Risk appetite dented

August 17, 2009 — Mitul Kotecha

The surprise decline in the Michigan reading of US consumer confidence which dropped to 63.2 in August put a dampener on risk appetite at the end of last week helping to fuel a sea of red for most US and European equity markets at the close of play on Friday.   Nonetheless, FX markets remained range-bound, albeit with the dollar taking a firmer bias at the end of the week.

The impact of the drop in confidence is likely to prove short lived as risk appetite continues to improve this week although don’t look for big market moves as summer trading conditions continue to dominate.  For the most part the data releases should not throw any spanners in the works over coming days as a positive tone to data is set to be retained.  

The highlights this week include more GDP data from Japan and Norway following surprise increases in growth from Germany and France in Q2 last week.  Japan’s release showed a marginally softer than expected 0.9% QoQ increase in GDP with growth led by external demand and government stimulus measures.  In contrast, capital spending continued to remain weak.  

US numbers are set to show further improvement as likely reflected in manufacturing surveys including the August Empire survey and the Philly Fed.  Similarly housing data including housing starts and existing homes sales will point to more stabilisation whilst Fed Chairman Bernanke is set to deliver a similar tone to the recent FOMC statement. 

The highlight of the European calendar is the German ZEW survey and flash August PMIs.  Firmer equities point to a higher ZEW whilst manufacturing indices are likely to reveal a slower pace of contraction.  In the UK the minutes of the BoE MPC meeting are likely to reveal a unanimous vote for extending QE policy. 

On balance, the beginning of the week is likely to see a bit of a risk aversion led sell off in risk currencies including commodity currencies such as the Australian and NZ dollars as well as weaker Asian currencies led by the likes of the Korean won but the pressure is unlikely to last for long.  Nonetheless, Commodity currencies will face another layer of pressure from the sharp drop in commodity prices at the end of last week as reflected in the drop in the CRB index.

Posted in central banks, Commodities, Currencies, Economics, Economy, equity markets, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

An unusual dollar reaction

August 8, 2009 — Mitul Kotecha

Although many market participants are on summer holidays this has not prevented some interesting market moves in the wake of yet more improvement in economic data and earnings.  The most noteworthy release was the July US jobs report which revealed a better than forecast 247,000 job losses and a surprise decline in the unemployment rate to 9.4%.  Moreover, past revisions added 43,000 to the tally.

Although it is difficult to get too optimistic given that job losses since December 2007 have totalled 6.7 million, the biggest drop since WW2, the direction is clearly one of improvement.  Nonetheless, markets were given a dose of reality by the drop in US consumer credit in June, which gives further reason to doubt the ability of the US consumer to contribute significantly to recovery.

The data spurred a further rally in stocks and a sell of in Treasuries.   Such a reaction was unsurprising but the more intriguing move was seen in the US dollar, which after some initial slippage managed a broad based appreciation in contrast to the usual sell off in the wake of better data and improved risk appetite.

It is too early to draw conclusions but the dollar reaction suggests that yield considerations are perhaps beginning to show renewed signs of influencing currencies following a long period where the FX/interest rate relationship was practically non-existent.  Indeed, the strengthening in the dollar corresponded with a hawkish move in interest rate futures as the market probability of a rate hike by the beginning of next year increased.

Since the crisis began the biggest driver of currencies has been risk aversion, a factor that relegated most other influences including the historically strong driver, interest rate differentials, to the background.  More specifically, much of the strengthening in the dollar during the crisis was driven by US investor repatriation from foreign asset markets as deleveraging intensified.   This repatriation far outweighed foreign selling of US assets and in turn boosted the dollar.

Over the past few months this reversed as risk appetite improved and the pace of deleveraging lessened.  Ultra easy US monetary policy also put the dollar in the unfamiliar position of becoming a funding currencies for higher yielding assets and currencies though admittedly this was all relative as yields globally dropped.   The dollar also suffered from concerns about its role as a reserve currency but failed to weaken dramatically as much of the concern expressed by central banks was mere rhetoric.

Where does this leave the dollar now?  Risk will remain a key driver of the dollar but already its influence is waning as reflected in the fact that the dollar has remained range bound over recent weeks despite an improvement in risk appetite.   As for interest rates their influence is set to grow as markets price in rate hikes and as in the past, more aggressive expectations of relative interest rate hikes will play the most positive for the respective currency.

It is still premature for interest rates to overtake risk as the principal FX driver.   Even if rates increase in importance I still believe interest rate markets are overly hawkish in the timing of rate hikes. A reversal in tightening expectations could yet push the dollar lower.  This is highly possible given the benign inflationary environment and massive excess capacity in the US economy.

Eventually the dollar will benefit from the shift in interest rate expectations as markets look for the Fed to be more aggressive than other central banks in reversing policy but this could take some time. Until then the dollar is a long way from a real recovery and will remain vulnerable for several months to come as risk appetite improves further.

Posted in central banks, Currencies, Economics, Economy, Financial crisis, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

Recovery hopes spoiled by the consumer

July 31, 2009 — Mitul Kotecha

News that US Q2 GDP dropped by less than expected, with the 1% fall in GDP over the quarter far smaller than the annualised 6.4% drop in the previous quarter, adds to the plethora of evidence highlighting that the US recession is coming closer to ending.  The bad news, albeit backward looking was revealed in the downward revisions to growth in the previous quarters, which indicated that the recession has been more severe than previously thought.  

Within the Q2 GDP data the details revealed that consumer spending weakened by far more than expected. The recession is also breaking all sorts of records as the annual 3.9% decline in growth was the biggest since WWII and the fourth quarterly decline in a row was the longest on record. Nonetheless, inventories look a lot leaner following their sharp drop over the quarter and the deterioration in business investment appears to be slowing.  The data also showed that the Fed´s preferred gauge of inflation (core PCE deflator) remained relatively well behaved.

The downward revisions to past data and the fact that growth was boosted in Q2 by government spending as well as very weak consumer spending will takes some of the shine off the less than forecast drop in GDP.  Nonetheless, the data is still backward looking.  The evidence of recovery highlighted in recent housing data as well as some bottoming out in manufacturing conditions, taken together with less severe readings in jobs data  are difficult to ignore.  This was echoed in the Fed´s Beige Book which revealed that economic deterioration was becoming less marked.

The most worrying aspect of the report and something that cannot be downplayed however, is consumer spending. Massive wealth loss, rising unemployment, tight credit conditions, reduced income and consumer deleveraging all point to a very subdued outlook for the US consumer in the months ahead and only a gradual pace of economic recovery. The US savings rate is set to move higher even from its current 15 year high and spending on big ticket items will remain fragile at best.   Although the upcoming US jobs report will likely show a less severe pace of Job losses in July, the drop in payrolls will still remain significant and hardly  conducive of a turnaround in spending. 

Although some policy makers have indicated that policy should not be kept too loose for too long the weak consumer outlook suggests that inflation is likely to remain subdued for a long time to come.  So whilst it is easy to get excited about the signs of recovery increasingly being revealed in economic data this should not be taken as a cue to reverse policy. The recovery process remains a “long, hard, slog” and the massive excess capacity in the global economy, especially  in developed countries suggests that interest rates will remain at ultra low levels for many months.

Some clues to central bank thinking will be seen over coming days as interest rate decisions in Australia, UK, and Eurozone move into focus. Although none of the Banks are expected to tighten policy it will be interesting to see whether the rhetoric becomes more hawkish. The RBA in particular will likely indicate that the room for further rate cuts has diminished. In Europe, following the very soft inflation data in July the ECB will be comfortable in its current policy settings.  In the UK attention will focus on the BoE´s asset purchase programme and the possibility of increasing purchases from the current GBP 125 billion, especially after the MPC surprisingly did not increase purchases at its last meeting.

Posted in central banks, Economics, Economy, Europe, Financial crisis, Interest rates, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

News flow to remain volatile

July 25, 2009 — Mitul Kotecha

In past posts I wrote that it will take positive news as opposed to less negative news to drive the rally in equity and credit markets forward.   Although I remain doubtful about the durability of the rally over coming months, there has been good news on the earnings front up until now, and equities have rallied strongly as a result.

Of the S&P 500 companies reporting Q2 earnings 74% have beaten forecasts.  Although there are still many companies scheduled to release earnings, if this pattern continues it would be the highest on record.  Data releases have also given reason for optimism even in Europe where manufacturing gauges and the closely watched German IFO showed some improvement.

Unfortunately, the news was not all unidirectional as Amazon and Microsoft spoiled the party somewhat with their below forecast earnings.  US consumer confidence dropped for the first time in 5 months according to the Michigan survey as rising unemployment in particular weighed on sentiment.  Meanwhile, in the UK GDP data revealed the severe and broad based nature of the recession.

The news flow will continue to remain volatile in the weeks ahead.  The bottoming out process for many economies will be drawn out and rising unemployment and tight credit will act to restrain consumers.  Banks will face spiralling defaults on credit cards and increasing loan delinquencies as some recent earnings have revealed.

Unlike past recessions emerging markets are leading the recovery, especially in Asia as recent data has revealed.  Nonetheless, unless the developed country consumer engine kicks back into life the sustainability of Asian and emerging market recovery remains in doubt.

It is telling that currency markets are not reacting too sharply to the recent positive earnings news.  On balance the usual losers, dollar and yen, in an environment of improved risk appetite, have come under pressure.  In contrast, risk currencies such as the Australian, NZ and Canadian dollars have strengthened. Other high beta currencies are also stronger. Nonetheless, for the most part currencies remain in well worn ranges and as liquidity thins further over summer, there appears to be little scope for new trends in FX markets.

I still favour some dollar resilience over coming weeks as renewed market doubts creep but this view is becoming increasingly difficult to hold.  The reality is that currencies will track equities, which in turn will be dependent on earnings.   If the current earnings trend continues the dollar will face even more pressure but not to the extent that it breaks out of recent ranges.

Posted in China, Currencies, Economics, Economy, US. Tags: , , , , , , , , , , . 1 Comment »
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