USD under pressure, AUD resilient

October 17, 2012 — Mitul Kotecha

Risk assets registered further gains in the wake of speculation that Spain is close to requesting aid and stronger than forecast US Q3 earnings and economic data. US earnings have beaten expectations at 73% of the 48 companies reporting while US industrial production rose by a bigger than expected 0.4%. Meanwhile German resistance to a full Spanish aid appears to be crumbling as the door opens wider to a formal Spanish request for a credit line.

Additionally German data was a big more encouraging as the German ZEW investor confidence survey recorded its second straight monthly gain. Aside from rallying global stock markets the Baltic Dry Index continued its ascent and even gold prices showed some stability around the $1750 level. There is little to distract from the more positive market tone today, with US earnings and the EU Council meeting in focus.

The USD has come under renewed pressure as risk appetite improves. Firmer US data has contributed to improving risk appetite which in turn would usually be expected to weigh on the USD. However, better data may also act to lessen expectations of the magnitude of Fed QE, which should play positive for the USD. This is the theory but in practice the USD relationship with risk aversion has slipped while a lot of QE expectations were already built into the currency.

I don’t see the pressure on the USD intensifying much further. Conversely the EUR remains very well supported as hopes grow of a Spanish request for bailout funds. I believe expectations of concrete action at the EU Summit beginning tomorrow are overdone, with significant decisions on Spain and Greece only likely in November. EUR/USD will struggle to break above resistance at 1.3180.

AUD bears failed to garner support yesterday as the currency easily overcame a blip lower in the wake of the RBA minutes yesterday. While sounding dovish there was little new in the minutes, with no fresh information on future policy actions. In any case markets have already priced in further easing at the 6 November RBA meeting suggesting little further risk to the AUD. Following its failure to build on any downside momentum AUD/USD looks set for a test of resistance around 1.0404, consistent with the upside signal from my quantitative model.

One impediment to AUD gains is the fact that speculative market positioning remains long. However, positioning is now much lower than its three-month average and well off its recent highs suggesting that there is less likelihood of a further bout of profit taking or position squaring. Reduced long positioning will allow the AUD to recoup some lost ground.

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Spain downgraded

October 11, 2012 — Mitul Kotecha

Pressure on Spain has intensified in the wake of a two notch downgrade to the country’s debt to just one notch above junk at BBB-. S&P cited “the significant risks to Spain’s economic growth and budgetary performance, and the lack of a clear direction in euro-zone policy”. The slow progress towards a sovereign bailout for Spain will have likely played a role in the decision, a factor that is also weighing on general market sentiment. The debt downgrade may on the margin increase the pressure on the Spanish government to request a formal bailout.

Nonetheless, risk assets including peripheral Eurozone bonds do not appear particularly stressed although it may only be a matter of time before pressure escalates. Italian bond supply today may give some further direction on this front. US Q3 earnings will have some bearing on sentiment too as concerns have grown that they will disappoint. With little on the data front (highlights include Eurozone country September inflation and US trade data) attention will focus on comments from the IMF meetings against the background of growing global growth worries.

Against this background the EUR is likely to continue to drift lower, with the currency set to test support just under the 1.2800 level AUD will have got a boost from the relatively positive September jobs report released this morning, which revealed a 14.5k increase in employment. The positive impact may slightly be mitigated by a rise in the unemployment rate to 5.4% from 5.3%, which also gives further evidence supporting the RBA’s recent rate cut. The data will at least help to alleviate some of the concerns about the jobs market following last month’s surprise drop in employment. My preference is to play AUD via going long positions versus EUR.

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USD buffeted, JPY firming, AUD risks receding

October 9, 2012 — Mitul Kotecha

A lacklustre day for equity markets yesterday saw many indices close lower and risk aversion edge higher, with the VIX ‘fear gauge’ being a prime mover, Some encouraging signs for global activity continue to emerge from the rise in the Baltic Dry Index but market growth fears remain high. Attention remains firmly focussed on events in Europe, with the Ecofin meeting today likely to see further discussions on a wide range of issues. As yet there is no breakthrough regarding a Spanish bailout or next tranche of Greek loan disbursement, with the latter only likely to be confirmed in November. A visit by German Chancellor Merkel to Athens today is unlikely to result in any breakthroughs. US corporate earnings will also garner greater attention as the week goes on, with Alcoa set to begin the earnings season tomorrow.

The USD is being buffeted by conflicting factors at present. QE3 is likely to cap any gains in the currency but the expansion of balance sheets by other central banks suggests that a weaker USD outlook is by no means a foregone conclusion. Moreover, from a growth perspective the USD comes out on top. Even though US recovery is a weak one by historical standards the economic outlook still looks better than in Europe, notwithstanding the looming US fiscal cliff. Further evidence of recovery will be gauged from the release of the September small business optimism survey today. A likely third straight gain will provide encouraging news although the survey still remains lower than levels it was at earlier in the year. Over coming days I expect the USD to edge higher as it capitalizes on the various strands of uncertainty in the Eurozone.

As Japan returns from an extended weekend USD/JPY has reversed its recent break higher and is verging on another test of 78.00. There seems little in terms of directional influences to give any major impetus to the currency pair especially as many JPY correlations have broken down lately. JPY speculative long positions remain relatively high suggesting scope for some reduction and JPY selling but I suspect that USD/JPY will remain stuck in its current 77.77 – 79.00 range for some time to come. Nonetheless, JPY bears may be encouraged by recent signs of strong bond outflows adding to data showing equity outflows over recent weeks. Indeed, in the week to 28 September 2012 Japan registered its biggest net equity and bond outflows since early May.

AUD has been a major underperformer this month, with pressure intensifying following last week’s surprise RBA rate cut. Although a further sharp drop appears unlikely hefty long speculative positioning suggests that upside traction will be limited. Nonetheless, my quantitative models show that the AUD is looking increasingly oversold against the USD. The market is already pricing in another RBA rate cut by the end of the year suggesting that the reaction to upcoming data will be asymmetric. In other words the AUD will rally more in the wake of positive data than it will weaken in the wake of soft data. Business and consumer confidence indicators will provide further direction over coming days, but the main driver will come from the September jobs report on Thursday where a further drop in employment is expected. I continue to look for strong support for AUD/USD around the 1.0100 level, with 1.0285 a barrier to any upside break.

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Lower range for the JPY, GBP vulnerable

September 27, 2012 — Mitul Kotecha

The announcement of the Spanish 2013 budget, German jobs data, and the release of European confidence measures mean that attention will remain focussed on the Eurozone today and the news is unlikely to be good. The request for a Spanish bailout moves ever closer and could eventually provide some relief but prevarication continues to weigh on sentiment.

US data releases will not provide much solace for markets either, with weak durable goods orders and a revision lower to US Q2 GDP expected to be revealed. All in all, another tough session for markets is in store.

Meanwhile, currencies against the USD continue to look vulnerable, with EUR/USD, AUD/USD, USD/CHF in particular, close to breaching their 200 day moving average levels. USD/JPY has closed below the 78.00 level throughout this week suggesting that the currency pair may be moving into a new lower range. So far, there is little sign of potential FX intervention by the Japanese authorities.

Interestingly USD/JPY has dropped despite a general rebound in the USD, suggesting that it is very difficult for the Japanese authorities to blame the move on a weaker USD this time. Nor is the JPY particularly sensitive to risk aversion at present. For a change the move in the JPY cannot be blamed on a narrowing in US versus Japanese bond yield differentials too as the sensitivity of USD/JPY to yield differentials has dropped to an insignificant level while the US yield advantage has actually widened.

Net securities inflows into Japan have been strong recently however, suggesting either or both repatriation into Japanese fiscal half year end or renewed foreign interest in Japanese portfolio assets are helping the JPY. USD/JPY is expected to run into bids around the 77.10 level.

EUR/GBP has tracked the move lower in EUR/USD, while GBP/USD appears to be showing some resilience despite a generally firmer USD. Renewed Eurozone tensions are helping GBP as investors once again look for relative save havens although many would question whether GBP can really be considered as a safe haven.

With little on the data front in the UK today (only the third reading of Q2 GDP) GBP will be left to follow the travails of the EUR. Notably my models show that EUR/GBP divergence from its short term fair value estimate is growing, implying that the drop in the currency pair is unlikely to persist, with GBP resilience likely to give way over coming sessions. My estimate for short term EUR/GBP fair value is 0.8143. This is corroborated by my GBP/USD quantitative model, which also shows downside risks.

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Euro firmer, AUD vulnerable to risk gyrations

August 29, 2012 — Mitul Kotecha

A surprise drop in US August consumer confidence which dropped to its lowest since November last year put a dampener on markets and notably the VIX index edged higher. Consequently treasuries rose and equities slipped despite a firmer than expected increase in US house prices in June. The confidence data adds the pressure on Fed Chairman Bernanke to give some indication of a further round of quantitative easing during his speech at Jackson Hole on Friday.

An upward revision to US Q2 GDP and a bounce in July pending home sales today are unlikely to change this perspective although the Fed’s Beige Book will likely show some moderate improvement providing the Fed with useful information.

Separately decent debt auctions in Spain and Italy helped to calm Eurozone market nerves further amid hopes of European Central Bank (ECB) action next week despite the news that Spanish region Catalonia formally asked for EUR 5 billion in funding. As a result the EUR retained a firmer tone.

Contrary to expectations, EUR/USD continued to push higher. Just why the currency is strengthening given the significant event risk in the days and weeks ahead is questionable although in part the move is attributable to an ongoing short squeeze. Hopes of constructive ECB action next week taken together with Fed quantitative easing expectations have helped to put the USD on the back foot, allowing the EUR to take advantage.

Admittedly the drop in Eurozone peripheral bond yields is certainly helpful for the EUR, while my short term quantitative ‘fair value’ estimate for EUR/USD suggests more upside too. Nonetheless, given the risk that so much could go wrong in the weeks ahead I am loathe to get on the bullish EUR bandwagon. While EUR/USD and EUR on the crosses will likely remain firm ahead of Jackson Hole I expect the EUR to struggle to hold onto gains into next week.

AUD has lost ground since around 10 August. This has roughly coincided with a rise in risk aversion over recent weeks. Indeed, AUD maintains a strong correlation with risk aversion and is therefore highly susceptible to swings in risk appetite. Additionally renewed China worries have also dampened the attraction of the AUD given the increasing dependency of Australia’s economy to China both directly through trade and indirectly via commodity prices.

While I remain positive on the AUD over the medium term, the high level of speculative positioning in the currency suggests some vulnerability to profit taking over the short term, with AUD/USD vulnerable to a drop to technical support around 1.0282. Much will depend on news out of China in terms of AUD direction, with Chinese stock market gyrations also providing some influence.

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