Optimism dissipates

January 23, 2010 — Mitul Kotecha

Markets have been highly fickle so far this year. Optimism about strong recovery led by China – recall the fact that disappointment from the surprisingly weak US non-farm payrolls report in December was outweighed by strong Chinese trade data – has dissipated. Instead of rejoicing at China’s robust GDP report last week, which revealed a 10.7% rise in the fourth quarter of 2009, investors began to fret about whether China would have to move more aggressively to tighten monetary policy. Fuelling these fears was the release of Consumer price data which showed inflation rising above expectations to 1.9% YoY in China.

If such fears were not sufficient to hit risk appetite, US President Obama’s plan to limit the size and trading activities of financial institutions dealt another blow to financial stocks. The plan followed quickly after the Democrats lost the state of Massachusetts to the Republicans and managed to shake confidence in bank stocks whilst fuelling increased risk aversion. Meanwhile, rumblings about Greece continue to weigh on markets and Greek debt spreads continued to widen even as global bond markets rallied.

Following the US administration’s plans to restrict banks’ activities the fact that the rise in risk aversion was US led rather than broad based led to an eventual pull back in the dollar which helped EUR/USD to avoid a break below 1.40. Risk trades including the AUD came under pressure as risk appetite pulled back. A drop in commodity prices did not help. The AUD was also hit by news that Australia’s Henry Tax Review would look to tax miners in the country. As a result AUD/USD dropped below 0.90 though this level is likely to provide good buying levels for those wanted to take medium term AUD long positions. The one currency that did benefit was the JPY which managed to drop below sub 90 levels.

The aftermath of the “Volker Plan” will reverberate around markets this week keeping a lid on equity sentiment. Meanwhile Greece will be in the spotlight especially its bond syndication. A bad outcome could be the trigger for EUR/USD to sustain a move below 1.40 though it looks as though it may find a bottom around current levels, with strong support seen around 1.4029. The German IFO business survey for January will be important to provide some direction for EUR and could be a factor that weighs on the currency if as expected it reveals some loss of momentum in the economy.

Aside from the Fed the other G3 central bank to meet this week is the Bank of Japan but unless the Bank is seen to be serious about fighting deflation, USD/JPY may remain under downward pressure against the background of elevated risk aversion. Below 90.0 there does appear to be plenty of USD/JPY buyers however, suggesting that further upside for the JPY will be limited. USD/JPY will find strong support around 88.84.

Much will depend on the key events in the US this week including the Fed FOMC meeting and the President’s State of the Union speech. USD bulls will look for some indication that the US government is serious about cutting the burgeoning budget deficit. Also watch out for the confirmation vote on the renomination of Bernanke as Fed Chairman which could end up being close. There is a heavy slate of data to contend with including new and existing home sales, consumer confidence, durable goods orders, the first glance at Q4 GDP and Chicago PMI.

Posted in Asia, Australia, bank rescue, Bond markets, central banks, China, Commodities, Currencies, Economics, Economy, emerging markets, equity markets, Europe, Fiscal/Budget, FX, Germany, Greece, Interest rates, Japan, Monetary Policy, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Modest growth in the G3 economies

January 14, 2010 — Mitul Kotecha

A few themes are already becoming evident into 2010. Firstly, the dominance of China and any news on the Chinese economy is becoming increasingly apparent as reflected in the market reaction to trade data and hike in reserve requirements this week. Despite the odd setback the second theme that is developing this year is the “risk on” environment for asset markets. Another theme is the problems and concerns about sovereign debt and ratings, which will likely intensify further.

I could add one more to the list; the underperformance of the Eurozone economy, a theme that is likely to become more apparent as the year progresses. As markets become increasingly bullish about the prospects for China’s economy the opposite is true for the eurozone. Growth over Q4 2009 appears to have lost momentum according to recent data. There is however, expected to be a rebound in November industrial production but this will follow a weak October reading, leaving overall output in Q4 looking lacklustre.

Economic conditions in Japan do not seem to be improving any more quickly, especially in the manufacturing sector as reflected in the surprisingly sharp 11.3% MoM drop in machinery orders in November. Orders have dropped by a whopping 20.5% annually sending a very negative signal for capital spending in the months ahead. Uncertainty over demand conditions has likely restrained capital spending plans whilst the strong JPY has not helped.

The US economy is showing more signs of life but even here the improvements are “modest” as reflected in the Fed’s Beige Book. Consumer spending showed some, limited improvement, whilst manufacturing performance was said to be mixed. In particular, the Beige Book noted that labour market conditions remained soft, with wage pressures subdued. Overall, the report highlighted the likely lack of urgency in a prospective Fed reversal of monetary policy.

In contrast to the modest growth improvements seen in the G3 economies, Australia seems to be powering ahead. Australian jobs data revealed a bigger than expected 35.2k increase in employment and surprise drop in the unemployment rate to 5.5% in December. The only slight negative about the jobs data was that many of the jobs (27.9k) were due to temporary hiring. Nonetheless, the report will give a boost to the AUD aiming for a test of resistance around 0.9326, and solidify expectations for a rate hike next month, when the RBA is set to hike by 25bps.

Posted in Asia, Australia, central banks, China, Currencies, Economics, Economy, emerging markets, FX, Interest rates, Japan, US. Tags: , , , , , , , , , , , , , , , , , , . Leave a Comment »

High yield / commodity currencies take the lead

January 7, 2010 — Mitul Kotecha

Although equity markets continue to tread water the appetite for risk looks untarnished. So far into the new-year the winners are commodity / high yield plays as well as emerging market assets. The AUD, NOK, NZD and CAD have been the stars on the major currency front, with only GBP registering losses against the USD so far this year. The move in these currencies has been well supported by resurgent commodity prices; the CRB commodities index is up close to 10% since its low on 9 December.

There is little reason to go against this trend and the USD index is set to continue to lose ground as risk appetite improves further. I highlighted the upside potential in high yield / commodity currencies in a post titled “FX Prospects for 2010” and stick with the view that there is much further upside. I still prefer to play long positions in these currencies versus JPY which I believe will come under growing pressure as the year progresses.

Economic data has also been supportive, especially in Australia, supporting the AUD’s yield advantage. Although comments from the central bank towards the end of last year downplayed expectations of much further tightening, data releases support the case for another rate hike at the 2 February RBA meeting, with a fourth consecutive hike of 25bps to 4.00% likely at the meeting.

There will be some important clues from next week’s jobs data in Australia but judging by the solid gain in November retail sales, which rose 1.4% versus consensus expectations of 0.3%, and 5.9% jump in building approvals, the case for a rate hike has strengthened.  AUD/USD will now set its sights on technical resistance around 0.9326. 

AUD/USD has the highest sensitivity with relative interest rate differentials – correlation of 0.85 with Australia/US interest rate futures differentials over the past month – and so unsurprisingly the AUD rallied further as markets reacted to the strong retail sales data. I believe Australian interest rates will eventually get back up to 6% – pointing to more upside for AUD/USD as this is more than is priced in by the market.

It is fortunate for the USD that the correlation between the USD index and interest rate expectations remains low but nonetheless the December 15 FOMC minutes may have provided another excuse to sell the currency. The minutes were interpreted as slightly dovish by the market, with many latching on to the comments that some members of the FOMC debated the potential to expand the scale of asset purchases and continuing them beyond the first quarter.

Posted in Australia, central banks, Commodities, Currencies, Economics, emerging markets, equity markets, FX, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , . 2 Comments »

“Risk On”- Which Currencies Will Benefit?

January 5, 2010 — Mitul Kotecha

It was a “risk on” beginning of the week as equity markets rallied, commodities prices rose, and G10 bonds and USD came under pressure. Stronger manufacturing PMIs helped to boost confidence in the global economic recovery, with solid PMIs revealed in China, and across the rest of Asia, UK, and the US. The US ISM manufacturing which rose to its highest since April 2006 also revealed a rise in the unemployment component, consistent with view of an unchanged reading for December payrolls.

In the Eurozone the PMI matched the flash release and remained in expansion territory though there was some slippage in Germany, Spain, and Italy, underscoring the likely underperformance of the Eurozone economy relative to expectations of faster recovery in the US. Nonetheless, the PMIs continued to show a picture of expansion, with the Eurozone PMI at its highest in 21-months.

The USD lost ground against the background of improved risk appetite and looks set to fall further abruptly ending its short covering rally. The USD appears to be finding little support from interest rate expectations, with the correlation between most currencies and relative interest rate differentials remaining relatively low for the most part (just -0.04 over the past 3-months between the USD index and US rate futures).  The correlation between the USD and US 10-year bond yields looks somewhat stronger however, and could offer some relief to the USD if yields continue to push higher.

Speculative (CFTC Commitment of Traders) data reveals just how massive the shift in USD positioning has been over recent weeks, with net aggregate USD positioning (vs EUR, JPY, GBP, AUD, NZD, CAD, CHF) registering its first net long USD position since May 2008. The swing in positioning has been dramatic, from -167k contracts on 15 September 2009 to +8.7k in the week ending 29th December 2009. The data also reveals the sharp deterioration in sentiment for the EUR to its lowest since September 2008. Likewise net JPY positions have shifted to their biggest net short since August 2008.

What does this imply? The market is very short EUR and JPY but the JPY has much further to go on the downside as it increasingly retakes the mantle of funding currency.  In any case compared to historical positioning JPY shorts are not so big suggesting more room to increase short positions.   

The EUR has moved into a short term uptrend, with the MACD (12,26,9) having crossed its signal line and positioning supports further upside. EUR/USD will need to take out strong resistance at 1.4459 (December 29) before it can embark on a more significant move higher. Asian currencies also look set to take more advantage of a resumption of USD weakness, especially in the wake of strong risk seeking capital flows into the region. KRW, TWD, IDR and PHP look bullish technically.

Posted in Asia, Commodities, Currencies, Economics, Economy, equity markets, FX, Interest rates, US. Tags: , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

All eyes on US payrolls

January 4, 2010 — Mitul Kotecha

Happy New Year.  Markets are likely to struggle for direction ahead of the key US December non-farm payrolls data though the end of the year ended on a softer note for equity markets in the US, whilst Asian stocks were somewhat firmer.  The USD has taken a firmer tone at the start of this week but is likely to face renewed pressure into the new-year.  The fact that USD/Asian FX has failed to build any momentum on the upside also highlights risks to the USD from current levels. 

Ahead of payrolls look for EUR/USD technical support around 1.4177, with strong resistance around 1.4459 whilst USD/JPY will find support at 91.00 and resistance around 94.08.   I favour a firmer bias for the USD at the beginning of the week but this may not last too long and would look to take profits on long USD / short risk currency positions into next week. 

2010 is set to be a year of two halves for currency markets and whilst the USD is to eventually recover, the rally seen at the end of last year is likely to prove unsustainable, especially now that a lot of short USD positions have been covered.   If anything the pull back in various risk currencies provide better levels to take long positions, especially in the AUD and NZD as well as many Asian currencies where renewed appreciation in the months ahead is likely.  I particularly like the IDR and KRW, two of last year’s winners. 

The US jobs report will provide some evidence of a normalisation in economic conditions, with December likely to have marked the best month in two years for payrolls (Bloomberg consensus forecasts a 1k drop in payrolls). Although hiring is unlikely to pick up quickly and wage pressures are set to remain subdued, the data will mark an encouraging shift in job market conditions following the loss of 7.2 million jobs since the US recession began.  The unemployment rate is likely to remain stubbornly high, however.

Ahead of the jobs data markets will be able to garner some clues to the data from the jobs component in today’s release of the December ISM data.  The ISM is likely to remain in expansion territory though is unlikely to register much of a gain from last month’s 53.6 reading.   The eurozone and UK also release their manufacturing PMIs today and although both will remain above the 50 boom/bust mark, neither are set to register much improvement from November’s reading. 

There will also be some attention on central bank thinking this week, with the release of the December 16 meeting FOMC minutes as well as the BoE rate decision to digest.  The minutes will likely acknowledge some signs of improvement in the economy but there will be no indication that the Fed is shifting its “extended period” thinking even if the Fed wants to reassure markets that it has an exit strategy in place.   The BoE meeting will be a non-event for markets, with more interest on the outcome of the February meeting.

Posted in Asia, central banks, Currencies, Economics, Economy, equity markets, FX, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , . 2 Comments »
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