Volatility Within Ranges

May 31, 2010 — Mitul Kotecha

Most investors will likely be happy to see the tail end of May given the sharp losses in many asset classes over the month. At least over the last few days there was a sense of some healing, particularly in risk assets though it is questionable how long this can continue given the still many and varied uncertainties afflicting markets. A reminder of this came late on Friday, with Fitch downgrading Spain’s sovereign credit ratings despite the passage of austerity measures.

The Fitch decision highlights that Spain is rapidly becoming the new epicenter of the crisis; focus on the savings banks or Cajas is intensifying ahead of the June 30 deadline for mergers to qualify for government money, the minority government’s popularity is in further decline, whilst unions are threatening more strikes across the country. Unions in Greece and Italy are also pushing for coordinated strikes, highlighting the difficulties in pushing through austerity measures.

At least economic data is providing some solace to markets. Releases last week in the US highlighted the fact that consensus expectations are underestimating the pace of recovery; consumer confidence, durable goods orders and new home sales all came in above expectations. The same story is likely this week, but there is really only one piece of data that attention will focus on and that’s the May jobs report. The consensus is for a strong 508k increase in non-farm payrolls following a 290k increase in April, though around three-quarters of this will be related to census hiring. The unemployment rate is likely to dip slightly to 9.8%.

Markets are likely to be in limbo, with volatility in ranges likely this week. USD sentiment remains strong as reflected in the CFTC IMM data where net aggregate positioning is at an all time high, but further USD gains may be harder to come by ahead of the US jobs report and G20 meeting this weekend. Stretched USD positioning has proven no barrier to USD strength over recent weeks but the fact that markets are very long USDs could at the least result in a slower pace of further appreciation.

EUR speculative sentiment remains close to all time lows although there are signs of some relative stability over recent weeks. EUR/USD is likely to range between 1.2134 and 1.2475 this week. There was a sharp drop in net short JPY positions over the week (ie short-covering) though this appears at odds with the fall in the JPY. GBP speculative positions showed little improvement, languishing close to all time lows, whilst net longs in commodity currencies were pared back sharply, especially in AUD where net longs were cut by around half though sharp declines in positioning were also registered for NZD and CAD.

GBP could suffer due to worries about the UK government’s plans to reduce its burgeoning budget deficit following the resignation of Treasury Minister David Laws, following an expense scandal. The resignation hits the coalition just three weeks before the emergency budget and could result in complications on the negotiations between the Liberal Democrats and Conservatives on the substance of the deficit cutting measures. GBP/USD is likely to find support around 1.4260 and resistance around 1.4612 this week.

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What To Watch This Week

May 24, 2010 — Mitul Kotecha

The end of last week proved to be a calmer affair than the preceding few days. There was some encouraging news on the Greek front, with Germany finally approving its share of the European Union (EU) aid package whilst Greece appeared to be on track with its budget deficit reduction as the country recorded a cash deficit of EUR 6.3billion in the first four months of the year, a 42% reduction compared to a year earlier. EU officials also agreed on tougher sanctions for countries breaching austerity rules.

There were plenty of negatives to offset the good news however, as European business surveys including the German IFO index and flash eurozone purchasing managers indices (PMIs) revealed some loss of momentum in growth as well as increased divergence. European banking sector concerns intensified as the Bank of Spain was forced to take control of CajaSur, a small savings bank holding 0.6% of total Spanish banking assets, which faced difficulties due to distressed real estate exposure. Its woes highlighted the problems faced by many Spanish savings banks due to property market exposure.

US data releases this week will confirm that economic recovery gathered steam in Q2. May consumer confidence data is likely to record a small gain, due in large part to improving job market conditions, whilst the Chicago PMI is set to retrace slightly in May, albeit from a healthy level. Both new and existing home sales are set to record gains in April, the former following a sizeable gain in March although the drop in house prices likely to be revealed by the Case-Shiller index will continue to fuel doubts about the veracity of the turnaround in the US housing market.

In Europe there is not much in terms of first tier releases and highlights include sentiment data such as German Gfk and French consumer confidence indices, and the May French business confidence indicator. The data are likely to be mixed, and as indicated by last week’s surveys will reflect a relatively healthy Q2 2010, but a worsening outlook for the second half of the year.

In the absence of UK data today there will be plenty of attention on the details of plans by Chancellor Osborne to cut GBP 6 billion from the budget deficit. The measures will be small change ahead of the emergency budget package on June 22nd when much bigger cuts are expected. Nonetheless, the first step today will be a crucial test of the new government’s ability to convince ratings agencies and markets that it is serious about reducing the burgeoning fiscal deficit.

Following the massive positioning adjustments of the last week markets will look somewhat calmer over coming days but risk aversion is likely to remain elevated, suggesting little respite for most currencies against the USD. The recent moves have left net aggregate USD positioning registering an all time high according to the CFTC Commitment of Traders data, in the latest week, but after the slight retracement lower in the USD index, it is set to make further gains over coming days.

It was notable that EUR and GBP looked more composed at the tail end of the week whilst attention turned to the liquidation of long positions in CHF, AUD, NOK and SEK. These risk currencies are set to remain under pressure but there will be little respite for EUR which is set to drift lower, albeit a less aggressive pace than over recent weeks and a re-test of EUR/USD technical support around 1.2296 is likely. GBP/USD has showed some resilience over recent days but remains vulnerable to further downside pressure, with 1.4310 immediate support.

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Greece Bailed Out, Euro Unimpressed

May 3, 2010 — Mitul Kotecha

After much debate eurozone ministers along with the International Monetary Fund (IMF), finally announced an emergency loan package for Greece amounting to  EUR 110 billion. In return for the bailout Greece agreed to enhanced austerity measures. The good news is that the package covers Greece’s funding requirements until 2012, and is sufficient to avoid debt restructuring and default. The loan package has also removed uncertainty ahead of bond redemption on May 19th.

One aim of the package was to prevent contagion to other eurozone countries, especially Portugal and Spain, where there has been growing pressure on local bond and equity markets. However, the path ahead is strewn with obstacles and it is too early to believe that the package has ensured medium term stability for the EUR.

The challenges ahead are two-fold, including both the implementation of the measures in Greece in the face of strong domestic opposition and the approval of the loans by individual country parliaments within the eurozone, both of which are by no means guaranteed.

The toughest approval process is likely to be seen in Germany where the government will face a grilling in parliament and a challenge in the constitutional court ahead of official approval of the package. European Union leaders are scheduled to meet on May 7th to discuss the parliamentary approval of loans to Greece whilst German officials meet on the same day.

Implementation risk is also high. Although the Greek government appears to be sufficiently committed, opposition within Greece is growing; various strikes planned over coming days. Aside from union opposition, the scale of the budgetary task ahead is enormous, having never been undertaken on such a large scale in recent history. The sharp decline in growth associated with the austerity measures will make the task even harder.

The EUR bounce on the news has been limited, with the currency failing to hold onto gains. The announcement seems to have triggered a “buy on rumour, sell on fact” reaction, with the size of the loan package falling within the broad estimates speculated upon over the last week. The lack of EUR bounce despite the fact that going into this week the CFTC Commitment of Traders report revealed record net short speculative positioning in EUR/USD, reveals the extent of pessimism towards the currency.

The EUR may benefit from a likely narrowing in bond spreads between Greece and Germany. Given that sovereign risk is being increasingly transferred from the periphery to the core, the net impact on bond markets may not be so positive for the EUR. Over the short-term there will be strong technical resistance on the upside around EUR/USD 1.3417 but more likely the currency pair will target support at around 1.3114.

The Herculean task ahead for the Greek government suggests that markets will not rest easy until there are credible signs of progress. Investors would be forgiven for having a high degree of scepticism given the degree of “fudging” involved in the past, whilst Greek unions will undoubtedly not make the government’s task an easy one by any means. Such scepticism will prevent a sustained EUR recovery and more likely keep the EUR under pressure.

As noted above the divergence in growth for the eurozone economy between Northern and Southern Europe will make policy very difficult. Moreover, the EUR is set to suffer from an overall weak trajectory for the eurozone economy, relative to the US and other major economies. The widening growth gap with the US will also fuel a widening in bond yield differentials, a key reason for EUR/USD to continue to decline to around or below 1.25 by the end of the year.

Posted in Bond markets, central banks, Currencies, Economics, Economy, equity markets, Europe, eurozone, Financial crisis, Fiscal/Budget, FX, Germany, Greece, IMF, Interest rates, Monetary Policy. Tags: , , , , , , , , , , , , , , , , , , . 1 Comment »
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