Australian dollar hit by weak jobs data

May 12, 2011 — Mitul Kotecha

The USD’s bounce since the beginning of the month appears to be gaining more traction, with the USD index up over 3% from its recent lows. I’m still cautious about whether this move can extend much further in the absence of a back up in US bond yields especially given ongoing asset purchases / global USD liquidity injections by the US Federal Reserve at least until the end of June.

Nonetheless, given the magnitude of USD short positioning, which had moved ever close to revisiting record levels, the potential for short-covering was significant. US data today could provide some influence, with attention on April retail sales data, PPI inflation and jobless claims. A relatively positive outcome for retail sales could give the USD further support.

The day has started badly for the AUD, with the currency hit by an awful jobs report, with employment dropping by 22.1k in April compared to consensus expectations of +17k. The details were even more negative than the headline reading, with full time employment dropping by 49.1k and only partially mitigated by a 26.9k rise in part time employment.

The Reserve Bank of Australia will likely pay close attention to the data and it will likely result in any residual expectation of a rate hike by the RBA next month being taken off the table. Already today there has been a sharp rally in bank bill futures as markets pare back interest rate expectations and markets are not even pricing in a further full 25bps rate hike by year end.

The data weighed heavily on the AUD, with AUD/USD hitting a low below 1.06. AUD is likely to trade with a heavy tone over coming sessions, with the currency already under pressure from a generally firmer USD. Moreover, the rally in Australian bank bill futures will add further pressure to the currency as Australia’s favourable rate differential narrows further with the US.

Taken together with the fact that AUD positioning is close to its all time highs and that even compared to interest rate differentials its gains look overdone, it suggests more downside risks over the short-term, with AUD/USD 1.0537 seen as a near term technical support level.

In contrast GBP benefitted from a back up in UK bond yields in reaction to the Bank of England’s Quarterly Inflation Report. Inflation forecasts were revised higher but growth forecasts were revised lower as expected. The In truth, the reaction looked overdone but GBP has gained some momentum versus EUR and looks set to extend its gains, with focus on the 200 day moving average level of 0.8558.

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RBA on hold, RBI hikes rates

May 3, 2011 — Mitul Kotecha

News of the death of Osama Bin Laden gave the USD a lift and its gains have extended for a second day. Extreme short market positioning as well as increasing risk aversion (perhaps due to worries about retaliation following Bin Laden’s death) have helped the USD.

However, the boost to the USD could be short-lived in the current environment in which it remains the preferred global funding currency. Indeed, the fact that US bond yields have dropped sharply over recent weeks continues to undermine the USD against various currencies.

The USD firmed despite the US ISM manufacturing index dropping slightly, albeit from a high level. The survey provided some useful clues to Friday’s US jobs report, with the slight decline in the employment component of the ISM survey to 62.7 consistent with a 200k forecast for April payrolls.

Ahead of the European Central Bank (ECB) meeting on Thursday hawkish rhetoric from new Council member and Bundesbank chief Weidmann (replacing Weber) and more reassurances from Greek and EU officials that there will be no debt restructuring or haircut on the country’s debt has helped the EUR although it is notable that it could not sustain a foot hold above 1.49. Eurozone bond yields have risen by around 20bps compared to US yields over the past month, a fact that suggests that the EUR may not fall far in the short-term.

USD/JPY is trading dangerously close to levels that may provoke FX intervention by the Japanese authorities. General USD weakness fuelled a drop in USD/JPY which has been exacerbated by a rise in risk aversion over recent days (higher risk aversion usually plays in favour of a stronger JPY). The biggest determinant of the drop in USD/JPY appears to a narrowing in bond yields (2-year bond yields have narrowed by around 20bps over the past month) largely due to a rally in US bonds.

Unsurprisingly the Reserve Bank of Australia (RBA) left its cash rate on hold at 4.75%. The accompanying statement showed little inclination to hike rates anytime soon, with credit growth noted as modest, pressure from a stronger exchange rate on the traded sector and temporary prices shocks which are expected to dissipate. The only indication that rates will eventually increase is the view that longer term inflation is expected to move higher.

I look for further rate hikes over coming months even with the AUD at such a high level. AUD has lost a bit of ground after hitting a high just above 1.10 against the USD and on the margin the statement is slightly negative for AUD. A slightly firmer USD overall and stretched speculative positioning, with IMM AUD positions close to their all time high, points to some downside risks in the short-term.

In contrast India’s central bank the RBI hiked interest rates by more than many expected. Both the repo and reverse repo rates were raised by 50bps, with the central bank governor highlighting renewed inflation risks in his statement. The decision reveals a shift in RBI rhetoric to an even more hawkish bias in the wake of rising inflation pressures, which should be beneficial to the rupee.

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Another Day, Another Drop In The US Dollar.

April 15, 2011 — Mitul Kotecha

The USD index is now close to breaching its November 2009 low around 74.17, with little sign of any turnaround in prospect. A surprise jump in weekly jobless claims to 412k (380k expected) did little to help the USD’s cause whilst higher commodity prices, and in particular energy prices played negatively.

Indeed, many USD crosses have experienced an increase in sensitivity to oil price movements over recent weeks, with the USD on the losing side when oil prices move higher. Commodity currencies including CAD and NOK are the key beneficiaries but EUR/USD is also highly correlated with the price of oil.

Various Fed comments overnight including supportive comments on the USD’s role as a reserve currency have done little to boost USD sentiment despite the generally hawkish slant to comments. A host of US data releases will keep markets busy.

The data are unlikely to deliver any strong surprises but given the growing FX attention on Fed policy, CPI data may take on more importance than usual. Our expectation of a trend like 0.2% increase in core CPI, which is unlikely to cause any consternation within the Fed, suggests that the USD will garner little support.

The ability of the EUR to withstand a torrent of bad news regarding the eurozone periphery is impressive. In particular, peripheral bond yields continue to rise especially Greek yields as expectations of debt restructuring grow. Comments from Germany’s finance minister have added to such expectations. News that the Bank of Spain approved the recapitalisation of 13 bank and that Spanish banks borrowed only EUR 44 billion last month, the lowest since Jan 2008, may have provided some relief.

However, given that markets are already relative hawkish about eurozone interest rates and given growing peripheral worries as well as overly long EUR market positioning, the upside for EUR/USD is looking increasingly restrained, with a break above technical support around 1.4580 likely to be difficult to achieve over the short-term.

AUD and NZD have registered stellar performances over recent weeks as yield attraction has come back to the fore and risk appetite has strengthened. The gains since their post Japan earthquake lows have been in the region of 7.3% and 10.5%, respectively for AUD and NZD.

The additional element of support, especially for AUD has come from central bank diversification, an increasingly important factor for both currencies. The gains in both currencies have been impressive and neither is showing signs of reversing but there are clear risks on the horizon.

One indication of such risks is the fact that market positioning is stretched especially in terms of AUD positioning, with CFTC IMM contracts registering an all time high. The move in AUD especially has been well in excess of what interest rate / yield differentials imply. Whilst I would not suggest entering into short AUD and NZD positions yet, the risks to the downside are clearly intensifying.

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Australian Dollar Looking Stretched

April 7, 2011 — Mitul Kotecha

Central bank decisions in Japan, Europe and UK will dictate FX market direction today. No surprises are expected by the Bank of Japan (BoJ) and Bank of England (BoE) leaving the European Central Bank (ECB) decision and press conference to provide the main market impetus. Although a hawkish message from ECB President Trichet is likely the market has already priced in a total of 75 basis points of tightening this year. We retain some caution about whether the EUR will be able to make further headway following the ECB meeting unless the central bank is even more hawkish than already priced in.

EUR/USD easily breached the 1.4250 resistance level and will now eye resistance around 1.4500. News that Portugal formally requested European Union (EU) aid came as no surprise whilst strong German factory orders provided further support to the EUR. The data highlights upside risks to today’s February German industrial production data. The EUR will find further support versus the USD from comments by Atlanta Fed’s Lockhart who noted that he doesn’t expect the Fed to hike interest rates by year end.

USD/JPY is now around 7.5% higher than its post earthquake lows. Japanese authorities will undoubtedly see a measure of success from their joint FX intervention. To a large degree they have been helped by a shift in relative bond yields (2-year US / Japan yield differentials have widened by close to 30 basis points since mid March, and are finally having some impact on USD/JPY as reflected in the strengthening in short-term correlations. Whilst the BoJ is unlikely to alter its policy settings today the fact that it is providing plenty of liquidity to money markets, having injected around JPY 23 trillion or about 5% of nominal GDP since the earthquake, is likely playing a role in dampening JPY demand.

AUD/USD has appreciated by close to 6% since mid March and whilst I would not recommend selling as yet I would be cautious about adding to long positions. My quantitative model based on interest rate / yield differentials, commodity prices and risk aversion reveals a major divergence between AUD/USD and its regression estimate. Clearly the AUD has benefitted from diversification flows as Asian central banks intervene and recycle intervention USDs. However, at current levels I question the value of such diversification into AUD.

Speculative AUD/USD positioning as indicated by the CFTC IMM data reveals that net long positions are verging on all time highs, suggesting plenty of scope for profit taking / position squaring in the event of a turn in sentiment. Moreover, AUD gains do not match the performance of economic data, which have been coming in worse than expected over recent weeks. Consequently the risks of a correction have increased.

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EUR boosted, USD under pressure

March 15, 2011 — Mitul Kotecha

Market attention remains fully focussed on events in Japan especially related to the country’s nuclear facilities. Risk aversion has spiked higher as a result, with ongoing Middle East tensions adding to the risk off tone. CHF is a key beneficiary of safe haven demand but the picture for JPY is obscured by repatriation expectations on one hand and FX intervention risks/Bank of Japan liquidity injections on the other, keeping USD/JPY clsoe to the 82.00 level. In contrast the AUD is vulnerable to a drop below parity with the USD on Japan worries, especially as Australia is a key destination for Japanese investment and therefore potential for reversal of such flows if Japanese institutions repatriate funds.

The EUR recovered over recent days as worries about the eurozone periphery ease and peripheral bonds spreads narrow. It is only a matter of time before overly long market positioning catches up with the EUR especially as the prospects of further interest rate support to the currency looked limited; markets have already priced in 75bps of policy rate hikes in the eurozone this year, which looks appropriate. It is difficult to see markets pricing in any more tightening than this over coming weeks. Despite its bounce back EUR/USD will struggle to break resistance around 1.4036.

Markets will digest the fallout from the informal EU leaders meeting last Friday which prepared the groundwork for the official meeting on 24/25 March. The initial reaction of the EUR appears to be positive but there is a significant risk of disappointment if the outcome of the meeting on 24/25 March does not live up to expectations. Indeed although Friday’s meeting resulted in an agreement in principle of a new “pact for the Euro” much will depend on the eventual details later this month.

Leaders also agreed on lowering interest rates to Greece by 100bps, and in principle enlarging the scope of the European Financial Stability Facility (EFSF) bailout fund to EUR 440 billion. The main positive surprise was opening the door for the fund to purchase eurozone debt. Data releases will offer little support to the EUR this week, with limited gains in the March German ZEW investor confidence survey today likely to leave markets unperturbed.

The USD’s gains last week proved short-lived and the currency will be tested by another relatively dovish Fed FOMC statement today and a benign reading for core CPI inflation in February. The Fed FOMC meeting is unlikely to deliver any changes to the Fed’s stance and whilst there has recently been some speculation that the Fed will soon remove its “extended period” comment, this is unlikely to happen any time soon. The statement will remind markets that the Fed is in no rush to alter its policy settings, an outcome that may limit the ability of the USD to strengthen this week even if data releases continue to remain on the positive side, including manufacturing survey and industrial production over coming days.

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