Fed pulls the trigger

December 19, 2013 — Mitul Kotecha

The guessing game is finally over as the US Federal Reserve took a major step away from the extremely easy policy conditions implemented since the financial crisis by tapering its asset purchases by USD 10 billion, split equally by reduced Treasury and mortgage backed securities purchases. Indeed the Fed finally put markets out of their misery but successfully massaged the market reaction.

The Fed is set to gradually reduce asset purchases over coming months, likely ending its QE program by late 2014. The decision was supported by most Fed officials but to soften the blow the Fed strengthened its forward guidance, helping equity markets to rally while encouraging the short end of the curve.

Conversely Treasuries came under pressure and yields rose, giving a boost to the USD. Markets are likely to digest the news well in the Asian session following the lead from US markets. Nonetheless, while the Fed decision was predicated on stronger growth, the decision will presage a competition for capital especially among emerging markets.

The biggest FX reaction unsurprisingly (given its greater sensitivity to US yields) came from USD/JPY, with the currency breezing past the 104 level. However, given that US yields have not pushed significantly higher in the wake of the Fed tapering decision the boost to the USD will be limited in the short term. Indeed, FX markets will likely digest the Fed news will little reaction both in major and emerging market currencies in the short term.

Further out, the prospects for contrasting policy stances between the Fed, ECB and BoJ imply that the USD will forge higher against the EUR and JPY as well as other major currencies. Meanwhile, highly correlated currencies with US Treasury yields, in particular in the emerging markets spectrum, including INR, TRY, and BRL, will be the most sensitive to an expected rise in US yields over the coming months.

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Running into resistance

December 18, 2013 — Mitul Kotecha

Currency markets will remain range bound today although many currencies appear to be running into resistance in the wake of recent sharp moves. For instance, GBP/USD has run into a wall and lost momentum following the release of softer than forecast UK November CPI data yesterday. Unless the UK jobs report and MPC minutes today are particularly strong, GBP/USD will remain capped around 1.6300.

Similarly EUR/USD will find it difficult to make much further headway although a gain in the German IFO survey will keep the currency pair supported around 1.3730. USD/JPY’s upside is being undermined by lower US yields but firmer Japanese equities are helping to keep the currency pair supported.

AUD faced yet more jawboning by RBA Governor Stevens attempting to talk the currency lower. Given that such comments are nothing new markets are beginning to discount them, with AUD/USD likely to consolidate above 0.8900.

Asian currency direction will be limited ahead of the Fed outcome too although lower US yields will give some relief. Overall, it remains a case of South East Asian FX underperformance versus North East Asia outperformance.

The exception is the INR which has outperformed so far this month but will face an obstacle in terms of today’s RBI policy decision. 25 bps hikes in the repo and reverse repo rates are widely expected in the wake of higher inflation readings but the INR will also have one eye on the Fed FOMC given that it is the most sensitive Asian currency to US yield movements as outflows from India’s bonds continue. INR will continue to remain capped against this background.

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What will the Fed do?

December 18, 2013 — Mitul Kotecha

Any market action today will be both tentative in terms of risk taking and limited in terms of direction, ahead of the Fed FOMC decision. Equities pulled back overnight while US Treasuries rose as markets tried to second guess what the Fed will do at its policy meeting. The USD meanwhile appears to have benefitted from some, albeit limited pre FOMC short covering amid thinning year end liquidity. Firmer data, especially in the US jobs market over recent weeks and the recent budget deal have raised the odds of tapering being announced tonight although a move in January still looks more likely.

Whether the Fed takes its foot off the QE pedal tonight or in January is probably a moot point however, as the bottom line is that tapering is very much going to happen and markets will need to adjust sooner rather than later. Ahead of the Fed decision there are some useful data releases on tap which may at least provide some direction including the December German IFO survey which is set to improve slightly, UK jobs data and the Bank of England MPC minutes. No change is likely to be revealed in terms of voting in the MPC minutes.

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JPY, EUR and GBP view

December 17, 2013 — Mitul Kotecha

It is highly unlikely that the Bank of Japan adjusts policy at its meeting later this week but further action next year remains likely. More importantly for USD/JPY will be the actions of the Fed this week and the subsequent move in US yields. US 10 year yields have struggled to sustain a move above 2.9% recently, reducing the yield advantage over JGBs and in turn pulling USD/JPY back from its highs.

It is only a matter of time before US yields resume their uptrend and in this respect the outlook remains for more USD/JPY upside. Nonetheless, I am cognisant of the large short (CFTC IMM) JPY position in the speculative market, which into year end suggests plenty of scope for position squaring and short USD covering.

The EUR is set to end the year on firm note but further upside looks limited and the risk / reward favours selling the currency from current levels. Although economic data reveals continued improvement as reflected in the flash Eurozone composite purchasing managers’ index yesterday, much in terms of recovery expectations is in the price.

While a strong basic balance (current account + FDI + portfolio flows) continues to underpin the EUR I do not expect this to persist. Nonetheless as many bears have found out the EUR is a difficult currency to sell and while EUR/USD is likely to increasingly struggle on its approach to 1.3800, any sell off will not be rapid unless the ECB belatedly adopts a more aggressive monetary policy stance.

Like the EUR, GBP is struggling to push higher, as profit takers emerge and a dose of reality sets in given the magnitude of its rally versus USD over recent months (around 10% since July). The rationale for GBP’s gains are clear; surprisingly good economic data and a reassessment of monetary policy implications. However, GBP bullishness has resulted in net long speculative positions reaching their highest since 15 January 2013.

Further GBP gains will require yet more positive economic surprises but this is unlikely to be delivered in the jobs data, inflation data and Bank of England MPC minutes over coming days. Consequently GBP/USD is unlikely to extend gains above 1.6300 in the near term.

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A lot to get through before year end

December 16, 2013 — Mitul Kotecha

As the end of the year nears markets will still need to get through a heavy week in terms of events and data releases before winding down. The main event is the Federal Reserve FOMC meeting on Tuesday and Wednesday and trading direction is likely to be limited ahead of this. There remains a considerable degree of uncertainty about the timing of Fed tapering, with most market participants split between this week and January 30th. We see a one in three chance of Fed tapering beginning this week, with our bet on a January move.

There are also plenty of US data releases on tap including the December Empire manufacturing and Philly Fed surveys, industrial production, CPI inflation, Q3 current account balance, housing starts, existing home sales and Q3 GDP this week. The data will be mixed with manufacturing surveys showing little improvement, home sales declining while in contrast GDP will be revised higher and industrial production will reveal a decent gain.

In Europe there is also plenty to digest amid thinning market liquidity. The final EU summit of the year on 19-20 December will focus on the steps towards banking union while Eurozone flash manufacturing and confidence purchasing managers confidence indices to be released today will show some, albeit limited improvement. Further gains in the German ZEW investor confidence and IFO business confidence surveys are likely to be recorded in December although the surveys are unlikely to match the pace of recent gains.

The UK will also reveal further economic clues in the form of the CPI inflation, jobs data and Bank of England Monetary Policy Committee (MPC) minutes. In particular, the minutes are unlikely to reveal any urgency to change policy despite the faster than anticipated drop in the unemployment rate. In terms of central banks the Bank of Japan is set to leave policy unchanged given recent the progress on inflation while the Reserve Bank of Australia (RBA) minutes will reveal further focus on the strength of the AUD.

The intense focus on the Fed means that there will very limited market movements until after the outcome of the meeting. It is unclear whether the recent slippage in US equities has been due to renewed nervousness about Fed tapering or simply year end profit taking. Either way, a delay in Fed tapering may provide some, albeit limited relief to risk assets.

The USD will benefit if tapering is announced this week, but much will depend on what US bond yields do. Recent moves in currency markets are looking increasingly stretched, with EUR and GBP failing to build on their recent gains, while USD/JPY is also struggling to move higher. This may continue over coming days as FX market activity thins further.

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