Dubai’s aftermath

November 27, 2009 — Mitul Kotecha

Dubai’s bolt out of the blue is hitting markets globally, with the aftershock made worse by the thin liquidity conditions in the wake of the US Thanksgiving holiday and Eid holidays in the Middle East.  The sell off followed news by government owned Dubai Holdings of a six month debt freeze.  Estimates of exposure to Dubai vary considerably, with European banks estimated to have around $40 billion in exposure though what part of this is at risk is another question. 

The lack of information surrounding the Dubai announcement made matters worse.  The aftermath is likely to continue to be felt over the short term, with further selling of risk assets likely.  Indeed, there is still a lot of uncertainty surrounding international exposure to Dubai or what risk there is to this exposure and until there is further clarity stocks look likely to face another drubbing.

The most sensitive currencies with risk aversion over the past month have been the JPY, and USD index, which benefit from rising risk aversion whilst on the other side of the coin, most Asian currencies especially the THB and KRW as well as the ZAR, and AUD look vulnerable to any rise in risk aversion.  JPY crosses look to be under most pressure, with the likes of AUD/JPY dropping sharply and these currencies are likely to drop further amidst rising risk aversion. 

The rise in the JPY has been particularly dramatic and has prompted a wave of comments from Japanese officials attempting to talk the JPY lower including comments by Finance Minister Fujii that he “will contact US and Europe on currencies if needed”.  So far, these comments have had little effect, with USD/JPY falling briefly through the key psychological level of 85.00, marking a major rally in the JPY from a high of 89.19 at the beginning of the week.  Unless markets believe there is a real threat of FX intervention by Japan the official comments will continue to be ignored.

It’s not all about risk aversion for the JPY, with interest rate differential playing a key role in the downward move in USD/JPY over recent weeks.  USD/JPY has had a high 0.79 correlation with interest rate differentials over the past month.  The US / Japan rate differential narrowed sharply (ie lower US rate premium to Japan) to just around 4.5bps from around 100bps at the beginning of August.  With both interest rate differentials and risk aversion playing for a stronger JPY the strong JPY bias is set to continue over the short term.

Is this the beginning of a new rout in global markets?  It is more likely another bump on the road to recovery, with the impact all the larger due to the surprise factor of Duba’s announcement as it was widely thought that Dubai was on the road to recovery.  The fact that the news took place on a US holiday made matters worse whilst the weight of long risk trades suggests an exaggerated fall out over the short term.

Posted in Asia, Currencies, Economics, emerging markets, equity markets, Europe, Financial crisis, FX, Interest rates, Japan, Middle East, Monetary Policy, US. Tags: , , , , , , , , , , , , , , . 1 Comment »

When things are just not right

November 20, 2009 — Mitul Kotecha

One knows when things aren’t quite right when a football team wins a game by using a hand to help score a goal rather than a foot.  In this case it was French striker Thierry Henry who helped France to qualify for the world cup at the expense of Ireland.  To English soccer fans this looks like decidedly similar situation to the “hand of god” goal scored by Diego Maradona during the 1986 World Cup. 

Similarly things don’t look quite right with markets at present and what began as a loss of momentum turned into a bit of a rout for US (Thursday) and Asian stocks (Friday).  In turn risk appetite has taken a turn for the worse whilst the USD is on a firmer footing.  Profit taking or simply repatriation at year end may explain some of the market moves but doubts about the pace and magnitude of economic recovery are playing a key role.

Ireland has called for a replay of the soccer game but markets may not get such an opportunity as sentiment sours into year end.  Markets chose to ignore some relatively positive news in the form a  stronger than forecast increase in the Philly Fed manufacturing survey and the improving trend in US jobless claims leaving little else to support confidence. 

The only event of note today was the Bank of Japan policy decision.   Interest rates were kept unchanged at 0.1%.  Given that official concerns about deflation are intensifying interest rates are unlikely to go up for a long while and we only look for the first rate hike to take place in Q2 2011.  The BoJ may however, be tempted to buy more government bonds in the future if deflation concerns increase further.   USD/JPY was unmoved on the decision, with the currency pair continuing to gyrate around the 89.00 level though higher risk aversion suggests a firmer JPY bias. 

In the short term increased risk aversion will play positively for the USD against most currencies, especially against high beta currencies such as the AUD, NZD and GBP.   Asian currencies will also be on the back foot due to profit taking on the multi-month gains in these currencies.

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Searching for inspiration

November 9, 2009 — Mitul Kotecha

After an eventful week which included several central bank meetings and the US Jobs report there is less for markets to get their teeth into this week.  Despite the weak US jobs report risk appetite looks relatively resilient suggesting that the USD will struggle to make much headway over coming days.  

Despite all of the events last week markets have been uninspired.  Even the G20 meeting delivered little to be excited about with no further developments on how to rebalance the global economy and the USD’s role in the process.  The lack of attention on the USD will leave it with little directional influence this week, with equity markets likely to the main driver once again.

One currency that may look a little better supported over coming days is the EUR.  GDP data later in the week is likely to reveal an expansion over Q3 after several quarters of contraction as indicated by various PMI data. Although it will likely be led by inventories and exports rather than domestic demand it will nonetheless come as good news, albeit backward looking.  Going forward growth in Europe is unlikely to match the pace of recovery in the US but for now the GDP data will be EUR supportive helping EUR/USD to gravitate around 1.50 and beyond. 

Meanwhile, central banks may also do their part in influencing currencies given their differing stances on monetary policy.  Although the Fed did not deliver any big surprises last week the FOMC statement will play for a softer USD as the currency looks to maintain its funding currency status for an “extended period”.   In contrast the RBA hiked rates as expected and despite hinting at more gradual rate increases in the months ahead the AUD continues to stand to benefit.   Going in the opposite direction the BoE increased its asset purchases but GBP avoided a significant negative fall out as the move is likely to be seen as the final step in the BoE’s asset purchase programme.

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Respite for the dollar

October 27, 2009 — Mitul Kotecha

Markets are increasingly discounting stronger than expected Q3 earnings.  Further gains in equities and risk appetite may be harder to achieve even if profits continue to be beat expectations, which so far around 80% of Q3 earnings have managed to do. Measures of risk such as the VIX “fear gauge” have highlighted an increasingly risk averse environment into this week.  The negative market tone could continue in the short term.

The USD has found some tentative relief, helped by the drop in equities and profit taking on risk trades.  The fact that the market had become increasingly short USDs as reflected in the latest CFTC Commitment of Traders’ (IMM) report in which aggregate short USD positions increased in the latest week (short USD positions numbered roughly twice the number of long positions), has given plenty of scope for some short covering this week.

The USD has even managed quite convincingly to shake off yet another article on the diversification of USD reserves in China.  The USD index looks set to consolidate its gains over the short term against the background of an up tick in risk aversion.  The USD index will likely remain supported ahead of the main US release this week, Q3 GDP on Thursday, but any rally in the USD is unlikely to be sustainable and will only provide better levels to short the currency.

Given the broad based nature of the reversal in risk sentiment with not only equities dropping but commodities sliding too, it suggests that high beta currencies, those with the highest sensitivity to risk will suffer in the short term.  These include in order of correlation with the VIX index over the past month, from the most to the least sensitive, MXN, AUD, MYR, SGD, NOK, EUR, CAD, INR, ZAR, BRL, TRY and NZD. The main beneficiary according to recent correlation is the USD.

EUR sentiment in particular appears to be weakening at least on the margin as reflected in the latest IMM report which revealed that net long EUR speculative positions have fallen to their lowest level in 6-weeks.  Whether this is due to profit taking as EUR/USD hit 1.50 or realisation that the currency appeared to have gone too far too quickly, the EUR stands on shakier ground this week.  EUR/USD may pull back to near term technical support around 1.4840 and then 1.4725 before long positions are re-established.

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Earnings in focus

October 19, 2009 — Mitul Kotecha

The majority of US Q3 earnings have beaten market expectations resulting in a boost to risk appetite and further pressure on the US dollar. At the time of writing, 61 companies have reported earnings in the S&P 500 and an impressive 79% have beaten forecasts according to Thomson Reuters. This week there are plenty of earnings on tap and although a lot of positive news appears to be priced in the overall tone to risk appetite remains positive. This implies a weaker US dollar bias given the strong negative correlation between US equities and the USD index.

Aside from the plethora of earnings there are plenty of data releases on tap this week including housing data in the US in the form of building permits and starts as well as existing home sales. The data will likely maintain the message of housing market stabilisation and recovery in the US. There will also be plenty of Fed speakers this week and markets will once again scrutinize the speeches to determine the Fed’s exit strategy.

Highlights this week also include interest rate decisions in Canada and Sweden. Both the BoC and Riksbank to leave policy unchanged and expect a further improvement in the German IFO in October though at a more gradual pace than in recent months. There will be plenty of interest in the UK MPC minutes given conflicting comments from officials about extending quantitative easing. RBA minutes will be looked at for the opposite reason, to determine how quickly the Bank will raise interest rates again.

The USD index managed a slight rebound at the end of last week but is likely to remain under pressure unless earnings disappoint over coming days. US dollar Speculative sentiment became more bearish last week according to the CFTC IMM data, with dollar bloc currencies including the AUD, NZD and CAD benefiting the most in terms of an increase in speculative appetite. GBP short positions increased to a new record but the rally towards the end of last week may have seen some of these short positions being covered. Overall any recovery in the USD this week may just provide better levels to go short.

Posted in central banks, Currencies, Economics, Economy, Interest rates, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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