Interest Rate Decisions Galore

March 10, 2011 — Mitul Kotecha

The Reserve Bank of New Zealand (RBNZ) decision to cut policy rates by a bigger than expected 50bps does not necessarily mark the onset of a new wave of NZD selling. Indeed, whilst the NZD was hit by the rate cut it recovered quickly.

The NZD was aided by comments from the RBNZ Governor Bollard that short term inflation may spike due to the earthquake but this tempered by another RBNZ official who stated that the central bank may hold rates at 2.5% at least until January 2012. The post meeting statement indicated that the RBNZ will not embark on a series of rate cuts, a fact that will provide some relief to the Kiwi. Moreover, the currency looks increasingly oversold especially relative to the AUD as indicated by relative positioning.

Weaker than expected employment data in Australia will also help to stem AUD strength versus NZD. After many months of positive surprises the labour market is showing signs of cracking. Admittedly full time employment rose but this was outweighed by an even bigger drop in part time employment, resulting in a 10.1k fall in overall employment.

Although the AUD is unlikely to face too much downside markets the data will likely dampen expectations of possible rate hikes in the months ahead. My preferred way of playing possible AUD underperformance is via the NZD. AUD/NZD is likely to face plenty of resistance around the 1.3800 level and eventually as indicated by our quantitative models the currency pair is likely to move lower over coming weeks.

In sharp contrast to the RBNZ, the Bank of Korea hiked interest rates by 25bps in a further move to normalize policy. The decision was not much of a surprise and the statement indicated that more rate hikes should be expected. The KRW remains rangebound but the currency remains on path for further appreciation over coming months. The surprise trade deficit in China has weighed on Asian currencies in general but weakness is likely to be limited.

The Bank of England is the next central bank on tap today but is unlikely to hike rates despite the hawkish shift within the Monetary Policy Committee. A rate hike is moving closer but the Bank will likely wait until at least May before moving. Further details about today’s decision will as usual wait for the minutes in two weeks time. GBP looks vulnerable and whilst a rate move today is not expected the currency may lose ground over coming days against the background of a firmer USD.

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Risk aversion spikes

March 2, 2011 — Mitul Kotecha

Increased risk aversion overnight in the wake of escalating Middle East tensions gave the USD some support but overall the USD index is gradually drifting towards its early November low around 75.631. The antithesis of USD weakness is strength in most other major currencies.

The USD is being undermined by relatively dovish expectations for US interest rates relative to elsewhere and last night’s semi annual testimony by Fed Chairman Bernanke to the US Senate did nothing to alter this tone, with Bernanke maintaining the emphasis on subdued inflation and elevated unemployment.

The USD index itself has a high (0.82) 3-month correlation with US interest rate futures and over recent weeks as the implied yield has dropped, the USD has lost ground. The prospects of higher US bond yields may eventually provide the USD with support, especially given the prospect of substantial short-covering but in the near term the USD is likely to remain under pressure.

The upbeat run of US data highlights another source of USD support over the medium term, given the likely outperformance of the US economy over coming months. Yesterday’s ISM manufacturing survey and vehicle sales data lend support to this view. Moreover, the rise in employment component of the ISM supports the view of at least a 195k increase in February payrolls.

The Fed’s Beige Book tonight and February ADP jobs report will not alter the USD’s trajectory. The Beige Book is unlikely to reveal anything to worry the Fed in terms of inflation risks although will probably reveal further signs of improved activity. The ADP report will give important clues for Friday’s February non-farm payrolls data although it’s worth noting that last month’s report was way off the mark. In any case neither release is likely to prevent a further drop in the USD.

EUR is a clear beneficiary of expectations of tighter monetary policy by the ECB and the widening interest rate (futures implied yield) differential between the US and eurozone has given the EUR plenty of support recently as reflected in the high correlation with EUR/USD. Further support to the hawkish market stance was given by the upward revision to eurozone 2011 growth and inflation forecasts by the EU. The fact that eurozone inflation increased to 2.4% YoY in February also reinforced expectations of ECB tightening sooner than later.

The ECB press conference following the council meeting tomorrow will likely shape such expectations further, the EUR has already priced in a hawkish ECB stance, limiting the prospects of further appreciation. Notably EUR/USD has failed to break resistance at its year high around 1.3861, which will prove to be a formidable cap in the short-term.

In contrast, the RBA has poured cold water over expectations of further policy rate hikes in Australia. The policy statement following yesterday’s decision to keep the cash rate on hold pointed to an extended pause in the months ahead. Despite this and perhaps because markets have already pared back Australian interest rate expectations AUD rebounded quite smartly from its post meeting low and despite some overnight weakness due to increased risk aversion it will soon verge on a break of resistance at 1.0257.

AUD/NZD has continued to charge ahead having hit a multi-year high above 1.3600. NZD underperformance has been exacerbated by the impact of the recent earthquake, with growth expectations for this year having been sharply revised lower and growing speculation of an interest rate cut. Indeed, such speculation was given further fuel by comments by NZ Prime Minister Key who noted he would welcome a policy rate cut. Nonetheless, my quantitative AUD/NZD model suggests that the cross looks over-extended at current levels, whilst relative speculative positioning supports this view.

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GBP troubles, KRW too weak

February 17, 2011 — Mitul Kotecha

The Fed FOMC minutes for the January meeting revealed that behind the unanimous vote to leave policy settings unchanged there was some unease about the completion of QE2. Nonetheless, the USD was left weaker given the Fed’s sanguine view on inflation and worries about unemployment. Inflation data will garner most market attention today but the fact that the core rate of CPI inflation is expected to remain well below the Fed’s preferred level could undermine the USD and add a further barrier to the USD’s recovery so far in February. Jobless claims data will also be of interest given the sharp drop last week. Another firm outcome will help to dispel worries about job market recovery.

As warned in my last post, downside risks to GBP were high given the long GBP speculative positioning overhang and hawkish expectations for the BoE Quarterly Inflation Report. In the event the Report revealed a downward growth forecast revision and an upward inflation forecast revision but importantly showed some reluctance to play into market expectations of an early UK policy rate hike. Following on from a weaker than expected UK January jobs report in which unemployment increased, GBP was hit on both counts. GBP/USD is unlikely to veer far from the 1.6000 level, but with markets reassessing interest rate expectations downside risks are beginning to open up.

News yesterday that Moody’s ratings agency has placed Australia and New Zealand’s major banks on review for possible downgrades went down like a lead balloon but once again AUD and NZD showed their usual resilience and acted as if little has happened. AUD and NZD have weakened since the turn of the year. Weaker data and a paring back in policy tightening expectations have contributed to the weaker performance of the AUD and NZD, but markets have gone too far in scaling back the timing and magnitude of interest rate hikes, suggesting that both currencies may bounce back as interest rate expectations become more hawkish.

Asian currencies continue to register mixed performances largely influenced by capital flows. Most equity markets in the region have registered outflows so far in 2011, with the exception of Taiwan and Vietnam. This has been reflected in Asian FX performance, with the strongest performer being the IDR, but its gains have only been around 0.72% versus USD, coinciding with the fact that it has registered some of the least capital outflows this year. Interestingly the worst performing currency has been the THB, one of last year’s star performers. Korea has also registered strong equity capital outflows but this will not persist and a resumption of inflows taken together with positive fundamentals and higher interest rates will boost the KRW this year.

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FX Winners and Losers

February 16, 2011 — Mitul Kotecha

There has been a sense of mean reversion in FX markets so far this year as some of last year’s winners have become losers. Namely NZD, CHF, JPY and AUD have all lost ground whilst EUR and GBP have gained ground. The odd one out is the SEK which has strengthened over 2010 and in 2011 versus USD. I expect this pattern to change and the likely winners over the next 3- months are NZD, AUD and CAD, with CHF and JPY the likely losers.

EUR held up reasonably well in the wake of slightly disappointing growth data, with eurozone GDP rising less than expected in Q4, and a smaller than expected gain in the February German ZEW investor confidence survey (economic sentiment component). My sense is that the net long EUR speculative position has already been pared back somewhat over recent days reducing the potential selling pressure on the currency in the near term.

Given that EUR/USD is one of the only major currency pairs being influenced by interest rate differentials, its direction will hinge more on policy expectations but in the near the announcement by the German Finance Minister this morning of a restructuring plan for WestLB may give the currency some support.

Perhaps one explanation for the stability of EUR/USD around the 1.3500 level is that US data was also disappointing yesterday. January retail sales rose less than forecast whilst revisions to back months suggest less momentum in Q4 consumer spending than previously envisaged. As with the eurozone data weather likely played a role in contributing to the outcome.

The net impact on currencies is that they are largely stuck within tight ranges. Further direction will come from the release of the Fed FOMC minutes for the January 26th meeting. The minutes may undermine the USD if a likely dovish slant continues to be expressed but given that the FOMC decision at that meeting to hold policy setting unchanged had no dissenters this should not come as a surprise.

Whilst the battle between the USD and EUR ended in a stalemate GBP outperformed in the wake of the increase in UK January CPI inflation and in particular the letter from the BoE governor to the Chancellor keeping open the door to a rate hike. The Quarterly Inflation Report (QIR) today will be particularly important to determine whether the bounce in GBP is justified.

I remain hesitant to build on long GBP positions given the net long speculative overhang in the currency. The risks following yesterday’s jump in GBP are asymmetric, with a hawkish QIR likely to have less impact on the currency than the negative impact from a more dovish than expected report.

Econometer.org has been nominated in FXstreet.com’s Forex Best Awards 2011 in the “Best Fundamental Analysis” category. The survey is available at http://www.surveymonkey.com/s/fx_awards_2011

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Global Themes

February 11, 2011 — Mitul Kotecha

It’s definitely been a strange start to the year, with markets taking plenty of time to get their bearings. Some general themes have developed but none have provided clear direction. As a result, the path over coming weeks and months is likely to remain highly volatile and in this respect, currencies, equities and bonds will continue to see strong gyrations.

One theme that has been evident since the start of the year is an improvement in sentiment towards the eurozone periphery as hopes of an enlargement/extension of the European Union bailout fund (EFSF) have increased. This is a key reason why the EUR has strengthened this year although nervousness on this front appears to have returned over recent days (note the recent widening in peripheral bond spreads, drop in EUR and European Central Bank purchases of Portuguese debt). It seems that a lot of good news has already been discounted in relation to the eurozone periphery and now markets are in wait and see mode for the EU Council meeting on 24/25 March. There is a strong chance that eventually market expectations will prove overly optimistic and the EUR will drop but more on that later.

The second theme is global inflation concerns, driven by higher food and energy prices. Certainly this has had an impact on interest rate expectations and in some cases resulted in a hawkish shift in central bank language, notably in the eurozone and UK. Although European Central Bank (ECB) President Trichet has toned down his comments on tighter monetary policy compared to the more hawkish rhetoric following the last ECB council meeting, expectations for monetary tightening in the eurozone still look overly hawkish, with a policy rate hike currently being priced in for August/September this year, which looks way too early. The EUR has benefitted from the relative tightening in eurozone interest rate expectations compare to the US but will suffer if and when such expectations are wound down.

Elsewhere in many emerging markets the impact of higher food prices is finding its way even more quickly into higher inflation, forcing central banks to tighten policy. In Asia, the urgency for higher rates is even more significant given that real interest rates (taking into account inflation) are negative in many countries. China has accelerated the pace of its rate hikes over recent months and looks set to continue to tighten policy much further to combat inflation. In India, worries about inflation and the need for further monetary tightening have clearly weighed on equity markets, with more pain to come. Although not the sole cause by any means, in the Middle East and Africa higher food prices are feeding social tensions such as in Egypt.

Another clear theme that has developed is the improvement in US economic conditions. The run of US data over recent months has been encouraging, confirming that the economy is gaining momentum. Even the disappointing January non-farm payrolls report has not dashed hopes of recovery, with many other job market indicators pointing to strengthening job conditions such as the declining trend in weekly US jobless claims. Manufacturing, business and consumer confidence measures have strengthened whilst credit conditions are easing, albeit gradually. The US economy is set to outperform many other major economies this year, especially the eurozone, which will be beset with a diverging growth outlook between northern and southern Europe.

Although the US dollar has not yet benefitted from stronger US growth given the still dovish tone of the Fed and ongoing asset purchases in the form of quantitative easing, the rise in US bond yields relative to other countries, will likely propel the dollar higher over 2011 after a rocky start over Q1 2011. In contrast, the EUR at current levels looks too strong and as noted above, hopes of a resolution of eurozone peripheral problems look overdone. EUR/USD levels above 1.3500 provide attractive levels to short the currency. Other growth currencies that will likely continue to do well are commodity currencies such as AUD, NZD and CAD, whilst the outlook for Asian currencies remains positive even despite recent large scale capital outflows. The JPY however, will be one currency that suffers from an adverse yield differential with the US as US bond yields rise relative to Japan.

Econometer.org has been nominated in FXstreet.com’s Forex Best Awards 2011 in the “Best Fundamental Analysis” category. The survey is available at http://www.surveymonkey.com/s/fx_awards_2011

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