EUR/USD takes a crack at 1.50, where now?

October 22, 2009 — Mitul Kotecha

It seemed inevitable and finally after flirting with the 1.50 level, EUR/USD managed to break through although there seems to be little momentum in the move, with the currency pair dipping back below 1.50 in the Asian trading session. Contrary to expectations the break above 1.50 did not lead to a sharp stop loss driven move higher. 

Even the break through 1.50 only provoked a limited reaction in the FX options market where implied EUR/USD volatility only moved slightly higher. In fact despite the warnings by ECB President Trichet about “excessive currency volatility” FX options volatility for most currency pairs has been on a downward trajectory over the past few months, implying that the move in EUR/USD and the USD itself has been quite orderly. 

Trichet’s warning is more likely a veiled threat on the level of EUR/USD rather than its volatility, unless of course the ECB chief is seeing something that the FX options market is not. Assuming that EUR/USD closes above 1.50 this week it technically has plenty of open ground on the run up to the record high of 1.6038 hit in July 2008 but there will also be plenty of official resistance to limit its appreciation. Such resistance is limited to rhetoric but it will not be long before markets begin discussing the prospects of actual FX intervention.  

Perhaps the reason that EUR/USD did not move sharply higher following the break of 1.50 was the late sell off in US stocks on Wednesday which helped to fuel some USD short covering.  The USD index is holding just above the 75.00 level but it’s not a big stretch from here to move down to the March 2008 low around 70.698, with the overall tone of broad USD weakness remaining intact and ongoing. 

GBP was helped by relief that the minutes of the BoE meeting showed no inclination to increase the level of quantitative easing despite the ongoing debate within the MPC.   The minutes even sounded slightly upbeat about economic prospects. GBP/USD hit a high of 1.6638 in the wake of these developments due in large part to more short covering whilst EUR/GBP briefly dipped below 0.90.  GBP/USD may find it tough going to make much headway above 1.66 as has been the case over recent months, with strong resistance seen around 1.6661.

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Risk On / Risk Off

October 16, 2009 — Mitul Kotecha

Risk was firmly back on over the past few days as the majority of earnings came in stronger than expected; around 80% of S&P 500 companies have beaten expectations so far. Data releases in the US have also continued to beat forecasts, the latest of which was the September industrial production report. The dollar stood little chance of a recovering against this background and continues to languish around 14-month lows.

Sterling has been the star performer, perhaps a reflection of the fact that the market was extremely short (CTFC IMM data revealed record net short sterling positions last week) and some hints that the Bank of England may not extend quantitative easing was sufficient to provoke a short covering rally. Still the pound’s gains may prove short-lived until there are clearer signs of economic recovery and of a turn in the interest rate cycle.

There will be some key events and data over the coming week that will give further direction to sterling including a speech by BoE Governor King, MPC minutes, retail sales and preliminary Q3 GDP data. Overall, the data are unlikely to deliver much of a boost to the pound even though both retail sales and GDP are likely to deliver positive readings. Sentiment for the pound continues to swing in a wide range and though a lot of negativity was in the price a sustained recovery is far off. The risks remain that GBP/USD will push back towards support around 1.5902.

I still believe that there is little positive to be said for the euro too. The currency benefits from a weaker dollar but is hardly supported by fundamentals especially as a stronger euro damages one of the main engines of eurozone growth, namely exports. EUR/USD will struggle to make headway through 1.50 though once through here it could easily be carried higher. The most positive factor supporting the euro is the continued recycling of central bank intervention flows here in Asia and this may be sufficient to propel EUR/USD through 1.50 before hitting a wall of resistance around 1.5084.

The dollar itself may be given a lifeline from what looks like a softer tone to markets at the end of the week but overall sentiment remains very bearish despite attempts by various US officials to talk the dollar higher this week. The Fed’s Fisher hit the nail on the head when he said that the dollar’s long term value depends on policymakers “getting it right”. In the short term however, it’s all about risk and increasingly it will be about interest rate differentials, both of which will play negatively for the dollar.

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No relief for Sterling

October 13, 2009 — Mitul Kotecha

Anybody in the UK thinking of taking a holiday overseas has had to think twice over recent months given the precipitous drop in the pound (GBP) that took place since the beginning of August 2008. At the lowest point around six months after the British pound began its decline it had lost around a third of its value against the US dollar. Against the euro, sterling has fared even more poorly over a longer period, with GBP losing around 45% of its value from the beginning of 2007.

Since then GBP has recovered but has given back some of its gains over recent weeks against the dollar but has continued to weaken against the EUR. The worsening in GBP sentiment has been particularly well reflected in CFTC data on speculative positioning which revealed a drop to an all time low in GBP speculative contracts in contrast to EUR speculative contracts reaching close to the year high.

GBP faces headwinds from expectations that the Bank of England will extend its quantitative easing especially in the wake of recent data whilst news that the Center for Economics and Business Research (CEBR) predicted that the Bank of England (BoE) will keep its base rate unchanged until at least the end of 2011 came as another blow.

Although currencies are not particularly sensitive to interest rate movements at present it is unlikely to be long before the historically strong FX/interest rate relationship re-exerts itself and if UK policy is likely to remain accommodative for a prolonged period this could be detrimental to GBP’s recovery prospects. It seems unlikely that the BoE will wait as long as the CEBR predict before raising interest rates although a rate hike anytime in 2010 also looks unlikely.

There is at least some hope that aggressive UK monetary policy will deliver a relatively quicker economic recovery than in the eurozone where policy has arguably been much less aggressive and this relatively more positive cyclical picture will eventually result in some strengthening in GBP.

Nonetheless, the interim outlook continues to look bleak and sentiment is likely to continue to deteriorate over the short term. EUR/GBP now looks on path to retest its high reached at the end of 2008 at just over 0.98 (or around 1.02 for those that prefer to look at GBP/EUR) whilst GBP/USD appears to be heading for a move back below 1.55 and back to around 1.50.

Perhaps one of the only positive things that GBP has going for it at present is that looks very undervalued and when recovery does happen it could bounce back quite quickly and aggressively as markets cover their short positions. In the meantime, the good news of low interest rates will at least benefit borrowers and mortgage holders holding GBP denominated loans but not anyone in the UK wanting to take a holiday overseas.

Posted in Currencies, Economics, Interest rates, Monetary Policy, UK. Tags: , , , , , , , , , , , , , , . 2 Comments »

Risk trades under pressure

July 11, 2009 — Mitul Kotecha

Having given presentations in Hong Kong, China and South Korea in the past week and preparing to do the same in Taiwan and Singapore this week it is clear that there is a lot of uncertainty and caution in the air.  

There can be no doubt now that risk aversion has forcibly made its way back into the markets psyche.  Government bonds, the US dollar and the Japanese yen have gained more ground against the background of higher risk aversion. 

Following a tough week in which global equity markets slumped, oil fell below $60 per barrel and risk currencies including many emerging market currencies weakened, the immediate outlook does not look particularly promising.

Data releases are not giving much for markets to be inspired about despite upgrades to economic growth forecasts by the IMF even if their outlook remains cautious.  US trade data revealed a bigger than expected narrowing in the deficit in May whilst US consumer confidence fell more than expected in July as rising unemployment took its toll on sentiment.   There was also some disappointment towards the end of the week as the Bank of England did not announce an increase in its asset purchase facility despite much speculation that it would do so.

Rising risk aversion is manifesting itself in the usual manner in currency markets.  The Japanese yen is grinding higher and having failed to weaken when risk appetite was improving it is exhibiting an asymmetric reaction to risk by strengthening when risk appetite is declining.  Its positive reaction to higher risk aversion should come as no surprise as it has been the most sensitive and positively correlated currency with risk aversion since the crisis began. 

Nonetheless, the Japanese authorities will likely step up their rhetoric attempting to direct the yen lower before it inflicts too much damage on recovery prospects.   The urgency to do so was made clear from another drop in domestic machinery orders last week as well as the poor performance of Japanese equities.  

The US dollar is also benefitting from higher risk aversion and is likely to continue to grind higher in the current environment.  Risk currencies such as the Canadian, Australian and New Zealand dollars, will be most vulnerable to a further sell off but will probably lose most ground against the yen over the coming days.   These currencies are facing a double whammy of pressure from both higher risk aversion and a sharp drop in commodity prices.    Sterling and the euro look less vulnerable but will remain under pressure too.   

There are some data releases that could provide direction this week in the US such as retail sales, housing starts, Empire and Philly Fed manufacturing surveys.  In addition there is an interest rate decision in Japan, and inflation data in various countries. The main direction for currencies will come from equity markets and Q2 earnings reports, however.  

So far the rise in risk aversion has not prompted big breaks out of recent ranges in FX markets.  However, unless earnings reports and perhaps more importantly guidance for the months ahead are very upbeat, there is likely to be more downside for risk currencies against the dollar but in particular against yen crosses where most of the FX action is set to take place.

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