GBP vulnerable, AUD downside limited

May 22, 2012 — Mitul Kotecha

Finally after weeks of selling, risk assets perked up helped by China’s pledge to focus more on supporting growth and signs of cooperation between Germany and France, as leaders of both countries agreed to do ‘everything necessary’ to ensure Greece stays in the Eurozone.

Just what this will entail is not clear but reports suggest that European officials are formulating plans ahead of the EU Summit on Wednesday. Markets are by no means out of the woods and much uncertainty will remain ahead of Greece’s election in just less than a month.

GBP has dropped both against the USD and EUR. The currency has not been helped by some dovish tones from Bank of England MPC member Posen who last week suggested that his decision to withdraw his vote for more quantitative easing may have been ‘premature’. The renewed spectre of more QE will likely weigh on GBP over coming weeks.

The fact that the market has got itself very long GBP may also have contributed to some profit taking as some caution in being excessively long GBP sets in. UK inflation data today will likely play negatively for GBP too given the sharp slowdown expected to be registered in the April CPI inflation data.

My quantitative model for EUR/GBP reflects the potential risks to GBP over coming days, with the model output suggesting further downside risks to GBP. Technical resistance will likely be seen around the 0.8198 level.

AUD’s slide has been pretty dramatic over recent weeks. Despite a bounce overnight the currency has lost close to 9% of its value against the USD since the beginning of March, weighed down by rising risk aversion and China growth worries.

My quantitative model has been persistently calling for a drop in the AUD (a fact that I have highlighted previously). Interestingly the model now shows that the gap between the current level of AUD/USD and its short term ‘fair value’ estimate has almost closed, suggesting that the downside for the currency will be limited to around the 0.96-0.97 region.

The only caveat is that a stark deterioration in risk appetite from current levels would result in a sharper fall but for now we believe that a lot of the expected downward correction in the currency has already occurred. While I would not go and rush out to buy AUD just yet, taking a short position looks much less attractive.

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EUR resilience, AUD hit by soft inflation

April 24, 2012 — Mitul Kotecha

A distinctly downbeat tone to risk assets in the wake of disappointing manufacturing sentiment surveys in Europe and China and political uncertainties in Europe threatens to engulf markets today. There is very little on the data and events front that will change this as markets refocus to the outcome of the Fed FOMC meeting tomorrow. Consequently risk assets will remain under a degree of pressure in the short term unless the Fed delivers any fresh hints of more quantitative easing tomorrow.

A round of weaker than expected readings for Eurozone purchasing managers indices has led to a renewed wave of pessimism towards the Eurozone economy and selling in Eurozone assets. The collapse of the Dutch government over budget cuts and the results of the first round of French elections only added to the malaise. Once again however, the EUR remains resilient and has hardly flinched in the wake of bad news in the region.

I believe it is only a matter of time before the EUR succumbs to growing pressure, especially given a likely widening in its growth gap versus the US. Today’s bond auctions in Spain, Italy and Netherlands will be in focus but ought to provide little relief for the EUR, with the currency likely to edge towards 1.3057 support versus USD.

Australian Q1 CPI inflation data came in much softer than expected, with the trimmed mean CPI coming in at 0.3%, half the consensus expectation and well within the Reserve Bank of Australia’s target range. The data seals the case for the RBA to pull the trigger at its 4 May monetary policy meeting. The main imponderable is the magnitude of the rate cut. A 25bps cut had already been priced in but speculation of a 50bps move is likely to have grown.

Nonetheless, I believe the market is overly dovish, with a lot of easing already priced in (100bps in the current cycle). I don’t agree with market pricing, suggesting that eventually the AUD will recover as rate expectations correct. However, wariness ahead of the RBA meeting and deterioration in risk appetite will keep the AUD under restrained in the near term. AUD/USD support is seen around 1.0226, with a break below this leading to a test of 1.0145.

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AUD risks, CHF speculation, CAD upside

April 18, 2012 — Mitul Kotecha

News that the IMF revised up its global growth forecasts, decent demand for a Spanish bill auction and a stronger than expected reading in the April German ZEW investor confidence survey helped to calm market nerves overnight. Some solid US Q1 earnings also supported equities too.

Weaker readings for US industrial production and housing starts were largely ignored. Hopes of an expansion of IMF funds were boosted by the news that Japan will be provide an extra $60 billion. High beta currencies rallied overnight but notably the EUR failed to register gains despite a narrowing in peripheral Eurozone bond yields.

AUD has undergone some major gyrations. The boost from by a strong jobs report last week was quickly undone by a relatively dovish set of RBA minutes, which appeared to confirm the view that a rate cut would take place in May. Of course, as the RBA pointed out the April 24 Q1 inflation report would be essential to provide the final clues to the rate decision.

As a rate cut is already priced in, an upside inflation surprise may actually result in a bounce in the AUD but any positive impetus will have to contend with a more fragile risk environment, yesterday’s risk rally not withstanding. AUD is one of the most highly sensitive currencies to risk aversion and bounced overnight as risk appetite improved but we suspect the risk rally will fade in the short term putting the AUD under renewed downward pressure.

EUR/CHF continues to track the 1.20 ‘line in the sand’ closely, but rumours of a shift in the floor continue to do the rounds. Swiss officials have not confirmed such speculation but have highlighted the impact of a strong CHF in fuelling deflation pressures. The case for a move higher in the CHF ceiling is therefore quite high, but the cost could also be high if speculators test the resolve of the Swiss authorities.

Although the Swiss economy continues to suffer it appears that the pain of a strong CHF is lessening slightly although not enough to ease concerns about the strength of the currency. The March KoF Swiss leading indicator revealed a second straight increase, albeit from a low level. Further gains may be limited however, given the ongoing downward pressure emanating from weaker growth in the Eurozone.

The Bank of Canada left policy rates unchanged at 1% but the accompanying statement appeared to pave the way for higher interest rates. Consequently expectations of rate hikes have been brought forward, with the CAD rallying due to its strong correlation with interest rate differentials. Firmer commodity prices also helped to boost CAD.

Our quantitative models show scope for further CAD gains over the short term, suggesting more gains ahead. Further direction will come from the BoC Monetary Policy Report today, with USD/CAD setting its sights on a test of technical support around 0.9766 in the near term.

Posted in Australia, Canada, FX, Switzerland. Tags: , , , , . 2 Comments »

FX volatility declining, AUD still vulnerable

March 29, 2012 — Mitul Kotecha

FX options appear to be increasingly comfortable with the current lack of movement in currencies. For example, 3-month EUR/USD implied volatility has dropped to multi-year lows while my measure of G3 implied volatility has been at very low levels over recent months.

This has corresponded with the drop in risk aversion as market fears over US growth and Eurozone debt issues recede. Over the short term there appears to be little to jolt markets out of their stupor and if anything EUR/USD is likely to continue to drift higher according to our short term quantitative models.

Indeed, firmer risk appetite, despite the odd hiccup, plays positively for the EUR while the pull back in US bond yields has restrained the USD. The Ecofin meeting beginning tomorrow will likely give further support to the EUR, if as expected, ministers bolster the Eurozone ‘firewall’.

It has been a one step forwards, two steps back motion for AUD/USD over recent weeks as it continues to edge lower. Although US bond yields have pulled back Australian yields have pulled back relatively more, reducing Australia’s yield advantage and weighing on the AUD in the process.

Over recent weeks speculative AUD positioning has also fallen, reflecting deteriorating sentiment for the currency, but the fact that the market is still long suggests scope for further short term downside.

Aside from yield differentials most of the usual correlations with AUD have broken down suggesting that the AUD is getting a dose of independent weakness. However, China news remains a key focal point for AUD and the decline in the Shanghai composite stock index has become an interesting lead indicator for AUD performance. Over the near term AUD will likely continue to weaken in jagged steps.

Dear readers please note that there will be very limited updates of econometer.org over the next couple of weeks due to my Easter vacation.

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Euro decline limited, AUD under pressure

March 23, 2012 — Mitul Kotecha

EUR looks like it’s going nowhere fast, with the currency failing to break above 1.33 versus the USD. Nonetheless any drop will be limited as there will be plenty of support for EUR/USD around the 1.30 level. Such support may be required following the disappointing reading for the Eurozone March flash purchasing managers index (PMI) and renewed growth worries even in Germany.

Moreover, there have been plenty of scare stories about ongoing problems in the Eurozone, centring on Portugal and Spain and even speculation of a third Greek bailout being needed at some point.

However, the reality is that the market has reduced its attention on Eurozone debt issues for the time being. Once the latest bout of risk aversion passes, this ought to allowing the EUR some room to push higher, with my short term models highlighting the scope for EUR/USD to edge back towards 1.35 over coming weeks.

AUD has been pummelled this week, alongside its neighbour NZD. Growth worries in China compounded by a weaker than expected March China PMI has piled on the pressure, especially on AUD where economic conditions are increasingly linked with China. My quantitative models highlight ongoing short term downside risks to both AUD and NZD.

However, declines in these currencies will provide better levels to eventually buy as I remain bullish in the medium term even though my valuation metrics reveal that both currencies remain overvalued. My view is built on the prediction that risk appetite will improve further this year, a boon to high beta currencies such as AUD and NZD. Additionally as yield gains importance and carry trades gain attraction AUD will look particularly attractive.

Posted in Australia, Currencies, eurozone, New Zealand. Tags: , , , , . Leave a Comment »
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