Risk Appetite Buoyed by Central Banks

December 1, 2011 — Mitul Kotecha

Co-ordinated central bank action led by the Federal Reserve to lower the rate on USD liquidity by 50bps was accompanied by a cut in China’s reserve requirements and an easing by Brazil of its benchmark Selic rate. Unsurprisingly risk assets have rallied strongly overnight but once the announcement effect wares off the reality that the underlying tensions in the Eurozone remain in place will see any boost to sentiment wane. The move by the Fed will be a boon to the banking sector but should actually not have been too surprising as this tool was an easy one to use and one that should have been expected given the ample room to cut pricing on USD liquidity swap arrangements.

The other boost to markets overnight was the strong November ADP jobs report, which came in at 206k in November, and will lead to upward revisions to Friday’s payrolls data. Indeed, we now look for a 175k increase in non-farm payrolls from 120k previously. The trend of better than expected US data continued with a stronger than forecast reading for November Chicago PMI at 62.6. We expect this to be echoed by an increase in the ISM manufacturing survey today and the Fed’s Beige Book, all of which will at least allay concerns of a renewed US recession.

What will be important is whether the Fed move will be followed up by other measures from governments and central banks over coming days. Although European Union (EU) leaders have agreed to enhance their bailout fund attention is centred on French and German leaders, with hints that there could be a strong announcement over coming days. At the least, the upcoming EU Summit on 8/9 December will be expected to deliver concrete results otherwise the market rout will continue.

The USD will remain under pressure following the moves by central banks in line with the improvement in risk appetite. High beta risk currencies ie those with the highest correlation to risk over the past 3-months will benefit the most. These include RUB, AUD, TRY, CNH, KRW, GBP and CAD in respective order of correlation. All of these currencies are likely to register gains over the short term, especially given anticipation of further announcements from European officials and a reasonable US jobs report tomorrow.

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IMF Hopes For Italy

November 28, 2011 — Mitul Kotecha

Following a week in which risk aversion increased further and equity markets fell sharply the start of this week looks a little steadier. Reports in the Italian press that the International Monetary Fund (IMF) is readying a EUR 600 billion loan for Italy in the event of a worsening in the debt crisis may help to support markets as the week kicks off.

Moreover a report in the German press that German Chancellor Merkel and French President Sarkozy are preparing a fast track “Stability Pact” for euro countries similar to the Schengen agreement, that may be announced this week, will also help to steady market nerves. However, neither report has been confirmed suggesting that as usual the scope for disappointment is high. The sell on risk on rallies environment is likely to persist for a while longer despite such reports.

Liquidity is likely to thin further this week and scope for volatility is high given that there are plenty of events and data on tap. Included among these are debt auctions in Belgium and Italy today and France and Spain later in the week against the background where Germany’s failed bond auction last week has fuelled even more nervousness in bond markets. A European Finance Ministers meeting beginning tomorrow will also come under scrutiny, especially given the lack of progress so far on many issues including the issue of Eurobonds.

The key data of the week will arrive from the US, with the November jobs report, ISM manufacturing survey, Beige Book and consumer confidence reports scheduled for release. Following what appears to be strong Thanksgiving holiday weekend spending the US data will continue to show improvement although this may not be enough to stem speculation that the Fed is verging on buying of mortgage backed securities in a third round of quantitative easing.

Risk currencies have commenced the week in strong firm, with the EUR and AUD rallying. Any gain in the EUR will prove limited and unsustainable unless the weekend press reports are confirmed. EUR/USD will find upside resistance around the 1.3412 level, while the risk of a downside test of support around its October 4 low at 1.3146 remains high over coming days.

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Germany Caught in the Contagion

November 24, 2011 — Mitul Kotecha

Equity markets came off their lows overnight despite a 236 point drop in the Dow Jones, but sentiment remains extremely fragile and any let up in pressure on risk assets will prove temporary. A weak bond auction in Germany highlights the severity of contagion across Europe. If the core is being hit then there is no safe haven in Europe anymore. On a positive note it might just make German officials finally realise that they need to act quickly to provide solutions to the crisis.

Weak data notably outside the US adds to the malaise, with in particular China’s HSBC November weaker purchasing managers’ indices coming in below the 50 boom/bust level. Europe’s weaker purchasing managers indices highlight the prospects of looming recession while the news in Germany is not only bad on the bond front bad also on the data front. Today’s German November IFO survey will continue in the same vein, with further weakness in this business survey expected.

Bearing in mind the US Thanksgiving holiday today thin liquidity will mean that conditions are ripe for exaggerated market moves. EUR/USD has already sustained a drop below the important 1.3500 level as even the underling strong Asian demand appears to have been pulled back. More downside is expected but technicals suggests that it will be hard trudge lower, with near term support seen around 1.3285 (10 day Bollinger Band). The near term range is likely to be 1.3285-1.3505 although given the US holiday the range may be even tighter.

Aside from the IFO attention today will focus on a meeting between Chancellor Merkel, President Sarkozy and Prime Minister Monti. As usual expect a lot of hot air but little action. Also note there is a general strike in Portugal today protesting against austerity measures in the country.

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Super Failure By Supercommittee

November 22, 2011 — Mitul Kotecha

The USD remains a clear beneficiary in the ‘risk off’ environment enveloping markets at present. Indeed as reflected in the latest jump in USD (IMM) speculative positioning the market is turning increasingly to the USD at a time of intense stress. Moreover, the run of better economic data over recent weeks including October existing home sales yesterday points to less need for further Fed quantitative easing, which comes as further relief to the USD.

Further information on this front will be revealed in the Federal Reserve FOMC minutes on Wednesday, with the Fed set to keep the option open. Even the lack of agreement by the US Congressional Supercommittee on a deal to cut the US budget deficit by $1.2 trillion has failed to dent the USD’s progress as the failure of deficit talks was largely expected. Further USD gains are likely but the pace of its upside move will slow.

Although sentiment towards the Eurozone has deteriorated further EUR/USD is just about clinging onto the 1.3500 level despite several forays lower. More active European Central Bank (ECB) bond buying likely helped dampen some bearishness on the currency although reports suggest that the central bank has imposed a limit of EUR 20 billion on such purchases.

The EUR is not being helped however, by ongoing rumblings of a EUR break up despite Greek Prime Minister Papademos attempting to downplay talk of a Greek EUR exit. A meeting today between Italian Prime Minister Monti and EU officials will be in focus, with markets looking to see further signs of commitment to reforms. We expect no let up in pressure on the EUR, though further declines are likely to be slower, with last week’s low around 1.3420 providing short term support.

GPB has been an underperformer, with the currency on the path for a re-test of the 6 October low around 1.5272. News this week will not be helpful for the currency, with potentially dovish Bank of England monetary policy committee (MPC) minutes likely to inflict further damage, with support from the MPC for more QE set to be revealed.

Ahead of the minutes, UK public finances data today will not make for attractive reading just over a week away from UK Chancellor Osborne’s Autumn statement, which will likely reveal a downward revision to growth forecasts and an upward revision to deficit forecasts. GBP has even lost ground against the beleaguered EUR although we continue to believe that the overall trend will continue to be lower for EUR/GBP over coming weeks.

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Extreme Uncertainty

November 20, 2011 — Mitul Kotecha

The level of uncertainty enveloping global markets has reached an extreme level. Who would have thought that close to 13 years after its introduction at a time when it has become the second largest reserve currency globally (26.7% of global reserves) as well as the second most traded currency in the world, European leaders would be openly talking about allowing countries to exit the EUR? No less an issue for currency markets is the sustainability of the USD’s role as the foremost reserve currency (60.2% of global reserves). The US debt ceiling debacle and the dramatic expansion of the Fed’s balance sheet have led to many official reserve holders to question their use of the USD. Perhaps unsurprisingly the JPY has been the main beneficiary of such concerns especially as global risk aversion has increased but to the Japanese much of this attention is unwanted and unwelcome.

The immediate focus is the travails of the eurozone periphery. Against the background of severe debt tensions and political uncertainties it is perhaps surprising that the EUR has held up reasonably well. However, this resilience is related more to concerns about the long term viability of the USD rather than a positive view of the EUR, as many official investors continue to diversify away from the USD. I question whether the EUR’s resilience can be sustained given that it may be a long while before the situation in the eurozone stabilises. Moreover, given the now not insignificant risk of one or more countries leaving the eurozone the long term viability of the EUR may also come into question. I believe a break up of the eurozone remains unlikely but such speculation will not be quelled until markets are satisfied that a safety net / firewall for the eurozone periphery is safely in place.

In this environment fundamentals count for little and risk counts for all. If anything, market tensions have intensified and worries about the eurozone have increased since last month. Politics remain at the forefront of market turmoil, and arguably this has led to the worsening in the crisis as lack of agreement between eurozone leaders has led to watered down solutions. Recent changes in leadership in Italy and Greece follow on from government changes in Portugal and Ireland while Spain is widely expected to emerge with a new government following elections. Meanwhile Chancellor Merkel has had to tread a fine line given opposition from within her own coalition in Germany while in France President Sarkozy is expected to have a tough time in elections in April next year. The likelihood of persistent political tensions for months ahead suggests that the EUR and risk currencies will suffer for a while longer.

Posted in Bond markets, Currencies, ECB, Economics, Economy, Europe, eurozone, Financial crisis, Fiscal/Budget, France, FX, Germany, Greece, Italy, UK, US, US administration. Tags: , , , , , , , , , , , , . Leave a Comment »
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