US dollar grinding higher

July 16, 2013 — Mitul Kotecha

As markets await Fed Chairman Bernanke’s semi-annual testimony to Congress over the next couple of days, sentiment has become relatively upbeat. Risk measures have shown improvement over recent weeks as reflected in gains in equity markets and the fall in the VIX ‘fear gauge’. Central banks have done a good job in massaging market fears over higher yields by implementing “forward guidance” and even in the US Treasury yields have fallen although 10 year yields look well supported above 2.5%.

Meanwhile, Q2 GDP data in China yesterday came in as expected revealing less of a slowdown than perhaps feared, while Q2 earnings in the US have for the most part have beaten forecasts so far. There is little to suggest that this tone will change even with a plethora of data releases scheduled for release today. The next trigger for market direction will come from Bernanke’s testimony.

A surprisingly weak reading for US June retail sales failed to take the shine off the USD. A spate of US data releases are on tap today including June CPI inflation, June industrial production and July NAHB housing data as well as the May TIC capital flow data. I do not expect the data to divert the USD’s path.

Given that there has been much talk that capital has been flowing to the US as US yields rise, the TIC data will be quite instructive given that US yields began their heady ascent from early May. Net long term capital flows into US portfolio assets have been negative for the previous three months and Treasuries registered major outflows in April. The USD is likely to continue to grind higher over coming days despite further revelation of capital outflows.

EUR/USD appears to be stuck around the middle of a relatively broad range at present. The build up of negative news including Portuguese political uncertainty, downgrade of France’s credit ratings, and corruption allegations in Spain among other factors, threatens to pressure the EUR lower. However, as has been the case over past months the EUR has managed to reveal an impressive resistance or “Teflon” coating to bad news.

Nonetheless, weak growth and a relatively strong move higher in US Treasury yields relative to German bunds recently suggests that downside risks to the EUR will dominate. A small gain expected in today’s release of the July German ZEW survey will do little to change this perspective.

I retain a bearish JPY stance but the move is not going to be a one way bet. Volatility will remain elevated especially ahead of Japanese Upper House elections. Prime Minister’s Abe’s LDP is likely to win but markets will be more interested in Abe’s reform program.

JPY positioning has become increasingly JPY short over recent weeks but does not look particularly stretched suggesting further scope to build JPY shorts. Fed policy expectations will drive USD/JPY, with a renewed relative increase in US yields required to push USD/JPY sustainably above the psychologically important 100 level.

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Markets taking their cue from China data and Bernanke

July 15, 2013 — Mitul Kotecha

After having been on the road visiting clients across Asia over the last two weeks the overall tone to markets feels slightly better than when I left. Risk appetite is improving as central banks attempt to dampen the spike in yields, by initiating “forward guidance”. On balance, markets appear to be making the volatile transition to Fed tapering with less angst than a couple of weeks back.

Despite the confusion over China’s GDP growth target the tone at the start of the week is positive. China’s Q2 GDP slowed compared to Q1 coming in at 7.5% YoY from 7.7% previously but arguably last week’s comments by China’s Finance Minister that China was targeting growth of 7% (later revised in to 7.5%) had arguably done a good job in guiding market expectations lower. In the event the market reaction to the Q2 GDP release was limited.

Aside from China’s data, markets have taken their cue from Fed Chairman Bernanke’s dovish comments last week when he noted that policy will remain “highly accommodative” for the “foreseeable future”. Discomfort at the sharp rise in US Treasury yields will have played a part in spurring such comments, with the net impact being one of improved risk appetite.

Further clarification from Bernanke will be sought during his semi-annual monetary policy report to Congress mid week although he is unlikely to diverge from his recent comments. Nonetheless, US yields and the USD will likely creep higher over coming days helped by firmer data including the June retail sales report today.

Eurozone markets will have little on the data front to digest aside from the German July ZEW survey this week, leaving the fragile state of Portuguese politics in the spotlight. Potential for fresh elections remains a distinct possibility although discussions over forming a new government will continue this week. Overall, this would suggest some underperformance of Eurozone markets and the EUR over the coming days.

In the UK the release of CPI inflation data in June and Bank of England MPC minutes will garner most attention. Inflation is likely to have pushed through the 3% threshold, requiring new governor Carney to write a letter to the UK Chancellor Osborne explaining the reasons for the rise in inflation pressures. Meanwhile the MPC minutes will take a slightly more hawkish stance, with a 7-2 vote expected as Carney will most likely have sided with the majority unlike his predecessor. Against this background GBP is set to gain some ground, especially against the EUR.

Asian currencies made up some ground following the Bernanke inspired drop in the USD last week but given that the region continues to suffer from equity portfolio outflows gains will be difficult to hold over coming days. Nonetheless, the good news is that the haemorrhaging in capital flows to the region has diminished, with only USD 73.6 million in equity outflows from Asia registered month to date.

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US dollar buoyed by higher yields, Asian currencies hit

July 8, 2013 — Mitul Kotecha

Efforts by the European Central Bank and Bank of England to disassociate themselves from Fed policy actions were overwhelmed by the US June jobs report which revealed a bigger than consensus 195k increase in payrolls and upward revisions to previous months. The data reinforced expectations that the Federal Reserve would begin tapering in September while the data also pushed US yields sharply higher (close to 23 basis points increase in US 10 year yields following the data) and fuelling further USD strength.

In fairness attempts by the ECB and BoE to introduce ‘forward guidance” may eventually garner some success but US yields will continue to dictate market direction, at least until the markets successfully transition to the reality of Fed tapering, which could take several weeks. During the interim expect transitional volatility to continue, with risk assets globally remaining under pressure.

Further detail on Fed policy will be looked for from within the minutes of the June FOMC meeting to be released on Wednesday although it is unlikely that there will be any real divergence from the message delivered by Fed Chairman Bernanke and a host of other Fed officials over recent weeks. Consequently the USD is likely to retain a broadly firm tone as it reacts to the sharp move higher in US yields at the end of last week.

The Bank of Japan will likely be emboldened in its ultra easy monetary policy stance following last week’s ECB and BoE announcements although no further policy action is likely at this week’s meeting as attention shifts to Japan’s Upper House elections on 21 July. The JPY in particular will remain susceptible to USD strength and widening yield differentials, with potential to test USD/JPY resistance around 102.45 this week.

European attention will centre on Greece and Portugal as the former will be the focus of discussions at the Eurogroup / Ecofin meetings today and tomorrow, with officials set to deliberate Greece’s bailout. Attempts in Portugal to resolve political differences between the main coalition parties appears to have garnered some success in a deal which could stave off fresh elections. None of this will help the EUR which is set to remain under pressure as it edges towards support levels at 1.2744 versus USD.

USD strength will also continue to be exhibited versus Asian currencies this week. Equity fund outflows continue to damage regional currencies lower. Since the end of May Asia has recorded around USD 15.4 billion in equity outflows. Total inflows this year have dropped to only around USD 3.6 billion. A renewed fall in the JPY will added pressure to more JPY sensitive currencies such as TWD and KRW but the overwhelming influence is higher US yields and capital outflows which will continue to have particularly negative impact on currencies with external funding needs, especially the INR and IDR.

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Australian dollar unworried by political developments

June 27, 2013 — Mitul Kotecha

The USD remains firm but is struggling to make further headway against major crosses. Some improvement in risk appetite, firmer equity markets and slightly lower yields today may limit the ability of the USD to extend its gains in the near term (as the USD usually suffers when risk appetite improves and US yields drop) although we expect any setback to prove temporary, with US Treasury bond yields set to continue to move higher over the coming weeks, albeit at a more gradual pace.

USD/JPY’s rebound has stalled over recent days despite the fact that US bond yields have continue to rise relative to Japanese JGB yields. My analysis of JPY performance during the last thee periods of sharply higher US yields shows that the JPY weakened versus USD in the first two periods and is on the verge of doing so in the third period (since early May).

Additionally the JPY has maintained a strongly negative correlation with US yields over the past 12 months. All of this suggests that the JPY will resume a weaker trend over coming weeks although markets may wait until the Japanese Upper House elections on July 21 and subsequent news of further reforms before pushing the JPY much weaker.

It if wasn’t enough that the AUD was suffering from higher US yields and China concerns, the announcement of a leadership election for the Labor leadership will have done little to bolster confidence in the currency. That said, politics is not an important driver of the AUD and the currency managed to eek out some gains despite Prime Minister Gillard’s loss in the contest.

Some easing in funding tensions among China’s banks has helped the AUD, with the currency showing encouraging signs of stabilization over recent days. However, its limited progress is still a long way from becoming a sustained rally. AUD/USD has a very negative correlation with 10 year US Treasury yields over the past 3 months, and continues to remain susceptible to further US yield increases until the market finally becomes accustomed the prospects of Fed tapering.

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Equity outflows from Asia accelerate

June 26, 2013 — Mitul Kotecha

A slate of better than expected US data releases including May durable goods orders, new home sales and June consumer confidence data (the latter two releases reaching their highest levels since 2008) helped to boost risk appetite, spurring equity markets higher and the VIX ‘fear gauge’ lower.

Firmer US data came alongside soothing comments from China’s central bank PBoC, about liquidity conditions in the banking sector, with an official noting that it will keep money market rates at “reasonable levels”. The European Central Bank’s Draghi added to the fray by noting that Outright Monetary Transactions (OMT) was even more essential now, highlighting the ongoing backstop provided by potential ECB peripheral bond purchases.

Meanwhile the positive US data releases helped to push Treasury yields higher, with the 10 year yield breaching 2.6%. Commodities remained under pressure, with higher yields in particular weighing on gold prices.

The calendar is rather light today and will provide little market direction, with an Ecofin meeting in Europe, UK spending review and US Q1 GDP revision in tap. Expect some positive follow through from the firmer tone to European and US equities overnight which will support risk assets including EM currencies although concerns about tapering are from over.

The rout in equity markets over recent weeks has had a devastating impact on equity flows to Asia. The outflow of equity portfolio capital from Asia accelerated sharply over June. Month to data Asia has recorded $10.2 billion in outflows, a massive move out of the region given that total inflows year to data have now dropped to $8.7 billion. One more month at this pace of outflows would see Asia registering net outflows for the year.

Indonesia, South Korea and Taiwan have been hit the most over June but no country has recorded net equity inflows. Year to date India has registered the strongest equity inflows of $14.7bn while South Korea has registered the biggest outflows of $7.3bn.

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