Sell into the USD/JPY rally, EUR bottoming out, GBP vulnerable

November 19, 2012 — Mitul Kotecha

Following a week when risk measures continued to worsen there may not be much respite over coming days. The usual suspects will continue to direct sentiment including US fiscal cliff discussions, Greece’s next loan tranche and debt sustainability, the timing of any possible Spanish bailout request, and the conflict between Israel and Hamas in the Gaza strip. Added to this list are worries about economic growth.

Data releases this week are expected to be soft in general, with US existing home sales set to slip in October, weak readings for Eurozone flash purchasing managers’ indices and an eight consecutive drop in the German IFO business climate survey in November. Trading conditions will likely thin over coming days as the US Thanksgiving holiday on Thursday approaches.

Events over coming days will at least give further clues on the monetary policy front, with Fed Chairman Bernanke scheduled to give a speech at the Economics Club of New York, an event which may shed some light on Fed policy once Operation Twist ends. In the UK Bank of England minutes will also be scrutinised for clues on more QE, with a likely split decision set to be revealed. GBP continues to suffer from a bad combination of weak activity and higher inflation, leaving the currency vulnerable to further selling, especially against EUR.

Additionally, the Bank of Japan will decide on policy although a pause is expected this week given that easing measures were only announced at the last meeting at the end of October. The general election on December 16 may also complicate BoJ policy. USD/JPY’s upside potential looks limited from current levels and a lack of action from the BoJ tomorrow will likely undermine the current pair further. USD/JPY will find strong resistance around 81.78.

In Europe policy decisions will focus on developments in Greece, with the next loan tranche for the country to be decided and discussions on the 2014-2015 EU budget set to take place. The loan Greek aid discussions tomorrow ought to lead to an agreement to distribute EUR 31.5 billion in aid to Greece. The decision may help the EUR to edge higher, although EUR/USD will need to break above its 200 day moving average around 1.2807 before it can register more concrete signs of recovery.

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JPY hit by politics, AUD losing ground

November 15, 2012 — Mitul Kotecha

A total solar eclipse as seen in Australia yesterday portends to a shift in market trends. Whether this is borne out by actual market movements is debatable as the major themes underlying investor psyche continue to dominate. First and foremost is the US fiscal cliff and the potential lack of resolution to this issue. Notably US and European equities slipped overnight as hopes/expectations of a solution by the end of the year continue to fade ahead of discussions between US politicians tomorrow.

In Europe, lack of progress in Spain and Greece are resulting in Eurozone peripheral bond yields creeping higher while safe haven demand continues to support core bonds. Geopolitical tensions increased following Israeli air strikes in the Gaza strip, helping to prop up oil prices. The USD remains supported against this background, but notably has failed to make much progress over recent days. All of this is not conducive to a positive environment for risks assets and as fiscal cliff talks are awaited a cautious tone is likely to permeate trading today.

The JPY took a hit following news that Japan’s Prime Minister Noda may dissolve parliament on November 16, paving the way for fresh elections. The JPY’s drop was not attributable to political uncertainty but rather the prospects that a likely opposition led LDP victory in any new election would likely lead to a more aggressive stance on policy, putting more pressure on the BoJ to ease.

USD/JPY has broken back above the 80.00 level but is susceptible to a renewed drop given the decline in US bond yields relative to Japanese bond yields. Moreover, risk aversion has intensified over recent weeks, providing another prop to the JPY. However, worsening economic news means that official pressure for JPY weakness will be maintained and regardless of the elections the BoJ has a lot further to act over coming months.

AUD extended its rally since the RBA kept policy on hold last week helped by better domestic and external data (especially in China). However, the currency has looked more vulnerable this week and my quantitative model estimates for AUD/USD and AUD/NZD highlight that AUD is looking increasingly overbought in the short term. While the models do not yet have a high conviction sell signal I suggest beginning to offload long positions around the 1.0400 level versus USD, playing for a short term pull back in the currency.

Any pull back will likely be short lived, but nonetheless, it will in my view provide better entry levels for investors looking to build medium term long positioning in AUD. Supporting my assessment is the fact that long AUD speculative positioning (IMM) is back at multi week highs, leaving the currency vulnerable to profit taking.

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Euro slippage, sterling under pressure

November 13, 2012 — Mitul Kotecha

A US holiday (bond market closed) and positive data in China over the weekend helped to result in an easing in risk aversion overnight although this was probably more due to relatively limited market action in thin trading conditions. Consequently the VIX ‘fear gauge’ fell sharply. Holidays in Asia today will similarly keep activity limited. The improvement in risk appetite did little to undermine the USD (index) which remained at its highest level since early September and shows little sign of reversing.

The Eurogroup meeting yesterday did not as result in an agreement to deliver Greece its next loan tranche but this came as no surprise. In the US there appeared to be some traction towards resolving the fiscal cliff, with a Senior Republican economist indicating that Congress should agree on higher taxes for the wealthy ahead of formal discussions on averting the fiscal beginning on Friday.

EUR/USD’s slide has continued unabated and looks set to test its 100 day moving average level around 1.2639. Its weakness can be attributed to the usual suspects, namely uncertainty surrounding Greece and Spain. The currency may gain a little respite today in the form of a small rise in the German ZEW investor confidence expectations index but it will be insufficient to turn the EUR around in the short term.

At a time when the US fiscal cliff is rapidly overtaking peripheral Eurozone issues as a cause for concern, the inability of the EUR to capitalize on this is a bit disconcerting. Some clues to the timing of the next Greek loan disbursement will undoubtedly help the currency assuming that it is not too far into the future. The EUR will also need today’s Greek treasury bill auction to go well to give it some support. Unfortunately for the currency the risks are still skewed to the downside.

UK data flow has been poor to say the least and includes a series of disappointments through November including manufacturing confidence, construction confidence, industrial production and retail sales (BRC). The Bank of England did not deliver on any further policy easing at its meeting last week and clues to further policy moves as well as GBP direction will emerge from a slate of data over coming days. Unfortunately the releases will not bode well for GBP.

October CPI Inflation today is set to reveal an increase while retail sales are likely to have fallen over the same month. The main event will be the quarterly inflation report (QIR) tomorrow and this will see upward revisions to short term inflation forecasts although we still see scope for more QE early in the new year. GBP will find little support from the data or the QIR leaving the currency exposed to further declines against a relatively firm USD and a resumption of weakness against the EUR. I look for a test of EUR/GBP 0.8081 in the short term.

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USD clambering up the fiscal cliff

November 12, 2012 — Mitul Kotecha

Following US elections the reality of the task ahead to resolve the looming fiscal cliff has cast a long shadow of markets, leaving risk assets under pressure. Despite comments from the US administration and Congressional leaders of a willingness to compromise, markets remain unconvinced, especially given the unchanged underling stance of both Democrats and Republicans, the former towards taxing the wealthiest and the latter towards no tax hikes.

US data and events will not help risk appetite, with a drop in retail sales, moderate gains in manufacturing surveys and a small gain in October industrial production expected. The main highlight will be the FOMC minutes. Perversely the USD will continue to benefit even though much of the rise in risk aversion and subsequent safe haven demand is US orientated.

News that Greece passed its 2013 budget over the weekend will do little to assuage concerns over the country’s precarious financing position. It will also not guarantee that the Eurogroup meeting will approve Greece’s next loan tranche today given disagreements over the country’s debt sustainability, with a decision only likely by the end of the month.

Greece’s ability to handle a EUR 5 billion debt repayment this week via a treasury bill auction tomorrow will be the immediate focal point for markets given the difficulty for the country to obtain financing. At least economic data in the Eurozone will be slightly less negative, with upside risks to preliminary Q3 GDP and a likely third straight gain in the German ZEW investor confidence index expected in October. None of this will offer much respite for the EUR which looks set to slip further on its way towards its 100 day moving average around 1.2639.

In Japan the release of Q3 GDP data this morning which revealed the first negative reading in 3 quarters and broad based weakness in GDP components adds to the pressure on Japanese officials, in particular the Bank of Japan to intensify its stimulus efforts. The likelihood of another negative reading in Q4 and therefore a technical recession also highlights the need to weaken the JPY in such efforts. However, as we have been warning the move in USD/JPY above the 80 level proved short lived, with the currency pair undermined by a drop in US bond yields and to a lesser extent higher risk aversion. We see little chance of USD/JPY sustaining a break back above 80 in the current environment.

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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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