Euro resilience

August 27, 2013 — Mitul Kotecha

The disappointing reading for US July durable goods orders released yesterday following on from the surprisingly large drop in new home sales at the end of last week has added further uncertainty about the timing of Fed tapering. Although the next meeting in September remains most likely as reflected in various Fed comments over the weekend it is by no means a done deal.

US Treasury yields slipped in the wake of the data but equities failed to sustain gains as Syria tensions escalated a factor that could cast a shadow over risk assets today, with rhetoric in the US strengthening and expectations of action growing. Further US data disappointment is likely today, with the August consumer confidence survey set to decline in contrast to a likely increase in the German IFO business confidence survey.

EUR resilience has been impressive over recent weeks. Despite all efforts at trying to sell the currency, investors have has their fingers burned. Today is also not a day to sell EUR. Although the growth trajectory looks firmer in the US, the propensity to surprise in a positive direction has come from Eurozone data releases.

Today expect a further positive surprise, with a likely further rise in the IFO German business survey which will contrast sharply with the drop in headline July US durable goods orders. It’s not all bullish for EUR, however. Technical indicators suggest that upside EUR/USD momentum is fading while Greek jitters could return as the Troika returns on September 16. Moreover, speculative market EUR positioning has risen to its highest since early February, leaving no more scope for short covering.

Although USD/JPY has crept higher over recent weeks it is still a long way off the 22 May high of 103.74. JPY bears have not yet given up hope, with JPY short positioning at around its 3-month average. Nonetheless, despite the rise in US Treasury versus Japanese JGB bond yield differential USD/JPY has failed to budge. Although this is likely to be a temporary phenomenon, yield differentials are clearly not impacting USD/JPY at present.

Eventually, the widening yield gap between the US and Japan will see increased capital outflows from Japan. Perhaps more details about Prime Minister Abe’s third arrow of reforms will prompt some downside for the JPY but unless risk appetite improves markedly it is unlikely that the JPY will fall far in the near term.

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Respite for Asian currencies

August 26, 2013 — Mitul Kotecha

Pressure on policymakers in developed economies to orchestrate more predictable exits from unconventional monetary policies has intensified as reflected in comments at the Jackson Hole symposium the wake of the intense volatility in emerging market assets over recent weeks. While it is unlikely that a crisis is looming there is no doubt that mixed messages and lack of clarity over exit policies is having a demonstrable impact on EM assets.

Such clarity is unlikely to come this week. However, a pull back in core bond yields from recent highs will likely contribute to a calmer tone to markets at the turn of the week and some further near retracement in a positive direction for risk assets. Whether this lasts will depend on the clarity of the message from central bankers and in this respect speeches by four Fed officials over coming days, ECB’s Weidmann today and BoE governer Carney on Wednesday, will be scrtutinized.

The data slate is not particularly heavy but looks skewed towards relatively more positive Eurozone releases. In the US a likely drop in July durable goods orders today and pull back in consumer confidence tomorrow will provide little support to US asset markets including the USD while the trend of positive data surprises in Europe including likely gains in August economic sentiment indices and German IFO will add further evidence that growth will turn positive in Q3.

In Japan labor market data will reveal relative strength, with a low unemployment rate, helping to support the consumer. Inflation is set to rise further too, suggesting that policy measures are garnering some success. However, the upward trend in inflation is by no means guaranteed and ultimately renewed aggressiveness on the JPY will be needed as inflation tops out.

How will this leave currency markets? The USD is likely to continue to fare poorly against the EUR and GBP especially given the less than impressive data releases expected this week while the JPY is likely to remain on the back foot, pressured in part by firmer risk tone.

On the Asian currency front, further short term retracement is likely, especially for those currencies that have been beat up the most, namely INR and IDR. However, gains will likely prove limited, with tapering concerns and capital outflows showing little sign of reversing. Additionally, a likely disappointing Q2 GDP release in India at the end of the week will be unhelpful for the INR.

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The “Great Rotation”

July 22, 2013 — Mitul Kotecha

Evidence that the “Great Rotation” is finally beginning to take place has been established. Capital is finding its way into US equities as reflected in recent flow data while flooding out of Treasuries and other fixed income instruments. However, another rotation of sorts is also taking place, with emerging market assets, both bonds and equities, continuing to register outflows much of which appears to be returning to the US.

Given that the Fed has helped to ease the transition process towards tapering, finally managing to establish effective communication with markets, there is little to suggest that this rotation will reverse. Indeed, the US equity risk premium remains high (ie bonds still look expensive relative to equities) despite the recent correction. Nonetheless, US bond yields pulled back last week (10 year yields have fallen by around 15 bps over the last two weeks) a factor that is also helping to take the wind out of the USD’s sails.

Events and data this week are unlikely to alter the dynamics noted above. US data will remain upbeat, with housing market data remaining positive; existing home sales will edge higher while new home sales will drop but largely due to low inventories, while durable goods orders will register solid gains, and Michigan consumer confidence will be revised higher.

Data in Europe will look less impressive but still encouraging as the German IFO and various purchasing managers’ indices record gains, albeit of an uneven nature. More distressing is the ongoing political travails in Spain, Portugal and Italy, factors that will likely continue to undermine Eurozone markets although EUR/USD will likely remain supported due to the recent softening in US yields.

In Japan, the political picture is now clearer, with an unsurprisingly solid election victory for Prime Minister Abe’s LDP, winning a majority in the Upper House with its partner New Komeito. Ultimately this should play for firmer Japanese assets and a weaker JPY although markets will now look for a clear reform strategy to justify such moves.

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Asian FX on the back foot

July 19, 2013 — Mitul Kotecha

Sentiment remains upbeat, if not a little subdued as thin summer conditions kicked in. US and European equities rose overnight while 10 year US Treasury yields moved back above 2.5% and the USD continued its grind higher, especially versus JPY ahead of looming Japanese Upper House elections this weekend. A combination of the ongoing impact of Fed Chairman Bernanke’s testimonies to Congress (note he added a little more to his dovish spin in the Q&A session to the Senate Banking Committee yesterday calling tighter financial conditions “unwelcome”), firmer US Q2 earning and positive economic data surprises, have shored up confidence.

This was reinforced by the decision by Moody’s ratings agency to raise the outlook on the US AAA rating from negative to stable. On the earnings front US banks in particular have beaten forecasts while in contrast tech heavyweights disappointed after the close last night, suggesting that sentiment may weaken in today’s session. Additionally news that the US city of Detroit filed for bankruptcy will act to partly counterbalance the positive ratings news. In Europe, firmer UK retail sales and a strong Spanish debt auction boosted sentiment. There is little on the data front today, suggesting a generally flat end to the week.

Against the background of a move higher in US yields and a firmer USD especially versus JPY, Asian currencies generally remain on the back foot, with losses registered overnight. India’s attempts to stem the drop in the INR are having a diminishing impact on the currency, with USD/INR edging back towards the key 60 level. The good news is that capital outflows from the region have been stemmed, with month to date equity inflows of $311 registered. However, this belies the fact that India, Indonesia and to a lesser extent South Korea continue to register outflows.

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USD softens on Bernanke, GBP firm, AUD oversold

July 18, 2013 — Mitul Kotecha

Fed Chairman Bernanke did not deliver anything particular new in his testimony yesterday but still managed to provide further reassurance to markets. The Fed chief noted that asset purchases are not on a preset course while highlighting that ‘tapering’ will only occur if economic data warrants it. His concerns about high unemployment and very low inflation emphasized the Fed’s commitment to easy policy settings.

Assisted by a weaker than expected housing starts report bonds liked what they heard, with 10 year Treasury yields dropping below 2.5% while equities rallied and the USD softened. Gold struggled however, failing again to break above USD 1300 and settling back into its USD 1270-1300 range.

Overall, Bernanke’s comments remain consistent with tapering beginning later this year, most likely in September. He will repeat the testimony to the Senate Banking Committee today but markets will look for further clues in the Q&A session.

The positive tone will likely creep into Asian trading today in the absence of other key market drivers, with the USD likely to be restrained against both major and Asian currencies although Asian currencies may struggle given the IMF’s more cautious comments on Chinese growth in which they highlighted the growing downside risks to their growth forecast.

GBP/USD has registered a solid recovery since its recent low just above 1.48. Helped by a hawkish surprise in the Bank of England MPC minutes in which the vote was 9-0 to maintain current monetary settings as new governor Carney managed to unite the MPC view, GBP looks well supported in the days ahead.

What’s surprising is the lack of GBP progress against the EUR especially given the relative outperformance of UK economic data recently and prospects of strengthening momentum into H2 13. Given the potential for alternative monetary policy instruments in the months ahead some caution on GBP may be warranted.

Nonetheless, as GBP is positioned short versus both EUR and USD, its downside looks limited and if anything it will register gains versus EUR. Today’s retail sales may be a risk, but any set back to GBP is likely to prove temporary.

A lot of bad news is already priced into the AUD and sentiment has become overly bearish even if Australia’s government and central bank would prefer to see further currency weakness. There is a risk of an AUD rally in the event of better economic news given that market positioning has become extremely short (close to the all-time low).

A combination of improving risk appetite, renewed search for carry, stabilization in commodity prices and reasonably strong growth in China will eventually help to spur the AUD higher. Clearly there are risks to AUD as the transition process to Fed tapering and higher US yields takes effect but assuming that US yields move gradually as opposed to rapidly higher it is unlikely to stand in the way of an AUD recovery.

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