JPY retracement, AUD restrained

January 8, 2013 — Mitul Kotecha

Equity markets looked more restrained overnight as the sharp rally so far this year stalled ahead of the US Q4 earnings season which kicks off with Alcoa earnings after the close today. The looming budget battle in the US has also prompted some hesitancy to buy risk assets.

Direction will remain limited given the notable absence of first tier data releases today, with only Eurozone economic sentiment gauges, German factory orders, US small business confidence and consumer credit on tap. The bulk of releases are due in the later part of the week including rate decisions from the ECB and BoE.

For a currency that spent most of last year trapped in a relatively tight the JPY has lost an incredible amount of ground (12.7%) versus USD since the beginning of October 2012. The historically strong relationship between bond yield differentials and USD/JPY has broken down (albeit temporarily in my view), and cannot be used to explain the jump in USD/JPY.

Expectations of more aggressive monetary policy action have pushed USD/JPY higher especially as Prime Minister Abe continues to highlight his desire for a 2% inflation target. Nonetheless, as wires report today there may be no deadline for achieving this target a factor which may help USD/JPY to push lower in the short term. USD/JPY is likely to find some support around 86.54 (Jan 2 low). Speculative positioning in JPY has become increasingly short but notably is a long way from the all time low, suggesting scope remains for an eventual increase in JPY shorts.

AUD/USD has made an impressive recovery from its lows around 1.0344 at the end of last year. Risk appetite and the USD index both register a limited and insignificant correlation with AUD/USD suggesting that the currency will not be influenced by either over coming weeks. Yield differentials however, remain important and the widening of Australia 2 year yield differentials with Treasuries has provided important support for AUD.

Further upside in the currency will require Australian yields to move higher and this may in turn depend on the outcome of November retail sales data tomorrow but 2 year yields have hit trend line resistance suggesting that the AUD will struggle to move higher from current levels. AUD/USD 1.0585 will offer strong resistance, while my quantitative model suggests AUD/USD short term fair value around 1.0557.

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Highlights this week

December 10, 2012 — Mitul Kotecha

Better than expected Chinese data over the weekend, speculation that Greece is close to reaching its debt buyback target and even some signs of progress in reaching a resolution to avert the fiscal cliff set up risk assets for a generally positive start to the week. Talks between the administration and senior Republicans will continue this week but it appears that some senior Republicans are willing to give up their objections to tax hikes on the very wealthy.

The November US jobs report released at the end of last week which revealed a 146k increase in payrolls and a drop in the unemployment rate to 7.7% is likely to have little influence at the turn of the week. The report was met with a muted reaction. While on the face of it the data was better than expected, downward revisions to past months and a surprising lack of impact from Hurricane Sandy left markets somewhat perplexed.

However, not everything is rosy. Last week’s sharp downward growth revisions to Eurozone growth by the European Central Bank (ECB), a plunge in US consumer sentiment and comments from Italian Prime Minister Monti that he intends to resign will cast a shadow over markets, restraining any upside.

Although activity will likely continue to thin as holidays approach there is still plenty too chew on this week. In the US the Fed is set to continue purchasing USD 85 billion of longer dated securities following the end of Operation Twist but this should come as little surprise to the market and therefore will yield little reaction. There will be some encouraging news on the consumer as retail sales bounce back in November.

Across the pond the European Council meeting beginning on Thursday will be in focus, with banking union and bank recapitalisation among the topics up for discussion. Given the hint of monetary easing by the ECB markets will scrutinise upcoming data for the timing but a likely increase in the German ZEW investor confidence survey in December and stabilisation in the Eurozone composite purchasing manager’s index will not prove compelling enough to warrant an imminent rate cut.

Elsewhere in Japan the upcoming elections will mark the highlight of the calendar over the weekend although the weaker than expected Q3 GDP reading this morning (-0.9% QoQ) and expected deterioration in the Tankan survey later in the week will maintain the pressure for more aggressive policy action and a weaker JPY.

EUR took a hit from the ECB’s dovish stance last week and will not take too kindly to the news of Monti’s intended resignation after the fiscal 2013 budget in Italy. EUR/USD 1.2880 still marks a solid support level for the currency.

USD/JPY continues to probe higher but extreme short market positioning will likely limit the ability of the currency pair to push higher. On the topside 83.15 will market strong resistance for the currency pair.

AUD and NZD look generally well supported, with Chinese data over the weekend giving further support although for AUD/USD 1.0519 will continue to act a tough technical barrier to crack.

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JPY hit by politics, AUD losing ground

November 15, 2012 — Mitul Kotecha

A total solar eclipse as seen in Australia yesterday portends to a shift in market trends. Whether this is borne out by actual market movements is debatable as the major themes underlying investor psyche continue to dominate. First and foremost is the US fiscal cliff and the potential lack of resolution to this issue. Notably US and European equities slipped overnight as hopes/expectations of a solution by the end of the year continue to fade ahead of discussions between US politicians tomorrow.

In Europe, lack of progress in Spain and Greece are resulting in Eurozone peripheral bond yields creeping higher while safe haven demand continues to support core bonds. Geopolitical tensions increased following Israeli air strikes in the Gaza strip, helping to prop up oil prices. The USD remains supported against this background, but notably has failed to make much progress over recent days. All of this is not conducive to a positive environment for risks assets and as fiscal cliff talks are awaited a cautious tone is likely to permeate trading today.

The JPY took a hit following news that Japan’s Prime Minister Noda may dissolve parliament on November 16, paving the way for fresh elections. The JPY’s drop was not attributable to political uncertainty but rather the prospects that a likely opposition led LDP victory in any new election would likely lead to a more aggressive stance on policy, putting more pressure on the BoJ to ease.

USD/JPY has broken back above the 80.00 level but is susceptible to a renewed drop given the decline in US bond yields relative to Japanese bond yields. Moreover, risk aversion has intensified over recent weeks, providing another prop to the JPY. However, worsening economic news means that official pressure for JPY weakness will be maintained and regardless of the elections the BoJ has a lot further to act over coming months.

AUD extended its rally since the RBA kept policy on hold last week helped by better domestic and external data (especially in China). However, the currency has looked more vulnerable this week and my quantitative model estimates for AUD/USD and AUD/NZD highlight that AUD is looking increasingly overbought in the short term. While the models do not yet have a high conviction sell signal I suggest beginning to offload long positions around the 1.0400 level versus USD, playing for a short term pull back in the currency.

Any pull back will likely be short lived, but nonetheless, it will in my view provide better entry levels for investors looking to build medium term long positioning in AUD. Supporting my assessment is the fact that long AUD speculative positioning (IMM) is back at multi week highs, leaving the currency vulnerable to profit taking.

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USD bounces back, JPY to strengthen, AUD rallies

November 8, 2012 — Mitul Kotecha

To put it mildly there was plenty of volatility in the wake of the US elections. Equities reacted badly as the prospects of higher taxes as part of a solution to resolving the fiscal cliff in the US came back into the frame. worries outweighed any positive impact from the potential for Fed QE to continue in its current form without the risk of being curtailed by Republican President.

Poor data out of Europe contributed to the market malaise as the growth trajectory into Q4 continued to worsen. The passage of Greek austerity measures through parliament failed to undo the damage. German industrial production fell sharply, down 1.8% MoM while downward growth revisions / upward deficit revisions from the European Commission dealt another blow to sentiment.

Growing pressure on the German economy may at the least prompt a more dovish stance at the European Central Bank (ECB) meeting today while the Bank of England (BoE) is set to increase its asset purchases today although it will be a close call on this front.

The USD came under pressure in the immediate aftermath of US President Obama’s victory. However, it didn’t take long for the usual higher risk aversion, stronger USD relationship to kick in, with the USD subsequently reversing all its losses and more. With elections out of the way markets are waking up to the reality of the considerable challenge ahead in resolving the fiscal cliff. Risk assets clearly don’t like what they see.

As only September US trade data and November Michigan confidence are left on the US calendar this week risk gyrations will continue to drive the USD though I suspect that gains will be restricted in the wake of lower US bond yields.

Most currencies except the JPY took advantage of a weaker USD but finally USD/JPY dropped on the back of the jump in risk aversion. The drop in US bond yields and the output of my quantitative models both suggest that the JPY should be firmer against the USD. The recently more aggressive stance of the Bank of Japan taken together with warnings of FX intervention may be helping to keep the JPY on the back foot, however.

Given that speculative JPY positioning has turned negative over recent weeks the BoJ’s stance maybe having some impact in shifting FX expectations especially as it has fuelled some portfolio outflows from Japan over recent weeks. Nonetheless, it won’t take long for JPY bears to become frustrated with the lack of downside traction in the currency, with USD/JPY subsequently set to edge back towards the 79.00 level

Stronger than expected Australian jobs numbers helped to boost the AUD this morning. Jobs were up 18.7k in October much more than consensus. Even better was the details of the report, with full time jobs up 18.7k and part time down 8k. The unemployment rate was at 5.4%, lower than expected. Overall, a solid report and in stark contrast to NZ jobs data this morning. The data will certainly give more juice to AUD/NZD and corresponds with my quant models looking for NZD downside and AUD resilience. The data will also likely dampen further expectations of another rate cut by the RBA in December which in any case looks like a close call.

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Negative yields hit the euro

November 6, 2012 — Mitul Kotecha

Market participants will be distracted by today’s US Presidential election and Thursday’s transfer of leadership in China. The USD seems to be enjoying strength despite a slight lead in the polls by President Obama. The consensus view is that a Romney win would be USD positive given that it may imply a more restrictive Fed in the form of less QE but the USD appears to be ignoring such polls.

The EUR is the worst performing currency so far this month after the CHF. Greek and Spanish concerns are placing a growing weight on the EUR the former due to tomorrow’s vote on austerity measures and the latter due to worsening economic data and a lack of traction towards requesting a bailout and thus activating the European Central Bank’s bond purchase program.

A massive weight on the EUR is the fact that Germany 2 year bond yields have turned negative, leading a widening US yield advantage and in turn a weaker EUR/USD. Indeed, the correlation between 2 year US – German yield differentials is very high, implying that the EUR will struggle below its 200 day moving average around 1.2828 until German yields push higher.

A generally firmer USD has also dealt a blow GBP, with the currency slipping below 1.6000. Notably GBP is holding up well against the EUR. Industrial and manufacturing production data today will give some direction to the currency but the news is unlikely to be positive, with a further sharp decline expected in September.

Thereafter attention will swiftly turn to the Bank of England policy decision on Thursday, where the decision will be a close call but we look for an additional GBP 25 billion in asset purchases to be announced. GBP could face some pressure in this event but given that the currency not been particularly impacted from QE in the past, we doubt that it will suffer a severe blow. However, the BoE action may help to stem the decline in EUR/GBP, with support seen around 0.7956.

AUD has lost some steam this week as speculative longs have been cut back ahead of the RBA policy decision. The pull back has largely to do with a generally firmer USD, some deterioration in risk appetite and lower commodity prices than any shift in policy expectations, however.

The market is pricing in around a 50% probability of a rate cut today Given that this is not fully priced in, the AUD is vulnerable in the wake of a rate cut. However, much will depend on the accompanying statement. Given that recent domestic and Chinese data have been a bit more encouraging we doubt that the statement will be particularly dovish, suggesting that downside risks to AUD will be limited to technical support around 1.0305 versus USD.

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