Bernanke eyed for QE clues

July 17, 2012 — Mitul Kotecha

Range trading is likely to dominate. However, the news flow remains negative, with disappointing retail sales data in the US combined with more the decision by the German constitutional court to delay its decision on the ESM bailout fund until September 12, highlighting the lack of potential for any rally in risk assets in the near term.

The International Monetary Fund (IMF) provided markets with a further dose of caution, with its warning that risks to global growth “loom large” as it cut its forecasts for global growth. Pressure on policy makers to provide more stimulus will grow, but the room for and efficacy of such stimulus is questionable.

The weaker than expected June US retail sales report released yesterday has resulted in fuelling expectations that Fed Chairman Bernanke will announce a shift towards more quantitative easing later today. Consequently the USD has come under pressure losing ground so far this week.

While the USD is set to be restrained ahead of Bernanke’s speech to the Senate we do not believe he will announce a change in stance. Therefore, any USD weakness is likely to prove temporary in the short term. The inability of risk appetite to improve further and the ongoing uncertainties in the Eurozone reinforce the view that the USD’s downside will be limited.

Today’s US releases are likely to reveal gains in June industrial production, and a likely strengthening in long term capital flows in May, factors that will help to provide the USD with further support.

Although the EUR has bounced this week data today will only serve to reinforce its overall downward trajectory. The July German ZEW survey is set to decline further. The range of forecasts for this volatile survey is wide between -10 to -30, with our forecast towards the lower end.

The plethora of negative news in terms of policy progress continues to dampen sentiment and hamper the EUR’s ability to recover. Whether its persistent downgrades of economic growth across Eurozone countries, stalling of reforms and austerity plans, or delays in implementing agreed upon measures, the news is unambiguously bad.

Dashed hopes of progress towards finding and implementing solutions have led to a renewed deterioration in speculative appetite for EUR. Although the potential for short covering remains high, the trigger for any short covering is decidedly absent. We maintain the view that EUR/USD will test 1.2000 over coming weeks.

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EUR slides as summit hopes fade

July 9, 2012 — Mitul Kotecha

Any boost to confidence following the recent EU Summit is fading fast. Policy easing from the European Central Bank, Bank of England, and PBoC in China, have done little to turn things around. Moreover, the weaker than expected US June jobs report has added to the calls for the Federal Reserve to inject more monetary stimulus via another round of quantitative easing but this is unlikely anytime soon.

Admittedly the jobs data which reported an 80k increase in payrolls and unemployment rate remaining at 8.2%, was disappointing but it was not weak enough to trigger imminent Fed action. Congressional testimony by Fed Chairman Bernanke on July 17 and 18 will provide the next key clues to whether the Fed is moving closer to more QE.

This leaves markets in a miserable state of being. It was hoped that the recent EU Summit would provide much needed breathing space and relief to Eurozone peripheral bond markets. However, renewed policy implementation doubts, concerns that the Summit did not go far enough and opposition from Finland and the Netherlands who appear to have taken an even tougher stance than Germany, have resulted in Spanish and Italian bonds facing significant pressure once again with yields higher than pre summit levels.

A delay in the ESM permanent bailout fund, timing of the setting up of a banking supervisory authority and doubts about the size of the bailout fund given that the ECB appears to have ruled out a banking license as a means of leveraging up the ESM, are just a few of the concerns afflicting markets. Meanwhile, added to this list is the fact that Greece’s next bailout tranche has been delayed to mid September. Many of these issues as well as the bailout of Spanish banks will be discussed at today’s Ecofin meeting but the chances of much progress remain limited.

The EUR which is of course not uncrorrelated with peripheral bond yields has itself fallen sharply. Thin trading conditions have helped to exacerbate the drop in the EUR while the realisation that the EU summit has been no game changer is increasingly weighing on the currency. I had thought that the Summit may have helped to at least provide a floor under the EUR but this now looks like a case of misplaced optimism.

The only supportive factor for the currency is that it looks heavily oversold, with market positioning extremely short. However, if a break below the 2012 EUR/USD low around 1.2288 can be sustained markets will quickly latch onto 1.20 as the next target. Given the lack of major events or data releases over coming days there looks like little to offer the EUR any support.

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Risk and carry attraction increasing

July 4, 2012 — Mitul Kotecha

The outcome of the EU Summit together with hopes of monetary stimulus has definitely helped to put a floor under risk appetite. Indeed, such monetary stimulus expectations are reflected in the price of gold which continued to rise overnight. Risk assets in general have maintained a positive tone recently and even forward looking indicators of global activity such as the Baltic Dry Index have been trending higher.

Although it is difficult to become too positive given the still very significant downdraft to global growth officials in Europe have bought some time to get their collective house back in order. Whether they will use it wisely is another question entirely. It is difficult to see much of a market move ahead of the ECB Council meeting and US June jobs report this week. Moreover, the US Independence Day holiday will keep trading subdued today.

My Risk Barometer has moved back into ‘risk neutral’ territory following several weeks of remaining in ‘risk hating’ territory. Consequently the backdrop for risk currencies has turned positive. Although FX trading has become more subdued amid summer conditions and a US holiday today as reflected in the drop in implied volatilities, there is a clear sense that investors are increasingly moving into carry trades.

My Yield Appetite Index {YAI) has surged over recent weeks, now at its highest in several months. I remain concerned that markets are addicted to stimulus while underlying economic conditions remain weak as likely revealed in today’s releases of June service sector purchasing managers’ indices in Europe.

Nonetheless, it seems likely according to my risk measures that the current tone of risk / carry attraction will persist for some weeks to come. The currencies that will benefit in an environment of improving risk appetite / yield attraction are the ZAR, MXN, PLN, CAD & NOK by order of magnitude of correlation with our risk barometer.

However, the beneficiaries are by no means limited to these currencies. Almost every currency except the ARS and PHP has a statistically significant correlation with the risk barometer. The only currencies that come under pressure as risk appetite improves are the USD and JPY given their negative correlations.

Currencies with healthy carry such as the AUD, which broke above its 200 day moving average versus USD overnight, will be even bigger beneficiaries as investors pile into carry trades over coming weeks as indicated by the jump in our YAI.

Notably there is plenty of scope to build carry positions as our speculative measure of yield attraction (based on CFTC IMM data) remains relatively low, suggesting that leveraged investors have still not jumped on the carry bandwagon.

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Plenty of event risk

July 3, 2012 — Mitul Kotecha

In the wake of the EU Summit at the end of last week sentiment has stabilised, with risk indicators such as the VIX ‘fear gauge’ reflecting a firmer tone to risk appetite. Although a few stumbling blocks have arisen such as the objections by both Finland and Holland to bond purchases by the ESM bailout fund they may not be sufficient to derail the project. The euphoria is likely to fade in the days ahead but the US Independence day holiday tomorrow may keep trading somewhat subdued.

There are plenty of events this week including central bank decisions by the RBA (Australia), Riksbank (Sweden), ECB (Eurozone) and BoE (UK), to provoke some excitement. A likely rate cut from the ECB and an extension of asset purchases by the BoE will give markets plenty to chew on. Finally, at the end of the week the US June jobs report will also be closely watched. We forecast a 100k increase in payrolls but will look for clues from tomorrow’s ADP jobs report.

The disappointing US June ISM manufacturing survey released yesterday highlighted that growth risks will remain a key weight on the market dampening any improvement in risk appetite over coming weeks. Moreover, weaker growth in Europe will make it more difficult to achieve budget targets, while adding to pressure to ease bailout terms. Undoubtedly the European summit was a step in the right direction but with plenty of details still needing to be thrashed out and growth concerns intensifying it would be highly optimistic to expect a fully fledged ‘risk on’ to ensue.

Notably the EUR has given back some of its gains after failing to break above 1.2700 against the USD. Further downside is likely but the EU Summit outcome has meant that the risk of a sharp drop lower has receded. Although there is likely to have been some short covering following the summit outcome EUR short positions remain significant, a factor that may also limit downside in the currency. EUR/USD will find some short term support around 1.2553 but will likely edge down to around 1.2500 over coming sessions.

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USD and JPY remaining firm

June 27, 2012 — Mitul Kotecha

The USD has rebounded since 19 June in the wake of growing uncertainties and potential disappointment emanating from the EU Summit. As I previously highlighted a rally in the USD was to be expected in the wake of an extension of Operation Twist.

Looking ahead, as Bernanke and Co. also left open the option of more quantitative easing the USD is not out of the woods yet. The USD’s path will not only depend on risk but also on upcoming data releases. A further run of weak data will once again raise the spectre of more QE potentially leading to a softer USD.

Today’s US releases are unlikely to lend support to QE expectations, however. A bounce in May durable goods orders is expected while pending home sales are likely to recoup some of the sharp drop registered in April. However, markets will have to wait until next week for the release of the most important indicator, the June jobs report, before a clearer USD direction emerges.

USD/JPY remains well and truly constrained below the 80.00 level. Elevated risk aversion and a decline in the US yield advantage over Japan are acting as a restraint to any upside move in USD/JPY. Moreover, I do not expect any impact on the JPY from the passage of a bill to raise the consumption tax. Evidence that the Japanese economy is recovering may explain the lack of official enthusiasm to weaken the JPY but this assessment is prone to disappointment.

Increasingly, JPY bears are becoming frustrated by the lack of JPY downside traction. This has been reflected in the turnaround in speculative sentiment which turned positive for the first time in 15 weeks. Going forward, it will be difficult for USD/JPY to rise much unless US yields move higher. Eventually I think this will happen and look for USD/JPY to end the year around 83.00

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