Asian currencies running into resistance

As the US Q3 earnings season gets underway caution is prevailing as reflected in the losses in US and European equity markets overnight. The VIX jumped as risk aversion increased in the wake of lower revised growth estimates from the IMF and worries that earnings will be far less flattering than in previous quarters. Nonetheless, stronger than forecast earnings from Alcoa helped to kick of the earnings season in positive mode.

In Europe the visit by Chancellor Merkel to Athens was accompanied by reassuring statements from the German leader but this was to little avail as demonstrations in the Greek capital continued. Reports that lenders are discussing extending Greece’s bailout program by two years may provide some relief, however.

Spain remains the major focal point and in this regard there is no progress in the country moving forward with a bailout request much to the chagrin of peripheral debt markets and the EUR. There are few data releases of interest today of which the Fed’s Beige Book will be the main highlight. The market tone will continue to remain cautious but we don’t expect a major relapse in risk appetite.

The USD continues to make good headway in an environment of higher risk aversion, as the USD index continues to maintain a strong correlation with risk. We see little reason for this to reverse although EUR/USD may run into some support around the 1.2824 area. Our preferred crosses include playing short EUR/AUD given that our model indicators show that AUD is oversold at current levels.

Asian currencies will run into some resistance against the background of a firmer USD and the ADXY index is struggling to break higher. The PHP and THB have been the major outperformers so far this month, with most other Asian currencies have weakening.

India has been the biggest beneficiary of renewed portfolio flows to the region, unsurprising in the wake of recent reform announcements registering around $1.3 billion of equity flows month to date. USD/KRW looks like it will struggle to break below 1110 having failed on its attempts to break through this level. Equity capital inflows to Asia are on par with the inflows registered in 2009 and 2010.

Advertisement

Risk assets rally, AUD jumps on strong jobs data

Risk assets rallied hard overnight overcoming, albeit temporarily, fears of a Eurozone calamity. The boost to markets appeared to come from hopes of stimulus on many fronts. Although the European Central Bank (ECB) did not cut policy interest rates President Draghi did note that he ‘stands ready to act’ if needed. This implies that rates cuts are in the pipeline very soon but any more action will require European politicians to act first. Following the G7 conference call there is also speculation that EU officials are coordinating some form of support for Spain, especially for its banking sector but details of what this will entail is lacking.

Meanwhile, speculation that the Fed will at least extend ‘Operation Twist” if not opt for a further round of quantitative easing has helped to support the uplift to sentiment. Further clues will come from Fed Chairman Bernanke’s testimony to Congress today although we don’t expect him to signal a policy shift. Markets are clearly grasping for any potential positives in the form of potential policy support but the risk of disappointment remains high, especially in Europe where policy makers have yet to reveal any fresh plans.

The USD dropped further overnight as risk currencies rallied. Market positioning had become very long USDs and some correction of long positioning / profit taking is obviously taking place Data releases did not provide any support to the currency although the Beige Book did note that the economy was continuing to grow ‘moderately’ which was perhaps less negative than it could have been. The USD may find some support from the Bernanke’s testimony today. Although the Fed chief is set to be cautious in his outlook he is unlikely to point to further stimulus at this stage.

It’s worth highlighting the Australian data this morning. Employment rose by surprisingly strong 38.9k. The details of the jobs report are even better than the headline. Full time employment was up 46.1k, while part time jobs were down 7.2k. The only slight negative is the rise in the unemployment rate to 5.1% but this was largely due to a rise in the participation rate to 65.5% from 65.2%. This is the second solid Australian reading in a row following on from the Q1 GDP data yesterday. Given today’s jump in risk assets the data will help compound AUD gains in the short term. AUD/USD will face strong resistance around 1.0021.

USD, EUR and JPY Outlook This Week

The USD lost more ground last week extending its drop from the early October. Interestingly its latest drop has occurred despite an uptick in risk aversion suggesting other factors are at work. Mixed US data and earnings have not given the USD much direction with a downbeat Beige Book counterbalanced by a firmer Philly Fed manufacturing survey and housing starts.

The data have not been sufficiently weak to fuel expectations of more Fed quantitative easing but some Fed officials including Yellen, Tarullo, Evans and Rosengren in indicating that further QE could be considered. The USD has therefore been somewhat undermined but will take its cue from data releases and events in Europe this week.

This data slate will be mixed but on balance will not support more Fed QE. In particular, Q3 Real GDP is expected to come in sharply higher than in Q2, with a 2.5% annual rate expected to be revealed. Other indicators will be less positive, with October consumer confidence set to slip further and remain at a recessionary level, while September durable goods orders will decline by around 1%.

Despite an expected increase in new home sales in September the overall picture of the US housing market will remain very weak. Overall, the USD may find some respite from the GDP report but the data will be seen as backward looking, with the jury still out on the issue of more quantitative easing.

The EUR struggled to make any headway last week amid a barrage of rumors about the outcome of Sunday’s EU Summit. In the event the summit failed to deliver concrete details although there appeared to be some progress in key areas. Attention will now turn to Wednesday’s summit but once again the risk of disappointment is high. EUR/USD will only extend gains if markets are satisfied at the result but this is by no means guaranteed.

Data releases will not be supportive for the EUR this week, with a further deterioration in ‘flash’ eurozone purchasing managers indices (PMIs) and European Commission confidence surveys expected in October but hopes of a concrete resolution at Wednesday’s EU Summit will keep the EUR/USD supported early in the week although it will find strong resistance around 1.3915.

The sensitivity of the JPY to risk aversion has actually fallen over the last three months while the influence of bond yield differentials also appears to have slipped. The fact that USD/JPY continues to remain in a very tight range with little inclination to break in either direction despite gyrations in risk and yield differentials almost appears if the currency pair has been pegged.
Obviously this is not the case but a break out of the current range does not look imminent.

Speculative JPY positioning has dropped over recent weeks while equity and bond flows have overall been negative but this has not been reflected in JPY weakness resulting in increased frustration by Japanese officials. We continue to look for the JPY to weaken over coming months but much will depend on a widening in US / Japan yield differentials and easing risk appetite as both will regain their hold on the currency. In the meantime, the currency will continue to offer little to get excited about.

Payrolls sour mood, Eurozone concerns intensify

The market mood has soured further and risk aversion has increased following disappointing August US jobs report in which the change in payrolls was zero and downward revisions to previous months has reinforced the negative mood on the US and global economy while raising expectations of more Federal Reserve action. Moreover, the report has put additional pressure on US President Obama to deliver fresh jobs measures in his speech on Thursday though Republican opposition may leave Obama with little actual leeway for further stimulus.

There is plenty of event risk over coming days, with a heavy slate central bank meetings including in Europe, UK, Japan, Australia, Canada and Sweden. The European Central Bank will offer no support to a EUR that is coming under growing pressure, with the Bank set to take a more neutral tone to policy compared its previously hawkish stance. In the UK, GBP could also trade cautiously given recent comments by Bank of England Monetary Policy Committee members about potential for more UK quantitative easing.

The EUR has been unable to capitalise on the bad economic news in the US as news there has been even worse. The negative news includes the weekend defeat of German Chancellor Merkel’s centre-right bloc in regional elections, which comes ahead of a vote in Germany’s constitutional court on changes to the EFSF bailout fund.

The withdrawal of the Troika (ECB, IMF and EU) from Greece has also put renewed emphasis on the country at a time when protests are escalating. If all of this is not enough there is growing concern about Italy’s apparent backtracking on austerity measures, with the Italian parliament set to discuss measures this week. Separately Germany, Holland and Finland will hold a meeting tomorrow on the Greek collateral issue. On top of all of this is the growing evidence of deteriorating growth in the euro area.

Data releases are unlikely to garner a great deal of attention amidst the events noted above, with mainly service sector purchasing managers indices on tap and at least threw will look somewhat better than their manufacturing counterparts. In the US the Beige Book and trade data will be in focus but all eyes will be on Obama’s speech later in the week. The USD has maintained a firm tone despite the jobs report but its resilience may be better explained by eurozone negativity rather than US positivity. Even so, the USD is looking less uglier than the EUR in the current environment.

Risk aversion spikes

Increased risk aversion overnight in the wake of escalating Middle East tensions gave the USD some support but overall the USD index is gradually drifting towards its early November low around 75.631. The antithesis of USD weakness is strength in most other major currencies.

The USD is being undermined by relatively dovish expectations for US interest rates relative to elsewhere and last night’s semi annual testimony by Fed Chairman Bernanke to the US Senate did nothing to alter this tone, with Bernanke maintaining the emphasis on subdued inflation and elevated unemployment.

The USD index itself has a high (0.82) 3-month correlation with US interest rate futures and over recent weeks as the implied yield has dropped, the USD has lost ground. The prospects of higher US bond yields may eventually provide the USD with support, especially given the prospect of substantial short-covering but in the near term the USD is likely to remain under pressure.

The upbeat run of US data highlights another source of USD support over the medium term, given the likely outperformance of the US economy over coming months. Yesterday’s ISM manufacturing survey and vehicle sales data lend support to this view. Moreover, the rise in employment component of the ISM supports the view of at least a 195k increase in February payrolls.

The Fed’s Beige Book tonight and February ADP jobs report will not alter the USD’s trajectory. The Beige Book is unlikely to reveal anything to worry the Fed in terms of inflation risks although will probably reveal further signs of improved activity. The ADP report will give important clues for Friday’s February non-farm payrolls data although it’s worth noting that last month’s report was way off the mark. In any case neither release is likely to prevent a further drop in the USD.

EUR is a clear beneficiary of expectations of tighter monetary policy by the ECB and the widening interest rate (futures implied yield) differential between the US and eurozone has given the EUR plenty of support recently as reflected in the high correlation with EUR/USD. Further support to the hawkish market stance was given by the upward revision to eurozone 2011 growth and inflation forecasts by the EU. The fact that eurozone inflation increased to 2.4% YoY in February also reinforced expectations of ECB tightening sooner than later.

The ECB press conference following the council meeting tomorrow will likely shape such expectations further, the EUR has already priced in a hawkish ECB stance, limiting the prospects of further appreciation. Notably EUR/USD has failed to break resistance at its year high around 1.3861, which will prove to be a formidable cap in the short-term.

In contrast, the RBA has poured cold water over expectations of further policy rate hikes in Australia. The policy statement following yesterday’s decision to keep the cash rate on hold pointed to an extended pause in the months ahead. Despite this and perhaps because markets have already pared back Australian interest rate expectations AUD rebounded quite smartly from its post meeting low and despite some overnight weakness due to increased risk aversion it will soon verge on a break of resistance at 1.0257.

AUD/NZD has continued to charge ahead having hit a multi-year high above 1.3600. NZD underperformance has been exacerbated by the impact of the recent earthquake, with growth expectations for this year having been sharply revised lower and growing speculation of an interest rate cut. Indeed, such speculation was given further fuel by comments by NZ Prime Minister Key who noted he would welcome a policy rate cut. Nonetheless, my quantitative AUD/NZD model suggests that the cross looks over-extended at current levels, whilst relative speculative positioning supports this view.

%d bloggers like this: