Pulling the rug from under the Euro

January 6, 2012 — Mitul Kotecha

The USD was spurred by stronger US data and a further deterioration in EUR sentiment. The data including an improvement in consumer confidence and in particular a strong (+325k) ADP private sector jobs report, support the case for medium term USD outperformance amid growing evidence of relatively superior US growth.

While having a limited impact on interest rate expectations due to the Fed’s commitment to maintain very accommodative policy and thus also limiting the scope of USD gains, the data nonetheless, highlights the scope for a relative rise in US bond yields relative to bunds over the medium term and in turn a firmer USD versus EUR.

Whether the December ADP data translates into a similarly strong December payrolls outcome today is debatable but consensus forecasts have been likely revised higher. We look for a 190k increase, which ought to provide more evidence of US economic and USD outperformance.

Part of the explanation for USD strength is simply a weaker EUR. Although France’s debt auction yesterday was not particularly negative it did reveal an increase in borrowing costs while yields in peripheral bond markets continue to move higher. As noted, data releases in the Eurozone are providing little support to the currency and today’s November retail sales release will add to the evidence of weakening growth, with a further contraction expected.

Central banks and official investors in general appear to be pulling the rug from under the EUR’s feet, meaning that the usual support for the currency is disappearing fast while German bond yields have moved below US 2-year yields. Nonetheless, the market is heavily short EUR and further downside may not be as rapid. Technically, a break below EUR/USD support around 1.2767 will open the door to a drop to 1.2642.

Following yesterday’s slightly disappointing trade data markets will turn their attention to next week’s November retail sales, building approvals and January consumer confidence data in Australia. AUD has held up relatively well in the first week of the new year despite the ongoing tensions in the Eurozone and related rise in risk aversion.

Fortunately for the AUD its correlation with risk aversion is quite low, suggesting some resilience to higher risk aversion. Nonetheless, the market appears long of the AUD and it may extend yesterday’s pull back as investors take profits ahead of the US jobs report.

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Renewed Eurozone Tensions

January 5, 2012 — Mitul Kotecha

The USD has so far failed to build on the strong momentum seen at the end of last year. Its early days yet however, and given the ongoing tensions in the Eurozone the USD is hardly likely to lose much ground in the weeks ahead. US data continues to impress relative to elsewhere as revealed in the December ISM manufacturing survey data and overnight news that sales at auto makers and retailers were firmer in December. This economic outperformance may however, feed into a tone of improved risk appetite which could play negatively for the USD.

The USD will face a test from the release of the December payrolls data tomorrow, with forecasts currently looking for the gradual improvement in job market conditions to continue. As usual the December ADP private sector jobs released today will be instrumental in finalising the forecasts for payrolls. Overall, the USD will continue to benefit from the travails in the Eurozone, keeping the USD index well supported around 80.00.

EUR/USD has failed to sustain gains above 1.3000 so far this week and has continued to come under pressure on the crosses. While the potential for short covering may limit its losses sentiment continues to be downbeat. Better than forecast December service sector PMI data have helped to allay the worse fears about the Eurozone economy but this will be of little help to the EUR as further deterioration is likely in the months ahead.

Meanwhile yield differentials continue to have some bearing on EUR/USD. The fact that German 2-year yields have dropped further below US 2-year yields therefore ought to spell bad news for the EUR and will likely act as a cap to any rally in the currency. The news flow in the Eurozone will continue to weigh on the EUR too, with speculation that Spain will need an European Union (EU) / International Monetary Fund (IMF) loan intensifying and press reports that Spain will need to increase its provisions for bad property assets by up to EUR 50 billion. Attention today will turn to a EUR 8 billion bond auction in France.

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Euro sentiment dives to a new low

January 3, 2012 — Mitul Kotecha

Equity markets in Europe began the year in positive mood, with gains led by the German DAX index following the release of firmer than expected readings for Eurozone purchasing managers indices (PMI). Chinese data which showed an increase in its PMI also helped to boost sentiment. The Eurozone data however, remained at a weak level, contracting for a fifth month in a row, and still consistent with Eurozone recession.

It seems unlikely that equity gains will be sustained over the rest of this week, with risk aversion set to remain elevated against the background of ongoing Eurozone debt and global growth concerns. Indeed, both French and German leaders in their new-year messages warned about the risks ahead. A meeting between Germany’s Merkel and France’s Sarkozy is scheduled for January 9th ahead of an EU Finance Ministers summit on January 23rd. It is unlikely that there will be any significant policy decisions in Europe before then.

Meanwhile, press reports noting that Germany is pushing for an even bigger write down of Greek debt than previously agreed will only add to risk aversion over the short term. The report in the Greek press highlighted the prospect of a 75% write down of Greek debt a far cry from the 20% proposed some months ago. Eurozone markets continue to be haunted by the prospects of credit downgrades by major ratings agencies at a time when many countries have to issue large amounts of debt to satisfy their funding requirements.

Against this background the EUR is set to remain under pressure, with a notable drop below EUR/JPY 100, its lowest level in over a decade registered. Reflecting the deterioration in sentiment for the currency, EUR speculative position hit an all time low at the end of last year according to the CFTC IMM data. This is unlikely to reverse quickly, with sentiment set to deteriorate further over coming weeks and months as the EUR slides further.

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Dollar, Euro and Yen Outlook 2012

December 16, 2011 — Mitul Kotecha

The USD index is set for another positive year over 2012 but it will not be a star performer. The USD has been a clear beneficiary of the crisis in the eurozone and will continue to find sustenance unless there are signs of a concrete resolution on the horizon. My forecasts still see the USD index rising to 82.5 by the end of 2012. This would be well below the highs reached during the height of the financial crisis in March 2009 around 89.

While economic recovery is expected to continue over 2012 it will be a tepid one, with prominent downside risks. Therefore, one of the factors likely to hold the USD back is the likelihood that the Fed embarks on a fresh round of quantitative easing which I believe will take place sometime in H1 2012, specifically aimed at mortgage backed securities.

I am not bullish on the EUR but it is clear in my view that there is an underlying degree of support for the currency. In 2012 I expect more downward pressure on the currency. News on the economic front will become more negative and the region is set to slip into recession, albeit a mild one (with downside risks). In contrast, the outlook for the US looks somewhat better even if the recovery will look tame compared to past growth.

Relatively weak growth will maintain the pressure on the ECB to ease monetary policy and further interest rate cuts are likely in the months ahead. Easier policy will be another factor that undermines the EUR. Even if the there was some progress on a resolution to the eurozone debt crisis I doubt that the stress on markets would be relieved overnight. While the crisis has and will not deliver a death blow to the EUR it will mean that investors, even official ones, take a much more cautious view on the currency going forward. I look for EUR/USD to fall to around 1.26 by end 2012.

The JPY has been one of the most well behaved currencies over past months, remaining within a relatively tight range. Unfortunately for the Japanese authorities and for the economy the JPY has failed to build on any negative momentum caused by intervention. I expect USD/JPY and EUR/JPY to edge higher over coming months but the upside for both currency pairs is likely to be gradual over 2012.

Much will depend on whether risk appetite improves and more importantly on yield differentials between Japan and other countries. My end 2012 forecast for USD/JPY and EUR/JPY remain at 85 and 107, respectively but its worth noting that I now expect a firmer JPY in March 2012 against both USD and EUR than previously forecast due to the likelihood of prolonged uncertainty and elevated risk aversion over Q1 2012

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Ratings agencies spoil the party

December 13, 2011 — Mitul Kotecha

Just as I thought that attention may finally switch to the US along comes the ratings agencies to spoil the party once again. Moody’s and Fitch Ratings criticised last week’s European Union Summit outcome for falling short of a comprehensive solution to Eurozone ills. Consequently the risk of further sovereign credit downgrades across Europe remains high over coming weeks especially as economic growth weakens. Moody’s also put 8 Spanish banks and two bank holding companies on review for a possible downgrade.

The EUR and Eurozone bonds came under pressure as a result, with EUR/USD verging on its strong support level around 1.3146. Further pressure is likely into year end although the fact that the speculative market is still very short EUR may limit its downside potential in the short term. Disappointment that the ECB has not stepped up to the plate to support the Eurozone bond market more aggressively is also having a damaging effect on confidence. A test of sentiment will come from today’s EFSF and Spanish bill auctions while on the data front we look for a below consensus outcome for the German December ZEW survey, which will deteriorate further.

The comments from the ratings agencies resulted in risk assets coming under pressure once again, leaving the market open to further selling today given the lack of positives. US data and events will at least garner some attention, with the Federal Reserve FOMC meeting and November retail sales on tap. We do not look for any big surprise from either of these, but at least the Fed may sound a little more positive in light of firmer data over recent weeks. Even so, speculation of more Fed QE early next year will remain in place. In the current environment demand for US Treasuries remains strong with a Treasury auction yesterday receiving the highest bid/cover ratio since 1993.

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