Pressure, panic and carnage

August 8, 2011 — Mitul Kotecha

Pressure, panic and carnage doesn’t even begin to describe the volatility and movements in markets last week. If worries about global economic growth and the eurozone debt crisis were not enough to roil markets the downgrade of the US sovereign credit rating after the market close on Friday sets the background for a very shaky coming few days. All of this at a time when many top policy makers are on holiday and market liquidity has thinned over the summer holiday period.

The downgrade of US credit ratings from the top AAA rating should not be entirely surprising. After all, S&P have warned of a possible downgrade for months and the smaller than hoped for $2.1 trillion planned cuts in the US fiscal deficit effectively opened the door for a ratings downgrade. Some solace will come from the fact that the other two main ratings agencies Moody’s and Fitch have so far maintained the top tier rating for the US although Fitch will make it’s decision by the end of the month.

Comparisons to 2008 are being made but there is a clear difference time this time around. While in 2008 policy makers were able to switch on the monetary and fiscal taps the ammunition has all but finished. The room for more government spending in western economies has now been totally used up while interest rates are already at rock bottom. Admittedly the US Federal Reserve could embark on another round of asset purchases but the efficacy of more quantitative easing is arguably very limited.

Confidence is shattered so what can be done to turn things around? European policy makers had hoped that their agreement to provide a second bailout for Greece and beef up the EFSF bailout fund would have stemmed the bleeding but given the failure to prevent the spreading of contagion to Italy and Spain it is difficult to see what else they can do to stem the crisis.

Current attempts can be likened to sticking a plaster on a grevious wound. Although I still do not believe that the eurozone will fall apart (more for political rather than economic reasons) eventually there may have to be sizeable fiscal transfers from the richer countries to the more highly indebted eurozone countries otherwise the whole of the region will be dragged even further down.

Where does this leave FX markets? The USD will probably take a hit on the US credit ratings downgrade but I suspect that risk aversion will play a strong counter-balancing role, limiting any USD fallout. I also don’t believe that there will be a major impact on US Treasury yields which if anything may drop further given growth worries and elevated risk aversion. It is difficult for EUR to take advantage of the USDs woes given that it has its own problems to deal with.

Despite last week’s actions by the Swiss and Japanese authorities to weaken their respective currencies, CHF and JPY will remain in strong demand. Any attempt to weaken these currencies is doomed to failure at a time when risk aversion remains highly elevated, a factor that is highly supportive for such safe haven currencies. From a medium term perspective both currencies are a sell but I wouldn’t initiate short positions just yet.

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Swiss franc to remain strong

August 3, 2011 — Mitul Kotecha

Given the uncertainties enveloping both the US and Europe safe haven and various emerging market currencies have looked increasingly attractive. Currencies that remain on top in the current environment are the CHF and to a lesser extent the JPY, much to the chagrin of the Swiss and Japanese authorities. Indeed, in reaction to unwanted CHF strength the Swiss central bank, SNB unexpectedly cut interest rates and said it will increase CHF liquidity to the money markets. The CHF fell in the wake of the announcement but the impact may prove short lived.

Both the JPY and CHF have registered a strong correlation with risk aversion over the last 3-months, strengthening as risk aversion has intensified. In particular, the CHF has been the best performing major currency this year and shows no sign of turning around despite the fact that it has already strengthened by around 21% against the USD and over 12% against the EUR. The Swiss National Bank had even ceased from intervening in the currency markets given the lack of success and pain on the SNB’s balance sheet.

The Japanese authorities last intervened in the FX market in March 2011 following the devastating earthquake in the country. However, despite the fact that the JPY has strengthened after a brief period of success, the authorities have been reluctant to intervene since. The major explanation for a lack of intervention is that the Japanese authorities blame the drop in USD/JPY on USD weakness rather than inherent JPY strength. A more accurate reason is that the yield differential between the US and Japan has narrowed, leading to JPY strength versus USD while more recently rising risk aversion has pushed the JPY higher.

I am bearish on both the CHF and JPY over the medium term but clearly any drop in these currencies is taking longer than initially anticipated. Higher relative yields taken together with some normalisation in risk appetite will help but the risks at present are still skewed for further CHF and JPY strength in the short term given that risk aversion remains elevated. The fact that peripheral bond spreads in Europe have continued to widen will only raise the attraction of the CHF as a safe haven currency so despite the SNB’s new measures, it may do little to prevent further strength in the currency.

Posted in central banks, Currencies, Economics, Economy, Europe, eurozone, FX, Interest rates, Japan, Switzerland, US. Tags: , , , , , , , , , , . 3 Comments »

CHF and JPY remain on top

August 2, 2011 — Mitul Kotecha

It’s been a tumultuous few week for global markets. First a debt deal in Europe and then a debt ceiling agreement in the US. In both cases any boost to sentiment has and will be limited. Europe’s debt deal, while comprehensive, left quite a few questions in terms of implementation, scope and mutual country agreements.

In the US the deal to raise the US debt ceiling by $1.2 trillion hammered out between Republican and Democrat party leaders helps to stave off a debt default but is far smaller and less comprehensive in terms of deficit reduction measures than had been hoped for and may still be insufficient to prevent a credit ratings downgrade by S&P and/or more ratings agencies. The deal will prove a disappointment to USD bulls.

Markets in the US have failed to find much to rally them despite the debt deal. Indeed, all that has happened is that attention has shifted back towards economic growth worries in the wake of a disappointing ISM manufacturing index in the US (50.9 in July, a reading which is just about in expansion territory) which follows on from a run of soft data in the US including the Q2 GDP report. Unfortunately data elsewhere is no better as a series of weak manufacturing surveys have highlighted this week.

Weak data and the US debt deal have pushed Treasury yields lower but despite this the USD has rallied, especially against the EUR, which is not only suffering from renewed peripheral debt concerns and weaker growth, but also from a run of disappointing earnings releases in contrast to the US where earnings have on the whole beaten forecasts. The USD may have benefited from a renewed increase in risk aversion and in this respect further US equity weakness may provide the USD with further support.

Whether EUR/USD will extend its recent losses is doubtful, however. Much will depend on Friday’s US July jobs report and if there is another weak outcome as looks likely, speculation of another round of Fed asset purchases could dent USD sentiment. The currencies that remain on top in this environment are the CHF and to a lesser extent the JPY much to the chagrin of the Swiss and Japanese authorities

Posted in Economics, Economy, Europe, eurozone, Financial crisis, Fiscal/Budget, FX, Greece, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Euro still looks uglier than the dollar

July 29, 2011 — Mitul Kotecha

Currency markets continue to vacillate between US debt ceiling concerns and eurozone peripheral debt worries. Despite a lack of agreement to raise the debt ceiling, with House Republicans failing to back a proposal by House speak Boehner, the USD actually strengthened towards the end of the week as eurozone peripheral issues shifted back into focus.

The resilience of the USD to the lack of progress in raising the debt ceiling is impressive and reveals that the EUR looks even uglier than the USD, in many investors’ eyes.

Much in terms of direction for the week ahead will depend on the magnitude of any increase in the debt ceiling and accompanying budget deficit reduction measures. Assuming that a deal is reached ahead of the August 2 deadline it is not obvious that the USD and risk currencies will enjoy a rally unless the debt ceiling deal is a solid and significant one.

Given the limited market follow through following the recent deal to provide Greece with a second bailout, the EUR remains wholly unable to capitalise on the USD’s woes.

A reminder that all is not rosy was the fact that Moody’s ratings agency placed Spain’s credit ratings on review for possible downgrade while reports that the Spanish parliament will be dissolved on September 26 for early elections on November 20 will hardly help sentiment for the EUR. Compounding the Spanish news doubts that the EFSF bailout fund will be ready to lend to Greece by the next tranche deadline in mid-September and whether Spain and Italy will participate, have grown.

Some key data releases and events will also likely to garner FX market attention, with attention likely to revert to central bank decisions including the Bank of Japan, European Central Bank, Bank of England, Reserve Bank of Australia and US July jobs report. None of the central banks are likely to shift policy rates, however.

The risk for the USD this week is not only that there is disappointing result to the debt ceiling discussions, but also that there is a weak outcome to the US July jobs report. An increase of around 100k in payrolls, with the unemployment rate remaining at 9.2%, will fixate market attention on weak growth and if this increases expectations for a fresh round of Fed asset purchases the USD could be left rather vulnerable.

The RBA is highly unlikely to raise interest rates but the tone of the accompanying statement is unlikely to be dovish. The RBA noted the strong emphasis on the Q2 CPI inflation data and in the event it came in higher than expected, a fact that supports my expectation that the Bank will hike policy rates at least once more by the end of this year.

Markets have largely priced out expectations of a rate cut but there is still scope for a more hawkish shift in Australian interest rate markets, which will give the AUD a boost. However, AUD remains vulnerable to developments in the US and Europe as well as overall risk aversion, and a preferable way to play a positive AUD view in the current environment is via the NZD.

Posted in Australia, central banks, Currencies, ECB, Economics, Economy, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Germany, Greece, Interest rates, Italy, Monetary Policy, New Zealand, Spain, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

US Dollar Under Broad Based Pressure

July 27, 2011 — Mitul Kotecha

ThE USD has registered broad based losses over recent days and the longer the stalemate with regard to extending the US debt ceiling the bigger the problem for the currency. Indeed, it appears that the USD is taking the brunt of the pressure compared to other assets. For example, although US treasury yields have edged higher there is still no sense of panic in US bond markets.

Failure to raise the debt ceiling does not automatically imply a debt default but it will raise the prospect should an agreement not be reached in the weeks after. However, the impact on US bonds maybe countered by the increased potential for QE3 or safe haven flows in the event that no agreement is reached.

The worst case scenario for the USD remains no agreement on the debt ceiling ahead of the August 2 deadline but a short term solution that appears to be favored by some in the US Congress may not be that much better as it would effectively be seen as ‘kicking the can down the road’.

The better than hoped for agreement to help resolve Greece’s debt problems at the end of last week came as a blow to the USD given the almost perfect negative correlation between the USD and EUR over recent months. Moreover, the debt ceiling stalemeate is pouring salt into the wound. However, the situation is highly fluid and should officials pull a rabbit out of the hat and find agreement the USD could rally sharply.

All is not rosy for the EUR either and its gains have largely come by courtesy of a weaker USD rather than positive EUR sentiment. Economic news hardly bodes well for the EUR, with data in the eurozone looking somewhat downbeat. For instance, the Belgian July business confidence indicator dropped to a 9-month low in line with the weaker than expected outcome of the July German IFO survey last week.

Moreover, there are still several questions about last week’s second Greek bailout agreement and contagion containment measures including parliamentary approvals and lack of enlargement of the EFSF which could keep markets nervous until there are clear signs that implementation is taking place successfully.

A clear sign that the EU agreement has failed to inspire as much confidence as officials had hoped for is the lack of traction in terms of narrowing peripheral bond spreads, with the exception of Greece. This partly reflects a renewed ‘risk off’ tone to markets but this is not the sole reason.

EUR/USD has extended gains benefiting from USD weakness rather than any positive sentiment towards EUR, breaking above 1.4446, the strong multi-month corrective channel resistance, signalling a bullish move. The next level of technical resistance is around 1.4568 but direction will continue to come from the debt ceiling talks.

Posted in Currencies, Economics, Europe, eurozone, Federal Reserve, Fiscal/Budget, Greece, Interest rates, Monetary Policy, US, US administration. Tags: , , , , , , , , , , , , , , , , , , . Leave a Comment »
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