Risk assets under growing pressure

January 27, 2014 — Mitul Kotecha

The growing turmoil in emerging markets is inflicting damage on risk assets across the board and no let up is expected in the near term. Even the rally in US Treasuries has failed to provide any relief to risk assets given the weight of negative sentient. Whether triggered by concerns about a slowing in Chinese growth, Argentina’s letting go of its currency support, and/or political tensions elsewhere such as in Thailand and Ukraine or a combination of all of these, the picture looks increasingly volatile.

Additionally, earnings and valuation concerns are acting to restrain equity markets. Finally, lurking in the background as another weight on asset markets is Fed tapering, with a further USD 10 billion reduction in asset purchases expected to be announced by the Fed this week (Wednesday). The combination of the above spells more bad news in the days ahead, with risk assets set to remain under pressure this week.

Amid the growing gloom in global markets there are still some key data releases and events that will garner some attention this week. In the US as noted the Fed FOMC meeting is the main event, but December new home sales today, January consumer confidence tomorrow and Q4 GDP on Thursday will also be important. However, the former two releases are set to record declines implying a mixed slate of US releases this week.

In Europe, coming off the back of some encouraging flash purchasing managers’ indices the January German IFO business climate index will record its third consecutive gain, while Spanish GDP is set to record its second consecutive quarterly gain. A slight rebound in January inflation is unlikely to stand in the way of a further reinforcement of forward guidance by the European Central Bank.

In Japan Trade data reported today revealed an 18th straight month of deficit while inflation data will reveal that the Bank of Japan still has a lot of work to do to reach its 2% inflation target implying that there will be some discomfort with the recent rebound in the JPY. Finally, expect no change from the RBNZ at its policy meeting on Wednesday, which will leave the NZD under further pressure.

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On track for a positive end to the year

December 23, 2013 — Mitul Kotecha

A solid revision higher to US Q3 GDP at the end of last week sets up a positive tone for risk assets into year end even as they digest the imminent onset of Fed tapering. The data revealed a revision higher to a 4.1% QoQ annualised pace of growth and if anything lent credence to the Fed’s decision to begin tapering. The GDP data will be followed by a series of positive data releases in the US this week including November personal income and spending and a likely upward revision to December Michigan consumer confidence both on tap today.

Tomorrow, November durable goods orders and next week December Conference Board consumer confidence will also paint a picture of broadening improvement in economic conditions, providing further validation to Fed tapering. Against this background US yields should be well supported along with the USD. Into next year US economic outperformance will continue, leading to both higher US yields and a firmer USD.

A Japanese holiday (Emperor’s birthday) today will dampen market action although Japanese data releases over the rest of the week will highlight further progress on the economic front, with November inflation pushing higher and industrial output expanding at a healthy clip. USD/JPY retained a foot hold above 104 but the large extent of short JPY positioning highlights scope for profit taking. Even so, the rise in US Treasury yields suggest limited downside risks for USD/JPY.

There is on little on tap on the data front in the Eurozone allowing markets to digest the steps towards banking union announced last week. Consequently EUR/USD is set to remain rangebound around 1.3650-1.3750.

There may be more interest in events in China as money market conditions and confidence surveys garner interest. Tight money market conditions will weigh on regional sentiment. A likely decline in both the manufacturing and service sector purchasing managers’ indices will also act to dampen Asian currencies reinforcing the pressure already in place from a broadly stronger USD. News in Thailand that the opposition Democratic Party has decided to boycott the Feb 2 elections will add to political uncertainty and pile more pressure on the THB although the regional underperform remain the IDR.

Overall, a thinning in market conditions as both liquidity and market participants disappear for the holidays imply limited activity over coming days. The fact is that the end of the year will market a solid year for equities and a poorer year for bonds but at least the debate over Fed tapering timing has finally been put to the rest. More of the same is likely next year but notably the growth gap between developed and developing economies will narrow, which at a time of heightened competition for capital amid Fed tapering, suggests that capital flows will increasingly be steered towards developed economies.

Dear readers, this is my last post for 2013. Thank you for taking the time to read my blog posts. I wish all Econometer readers happy holidays, success, prosperity and good health in the year ahead.

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Beware of yield sensitive currencies

December 10, 2013 — Mitul Kotecha

Markets are becoming increasingly accustomed to the idea of an imminent Fed tapering as reflected in ongoing gains in risk assets. Indeed, these gains have taken place even in the face of comments by Fed officials overnight including Bullard and Fisher which on balance supported the view of beginning tapering sooner rather than later.

The fact that US bond yields continue to decline despite the release of a slate of firmer US and global data also suggests that a lot in terms of tapering expectations are priced in. Nonetheless, year end position adjustment may also account for some of the moves, particularly with the USD coming under near term pressure against most currencies except JPY as US yields slip.

I remain constructive on the USD given that US growth will outperform, with an attendant rise in US yields. Not only am I constructive on the USD against many major currencies, I expect the USD to strengthen versus many emerging market currencies too.

Those currencies most sensitive to US yields (10 year US Treasuries) will be among the biggest underperformers in 2014. This list includes the INR, TRY, MYR, and BRL. The rationale for weakness in these currencies is that Fed tapering and higher US yields will further increase capital outflows or at least reduce inflows to many countries.

Conversely some of the currencies least effected by tapering / higher US yields are in the top half of the likely outperformers next year including KRW and TWD.

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Rising risk aversion

December 5, 2013 — Mitul Kotecha

The US ADP November jobs report and October new home sales both beat expectations yesterday piling on the pressure on US Treasuries and adding further weight to support those looking for the Fed to taper at the December 17-18 FOMC meeting. Consequently non farm payrolls expectation will likely be revised higher from the current consensus of around 180k. In contrast the ISM non manufacturing index came in below consensus, with the jobs component slipping. US equities ended marginally lower while the USD held its ground. However, risk measures such as the VIX “fear gauge” moved higher. Rising risk aversion may reflect expectations of imminent tapering and some angst ahead of US budget talks.

US November payrolls data to be released tomorrow will be crucial to provide more decisive clues to the timing of Fed tapering. Attention ahead of the jobs report will turn to the European Central Bank policy decision where no action is expected although some downward revisions to staff forecasts are likely. We continue to expect a more aggressive ECB stance into 2014. The Bank of England and Norges Bank will also decide on policy rates but no change is expected in both cases. In the US an upward revision to Q3 US GDP is expected to around 3.1% QoQ annualised while jobless claims will also be in focus. Market nervousness is likely to continue today although activity is likely to be limited ahead of the US payrolls data tomorrow.

The USD should be supported due to higher US Treasury yields although USD/JPY has lost some ground in the wake of higher risk aversion. The large short JPY market position may also be limiting the JPY’s downside for now. EUR/USD is trading shy of its recent highs above 1.36 and could be vulnerable to a dovish ECB statement today as well as to growth forecast downgrades by the ECB. AUD continues to remain under pressure having traded just below 0.90 overnight in the wake of disappointing GDP data yesterday and is likely to remain vulnerable to further slippage. CAD was further undermined by a relatively dovish Bank of Canada statement following the decision overnight to leave policy rates unchanged.

Given that US Treasury yields have risen by around 33bps since the end of October it is worth looking at which currencies are most sensitive to rising yields. In Asia the most correlated currencies with 10 year US Treasury yields over the last 3 months and therefore most vulnerable currencies are the SGD, THB, and MYR. The least sensitive have been CNY, IDR and KRW. Playing long KRW / short SGD appears to be a good way of playing an environment of rising US yields, especially given that yields are set to continue to rise over the coming months.

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USD firms, JPY bears in the ascendency, RBA weighs on AUD

December 3, 2013 — Mitul Kotecha

Despite some encouraging economic news from manufacturing surveys globally equity markets and risk assets in general failed to benefit overnight, with stocks showing a little fatigue following recent gains. The US ISM manufacturing confidence survey beat expectations rising to its highest level since April 2011 while its components looked upbeat, especially the employment component.

This was echoed in the UK and even in the Eurozone the final manufacturing purchasing managers index was slightly higher than forecast. Consequently core bond yields and the USD continued to push higher while gold came under further pressure. The US data also has put the spectre of a December tapering on the table although the November employment report will be scrutinised for further clues.

While JPY bears have been encouraged by the rise in Japanese inflation revealed last week (which was not only energy price led) there’s a long way to go before claiming success in hitting the BoJ’s 2% inflation target. The good news is that the higher real yield differential between the US and Japan is consistent with USD/JPY upside.

The bad news is that more BoJ policy easing is likely to sustain the move and we suspect the central bank will oblige early next year. Indeed, BoJ Governor Kuroda alluded to this yesterday, and his comments were taken at face value by markets, pushing the JPY even lower, with USD/JPY breaching 103 overnight. We keep open our trade idea to buy USD/JPY initiated on 28 October at 97.64 targeting 103.74.

AUD/USD has lost close to 6% since its high around 0.9759 on 23rd October but has found some respite recently from short covering over recent days. The Reserve Bank of Australia however, continues to do its best to weaken the currency. Unsurprisingly left policy rates unchanged today but the accompanying statement noted that the currency remained “uncomfortably high”.

The AUD has been particularly sensitive to a renewed rise in US Treasury yields, being one of the most correlated currencies over recent months and in this respect remains vulnerable to any increase in US yield. Given that we expect US yields to continue to push higher into next year this suggest only a limited AUD recovery over the coming months. In the near term AUD/USD has found some solid technical support around 0.9038.

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