JPY firmer ahead of Fed decision

September 12, 2012 — Mitul Kotecha

The USD has come under growing pressure ahead of tommorow’s Fed FOMC decision. While by no means a done deal the majority of market participants are looking for the Fed to embark on a fresh round of quantitative easing or QE3. The Fed is also expected to shift its guidance to maintaining highly accommodative monetary policy into 2015 from 2014. There is a non-negligible risk of no action at the FOMC meeting which if correct will result in market disappointment, with an attendant sell off in risks assets.

Heading into the Fed meeting, comments by Republican House speaker Boehner that he was ‘not confident’ about reaching a deal with President Obama on avoiding the fiscal cliff as well as renewed warnings by Moodys ratings on the US AAA credit ratings, dealt the USD a further blow. It seems unlikely that the USD will be able to make much of a recovery if the Fed pulls the trigger for more QE. However, it should be noted that with so much in the price, should the Fed not deliver on expectations, the USD may actually bounce.

One currency that has felt the consequences of a weaker USD has been the JPY, which finally broke through the 78.00 level against the USD yesterday. A stronger JPY was greeted with plenty of disquiet in Japan (I’m in Tokyo this week) at a time when economic indicators are turning south. The fact that both the European Central Bank and the Fed are outpacing the Bank of Japan in terms of balance sheet expansion means that any JPY weakness is likely to be limited, with further upside risks to the currency prevailing.

Much will depend on the impact on US Treasury yields from Fed QE. Currently Japanese investors are disinclined to pour money overseas at a time when the yield advantage of US Treasuries or German bunds versus Japanese JGBs is limited. If US yields remain low, the prospects for further JPY weakness will also be limited while the pressure on the Japanese authorities to act to meet their 1% inflation goal and weaken the JPY will grow.

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US Dollar On The Rise

May 16, 2011 — Mitul Kotecha

There are plenty of US releases on tap this week but perhaps the most important for the USD will be the minutes of the April 26-27 Fed FOMC meeting. Taken together with speeches by Fed officials including Bernanke, FX markets will attempt to gauge clues to Fed policy post the end of QE2. The Fed’s stance at this point will be the major determinant of whether the USD can sustain its rally over the medium term. The lack of back up in US bond yields suggests that USD momentum could slow, with markets likely to move into wide ranges over coming weeks.

It is worth considering which currencies will suffer more in the event that the USD extends its gains. The correlation between the USD index and EUR/USD is extremely strong (even accounting for the fact that the EUR is a large part of the USD index) suggesting that the USDs gains are largely a result of the EUR’s woes. Aside from the EUR, GBP, AUD and CAD are the most sensitive major currencies to USD strength whilst many emerging market currencies including ZAR, TRY, SGD, KRW, THB, IDR, BRL and MXN, are all highly susceptible to the impact of a stronger USD.

Robust Q1 GDP growth readings in both Germany and France helped to spur gains in the EUR but this proved short-lived. Sentiment for the currency has soured and as reflected in the CFTC IMM data long positions are being scaled back. Nonetheless, there is still plenty of scope for more EUR selling given ongoing worries about the eurozone periphery, which are finally taking their toll on the EUR. A break below EUR/USD 1.4021 would open the door for a test of 1.3980.

The eurogroup and ecofin meetings will be of interest to markets this week but any additional support for Greece is unlikely to be announced at this time. However, likely approval of Portugal’s bailout may alleviate some pressure on the EUR but any positive impetus will be limited. Even on the data front, markets will not be impressed with the German ZEW index of investor confidence likely to register a further decline in May.

Japanese officials have been shying away from further FX intervention by blaming the drop in USD/JPY over recent weeks on general USD weakness despite the move towards 80. However, this view is not really backed up by correlation analysis which shows that there is only a very low sensitivity of USD/JPY to general USD moves over recent months. One explanation for the strength of the JPY is strong flows of portfolio capital into Japan, with both bond and equity markets registering net inflows over the past four straight weeks.

This is not the only explanation, however. One of the main JPY drivers has been a narrowing in yield differentials. This is unlikely to persist with yield differentials set to widen sharply over coming months resulting in a sharply higher USD/JPY. As usual data releases are unlikely to have a big impact on the JPY this week but if anything, a further decline in consumer confidence, and a negative reading for Q1 GDP, will maintain the pressure for a weaker JPY and more aggressive Bank of Japan (BoJ) action although the BoJ is unlikely to shift policy this week.

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Australian Dollar Looking Stretched

April 7, 2011 — Mitul Kotecha

Central bank decisions in Japan, Europe and UK will dictate FX market direction today. No surprises are expected by the Bank of Japan (BoJ) and Bank of England (BoE) leaving the European Central Bank (ECB) decision and press conference to provide the main market impetus. Although a hawkish message from ECB President Trichet is likely the market has already priced in a total of 75 basis points of tightening this year. We retain some caution about whether the EUR will be able to make further headway following the ECB meeting unless the central bank is even more hawkish than already priced in.

EUR/USD easily breached the 1.4250 resistance level and will now eye resistance around 1.4500. News that Portugal formally requested European Union (EU) aid came as no surprise whilst strong German factory orders provided further support to the EUR. The data highlights upside risks to today’s February German industrial production data. The EUR will find further support versus the USD from comments by Atlanta Fed’s Lockhart who noted that he doesn’t expect the Fed to hike interest rates by year end.

USD/JPY is now around 7.5% higher than its post earthquake lows. Japanese authorities will undoubtedly see a measure of success from their joint FX intervention. To a large degree they have been helped by a shift in relative bond yields (2-year US / Japan yield differentials have widened by close to 30 basis points since mid March, and are finally having some impact on USD/JPY as reflected in the strengthening in short-term correlations. Whilst the BoJ is unlikely to alter its policy settings today the fact that it is providing plenty of liquidity to money markets, having injected around JPY 23 trillion or about 5% of nominal GDP since the earthquake, is likely playing a role in dampening JPY demand.

AUD/USD has appreciated by close to 6% since mid March and whilst I would not recommend selling as yet I would be cautious about adding to long positions. My quantitative model based on interest rate / yield differentials, commodity prices and risk aversion reveals a major divergence between AUD/USD and its regression estimate. Clearly the AUD has benefitted from diversification flows as Asian central banks intervene and recycle intervention USDs. However, at current levels I question the value of such diversification into AUD.

Speculative AUD/USD positioning as indicated by the CFTC IMM data reveals that net long positions are verging on all time highs, suggesting plenty of scope for profit taking / position squaring in the event of a turn in sentiment. Moreover, AUD gains do not match the performance of economic data, which have been coming in worse than expected over recent weeks. Consequently the risks of a correction have increased.

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ECB to Hike, BoJ, BoE & RBA on Hold

April 4, 2011 — Mitul Kotecha

The better than expected March US jobs report will likely help to shift the debate further towards the hawkish camp in the Fed. There is little this week to match the potency of payrolls in terms of market moving data this week. Instead attention will focus on a raft of Fed speakers over coming days as well as the minutes of the March 15 FOMC meeting.

This week’s Fed speakers include Lockhart, Evans, Bernanke, Kocherlakota, Plosser and Lacker. Of these only Lockhart and Lacker are non voters. Given the intense focus on recent Fed comments FX markets will be on the lookout for anything that hints a broader Fed support for a quicker hike to interest rates and/or reduction in the Fed’s balance sheet.

In any case the USD may struggle to make much headway ahead of an anticipated European Central Bank (ECB) rate hike of 25 basis point on Thursday. Much will depend on the press statement, however. If the ECB merely validates market expectations of around 75bps of policy rate hikes this year the EUR will struggle to rally.

It may also be possible that once the ECB meeting is out of the way the EUR may finally be susceptible to pressure related to ongoing peripheral tensions. Last week the outcome of the Irish bank stress tests, and political vacuum in Portugal ahead of elections set for June 5 were well absorbed by the EUR but it is questionable whether the dichotomy between widening peripheral bond spreads and the EUR can continue.

The Tankan survey in Japan released today unsurprisingly revealed a deterioration in sentiment. The survey will provide important clues for the Bank of Japan (BoJ) at its meeting on April 6 & 7th. Although a shift in Japan’s ultra easy monetary policy is unlikely whilst strong liquidity provision is set to continue, pressure to do more will likely grow. This will be accentuated by a likely downward revision in the economic outlook by the BoJ.

The JPY will not take much direction from this meeting. Nonetheless, its soft tone may continue helped by foreign securities outflows (particularly out of bonds), with USD/JPY eyeing the 16 December high around 84.51. Speculative positioning as reflected in the CFTC IMM data reveals a sharp deterioration in JPY sentiment as the currency evidence that finally the currency maybe regaining its mantle of funding currency.

It is still too early for the Bank of England to hike rates despite elevated inflation readings and MPC members are likely to wait for the May Quarterly Inflation Report before there is decisive shift in favour of raising policy rates. Even then, members will have to grapple with the fact that economic data remains relatively downbeat as reflected in the weaker than expected March manufacturing purchasing managers index (PMI) data.

Today’s PMI construction data will likely paint a similar picture. The fact that a rate hike is not expected by the market will mean GBP should not suffer in the event of a no change decision by the BoE this week but instead will find more direction from a host of data releases including industrial production. GBP has come under growing pressure against the EUR since mid February and a test of the 25 October high of 0.89415 is on the cards this week.

Finally, congratulations to the Indian cricket team who won a well deserved victory in the Cricket World Cup final over the weekend. The celebrations by Indians around the world will go on for a long while yet.

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Contrasting Stance

October 13, 2010 — Mitul Kotecha

Despite some recent Fed speakers putting doubts into the minds of the many now looking for the Fed to embark on QE2 in November, the minutes of the 21 September FOMC meeting gave the green light to the commencement of asset purchases next month. Although there is clearly no unanimity within the FOMC the majority favour further easing. Incremental data dependent asset purchases will be the most likely path.

The minutes leave the USD vulnerable to further declines but extreme short USD positioning suggest that there is plenty of risk of short covering and more likely we are probably set for a period of consolidation over coming weeks before the USD resumes its decline.

Unlike the Fed, BoJ and BoE, which remain in easing mode the ECB is already veering towards an exit strategy, albeit one that is unlikely to take effect for some time. Hawkish comments by the ECB’s Weber overnight managed to give a lift to the EUR in the wake of a further widening in interest rate differentials between the eurozone and US. Indeed, interest rate differentials (2nd contract futures) are at the widest since Feb 2009, a factor that is providing plenty of underlying support for the EUR.

Further out the follow through on the EUR will depend on whether markets believe Weber’s stance is credible. Germany’s economy is doing well but it is highly likely that Southern European officials would oppose any premature tightening in policy given the parlous state of their economies. The stronger EUR will also do some damage to growth, with its recent appreciation acting as a de facto monetary tightening.

Despite the positive influence of Weber’s comments short-term technical indicators show that the trend in EUR is vulnerable, with clear signs of negative divergence as the spot rate is still trending higher whilst the relative strength indices (RSI) are trending lower. Moreover, EUR speculative positioning is at its highest in a year, albeit still well of its all time highs. Speculators may be reluctant to build on longs in the near term. A clean and sustained break above EUR/USD 1.4000 level still looks like a stretch too far though any downside is likely to be limited to strong support around 1.3895.

Unlike the perception that the ECB is highly unlikely to follow the Fed in a path of QE2 the policy stance of the BoE is far more uncertain, a fact that continues to weigh on GBP, especially against the EUR. Recent data in the UK has played into the hands of the doves, with housing market activity and prices coming under renewed pressure, retail sales surveys revealing some deterioration and consumer confidence as revealed in the Nationwide survey overnight, weakening further.

BoE MPC member Miles summarized the situation by highlighting that the UK faces “some big risks” and even hinted that the BoE may “come to use QE”. UK jobs data today is unlikely to give any support to sentiment for GBP although as per its recent trend GBP is likely to remain resilient against the USD whilst remaining under pressure against the EUR, with a move to resistance around EUR/GBP 0.8946 on the cards in the short-term

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