets. A reminder of this came late on Friday, with Fitch downgrading Spain’s sovereign credit ratings despite the passage of austerity measures.

The Fitch decision highlights that Spain is rapidly becoming the new epicenter of the crisis; focus on the savings banks or Cajas is intensifying ahead of the June 30 deadline for mergers to qualify for government money, the minority government’s popularity is in further decline, whilst unions are threatening more strikes across the country. Unions in Greece and Italy are also pushing for coordinated strikes, highlighting the difficulties in pushing through austerity measures.

At least economic data is providing some solace to markets. Releases last week in the US highlighted the fact that consensus expectations are underestimating the pace of recovery; consumer confidence, durable goods orders and new home sales all came in above expectations. The same story is likely this week, but there is really only one piece of data that attention will focus on and that’s the May jobs report. The consensus is for a strong 508k increase in non-farm payrolls following a 290k increase in April, though around three-quarters of this will be related to census hiring. The unemployment rate is likely to dip slightly to 9.8%.

Markets are likely to be in limbo, with volatility in ranges likely this week. USD sentiment remains strong as reflected in the CFTC IMM data where net aggregate positioning is at an all time high, but further USD gains may be harder to come by ahead of the US jobs report and G20 meeting this weekend. Stretched USD positioning has proven no barrier to USD strength over recent weeks but the fact that markets are very long USDs could at the least result in a slower pace of further appreciation.

EUR speculative sentiment remains close to all time lows although there are signs of some relative stability over recent weeks. EUR/USD is likely to range between 1.2134 and 1.2475 this week. There was a sharp drop in net short JPY positions over the week (ie short-covering) though this appears at odds with the fall in the JPY. GBP speculative positions showed little improvement, languishing close to all time lows, whilst net longs in commodity currencies were pared back sharply, especially in AUD where net longs were cut by around half though sharp declines in positioning were also registered for NZD and CAD.

GBP could suffer due to worries about the UK government’s plans to reduce its burgeoning budget deficit following the resignation of Treasury Minister David Laws, following an expense scandal. The resignation hits the coalition just three weeks before the emergency budget and could result in complications on the negotiations between the Liberal Democrats and Conservatives on the substance of the deficit cutting measures. GBP/USD is likely to find support around 1.4260 and resistance around 1.4612 this week.

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Criminals Favouring The Euro

May 14, 2010 — Mitul Kotecha

It says a lot for a currency when banks stopped accepting it as a means of exchange. The EUR’s woes continue to pile up and the currency received more bad news unrelated to Europe’s fiscal woes when it was announced that banks and foreign exchange bureax in the UK have stopped exchanging EUR 500 banknotes. The rationale was not because the currency is dropping sharply in value though this is also a credible reason, but due to the fact that 90% of the notes were found to be linked to tax evasion, terrorism and other crimes.

EUR/USD came close to the technical support level around 1.2510. Options barriers will likely provide some strong support around this level, temporarily delaying an inevitable drop to the next support at 1.2457. It was not just the EUR that suffered, with GBP faring even worse, in part due to a wider than expected trade deficit, with GBP/USD heading for a test of 1.4500. Sovereign woes continue to depress the EUR in what is turning into a no-win situation. Fresh austerity measures in Greece, Spain and Portugal failed to assuage market fears, and instead the measures have only heightened concerns about social unrest and a weakening growth outlook.

Posted in Currencies, Economics, Economy, Europe, eurozone, Financial crisis, Fiscal/Budget, FX, Greece, UK. Tags: , , , , , , , . Leave a Comment »
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