USD bounces back, JPY to strengthen, AUD rallies

November 8, 2012 — Mitul Kotecha

To put it mildly there was plenty of volatility in the wake of the US elections. Equities reacted badly as the prospects of higher taxes as part of a solution to resolving the fiscal cliff in the US came back into the frame. worries outweighed any positive impact from the potential for Fed QE to continue in its current form without the risk of being curtailed by Republican President.

Poor data out of Europe contributed to the market malaise as the growth trajectory into Q4 continued to worsen. The passage of Greek austerity measures through parliament failed to undo the damage. German industrial production fell sharply, down 1.8% MoM while downward growth revisions / upward deficit revisions from the European Commission dealt another blow to sentiment.

Growing pressure on the German economy may at the least prompt a more dovish stance at the European Central Bank (ECB) meeting today while the Bank of England (BoE) is set to increase its asset purchases today although it will be a close call on this front.

The USD came under pressure in the immediate aftermath of US President Obama’s victory. However, it didn’t take long for the usual higher risk aversion, stronger USD relationship to kick in, with the USD subsequently reversing all its losses and more. With elections out of the way markets are waking up to the reality of the considerable challenge ahead in resolving the fiscal cliff. Risk assets clearly don’t like what they see.

As only September US trade data and November Michigan confidence are left on the US calendar this week risk gyrations will continue to drive the USD though I suspect that gains will be restricted in the wake of lower US bond yields.

Most currencies except the JPY took advantage of a weaker USD but finally USD/JPY dropped on the back of the jump in risk aversion. The drop in US bond yields and the output of my quantitative models both suggest that the JPY should be firmer against the USD. The recently more aggressive stance of the Bank of Japan taken together with warnings of FX intervention may be helping to keep the JPY on the back foot, however.

Given that speculative JPY positioning has turned negative over recent weeks the BoJ’s stance maybe having some impact in shifting FX expectations especially as it has fuelled some portfolio outflows from Japan over recent weeks. Nonetheless, it won’t take long for JPY bears to become frustrated with the lack of downside traction in the currency, with USD/JPY subsequently set to edge back towards the 79.00 level

Stronger than expected Australian jobs numbers helped to boost the AUD this morning. Jobs were up 18.7k in October much more than consensus. Even better was the details of the report, with full time jobs up 18.7k and part time down 8k. The unemployment rate was at 5.4%, lower than expected. Overall, a solid report and in stark contrast to NZ jobs data this morning. The data will certainly give more juice to AUD/NZD and corresponds with my quant models looking for NZD downside and AUD resilience. The data will also likely dampen further expectations of another rate cut by the RBA in December which in any case looks like a close call.

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Negative yields hit the euro

November 6, 2012 — Mitul Kotecha

Market participants will be distracted by today’s US Presidential election and Thursday’s transfer of leadership in China. The USD seems to be enjoying strength despite a slight lead in the polls by President Obama. The consensus view is that a Romney win would be USD positive given that it may imply a more restrictive Fed in the form of less QE but the USD appears to be ignoring such polls.

The EUR is the worst performing currency so far this month after the CHF. Greek and Spanish concerns are placing a growing weight on the EUR the former due to tomorrow’s vote on austerity measures and the latter due to worsening economic data and a lack of traction towards requesting a bailout and thus activating the European Central Bank’s bond purchase program.

A massive weight on the EUR is the fact that Germany 2 year bond yields have turned negative, leading a widening US yield advantage and in turn a weaker EUR/USD. Indeed, the correlation between 2 year US – German yield differentials is very high, implying that the EUR will struggle below its 200 day moving average around 1.2828 until German yields push higher.

A generally firmer USD has also dealt a blow GBP, with the currency slipping below 1.6000. Notably GBP is holding up well against the EUR. Industrial and manufacturing production data today will give some direction to the currency but the news is unlikely to be positive, with a further sharp decline expected in September.

Thereafter attention will swiftly turn to the Bank of England policy decision on Thursday, where the decision will be a close call but we look for an additional GBP 25 billion in asset purchases to be announced. GBP could face some pressure in this event but given that the currency not been particularly impacted from QE in the past, we doubt that it will suffer a severe blow. However, the BoE action may help to stem the decline in EUR/GBP, with support seen around 0.7956.

AUD has lost some steam this week as speculative longs have been cut back ahead of the RBA policy decision. The pull back has largely to do with a generally firmer USD, some deterioration in risk appetite and lower commodity prices than any shift in policy expectations, however.

The market is pricing in around a 50% probability of a rate cut today Given that this is not fully priced in, the AUD is vulnerable in the wake of a rate cut. However, much will depend on the accompanying statement. Given that recent domestic and Chinese data have been a bit more encouraging we doubt that the statement will be particularly dovish, suggesting that downside risks to AUD will be limited to technical support around 1.0305 versus USD.

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Extreme Uncertainty

November 20, 2011 — Mitul Kotecha

The level of uncertainty enveloping global markets has reached an extreme level. Who would have thought that close to 13 years after its introduction at a time when it has become the second largest reserve currency globally (26.7% of global reserves) as well as the second most traded currency in the world, European leaders would be openly talking about allowing countries to exit the EUR? No less an issue for currency markets is the sustainability of the USD’s role as the foremost reserve currency (60.2% of global reserves). The US debt ceiling debacle and the dramatic expansion of the Fed’s balance sheet have led to many official reserve holders to question their use of the USD. Perhaps unsurprisingly the JPY has been the main beneficiary of such concerns especially as global risk aversion has increased but to the Japanese much of this attention is unwanted and unwelcome.

The immediate focus is the travails of the eurozone periphery. Against the background of severe debt tensions and political uncertainties it is perhaps surprising that the EUR has held up reasonably well. However, this resilience is related more to concerns about the long term viability of the USD rather than a positive view of the EUR, as many official investors continue to diversify away from the USD. I question whether the EUR’s resilience can be sustained given that it may be a long while before the situation in the eurozone stabilises. Moreover, given the now not insignificant risk of one or more countries leaving the eurozone the long term viability of the EUR may also come into question. I believe a break up of the eurozone remains unlikely but such speculation will not be quelled until markets are satisfied that a safety net / firewall for the eurozone periphery is safely in place.

In this environment fundamentals count for little and risk counts for all. If anything, market tensions have intensified and worries about the eurozone have increased since last month. Politics remain at the forefront of market turmoil, and arguably this has led to the worsening in the crisis as lack of agreement between eurozone leaders has led to watered down solutions. Recent changes in leadership in Italy and Greece follow on from government changes in Portugal and Ireland while Spain is widely expected to emerge with a new government following elections. Meanwhile Chancellor Merkel has had to tread a fine line given opposition from within her own coalition in Germany while in France President Sarkozy is expected to have a tough time in elections in April next year. The likelihood of persistent political tensions for months ahead suggests that the EUR and risk currencies will suffer for a while longer.

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Risk appetite remains fragile

November 11, 2011 — Mitul Kotecha

Fortunately for the USD the situation in the eurozone has become so severe that the problems in the US are all but being ignored. Even in the US, attention on the nomination of the Republican presidential candidate has over shadowed the looming deadline for an agreement on medium term deficit reduction measures.

The Joint Select Committee on deficit reduction is due to submit a report to Congress by November 23 and a final package would be voted on by December 23. A lack of agreement would trigger automatic deficit reduction of $1.2 trillion, a proportion of which would take place in 2012. If this is the case it could potentially tip the economy into recession, necessitating QE3 and consequently a weaker USD.

Reports that the eurozone could fall apart at the seams as countries exit have shaken confidence, yet the EUR has managed to hold above the psychologically important 1.35 level. The strong reluctance of the European Central Bank (ECB) to embark on unsterilized bond purchases and to act as lender of the last resort, suggests that the crisis could continue to brew for a long while to come.

Nonetheless, the EUR found a semblance of support from news that former ECB vice-president Papademos was named new Prime Minister of Greece, the ECB was reported to be a strong buyer of peripheral debt, Italy’s debt auction was not as bad as feared, affirmation of the EFSF’s AAA rating by Moody’s and France’s AAA rating by S&P (following an erroneous report earlier). EUR/USD remains a sell on ralliesup to resistance around 1.3871, with initial resistance around the 1.3665 level.

The underlying pressure over the near term is for further JPY strength in the face of rising risk aversion and a narrowing in the US yield advantage over Japan. Given that the situation in the eurozone remains highly fluid as well as tense, with little sign of resolution on the horizon, risk aversion is set to remain elevated. Moreover, yield differentials have narrowed sharply and the US 2-year yield advantage over Japan is less than 10bps at present.

Against this background it is not surprising that the Japanese authorities are reluctant to intervene aggressively although there are reports that Japan has been conducting secret interventions over recent weeks. However, given that speculative and margin trading net JPY positioning have dropped significantly the impact of further JPY intervention may be less potent. In the meantime USD/JPY will likely edge towards a break below 77.00.

Swiss officials have continued to jawbone against CHF strength, with the country’s Economy Minister stating that the currency remains massively overvalued especially when valued against purchasing power parity. Such comments should be taken at face value but the CHF is unlikely to embark on a weaker trend any time soon.

Although the EUR/CHF floor at 1.20 has held up well while the CHF has lost some its appeal as a safe haven the deterioration in the situation in the eurozone suggests that the CHF will not weaken quickly.

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Payrolls sour mood, Eurozone concerns intensify

September 5, 2011 — Mitul Kotecha

The market mood has soured further and risk aversion has increased following disappointing August US jobs report in which the change in payrolls was zero and downward revisions to previous months has reinforced the negative mood on the US and global economy while raising expectations of more Federal Reserve action. Moreover, the report has put additional pressure on US President Obama to deliver fresh jobs measures in his speech on Thursday though Republican opposition may leave Obama with little actual leeway for further stimulus.

There is plenty of event risk over coming days, with a heavy slate central bank meetings including in Europe, UK, Japan, Australia, Canada and Sweden. The European Central Bank will offer no support to a EUR that is coming under growing pressure, with the Bank set to take a more neutral tone to policy compared its previously hawkish stance. In the UK, GBP could also trade cautiously given recent comments by Bank of England Monetary Policy Committee members about potential for more UK quantitative easing.

The EUR has been unable to capitalise on the bad economic news in the US as news there has been even worse. The negative news includes the weekend defeat of German Chancellor Merkel’s centre-right bloc in regional elections, which comes ahead of a vote in Germany’s constitutional court on changes to the EFSF bailout fund.

The withdrawal of the Troika (ECB, IMF and EU) from Greece has also put renewed emphasis on the country at a time when protests are escalating. If all of this is not enough there is growing concern about Italy’s apparent backtracking on austerity measures, with the Italian parliament set to discuss measures this week. Separately Germany, Holland and Finland will hold a meeting tomorrow on the Greek collateral issue. On top of all of this is the growing evidence of deteriorating growth in the euro area.

Data releases are unlikely to garner a great deal of attention amidst the events noted above, with mainly service sector purchasing managers indices on tap and at least threw will look somewhat better than their manufacturing counterparts. In the US the Beige Book and trade data will be in focus but all eyes will be on Obama’s speech later in the week. The USD has maintained a firm tone despite the jobs report but its resilience may be better explained by eurozone negativity rather than US positivity. Even so, the USD is looking less uglier than the EUR in the current environment.

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