Edging Towards A European Deal For Greece

July 21, 2011 — Mitul Kotecha

The momentum towards some form of agreement at the Special EU Summit today is growing, with French and German leaders reaching a “joint position on Greece’s debt situation”. Details of this position are still unknown, however. EUR has found support as expectations of a positive outcome intensify.

However, given that positive news is increasingly being priced in, and the market is becoming increasingly long, upside EUR potential will be limited even in the wake of a comprehensive agreement. A break above EUR/USD resistance around 1.4282 would bring in sight the next key resistance level around 1.4375 but this where the rally in EUR/USD is set to be capped.

Prospects of a major US debt default or at the least a government shutdown appear to be receding as the US administration has indicated some willingness to opt for a short term increase in the US borrowing limit to give more time for a bigger deficit reduction deal to be passed by Congress. Meanwhile, there will be further news on the deficit reduction plans put forward by the “gang of six” US senators, with a press conference scheduled for later today.

Debt ceiling negotiations are likely to be the main focus of market attention, with the Philly Fed manufacturing survey and weekly jobless claims relegated to the background. A speech by Fed Chairman Bernanke is unlikely to deliver anything new today. The USD is likely to be on the back foot given expectations of a deal in Europe and improved risk appetite but we expect losses to be limited.

The JPY continues to defy my bearish expectations. Over recent days the US yield advantage over Japan in terms of 2Y bonds dropped to multi-year lows below 20bps. Given the high correlation between USD/JPY and yield differentials, this has corresponded with the fall below 80.00.

Expectations of JPY weakness versus USD is highly dependent on the US – Japan yield gap widening over coming months. For this to happen it will need concerns about the US economy and expectations of more Fed asset purchases to dissipate, something that may not happen quickly given the rash of disappointing US data releases lately.

GBP found itself on the front foot following the release of the Bank of England Monetary Policy Committee minutes, which were less dovish than anticipated. They also revealed that the BoE expects inflation to peak higher and sooner than previously expected. However, the fact that the overall tone was similar to the last set of minutes meant there was little follow through in terms of GBP.

Further direction will come from June retail sales data today and forecasts of a bounce in sales will likely help allay concerns about a downturn in consumer spending. Nonetheless, GBP is still likely to struggle to break through resistance around 1.6230 versus USD.

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Euro unimpressed by Greek confidence vote

June 22, 2011 — Mitul Kotecha

News that the Greek government won a confidence vote has left the EUR unimpressed and gains will be limited ahead of the June 28 vote on the country’s 5-year austerity plan. The EUR was in any case rallying ahead of the vote, which the government won by 155-143 votes, and has actually lost a little ground following the vote.

EUR sentiment is likely to remain somewhat fragile given the ongoing uncertainties, but now that the first hurdle has been passed markets there is at least a better prospect of Greece receiving the next EUR 12 billion aid tranche before the July 15 “do or default” deadline. Over the near term EUR/USD upside is likely to remain capped around the 1.4451 resistance level (15 June high).

The next key event for markets is the Fed FOMC meeting outcome and press conference. This is unlikely to bode particularly well for the USD given that the Fed is set to downgrade its growth forecasts, with the comments on the economy likely to sound a little more downbeat given the loss of momentum recently as reflected in a string of disappointing data releases.

Nonetheless, monetary settings are unlikely to be changed, with the Fed committed to ending QE2 by the end of June. I remain positive on the USD’s prospects but its recovery is fragile due to the fact that US bond yields remain at ultra low levels.

Whilst only AUD/USD and USD/JPY have maintained significant correlations with bond yield differentials over the past three months, it will eventually require US bond yields to move higher in relative terms for the USD to find its legs again on a more sustainable basis.

In the meantime the approach of the end of QE2 by the end of June will on balance play positively for the USD as at least the Fed’s balance sheet will no longer be expanding even if the reinvestment of principle from its holdings of US Treasuries suggest that there will not be a quick or immediate reduction in the size of the balance sheet anytime soon.

There is little appetite to intervene to weaken the JPY at present, with the Japanese authorities blaming the strengthening in the JPY versus USD on the latter’s weakness rather than the former’s strength. Until yield differentials widen, USD/JPY will continue to languish at current levels or even lower.

GBP will garner direction from the release of the Bank of England Monetary Policy Committee meeting minutes. Whilst GBP has edged higher against the USD it has remained vulnerable against EUR. A likely dovish set of minutes reflecting some weak activity data, easing core inflation and soft wage growth, suggests little support for GBP over the short term.

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EUR Supported, AUD dives, NZD jumps

June 9, 2011 — Mitul Kotecha

Today is probably not the best day to sell EUR given that the ECB policy decision looms on the horizon. Whilst there is a risk of a ‘buy on rumour, sell on fact’ impact on the EUR following the European Central Bank (ECB) decision later today the relatively high probability that the ECB flags a rate hike in July will likely give further support to the EUR especially as it is not fully priced in by the market.

Of course should ECB President Trichet fail to mention “strong vigilance” in his press conference the EUR could suffer but this is likely to be a lower probability event. Some justification for higher rates will come from an upward revision in the ECB’s inflation forecasts. Consequently EUR/USD looks well supported around 1.4450.

The Bank of England is unlikely to deliver any surprises today, with an unchanged policy rate outcome and asset purchases target likely. The outcome will keep GBP restrained versus USD but given the likely contrast with the ECB, EUR/GBP could head higher as the currency pair continues to set its sights on the 0.90 level.

Even against the USD, GBP is unlikely to extend its gains, with 1.6474 likely providing a near term technical cap. The dichotomy of weaker activity and higher inflation is clearly causing a problem for policy makers but we still believe a rate hike is likely later in the year. In the meantime GBP remains vulnerable to further data disappointments over coming weeks.

There was more bad news for the AUD today in the form of a weak than forecast May employment report. The data will reinforce expectations that the RBA will not hike interest rates over coming months, with July and August effectively ruled out, though a hike in September remains probable.

The data had major impact on AUD which dropped sharply below the 1.0600 handle versus USD. Clearly the combination of the RBA statement and weak jobs data has resulted in a major headwind against further near term AUD appreciation. AUD will remain under downward pressure in the short-term, with technical support seen at 1.0440.

Unlike the RBA the Reserve Bank of New Zealand (RBNZ) opened the door for higher interest rates following its unchanged policy decision today, with the Bank stating that “a gradual increase in the overnight cash rate over the next two years will be required”. Despite noting some caution about the strength of the NZD and its impact on the economy the Kiwi strengthened versus the USD

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Position Unwinding Boosts USD

May 9, 2011 — Mitul Kotecha

The USD’s multi-month fall has come to an abrupt halt, with the currency registering gains in reaction to what appears to be a major position unwinding across asset markets, led by a drop in commodity prices.

Will it continue? Whilst I am amongst the more bullish forecasters on the USD over the medium term, the current rally could prove to be short-lived in the absence of a shift in Federal Reserve rhetoric or end to quantitative easing (QE2). Nonetheless, the market had got itself very short USDs (as reflected in the CFTC IMM data as of early last week which showed an increase in net short positions) and the rally in the USD last week was likely spurred by major short-covering which could extend further into this week.

The move in the USD gained momentum as European Central Bank (ECB) President Trichet proved to be less hawkish than many expected in the press conference following last Thursday’s ECB meeting. Moreover, renewed worries about Greece at the end of last week, with a report in the German Der Spiegel, later denied by Greek officials, that the country was planning to leave the Eurozone dented the EUR,

Taken together with the improving trend in US April non-farm payrolls (April registered +244k increase, with private payrolls 268k), these factors colluded to provide further positive stimulus to the USD and negative fallout on the EUR. The room for EUR downside is evident in the net long EUR speculative position, which rose to its highest since December 2007 as of 3rd May.

This week’s batch of US releases including March trade data, April retail sales and CPI, are unlikely to result in a reversal in last week’s trend though a trend like reading for core CPI, with the annual rate below the Fed’s comfort zone will reinforce expectations of dovish Fed policy being maintained, which could inject a dose of caution into the USD’s rally.

Against the background of a likely widening in the US trade deficit in March there will plenty of attention on the annual strategic and economic dialogue beginning today, with markets interested in discussions on Chinese worries about the gaping US fiscal deficit and US concerns about China’s exchange rate policy.

Greece’s denial of plans to leave the eurozone and discussions over a further adjustment to Greece’s bail out package, may help limit any drop in the EUR this week though it will by no means mark the end of such speculation about the periphery especially with this weeks’ Q1 GDP data releases across the eurozone likely to further highlight the divergence between the core and the periphery even if the headline eurozone reading rebounds strongly as we expect.

In the UK the Bank of England Quarterly Inflation Report will be the main influence on GBP. Downward growth revisions will play into the view that inflation will eventually moderate, capping expectation of higher interest rates over the coming months. However, the likely upward revision to near term inflation forecasts will help limit any damage to GBP.

GBP has lost ground to the USD but it should be noted that it has outperformed the EUR over recent days, reversing some of the recent run up in EUR/GBP. Given that EUR sentiment is likely to remain fragile this week, GBP may continue to capitalise, with a test of EUR/GBP 0.8672 on the cards.

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Central bank decisions and US payrolls in focus

May 1, 2011 — Mitul Kotecha

The USD’s troubles are far from over. Data and events this week will do little to stop the rot. As US Federal Reserve Chairman Bernanke made clear last week the Fed is committed to completing its asset purchase programme by the end of June though there is plenty of debate about what comes after. Reduced growth forecasts and the Fed’s view that price pressures are “transitory” have been sufficient to keep the USD on its knees.

The weaker than expected reading for Q1 US GDP growth at 1.8% QoQ clearly did nothing to alleviate pressure on the USD even though it is widely believed that the soft growth outcome will prove fleeting, with recovery set to pick up pace over the coming months. In truth much will depend on the trajectory for oil prices, especially as petrol prices in the US verge on the psychologically important $4 per gallon mark. Even higher energy prices could dent growth further but lower or stable prices will keep the recovery on track.

The highlight in this holiday shortened week for many countries this week is the US April jobs report at the tail end of the week. Estimates centre on around a 200k gain in payrolls but forecasts will be refined with the release of the ADP private sector jobs report and ISM manufacturing survey earlier in the week. The unemployment rate may prove sticky and will likely remain at 8.8%, a disappointment to those looking for a quicker recovery. The elevated unemployment rate will only reinforce expectations that the Fed will not be quick to reverse policy, with the USD continuing to suffer as a result.

Central bank meetings will be plentiful this week, with the European Central Bank (ECB) and Bank of England (BoE) likely to garner most attention. Recent data in the Eurozone has provided further evidence of growth divergence between North and South, but the EUR has remained resilient to this as well as to increased concerns about the periphery. This make the ECB’s job even tougher than usual when it meets this week and it is unlikely that the Bank will hike rates again so soon, especially given the strength of the EUR. Nonetheless, Trichet will continue to sound hawkish, limiting any damage to the EUR (if any) of no move in policy rates.

Similarly the Bank of England will also remain on the sidelines though this should come as little surprise in the wake of disappointing data recently and a surprise drop in inflation, albeit to still well above the BoE’s target. GBP has made up ground against a generally weak USD but judged against other currencies it has been an underperformer as expectations of monetary tightening have been pared back. Finally, the Reserve Bank of Australia (RBA) is set to remain on hold, but a hike over coming months remains likely even with the AUD at such a high level. Quite frankly although the USD is looking increasingly oversold there is nothing this week that would suggest it will recover quickly.

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