USD Pressured As Yields Dip

February 18, 2011 — Mitul Kotecha

The USD came under pressure despite a higher than forecast reading for January US CPI and a strong jump in the February Philly Fed manufacturing survey. On the flip side, an increase in weekly jobless claims dented sentiment. The overnight rally in US Treasury yields was a factor likely weighing on the USD. The US calendar is light today leaving markets to focus on the G20 meeting and to ponder next week’s releases including durable goods orders, existing and new home sales.

The jump in the European Central Bank (ECB) marginal facility borrowing to EUR 15 billion, its highest since June 2009, provoked some jitters about potential problems in one or more eurozone banks. At a time when there are already plenty of nerves surrounding the fate of WestLB and news that Moody’s is reviewing another German bank for possible downgrade, this adds to an already nervous environment for the EUR.

Nonetheless, EUR/USD appears to be fighting off such concerns, with strong buying interest on dips around 1.3550. The G20 meeting under France’s presidency is unlikely to have any direct impact on the EUR or other currencies for that matter, with a G20 source stating that the usual statement about “excess volatility and disorderly movements in FX” will be omitted.

Although USD/JPY has been a highly sensitive currency pair to differentials between 2-year US and Japanese bonds (JGBs), this sensitivity has all but collapsed over recent weeks. USD/JPY failed to break the 84.00 level, coming close this week. There appears to be little scope to break the current range ahead of next week’s trade data and CPI.

Given the recent loss in momentum of Japan’s exports the data will be instructive on how damaging the strength of the JPY on the economy. In the near term, escalating tensions in the Middle East will likely keep the JPY supported, with support around USD/JPY 83.09 on the cards.

It seems that the jump in UK CPI this week (to 4.0%) provoked even more hawkish comments than usual from the Bank of England BoE’s Sentance, with the MPC member stating that the Quarterly Inflation Report understates the upside risks to inflation indicating that interest rates need to rise more quickly and by more than expected. Specifically on GBP he warned that the Bank should not be relaxed about its value.

Although these comments should not be particularly surprising from a known hawk, they may just help to underpin GBP ahead of the January retail sales report. Expectations for a rebound in sales following a weather related drop in the previous month will likely help prop up GBP, with GBP/USD resistance seen around 1.6279.

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GBP troubles, KRW too weak

February 17, 2011 — Mitul Kotecha

The Fed FOMC minutes for the January meeting revealed that behind the unanimous vote to leave policy settings unchanged there was some unease about the completion of QE2. Nonetheless, the USD was left weaker given the Fed’s sanguine view on inflation and worries about unemployment. Inflation data will garner most market attention today but the fact that the core rate of CPI inflation is expected to remain well below the Fed’s preferred level could undermine the USD and add a further barrier to the USD’s recovery so far in February. Jobless claims data will also be of interest given the sharp drop last week. Another firm outcome will help to dispel worries about job market recovery.

As warned in my last post, downside risks to GBP were high given the long GBP speculative positioning overhang and hawkish expectations for the BoE Quarterly Inflation Report. In the event the Report revealed a downward growth forecast revision and an upward inflation forecast revision but importantly showed some reluctance to play into market expectations of an early UK policy rate hike. Following on from a weaker than expected UK January jobs report in which unemployment increased, GBP was hit on both counts. GBP/USD is unlikely to veer far from the 1.6000 level, but with markets reassessing interest rate expectations downside risks are beginning to open up.

News yesterday that Moody’s ratings agency has placed Australia and New Zealand’s major banks on review for possible downgrades went down like a lead balloon but once again AUD and NZD showed their usual resilience and acted as if little has happened. AUD and NZD have weakened since the turn of the year. Weaker data and a paring back in policy tightening expectations have contributed to the weaker performance of the AUD and NZD, but markets have gone too far in scaling back the timing and magnitude of interest rate hikes, suggesting that both currencies may bounce back as interest rate expectations become more hawkish.

Asian currencies continue to register mixed performances largely influenced by capital flows. Most equity markets in the region have registered outflows so far in 2011, with the exception of Taiwan and Vietnam. This has been reflected in Asian FX performance, with the strongest performer being the IDR, but its gains have only been around 0.72% versus USD, coinciding with the fact that it has registered some of the least capital outflows this year. Interestingly the worst performing currency has been the THB, one of last year’s star performers. Korea has also registered strong equity capital outflows but this will not persist and a resumption of inflows taken together with positive fundamentals and higher interest rates will boost the KRW this year.

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Euro Sentiment Jumps, USD Sentiment Dives

January 24, 2011 — Mitul Kotecha

The bounce in the EUR against a broad range of currencies as well as a shift in speculative positioning highlights a sharp improvement in eurozone sentiment. Indeed, the CFTC IMM data reveals that net speculative positioning has turned positive for the first time since mid-November. A rise in the German IFO business confidence survey last week, reasonable success in peripheral bond auctions (albeit at unsustainable yields), hawkish ECB comments and talk of more German support for eurozone peripheral countries, have helped.

A big driver for EUR at present appears to be interest rate differentials. In the wake of recent commentary from Eurozone Central Bank (ECB) President Trichet following the last ECB meeting there has been a sharp move in interest rate differentials between the US and eurozone. This week’s European data releases are unlikely to reverse this move, with firm readings from the flash eurozone country purchasing managers indices (PMI) today and January eurozone economic sentiment gauges expected.

Two big events will dictate US market activity alongside more Q4 earnings reports. President Obama’s State of The Union address is likely to pay particular attention on the US budget outlook. Although the recent fiscal agreement to extend the Bush era tax cuts is positive for the path of the economy this year the lack of a medium to long term solution to an expanding budget deficit could come back to haunt the USD and US bonds.

The Fed FOMC meeting on Wednesday will likely keep markets treading water over the early part of the week. The Fed will maintain its commitment to its $600 billion asset purchase program. Although there is plenty of debate about the effectiveness of QE2 the program is set to be fully implemented by the end of Q2 2011. The FOMC statement will likely note some improvement in the economy whilst retaining a cautious tone. Markets will also be able to gauge the effects of the rotation of FOMC members, with new member Plosser possibly another dissenter.

These events will likely overshadow US data releases including Q4 real GDP, Jan consumer confidence, new home sales, and durable goods orders. GDP is likely to have accelerated in Q4, confidence is set to have improved, but at a low level, housing market activity will remain burdened by high inventories and durable goods orders will be boosted by transport orders. Overall, the encouraging tone of US data will likely continue but markets will also keep one eye on earnings. Unfortunately for the USD, firm US data are being overshadowed by rising inflation concerns elsewhere.

Against the background of intensifying inflation tensions several rate decisions this week will be of interest including the RBNZ in New Zealand, Norges Bank in Norway and the Bank of Japan. All three are likely to keep policy rates on hold. There will also be plenty of attention on the Bank of England (BoE) MPC minutes to determine their reaction to rising inflation pressures, with a slightly more hawkish voting pattern likely as MPC member Posen could have dropped his call for more quantitative easing (QE). There will also be more clues to RBA policy, with the release of Q4 inflation data tomorrow.

Both the EUR and GBP have benefitted from a widening in interest rate futures differentials. In contrast USD sentiment has clearly deteriorated over recent weeks as highlighted in the shift in IMM positioning, with net short positions increasing sharply. It is difficult to see this trend reversing over the short-term, especially as the Fed will likely maintain its dovish stance at its FOMC meeting this week. This suggests that the USD will remain on the back foot.

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Talk but no action

January 19, 2011 — Mitul Kotecha

The eurozone periphery remains in the eye of the storm but markets may have to wait before any concrete action is taken. The possibility of increasing the size of the bailout fund (EFSF), preparation of new European bank stress tests and/or allowing the EFSF to purchase eurozone government debt are all on the table but so far agreement has been lacking. Ministers apparently rejected the idea of increasing the size of the fund from EUR 440 billion to EUR 750 billion whilst disagreement over stricter criteria may also be hampering any progress.

Nonetheless, the EUR has found renewed support, helped by the firm German IFO investor confidence survey and news that Russia is looking to buy EFSF bonds. EUR/USD upside may be face a hurdle around 1.3500 over the short term and gains above this level are likely to be difficult to sustain given the ongoing uncertainties about the EFSF none of which are likely to be resolved anytime soon. The bottom line is that talk but not action will not be sufficient to keep the EUR supported.

GBP is also doing well, partly on the coat tails of a firmer EUR but also in the wake of an acceleration in UK CPI inflation which came in at 3.7% YoY a two year high, surpassing the Bank of England’s (BoE) ceiling for the 10th straight month. Inflation is likely to remain elevated pushing closer to 4% due to the VAT hike to 20% which came into effect at the beginning of this year. The data puts the BoE in a difficult situation testing the Monetary Policy Committee (MPC) expectation that the jump in inflation will prove temporary. However, the market is increasing taking the stance that a rate hike is going to take placer sooner rather than later, with a growing probability of a rate hike.

Since the end of last year there has been a 25bps spread widening (between 2nd contract rate futures) as markets have become more hawkish on UK interest rate expectations. This has coincided with an increasing correlation with GBP/USD resulting in the currency pair cracking above the psychologically important 1.60 level. Much will depend on whether the BoE’s predictions come true. If inflation remains sticky on the upside the Bank may be forced into an earlier tightening. Whether this is good news for GBP will depend on the economy. The worst case scenario is premature monetary tightening just as austerity measures start to bite.

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Ratings rampage hits Euro

December 20, 2010 — Mitul Kotecha

Both the data flow and market liquidity will be thin over the last couple of weeks of the year. After a bashing over much of H2 2010 it looks as though the USD will end the year in strong form having risen by over 6% since its early November low. In contrast the EUR is struggling having found no support from the meeting of European Union officials at the end of last week in which they agreed to a permanent sovereign debt resolution after 2013 but failed to agree on expanding the size of the bailout fund (EFSF). Similarly there was no traction towards a common euro bond. EUR/USD is now verging on its 200-day moving average around 1.3102, a break of which could see a drop to around 1.2960.

The failure to enlarge the size of the EFSF was disappointing given worries that it is perceived to be insufficient to cope with the bailout of larger eurozone countries if needed. It also highlight that the burden on the European Central Bank (ECB) to prop up eurozone bond markets until confidence improves. The increase in the size of ECB capital from EUR 5.8 billion to EUR 10.8 billion will help in this respect. Such support was clearly needed last week following the rampage across Europe by ratings agencies culminating in Moody’s five notch downgrade of Ireland’s credit ratings, surprising because of its severity rather than the downgrade itself. Ireland’s ratings are now just two notches above junk status and the negative outlook could mean more to come.

It was not just Ireland’s ratings that came under scrutiny. Ireland’s multi notch downgrade followed Moody’s decision to place Greece and Spain on review for a possible downgrade whilst S&P revised Belgium’s outlook to negative. Unsurprisingly peripheral debt markets came under renewed pressure as a result outweighing positive news in the form of strong flash eurozone PMI readings and firm German IFO business confidence survey. EUR did not escape and sentiment for the currency remains weak, with CFTC IMM speculative positioning data revealing a fourth straight week of net EUR short positioning in the week to 14th December.

In contrast, sentiment for the US economy continues to improve. Congress’ swift passage of President Obama’s fiscal plan will help to shore up confidence in US recovery. Data this week will be broadly positive too. On Wednesday, US Q3 GDP data is likely to be upwardly revised to a 2.8% QoQ annualized rate. Durable goods orders excluding transportation are set to increase by a healthy 2.0% (Thu) whilst both existing (Wed) and new (Thu) home sales will reveal rebounds in November following a drop in the previous month.

In the UK the main highlight is the Bank of England (BoE) MPC minutes. Another three way split is expected but this should not cause more than a ripple in FX markets. GBP/USD has slipped over recent days but there appears to be little other than general USD strength responsible for this. The currency pair looks vulnerable to a drop below 1.5500, with 1.5405 seen as the next support level. On balance, the USD will be in good form this week although the drop in US bond yields at the end of last week may take some of the wind out of its sails.

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