Fed keeps the risk trade party going

November 17, 2009 — Mitul Kotecha

Risk is back on and the liquidity taps are flowing. Fed Chairman Bernanke noted that it is “not obvious” that US asset prices are out of line with underlying values, comments that were echoed by Fed Vice Chairman Kohn, effectively giving the green light to a further run up in risk trades. The last thing the Fed wants to do is ruin a good party and the comments indicate that the surge in equities over recent months will not be hit by a reversal in monetary policy any time soon.  

Aside from comments by Fed officials risk appetite was also boosted by a stronger than forecast rise in US October retail sales, with US markets choosing to ignore the sharp downward revision to the previous month’s sales, the weaker than forecast ex-autos reading and a surprisingly large drop in the Empire manufacturing survey in November.

Fed comments were not just focussed on the economy and equity markets as Bernanke also tried to boost confidence in the beleaguered USD, highlighting that the Fed is “attentive” to developments in the currency.  He added that the Fed will help ensure that the USD is “strong and a source of global financial stability”.  The comments had a brief impact on the USD and may have given it some support but this is likely to prove short lived. 

The reality is that the Fed is probably quite comfortable with a weak USD given the positive impact on the economy and lack of associated inflation pressures and markets are unlikely to take the Fed’s USD comments too seriously unless there is a real threat of the US authorities doing something to arrest the decline in the USD, a threat which has an extremely low probability.

It is perhaps no coincidence that the Fed is attempting to talk up the USD at the same time that US President Obama meets with Chinese officials.  The comments pre-empt a likely push by China for the US not to implement policies that will undermine the value of the USD but comments by Obama appear to be fairly benign, with the President noting that the US welcomes China’s move to a “more market based currency over time”. The relatively soft tone of these comments will further dampen expectations of an imminent revaluation of the CNY.

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Is China about to revalue the Yuan?

November 15, 2009 — Mitul Kotecha

Speculation has intensified that China will allow the CNY to resume appreciation. As well as a move in USD/CNY NDFs, implied options volatility has also risen. Speculation of CNY revaluation follows a significant change by China’s central bank, the PBOC to its stated FX policy in its quarterly monetary policy report last week.

The timing of the change in rhetoric should come as little surprise as it coincides with greater international calls for a stronger CNY to help rebalance the global economy as well as an improvement in economic data domestically. China has so far resisted such calls but the time may now be right for China to play its part in the global rebalancing process.

Recall that China had allowed a close to 20% appreciation of the CNY between July 2005 and July 2008 but re-pegged to the USD as the financial crisis intensified. This policy proved to be the correct one during the crisis as a stable versus appreciating exchange rate not only helped exports but helped contribute to China’s economic resilience during the crisis.

Now however, this policy is no longer needed. The worst of the crisis is over and China’s economy is doing remarkably well. Keeping the CNY artificially undervalued may stoke potential inflationary problems and distort the recovery process, whilst limiting the shift to a more consumer based economy. Managing China’s massive $2 trillion + of exchange reserves is becoming a more complicated and difficult process too. Moreover, the undervalued CNY is proving to be a global problem and hindering the adjustment of global imbalances.

Will there be an imminent revaluation of the CNY? China is in no rush to see the CNY appreciate and is unlikely to act when US President Obama is visiting. If anything, the Chinese authorities will renew the CNY appreciation trend when there is less political pressure as the last thing they want to do is to appear to be bowing to US or international pressure.

Yes the CNY is undervalued and the Chinese know this well. What is different this time is that the rest of Asia wants China to move and this is sufficient for China to act eventually but not imminently. The Chinese authorities are concerned about hot money flows and do not want to give the impression that they are embarking on an aggressive revaluation path. Gradual is the way to go but there is still room for markets to price in more appreciation next year.

What will happen during Obama’s visit is that the Chinese delegation will push for the US not to implement policies that will undermine the value of the USD especially in relation to the US fiscal deficit and the burgeoning Fed balance sheet. In return the US will push China into allowing the CNY to strengthen.

China appears to be in a stronger bargaining position given that China remains the biggest buyer of US Treasuries and the US will do little to jeopardise these investment flows. Perhaps China has pre-empted the US calls for a stronger CNY by changing the language in its monetary policy statement and it was likely no coincidence that the change happened just ahead of the US visit.

Posted in Asia, central banks, China, Currencies, Economics, emerging markets, FX, US. Tags: , , , , , , , , , . 2 Comments »

CNY appreciation speculation hits EUR

November 12, 2009 — Mitul Kotecha

The USD index is trading close to a 15-month low and direction remains firmly downwards as risk appetite continues to improve and the USD’s status as a funding currency remains unaltered.   Whether it’s a weak USD driving stocks higher or vice-versa, US stocks are currently trading at 13-month highs, maintaining the negative correlation with the USD index. 

One currency that has failed to take advantage of the weak USD over recent days is EUR/USD and its failure to make a sustainable break above 1.50 highlights that momentum in the currency is fading.  EUR/USD looks vulnerable on the downside in the short term, with resistance seen around 1.5050.  Speculation that China will resume CNY appreciation has taken some of the steam out of the EUR given that it implies less recycling of intervention flows into the currency.  

The speculation that China will allow a stronger CNY follows a significant change by China’s central bank, the PBOC to its stated FX policy. The Bank removed the statement  that it will keep the CNY “basically stable” and noted instead that foreign exchange policy would take into account “capital flows and major currency movements”.   

Although this does not mean the CNY will immediately strengthen it will add to speculation that China will allow some appreciation next year following a long stretch in which the CNY has effectively been stuck in a very tight range against the USD.   The timing of the change in rhetoric should come as little surprise as it coincides with greater international calls for a stronger CNY to help rebalance the global economy as well as an improvement in economic data domestically.  

Any change in stance on the CNY could be a significant factor in determining the direction for the EUR given that it not only implies less flows into EUR from China but also from other central banks in Asia which may take China’s cue and allow greater strengthening of their currencies versus USD.  Given that central banks in Asia had been intervening to prevent local currency strength and then recycling this USD buying into other currencies, especially EURs, the change in stance could play negatively for the EUR. 

Currencies are also a focus of the APEC meeting of finance ministers, with the draft statement agreeing that flexible exchange rates and interest rates are critical in obtaining balanced and sustainable growth.  This has interesting implications given the FX intervention by Asian central banks to prevent their respective currencies from strengthening and attention will focus squarely on China’s CNY policy.

Posted in Asia, central banks, China, Currencies, emerging markets, FX, US. Tags: , , , , , , , , , , , , , , , . 1 Comment »

Searching for inspiration

November 9, 2009 — Mitul Kotecha

After an eventful week which included several central bank meetings and the US Jobs report there is less for markets to get their teeth into this week.  Despite the weak US jobs report risk appetite looks relatively resilient suggesting that the USD will struggle to make much headway over coming days.  

Despite all of the events last week markets have been uninspired.  Even the G20 meeting delivered little to be excited about with no further developments on how to rebalance the global economy and the USD’s role in the process.  The lack of attention on the USD will leave it with little directional influence this week, with equity markets likely to the main driver once again.

One currency that may look a little better supported over coming days is the EUR.  GDP data later in the week is likely to reveal an expansion over Q3 after several quarters of contraction as indicated by various PMI data. Although it will likely be led by inventories and exports rather than domestic demand it will nonetheless come as good news, albeit backward looking.  Going forward growth in Europe is unlikely to match the pace of recovery in the US but for now the GDP data will be EUR supportive helping EUR/USD to gravitate around 1.50 and beyond. 

Meanwhile, central banks may also do their part in influencing currencies given their differing stances on monetary policy.  Although the Fed did not deliver any big surprises last week the FOMC statement will play for a softer USD as the currency looks to maintain its funding currency status for an “extended period”.   In contrast the RBA hiked rates as expected and despite hinting at more gradual rate increases in the months ahead the AUD continues to stand to benefit.   Going in the opposite direction the BoE increased its asset purchases but GBP avoided a significant negative fall out as the move is likely to be seen as the final step in the BoE’s asset purchase programme.

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US dollar remains funding currency of choice

November 5, 2009 — Mitul Kotecha

Rate hikes in some countries including Australia and Norway and a general improvement in economic data had led to some expectations that the Fed would shift its rhetoric on monetary policy but in the event this was not to be the case.  The key comment in the FOMC statement following the interest rate decision was that rates would be kept low for an “extended period”. The Fed added that its policy stance was contingent on “low rates of resource utilization, subdued inflation trends and stable inflation expectations.”  

The fact that the Fed maintained its relatively dovish stance contrary to some expectations ahead of the FOMC meeting resulted in interest rate markets paring back expectations for future rate hikes though I still believe that a rate hike anytime in 2010 will prove premature.  The Fed’s new conditions mean however, that the Fed will be more restricted when it does come to timing rate hikes and markets will watch closely, the unemployment rate and inflation expectations to determine this timing. 

Given that the unemployment rate is still rising and is expected to decline only slowly over coming months whilst core inflation is set to decline further, and excess slack in the economy is only likely to be reduced gradually, markets are still too aggressive in looking for increases in interest rates next year.  The Fed did not remove the reference to an “extended period” of low rates despite speculation ahead of the meeting and whilst many in the market continue to debate how long this will be, the Fed will not feel any need to rush to reverse policy. 

The USD weakened following the FOMC meeting but did not suffer a particularly hard blow.  Going forward the USD will not recover until there is clearer evidence that the Fed is ready to reverse policy and in the near term this means that the USD will remain under pressure, especially if markets push back expectations of rate hikes.  This will mean that the USD will continue to be the funding currency of choice for several months yet.  Cyclical USD recovery is still some way off but eventually the Fed’s actions will pay off and the USD will recover by around mid 2010 as the market becomes more aggressive in pricing in rate hikes in the US.

Posted in central banks, Currencies, Economics, Economy, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , . Leave a Comment »
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