Cyprus deal reached but risk rally to fade

March 25, 2013 — Mitul Kotecha

A deal between Cyprus and the Troika has been reached “in principle”, an outcome that will be met with relief across markets, with the EUR and risk assets rallying. Most details have yet to emerge but it appears that only depositors above EUR 100k will be hit by a levy while the country’s second largest bank will be closed. However, the levy is likely to be fairly hefty.

The bailout deal will mean that the risks of Cyprus defaulting and leaving the Eurozone will have significantly diminished. Nonetheless, the deal will still involve a huge amount of work on Cyprus’ part to find the USD 5.8 billion needed to supplement the EUR 10 billion bailout and subsequently a lot of economic pain involved. The current risk rally is likely to fade quickly as markets begin to focus on the task at hand.

Elsewhere Italy begins the formal process of forming a government this week but the prospects of a quick resolution to the political impasse in the country looks very limited, with fresh elections still a very possible outcome. Reflecting the uncertainty both around Cyprus and Italy, economic sentiment gauges in Europe will likely decline in March.

Meanwhile in the US data releases will look more impressive, with Durable goods orders set to record an impressive gain in February and Q4 GDP likely to be revised sharply higher. Although consumer confidence and new home sales will slip, this will take place from healthy levels.

EUR/USD broke through 1.3000 following the Cyprus deal but will run into resistance around 1.3135 and we expect gains to fade in the short term as markets look past the headlines. Downside risks to EUR will remain in place due to relatively unfavourable data releases and ongoing political uncertainty in Italy.

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USD buoyant

March 13, 2013 — Mitul Kotecha

After finally returning from a two week trip visiting clients across North America it appears that the USD continues to remain in buoyant mood. I have been highlighting the prospects for a stronger USD against major currencies for some time and this has been borne out by the strong USD performance since early February.

Despite a lackluster performance for US stocks overnight overall sentiment remains largely upbeat as reflected by the fact that my risk barometer has breached its lower threshold and has moved into risk loving territory. Similarly the VIX fear gauge is trading at multi year lows although it did move higher overnight.

The sharp drop in UK industrial production and a warning by the Bundesbank’s Weidmann that the Eurozone crisis was not over added a dose of caution to the market. On a more positive note the Baltic Dry Index is at its highest level so far this year, sending a positive signal for global growth expectations.

While there is still much wrangling in the US over budget proposals, and in Europe, Italian political uncertainty continues, markets remain focused on the positives of improving growth against the background of highly accommodative monetary policies. Nonetheless, the divergence between the US and Europe in terms of growth is set to continue. A likely bigger than forecast increase in US February retail sales in contrast to a bigger than forecast fall in Eurozone industrial production in January will attest to this.

EUR/USD has managed to garner a semblance of stability over recent days, with the currency pair finding it difficult to sustain any decline below the psychologically important 1.3000 level. The drop in EUR/USD over much of February has been more aggressive than implied by the performance of Eurozone peripheral bonds but this is no surprise given that this is not the biggest influence on the currency.

Instead the explanation for the EUR decline is found when viewing the move in US 2 year Treasury yields relative to 2 year bunds. The strong correlation with EUR/USD highlights this relationship, reflecting the impact of lower bund yields and higher Treasury yields. The EUR’s stability over recent days is therefore a function of a slight drop in the US yield advantage.

Given that the trend of firmer US data and weaker Eurozone data is set to continue, this stability is likely to be short lived. Our quantitative model suggests EUR/USD may rally in the short term but we suggest selling into it.

GBP/USD’s decline has continued unabated and there appear to be little to stand in the way of further weakness apart perhaps from the fact that a lot of bad news is priced in. Sentiment for GBP has clearly deteriorated as reflected in the CFTC IMM data revealing four straight weeks of negative positioning. The deviation with the 3 month average positioning has widened significantly, highlighting the pace of the move but also that the drop is beginning to look excessive.

Nonetheless, the bigger than expected drop in January industrial production data revealed yesterday has helped to compound the negativity towards the currency in the wake of deteriorating economic data and in turn heightened expectations of more BoE quantitative easing. Strong technical support around GBP/USD 1.4767 may hold in the short term but momentum indicators are showing no sign of a slowing in GBP selling pressure.

For GBP bulls (if there any left) there may be more value in looking to eventually re-enter long positions against EUR but we would not rush into this trade. .

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USD undermined, CHF and NZD risks

January 31, 2013 — Mitul Kotecha

The surprise drop in US Q4 GDP (-0.1% QoQ annualised) and relatively cautious but not much different Fed statement (pause in growth, elevated unemployment, inflation below long term objective) helped to undermine risk assets, and the USD overnight while 10 year Treasury yields slipped back below 2%. Consequently EUR/USD was propelled above the 1.35 level. Gold prices benefitted however, with the precious metal trading above its 200 day moving average.

The Fed showed little indication of pulling back from its USD 85 billion in monthly asset purchases but that did little to prevent stocks from closing lower. The data calendar is limited in terms of first tier releases today, with ranges likely to dominate and markets turning their attention to tomorrow’s US jobs report.

Following an impressive drop of around 3% from around 9 January the CHF appears to have stabilised, at least temporarily versus EUR. I believe this stability will prove short lived. CHF is finally seeing a reversal in safe haven flows while also suffering from its growing use as a funding currency (again). Indeed, recent weeks have seen a decline in speculative CHF appetite, which I expect to continue over coming weeks.

The recent drop in the CHF has done little to placate Swiss government officials however, while economic data such as the 8 month low registered for the January KoF leading indicator give further support for a weaker currency. There is even renewed speculation that the Swiss National Bank should catch markets on the hop by raising the EUR/CHF 1.200 floor. I don’t expect the floor to be raised anytime soon but do expect more weakness in the still overvalued CHF.

My quantitative models now send a ‘strong sell; signal for NZD but maintain a neutral signal for AUD. Is it time to buy AUD/NZD? Technical signals suggest little upside directional impetus in the short term. Moreover, speculative positioning in AUD/NZD looks stretched. In other words expect range trading in the near term and better opportunities once stale longs have been shaken out.

The RBNZ’s decision to keep policy on hold overnight will have little impact on the NZD given that it was widely expected but the concerns expressed about Kiwi strength will not go unnoticed by market players. NZD has benefited more from the risk rally over recent weeks than AUD but gains in risk appetite according to my risk barometer appear to have stalled. I suggest waiting for opportunities to sell kiwi on any move the 0.84 versus USD

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Currency frictions

January 28, 2013 — Mitul Kotecha

I would like to apologise for the lack of posts over the last couple of weeks. I have been on a client roadshow presenting our macro and markets outlook for 2013 to clients across Asia. Having returned the mood of the markets is clearly bullish as risk assets rally globally. Recovery hopes are intensifying as tail risk is diminishing while central banks continue to keep their monetary levers fully open.

A heavy slate of US data releases this week will keep markets busy but overall I see little to dent the positive tone to risk assets over coming sessions. The main events this week include the US January jobs report (forecast +160k) and Fed FOMC meeting (no change likely) while consumer and manufacturing confidence, Q4 GDP and December durable goods orders are also on tap.

In the Eurozone attention will focus less on data but more on Eurozone banks’ balance sheets, with further capital inflows likely to be revealed, marking another positive development following last week’s strong payback of LTRO funds. Elsewhere, industrial production in Japan is likely to reveal a healthy gain while an interest rate decision in New Zealand (no change likely) will prove to be a non event.

As fiscal and monetary stimulus measures are largely becoming exhausted or at least delivering diminishing returns the next policy push appears to be coming from the currency front. The issue of ‘currency war’ is once again doing the rounds in the wake of Japan’s more aggressive stance on the JPY leading to growing friction in currency markets.

In contrast the easing of Eurozone peripheral strains have boosted the EUR, in turn resulting in a sharp and politically sensitive move higher in EUR/JPY. Central banks globally are once again resisting unwanted gains in their currencies, a particular problem in emerging markets as yield and risk searching capital flows pick up. Expect the friction over currencies to gather more steam over the coming weeks and months.

In the near term likely positive news in the form of large capital inflows into Eurozone peripheral banks and sovereign bond markets will keep the EUR buoyed. The USD in contrast will be restrained as US politicians engage in battle over the looming budget debate and spending cuts despite the move to extend the debt ceiling until May.

GBP has slid further and was not helped by the bigger than expected drop in Q4 GDP revealed last week which in turn suggests growing prospects of a ‘triple dip’ recession. The lack of room on the fiscal front implies prospects for more aggressive Bank of England monetary policy especially under the helm of a new governor and in turn even greater GBP weakness.

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USD under pressure, except versus JPY

January 14, 2013 — Mitul Kotecha

Following another positive week for risk assets where equities in particular benefitted from substantial capital inflows this week is unlikely to look much different. A host of earnings, especially from financials will help dictate the equity market and in turn risk tone over coming days. There will also be plenty of focus on speeches by various Fed and European Central Bank (ECB) officials including Fed Chairman Bernanke today.

The week will start off in more subdued fashion however, with a Japanese holiday and little fresh news to digest over the weekend. Hope and faith in global economic recovery helped by data releases in the US and China in particular, have helped to calm markets while there is little angst as yet about the looming debt ceiling / spending cut negotiations in the US.

Despite the rush into equities, core bond yields appear to have hit a short term ceiling. Meanwhile, the USD is likely to maintain a weaker tone over the short term except versus JPY where the currency pair has broken through key technical barriers on the top side and is verging on a break of 90.00 helped by more comments over the weekend by Japanese Prime Minister Abe pushing for a 2% inflation target to be implemented.

Data releases this week will maintain the growth recovery story in the US while the Eurozone will continue to show a weaker trajectory. In the US there are plenty of releases to chew on including December retail sales, inflation, industrial production, manufacturing surveys, housing starts, Michigan confidence, and the Fed’s Beige Book. Overall, US releases will help paint a picture of steady and gradual recovery.

In contrast the Eurozone data slate is more limited and what there is (German GDP, Eurozone industrial production) will be less impressive supporting the view of Eurozone economic underperformance over coming months. Admittedly this has yet to affect the EUR which continue to benefit from peripheral bond yield compression and receding crisis fears although EUR/USD will likely run into resistance around 1.3385 which if broken will open the door for a test of 1.3486.

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