USD edges higher

August 29, 2013 — Mitul Kotecha

There appears to be some prevarication over possible military strikes on Syria resulting in less angst in markets over an imminent strike. Consequently risk appetite edged higher overnight while US Treasury yields also rose. Potential military strikes have also led to firming oil prices. Pressure on vulnerable emerging market assets has continued unabated however, with tapering worries and domestic vulnerabilities resulting in ongoing capital outflows.

In Asia the INR and IDR remain under considerable pressure. However, INR forwards recovered somewhat overnight and the spot rate strengthened in the wake of the introduction of a forex swap window for Indian oil firms. The measure will help to alleviate some of the demand/supply pressures for USDs but is however, unlikely to arrest the decline in the INR for long. In Indonesia the central bank may increase policy rates by 50bps today which ought to help the IDR in the short term.

The USD gained a little ground as US yields rose. The USD may benefit as markets fret about possible military action against Syria resulting in an attendant rise in risk aversion. Nonetheless, a series of negative data surprises over recent days contrasting with positive surprises in Europe leaves the USD rather vulnerable against major currencies. In contrast the USD is set to continue to remain firm against many emerging market currencies given the ongoing outflow of capital in the wake of higher US yields and tapering fears.

AUD’s tentative recovery in early August has proven to be an abject failure. Like many other high beta currencies AUD has suffered as risk aversion has intensified recently. Additionally speculation of further policy easing has also dampened the AUD. Consequently speculative sentiment remains weak. In reality, further rate cuts may depend on whether the AUD can rally following an over 15% fall since April. Any failure for the AUD to gain ground may stay the hand of the RBA. Although it has found some support today, further downside pressure is likely with a breach of the 5 August low at 0.8848 expected.

GBP underwent some volatility in the wake of BoE governor Carney’s speech. Initial weakness was bought into as shorts were covered however, leaving the currency back where it started. Carney’s speech was interpreted as dovish, with the governor noting that the BoE was read to loosen policy if higher market rates impacted the economy. Nonetheless, there was little immediate implication for policy. Overall GBP is likely to be constrained around resistance at 1.5590, with gains limited ahead of the BoE policy meeting next week.

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USD softens on Bernanke, GBP firm, AUD oversold

July 18, 2013 — Mitul Kotecha

Fed Chairman Bernanke did not deliver anything particular new in his testimony yesterday but still managed to provide further reassurance to markets. The Fed chief noted that asset purchases are not on a preset course while highlighting that ‘tapering’ will only occur if economic data warrants it. His concerns about high unemployment and very low inflation emphasized the Fed’s commitment to easy policy settings.

Assisted by a weaker than expected housing starts report bonds liked what they heard, with 10 year Treasury yields dropping below 2.5% while equities rallied and the USD softened. Gold struggled however, failing again to break above USD 1300 and settling back into its USD 1270-1300 range.

Overall, Bernanke’s comments remain consistent with tapering beginning later this year, most likely in September. He will repeat the testimony to the Senate Banking Committee today but markets will look for further clues in the Q&A session.

The positive tone will likely creep into Asian trading today in the absence of other key market drivers, with the USD likely to be restrained against both major and Asian currencies although Asian currencies may struggle given the IMF’s more cautious comments on Chinese growth in which they highlighted the growing downside risks to their growth forecast.

GBP/USD has registered a solid recovery since its recent low just above 1.48. Helped by a hawkish surprise in the Bank of England MPC minutes in which the vote was 9-0 to maintain current monetary settings as new governor Carney managed to unite the MPC view, GBP looks well supported in the days ahead.

What’s surprising is the lack of GBP progress against the EUR especially given the relative outperformance of UK economic data recently and prospects of strengthening momentum into H2 13. Given the potential for alternative monetary policy instruments in the months ahead some caution on GBP may be warranted.

Nonetheless, as GBP is positioned short versus both EUR and USD, its downside looks limited and if anything it will register gains versus EUR. Today’s retail sales may be a risk, but any set back to GBP is likely to prove temporary.

A lot of bad news is already priced into the AUD and sentiment has become overly bearish even if Australia’s government and central bank would prefer to see further currency weakness. There is a risk of an AUD rally in the event of better economic news given that market positioning has become extremely short (close to the all-time low).

A combination of improving risk appetite, renewed search for carry, stabilization in commodity prices and reasonably strong growth in China will eventually help to spur the AUD higher. Clearly there are risks to AUD as the transition process to Fed tapering and higher US yields takes effect but assuming that US yields move gradually as opposed to rapidly higher it is unlikely to stand in the way of an AUD recovery.

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Australian dollar unworried by political developments

June 27, 2013 — Mitul Kotecha

The USD remains firm but is struggling to make further headway against major crosses. Some improvement in risk appetite, firmer equity markets and slightly lower yields today may limit the ability of the USD to extend its gains in the near term (as the USD usually suffers when risk appetite improves and US yields drop) although we expect any setback to prove temporary, with US Treasury bond yields set to continue to move higher over the coming weeks, albeit at a more gradual pace.

USD/JPY’s rebound has stalled over recent days despite the fact that US bond yields have continue to rise relative to Japanese JGB yields. My analysis of JPY performance during the last thee periods of sharply higher US yields shows that the JPY weakened versus USD in the first two periods and is on the verge of doing so in the third period (since early May).

Additionally the JPY has maintained a strongly negative correlation with US yields over the past 12 months. All of this suggests that the JPY will resume a weaker trend over coming weeks although markets may wait until the Japanese Upper House elections on July 21 and subsequent news of further reforms before pushing the JPY much weaker.

It if wasn’t enough that the AUD was suffering from higher US yields and China concerns, the announcement of a leadership election for the Labor leadership will have done little to bolster confidence in the currency. That said, politics is not an important driver of the AUD and the currency managed to eek out some gains despite Prime Minister Gillard’s loss in the contest.

Some easing in funding tensions among China’s banks has helped the AUD, with the currency showing encouraging signs of stabilization over recent days. However, its limited progress is still a long way from becoming a sustained rally. AUD/USD has a very negative correlation with 10 year US Treasury yields over the past 3 months, and continues to remain susceptible to further US yield increases until the market finally becomes accustomed the prospects of Fed tapering.

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A volatile period of transition

June 4, 2013 — Mitul Kotecha

The drop in the US ISM manufacturing confidence index in May to close to 4 year low failed to have a sustained impact on equity markets. Perversely weaker data is leading to less fears of Fed tapering which in turn is boosting equity markets. Surely equities should fall as data comes in weak but clearly that is not the case. In any case the contraction in the ISM is highly unlikely to presage a new phase of economic weakness.

Markets continue to await central bank meetings and the US May jobs data at the end of the week for further direction but ahead of that volatility whether in the interest rate, FX or equity spectrum shows little sign of dissipating. During a period of policy transition as we appear to be in now, such volatility should be expected but could prove dangerous if prolonged.

The USD has lost ground even as risk aversion has moved higher, a factor that would normally be associated with a stronger USD. The USD received a blow from the weaker than forecast US ISM manufacturing index which led to Treasury yields slipping from their highs.

Hesitation ahead of Friday’s payrolls data may also explain some of the inability of the USD to strengthen and given that aggregate USD speculative positioning reached an all time high last week profit taking on USD longs is unsurprising. However, the move is unlikely to mark the start of a deeper pull back and assuming that the US jobs report continues on an improving trajectory the USD will likely resume its uptrend over coming weeks.

After reaching a high close to 104 USD/JPY has dropped all the way back to below the 100 level. Part of the explanation comes from elevated risk aversion but also heightened volatility in the local equity and bond markets which has prompted USD/JPY liquidation. Is this the end for JPY bears? More likely the pull back will prove temporary especially as yield differentials have actually widened in favour of the USD over recent days.

Meanwhile, capital flow data will continue to be watched carefully to determine whether Japanese lifers and the government pension fund are finally moving money offshore, something that has not happened yet. Strong support for USD/JPY is seen around the 50 day moving average level at 99.08.

AUD/USD has benefitted from a short squeeze and looks to have bottomed out just above 0.96 versus USD which ought to provide a solid base for the currency. AUD looks especially attractive relative to NZD. As I have been noting the AUD has already priced in a lot of bad news and our quantitative model points to upside versus USD. Reflecting this is the fact that speculative positioning has dropped to extreme levels leaving the AUD susceptible to further short covering.

One obstacle to AUD recovery is the RBA but perversely the drop in the AUD over recent weeks will have given the Bank further reason not to ease policy today, which in turn will play well for the currency.

Rather than facing more pressure as would be expected in the wake of weaker US manufacturing confidence data Asian currencies have actually benefitted as the USD has weakened overnight. The PHP has been a star performers and according to my quantitative models is set for further gains. I am wary of looking for much further upside for Asian currencies, however, especially as the USD pull back is likely to prove short lived.

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Changing dynamics

June 3, 2013 — Mitul Kotecha

A change in market dynamics appears to be taking place. Nervousness over a prospective paring back in US quantitative easing as the Fed ponders the timing of a tapering in asset purchases taken together with elevated volatility in Japanese markets is leading to a decrease in risk appetite, higher core bond yields and weaker equity markets. Consequently emerging market assets especially high beta currencies are coming under significant pressure under the weight of capital outflows and rising risk aversion.

Unsurprisingly the USD has been a major beneficiary although it did lose steam last week. In Japan “Abeconomics” is leading to a rise in inflation expectations and higher Japanese government bonds (JGB) yields which could in turn derail recovery unless the rise in yield is capped by the Bank of Japan’s policy actions. Overall, the background is set for a further increase in uncertainty and market volatility this week.

The lack of clarity over Fed policy in particular is fuelling market volatility and given the intense focus on the Fed and in turn the Fed’s focus on the jobs market, the US May jobs report at the end of the week will be crucial to determine the direction of activity over the coming weeks. The consensus forecast for May payrolls is 165k. Opportunity to refine the forecast will follow the release of ISM manufacturing confidence (today) and ADP private sector jobs data (Wed).

Other potentially market moving events include the European Central Bank (Thu), Bank of England (Thu) and Reserve Bank of Australia meetings (Thu). None of the central banks are likely to change policy settings although there is potential for a dovish statement from the ECB (possible discussion of negative deposit rates and/or liquidity provision).

Currencies are reacting to higher US yields, which have driven the USD to multi month highs. EUR/USD in particular has a high correlation with 2 year bond yield differentials. As noted last week was less positive for the USD, with both the EUR and JPY making up some ground, with further direction coming from relative yield movements. In the case of the JPY, reduced risk appetite is also playing for a firmer currency. Nonetheless, it will be difficult for EUR/USD to sustain any gain above 1.3000 and USD/JPY to sustain any drop below 100.

Better than forecast Chinese manufacturing confidence data over the weekend has helped give some support to AUD, NZD and Asian currencies although it may provide limited relief, especially to Asian currencies which are suffering from increased risk aversion and the impact of higher US yields. While Asia has recorded the strongest inflow into equity markets compared to past years concerns about capital outflows from the region are intensifying. Korea and Thailand have suffered in particular from equity outflows over recent weeks.

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