Lots of event risk in the days ahead

November 3, 2009 — Mitul Kotecha

Fears about yet another market crash in October proved unfounded but there were severe bouts of nervousness during parts of the month.  This was hard to tie in with the strength of earnings and continued good news on the economic front but perhaps markets had already priced in a lot of good news.   This was evident in the fact that economic surprises were becoming increasingly negative.

Nervousness is good for the dollar and has at least given the currency a semblance of support.   However, not all the economic news is coming in below forecast as demonstrated by the stronger than consensus reading for the US ISM index for October whilst even the eurozone PMI moved back into expansion territory following 17 months of contraction.

The tone over the rest of the week will depend on the outcome of several central bank meetings the main ones being the Fed, ECB and BoE as well as the US non-farm payrolls report.  None of the central banks are likely to hike rates but in an FX market that is becoming increasingly reactive to interest rate differentials whichever bank sounds relatively more hawkish will see their respective currency strengthen the most.

Unless the Fed sounds particularly dovish the dollar is likely to consolidate further over the short term and given the still significant size of dollar short positioning there is still some scope for some further relief for the dollar.   However, don’t expect much movement out of current ranges until after the payrolls report and even then markets may be hesitant ahead of this weekend’s G20 meeting.

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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 »

Talking about currencies

October 5, 2009 — Mitul Kotecha

It’s always the same story.  Ahead of the G7 (or G8 and now more important G20) meetings speculation of decisive action on currencies intensifies.  Traders and investors become cautious on the off chance that something significant will happen but the majority of times nothing of note emerges.

There was no difference this time around.  The G7 Finance Ministers meeting in Istanbul failed to deliver anything substantive on currencies, repeating the usual mantra about the adverse impact of “excess volatility and disorderly movements”.  Although the group pledged to monitor FX markets there was no indication of imminent action. 

The lack of action is perhaps surprising in one respect as there were plenty of central bankers and finance officials talking about currencies in the run up to the G7 meeting, most of which were attempting to talk the dollar higher against their respective currencies.  Given the increase in rhetoric ahead of the meeting, the relatively weak statement now leaves the door open to further dollar weakness.

The strongest indication of any FX action or intervention came from the country that was supposedly the least concerned about currency strength; Japanese Finance Minister Fujii warned that Japan “will take action” if “currencies show some excessive moves”.  The shift in stance from Japan since the new government took power has been stark (considering that the new government was supposedly in favour of a stronger yen).  Markets will likely continue to test the resolve of the Japanese authorities and buy yen anyway.

Although the G7 statement said little to support the dollar and the overall tone to the dollar likely remains negative over coming months, the softer tone to equity markets and run of weaker economic data in the US – the latest data to disappoint was the September US jobs report – may give some risk aversion related relief to the dollar this week. 

Weaker data and equities alongside the impact of official rhetoric is being reflected in CFTC Commitment of Traders’ data (a good gauge of speculative market positioning) which revealed a sharp drop in short dollar positions, by around a quarter, highlighting for a change, an improvement in dollar sentiment over the last week. 

The biggest losers in terms of speculative positioning were the British pound, where the net short position reached its most extreme since mid September 2008, and Canadian dollar where the net long position was cut by almost half.  Again this may reflect official views on currencies, with Canadian officials expressing concern about the strength of the Canadian dollar in contrast to the perception that UK officials favour a weaker pound.
Central bank meetings (BoE, ECB, RBA) will dominate the calendar this week and more comments on currencies are likely even if interest rates are left unchanged.  Meanwhile FX markets will continue to watch equities, and the start of the US Q3 earnings season will give important signals to determine the sustainability of the recent equity market rally.  Recent weak economic data has already cast doubt about a speedy recovery and if earnings disappoint risk aversion could once again be back on the table.

Posted in central banks, Currencies, Economics, Economy, equity markets, Europe, Japan, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »
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