Skittish Markets Amid Higher Yields

The US and to some extent global bond market rout over recent weeks has caused particular pain to crowded growth/momentum stocks.  US 10 year Treasury yields have now risen by around 50 basis points this year, bringing back memories of the 2013 Taper Tantrum and 2016 spike in US yields following the election of Donald Trump as President.  Improving data and falling virus cases have helped fuel the move higher in yields, with the rise in yields hitting equity markets globally and in particular technology stocks as investors focus on the cost of funding amid relatively high valuations in some growth/momentum stocks. 

US rates markets stabilised somewhat at the end of last week after taking a drubbing over much of the week. The rally in interest rate markets on Friday helped to buoy equities, albeit to a limited extent with the Nasdaq managing to eke out gains.  Commodity prices dropped sharply while the US dollar continued to firm up.  Even so market volatility measures such as the VIX (equity volatility) remain elevated.

Currency volatility measures have moved higher too, but not to the same degree as equities or rates.  Emerging markets (EM) FX volatility has reacted even less than developed market FX volatility.  Perhaps this is the next shoe to fall, but so far EM FX have looked relatively well composed despite the rout in rates markets, partly due to a more limited US dollar (USD) reaction than would be expected.  The sharp spike in US yields does not bode well for EM currencies, however.  Higher market volatility, pressure on yield differentials and a slide in growth/momentum stocks could hurt EM assets and it will be very hard for the USD to continue to ignore higher yields. 

While gains in US risk assets may help Asian markets at the beginning of this week any follow through will be dampened by the release of a weaker than expected China manufacturing and services purchasing managers index (PMI) data. The manufacturing PMI dropped to its weakest since May 2020 while the services PMI fell to its lowest since the Feb 2020 COVID related collapse.  I would however, be wary of over interpreting the data given the usual seasonal weakness around Chinese New Year holidays.  Services in particular was impacted by reduced travel over the holidays.  

Other high frequency indicators show that China’s growth momentum remains positive and growth this year is likely to be solid.  More information on the official outlook and forecasts will come from China’s National People’s Congress beginning Friday, which will present the annual work report for 2021 and the release of China’s 14th 5-year plan.  Once again, a growth target for this year will likely be excluded though targets for economic variables are likely while the annual average growth target is likely to be lowered, possibly down to around 5% from “over 6.5%” for the previous 5 years.  

Data on tap this week largely consists of a slew of February PMIs while in the US the February ISM manufacturing survey will be released, with confidence likely boosted optimism about COVID and fiscal stimulus.  Over the rest of the week key releases include US jobs data (Fri), Eurozone February CPI inflation (Tue), Turkey CPI (Wed), UK Spring Budget (Wed), Australia Q4 GDP (Wed) and monetary policy decisions in Australia (Tue), Malaysia (Wed) and Poland (Wed).  None of these central banks are expected to shift policy. 

GBP on a rollercoaster, NOK to bounce back

GBP has had a rollercoaster ride both against the USD and the EUR. On balance, it has fared better than the EUR vs. USD. News that Fitch ratings put the UK’s AAA ratings on negative watch had little impact although it may yet restrain GBP. If anything the news will likely help UK Chancellor Osborne formulate a relatively austere budget next Wednesday. Unlike the beleaguered JPY, GBP has not suffered from a widening in the yield differential with the US.

In fact 2-year UK Gilt yields have echoed the rise in US 2-year bond yields over recent days. This suggests that GBP ought to face less downward pressure compared to other currencies. Although I continue to see further GBP strength against the EUR over the medium term, the near prospects look volatile. Instead, I suggest playing a GBP positive view via the AUD.

It is worth commenting, albeit belatedly, on the outlook for the NOK following the surprise decision by Norway’s central bank, Norges Bank, which cut its policy rate by 25bps on Wednesday. Does it significantly change the outlook for the NOK? I believe it doesn’t and the recent drop in the NOK will provide a good opportunity to reinstate long positions.

Although the central bank may ease policy once again over coming months this will not undermine the NOK given that the influence of interest rate differentials on the currency is limited. Moreover, lower interest rates threaten to push already high property prices even higher suggesting that the Norges Bank may have limited room to cut rates further. Elevated oil prices continue to provide solid support for the currency and unless oil prices correct lower, the NOK will remain well supported versus EUR, with a drop to around 7.45 on the cards.

Posted in FX, Norway, UK. Tags: , , , , , . 1 Comment »

Speculators still short Euro

Since I wrote “Beware of EUR short covering” EUR/USD has gained around 4%. EUR/USD is trying to gain a foothold above 1.3200 but failed overnight. Further gains will be more gradual. Helping the EUR is the fact that short positions hit an all time high according to IMM data for last week. However, data releases are unlikely to provide much impetus to the EUR, with most attention on the monthly series of PMI manufacturing confidence indices as consumer confidence readings.

At best the data will show some stabilisation but market will focus instead on the EU Summit beginning today and ongoing Greek debt talks as well as Italian debt auctions today. Greek debt talks are expected to be finalised this week including writedowns of around 70% but tensions over a German proposal to create a “budget commissioner” could yet hit the EUR.

The major release of the week in the UK is the January PMI manufacturing survey although there will also be attention on housing data including mortgage approvals and house price surveys from the Nationwide and Halifax. Overall the data will do little to dispel fears about the UK economy following the contraction in Q4 GDP revealed last week.

GBP will likely remain resilient to any bad economic news however, but its gains look limited especially given the revelation in the BoE MPC minutes that some members thought that more quantitative easing will be required. Having strengthened against the USD but weakened against the EUR over recent days, GBP continues to trade in a middle of the road manner. GBP/USD sellers will likely emerge around the 1.5870 resistance level while EUR/GBP is set to consolidate around 0.8350.

All Eyes On US Jobs Data

Happy New Year!

2010 ended on a sour note especially for eurozone equity markets (and the Australian cricket team) where there has yet to be a resolution to ongoing growth/fiscal/debt tensions.  The EUR strengthened into year end but this looked more like position adjustment than a shift in sentiment and EUR/USD is likely to face stiff resistance around the 1.3500 level this week, with a drop back towards 1.3000 more likely.  In the US there was some disappointment in the form of a surprise drop in December consumer confidence data but pending home sales and the Chicago PMI beat expectations, with the overall tone of US data remaining positive.

There will be plenty to chew on this week in terms of data and events which will provide some much needed direction at the beginning of the year.  The main event is the December US jobs report at the end of the week.   Ahead of this there will be clues from various other job market indicators including the Challenger jobs survey, ADP employment report, and the ISM manufacturing and non-manufacturing surveys.  The data will reflect a modest improvement in job market conditions and the preliminary forecast for December payrolls is for a 135k increase, with private payrolls set to rise by 145k and the unemployment rate likely to fall slightly to 9.7%.

The minutes of the 14 December Fed FOMC meeting (Tue) will also come under scrutiny against the background of rising US bond yields.  In addition, Fed Chairman Bernanke will speak on the monetary and fiscal outlook as well as the US economy to the Senate Budget Panel.   Bernanke will once again defend the use of quantitative easing whilst keeping his options open to extend it if needed.  However, the changing composition of the FOMC with four new members added in 2011 suggests a more hawkish tinge, which will likely make it more difficult to agree on further QE.   In any case, the tax/payroll holiday package agreed by the US administration means that more QE will not be necessary. 

It’s probably not the most auspicious time for new member Estonia to be joining the eurozone especially as much of the speculation last year focussed on a potential break up.  The beginning of the year will likely see ongoing attention on the tribulations of Ireland after its bailout, with looming elections in the country.  Portugal and Spain will also remain in focus as the “two-speed” recovery in 2011 takes shape.  Data releases this week include monetary data in the form of the eurozone December CPI estimate and M3 money supply.  Inflation will tick up to 2% but this ought to be of little concern for the ECB.  Final PMI data and confidence indices will likely paint a picture of slight moderation.   

The USD ended the year on a soft note, with year lows against the CHF and multi year lows vs. AUD registered, but its weakness is unlikely to extend much further.  The key driver will remain relative bond yields and on this front given the prospects for relative US yields to move higher, the USD will likely gain support.  There maybe a soft spot for the USD in Q1 2011 but for most of the rest of the year the USD is set to strengthen especially against the EUR which will increasingly comer under pressure as peripheral tensions and growth divergence weigh on the currency.

Irish bailout leaves EUR unimpressed

As has been the case since the beginning of the global financial crisis policy makers have found themselves under pressure to deliver a solution to a potentially destabilising or even systemic risk before the markets open for a new week in order to prevent wider contagion. Last night was no different and following urgent discussions a EUR 85 billion bailout for Ireland to be drawn down over a period of 7 ½ years was agreed whilst moves towards a permanent crisis mechanism were brought forward. As was evident over a week ago a bailout was inevitable but the terms were the main imponderable.

Importantly the financing rate for the package is lower than feared (speculation centered on a rate of 6.7%) but still relatively high at 5.8%. Moreover, no haircuts are required for holders of senior debt of Irish banks and Germany’s call for bondholders to bear the brunt of losses in future crises was watered down. The package will be composed of EUR 45 bn from European governments, EUR 22.5 bn from the IMF and EUR 17.5 bn from Ireland’s cash reserve and national pension fund.

The impact on the EUR was stark, with the currency swinging in a 120 point range and failing to hold its initial rally following the announcement. A break below the 200-day moving average for EUR/USD around 1.3131 will trigger a drop to around 1.3020 technical support. Officials will hope that the bailout offers the currency some deeper support but this already seems to be wishful thinking. The EUR reaction following the Greek bailout in early May does not offer an encouraging comparison; after an initial rally the EUR lost close to 10% of its value over the following few weeks.

Although it should be noted that the bailout appears more generous than initially expected clearly the lack of follow through in terms of EUR upside will come as a blow. The aid package has bought Ireland some breathing space but this could be short lived if Ireland’s budget on December 7 is not passed. Moreover, the bailout will not quell expectations that Portugal and perhaps even Spain will require assistance. Indeed, Portugal is the next focus and the reaction to an auction of 12-month bills on 1 December will be of particular interest.

Taken together with continued tensions on the Korean peninsular, position closing towards year end ongoing Eurozone concerns will likely see a further withdrawal from risk trades over coming weeks. For Asian currencies this spells more weakness and similarly commodity currencies such as AUD and NZD also are likely to face more pressure. The USD remains a net beneficiary even as the Fed continues to print more USDs in the form of QE2.

Data and events this week have the potential to change the markets perspective, especially the US November jobs report at the end of the week. There is no doubt that payrolls are on an improving trend (145k consensus) in line with the declining trend in jobless claims but unfortunately the unemployment rate is set to remain stubbornly high at 9.6% and this will be the bigger focus for the Fed and markets as it implies not let up in QE. As usual further clues to the payrolls will be garnered from the ADP jobs report and ISM data on Wednesday.

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