USD and EUR contrasts

November 11, 2013 — Mitul Kotecha

Finally markets appear to be reacting rationally to economic data. There was always a risk that strong US data releases would prompt renewed Fed tapering fears and result in a sell off in risk assets as has been the case in the past. However, the reaction to Friday’s much stronger than expected US October jobs data (+204k + upward revisions to previous months) was what would be normally be expected. US equities rallied, US yields rose and the USD strengthened.

While the US data added further weight to the potential for Fed tapering in December or January it was also recognised as evidence of a growing economy, and one that barely flinched in the wake of the government shutdown. This week’s US data is unlikely to detract from this view, with the November Empire manufacturing survey and October manufacturing production likely to have shown further improvements. This should ensure that the USD remains firmly supported over coming days.

In Europe, the opposite is true. Faced with very low inflation (this is an issue across most major economies) the European Central Bank cut policy rates last week and looks set to intensify its dovish shift with other policy measures to reinforce its forward guidance. Consequently the EUR sold off sharply and is set remain under pressure.

This week’s Eurozone data releases will add more weight to the argument for further policy actions, with Eurozone GDP set to barely expand in Q3 while inflation likely to be confirmed at 0.7% YoY in October. Meanwhile industrial production is set to have declined in September (-0.4%). Given the contrasts in data releases and in policy stance, EUR/USD is set to decline further, with initial support seen around 1.3295.

In the UK, there will be attention on the Bank of England’s Quarterly Inflation Report, with jobs data and retail sales also on tap. Faced with mounting evidence of firming growth, the BoE will likely have to revise its assumptions upwards. Consequently this bodes well for GBP and while gains against the USD are likely to be limited, EUR/GBP is set for a further downward correction, with a break 0.8300 on the cards shortly.

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Risk appetite still supported

November 5, 2013 — Mitul Kotecha

Relatively subdued trading yesterday ended with stocks higher and US bond yields lower. Our risk barometer is currently around its lowest since February 2011, signifying still strong appetite for risky assets, as also reflected by the drop in the VIX “fear gauge”. After a sharp 30+% drop since early October the Baltic Dry Index has also turned higher while gold prices are holding in a relatively tight range around its 100 day moving average at USD 1320.

There are a few releases and events to give direction to markets, with the RBA policy meeting, European Commission autumn economic forecasts, and service sector confidence surveys from the UK and US, all on tap today. Overall, there will be little to dent the positive risk bias but caution will intensify ahead of the ECB Council meeting and US employment report towards the end of the week.

Following last week’s USD rally the currency is likely to consolidate its gains over the short term ahead of Friday’s US October employment report. A dip in US yields helped by a softer US factory orders report took some of the steam out of the USD as caution crept in. A series of Fed speakers overnight did little to clarify the picture regarding the timing of tapering and thus provided little direction for the USD.

Nonetheless, despite some near term consolidation the USD looks set to gain further over the coming weeks helped by the fact that the market had already squared a lot of long positions over past weeks. A renewed increase in US yields accompanied by better economic data will help the USD’s cause but much will depend on when there is greater clarity regarding the timing of tapering. Expectations of a March 2014 may yet prove off the mark, leaving the USD plenty of scope for further recovery.

AUD benefitted from the robust September retail sales report yesterday but faces another hurdle today in the form of the RBA policy meeting. Although AUD remain a loser year to date, the currency has registered impressive gains from the beginning of September, much to the chagrin of the RBA.

Although a policy rate cut is highly unlikely today (I believe the RBA is at the bottom of its easing cycle), Governor Stevens is set to warn that the strength of the currency could warrant further policy easing in the months ahead. However, such warnings may sound hollow given worries about house price inflation and recently firmer data. Given some likely restraint in the USD ahead of the US employment report, AUD/USD will find some any losses limited to support around 0.9430.

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Consolidating ahead of payrolls

October 22, 2013 — Mitul Kotecha

Ahead of the belated release of the US September jobs report markets are set to remain range bound, with most assets consolidating recent moves. For instance, the VIX “fear gauge” edged higher following steep declines while US Treasury yields gained a few basis points helping the USD index to push slightly higher. Equity investors will have one eye on earnings reports hoping that the recent run of positive Q3 US earnings surprises continues.

The consensus for US September non farm payrolls is 180k, with a low of 100k and high of 256k according to Bloomberg and unemployment rate likely to remain 7.3%. The data will have important implications for Fed tapering expectations, with the outcome likely to help support expectations that the Fed will not begin tapering until early next year.

Like other asset classes little movement is expected in FX markets ahead of the release of the US jobs report. A payrolls outcome around the consensus will have little market impact but it appears that the consensus is skewed towards a weaker outcome, suggesting a bigger FX reaction should there be an above consensus outcome (around 200k+).

Both the EUR and JPY are struggling to make further headway against the USD. There is nothing of note on the data front from the Eurozone or Japan today suggesting that attention will be mainly centred on US data. Stabilisation in US bond yields leaves the USD in better form against both currencies and given that a lot of bad news is now priced into the USD its downside looks more limited although much will depend on today’s jobs data.

The AUD is the outright winner in terms of gains versus the USD so far this month alongside other commodity currencies, NOK and NZD. AUD has benefitted from receding expectations of interest rate cuts, and firmer Chinese data alongside improving risk appetite. While I have been far more bullish than the consensus on AUD, it may be worth taking profits on recent gains versus USD as consolidation is likely in the short term. I see more scope for gains in AUD versus NZD over coming weeks, however.

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Bracing for the worst

September 30, 2013 — Mitul Kotecha

There was little progress over the weekend during discussions between US politicians attempting to agree on a budget deal and thus avoiding a partial government shutdown by the end of today. The US Senate is now set to reject a House of Representatives plan to delay President Obama’s Affordable Health Care Act while renewing funding for the government until December 15, leaving an ongoing stalemate in discussions.

Markets are bracing for the worst, with risk aversion rising, US equities and the USD falling. Meanwhile US Treasury yields remain capped having dropped sharply since early September. Political shenanigans in the US threaten to overshadow the US September jobs report at the end of the week. Nonetheless, the data will provide major clues to the timing of Fed tapering regardless of the budget/debt discussions.

It’s not just in the US where politics is fuelling market tensions. In Italy former Prime Minister Berlusconi withdrew his party’s support from the coalition government, leaving current Prime Minister Letta scrambling to form a new parliamentary majority in order to avoid snap elections. The impact will likely be felt on Italian and peripheral bond yields over coming days.

Meanwhile following elections in Germany last week coalition discussions to form a new government are ongoing although no deal is in sight yet and talks could go on for some time yet. Political uncertainties are unlikely to alter the European Central Bank’s (ECB) course this week, with an unchanged policy decision expected although benign inflation and weak credit growth will reinforce the need for an easing bias and forward guidance. Political issues are set to dominate markets over coming days, leaving risk aversion elevated and risk assets under generalised pressure.

The USD index lurched lower in the wake of the uncertainties in the US, extending its drop from early September. The near term prospects for the currency are bleak, with limited potential for any upside unless a budget deal is reached. Safe haven currencies in particular the JPY will be buoyed in this environment. The EUR will not fully be able to take advantage of USD weakness however, given the political tensions within the Eurozone.

In terms of high beta emerging market currencies including Asian currencies, any positive impact from the fact that US yields are capped, with 10 year treasury yields dropping sharply recently (higher US yields have been negative for EM currencies over past weeks so a drop will be positive for them) will be outweighed by rising risk aversion, leaving most Asian currencies vulnerable.

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USD momentum fading, EUR and gold supported

September 10, 2013 — Mitul Kotecha

Although Syria tensions continue to linger in the background risk assets performed well overnight helped in part by Chinese trade and inflation data released over the weekend. Meanwhile the weaker than forecast US jobs report has eased some of the markets fears about tapering, with the Fed looking less likely to pare back asset purchases too aggressively. Even the situation in Syria looks a little less tense as US President Obama opened the door to holding off any air strikes on Syria if the country handed over its stock of chemical weapons as proposed by Russia. A limited data slated today, with only second tier releases on tap suggests there will be some positive follow through to markets today.

The USD has lost momentum in the wake of last Friday’s US employment report and subsequent drop in US yields. The USD may be helped by a relatively firm US retail sales reading expected at the end of the week but tapering uncertainty will likely act to restrain any topside. Additionally, underperformance of US bonds and equities alongside foreign selling of US portfolio assets (especially by reserve managers) highlights the uphill struggle faced by the USD in the short term. Notably aggregate net USD positioning increased again last week, with net long USD positioning around its three month average, highlighting the lack of USD momentum at present. Further USD gains may need to wait for when the Fed finally begins to taper next week.

EUR has been the most resilient major currency against the USD this year. It has easily quashed expectations that it would face a difficult time in the wake of a weaker growth trajectory and ongoing peripheral worries. Admittedly the Eurozone economy remains weak and will contract this year, but there are already signs of improvement, with positive data surprises being revealed. Moreover, the Eurozone external position has strengthened due to strong portfolio inflows and a healthy current account surplus. Although there a number of risks ahead including Italian political tensions and German elections the near term outlook for the EUR looks constructive, with strong technical support seen around 1.3220.

Gold has moved into consolidation mode, with a range of 1360-1400 being observed over recent days. Lower US bond yields, and a weaker USD in the wake of the softer US August jobs report suggests will offer some support to gold prices while speculative positioning has shown a significant improvement over recent weeks, with positioning well above the three month average. Some resolution towards ending South African strikes and improving risk appetite may dampen the upside but we expect gold prices to be relatively resilient over the coming weeks as seasonal demand kicks in (our analysis shows that historically gold has a positive month in September) with a retest of the recent high around USD 1434 set be breached over the coming week.

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