Rising risk aversion

The US ADP November jobs report and October new home sales both beat expectations yesterday piling on the pressure on US Treasuries and adding further weight to support those looking for the Fed to taper at the December 17-18 FOMC meeting. Consequently non farm payrolls expectation will likely be revised higher from the current consensus of around 180k. In contrast the ISM non manufacturing index came in below consensus, with the jobs component slipping. US equities ended marginally lower while the USD held its ground. However, risk measures such as the VIX “fear gauge” moved higher. Rising risk aversion may reflect expectations of imminent tapering and some angst ahead of US budget talks.

US November payrolls data to be released tomorrow will be crucial to provide more decisive clues to the timing of Fed tapering. Attention ahead of the jobs report will turn to the European Central Bank policy decision where no action is expected although some downward revisions to staff forecasts are likely. We continue to expect a more aggressive ECB stance into 2014. The Bank of England and Norges Bank will also decide on policy rates but no change is expected in both cases. In the US an upward revision to Q3 US GDP is expected to around 3.1% QoQ annualised while jobless claims will also be in focus. Market nervousness is likely to continue today although activity is likely to be limited ahead of the US payrolls data tomorrow.

The USD should be supported due to higher US Treasury yields although USD/JPY has lost some ground in the wake of higher risk aversion. The large short JPY market position may also be limiting the JPY’s downside for now. EUR/USD is trading shy of its recent highs above 1.36 and could be vulnerable to a dovish ECB statement today as well as to growth forecast downgrades by the ECB. AUD continues to remain under pressure having traded just below 0.90 overnight in the wake of disappointing GDP data yesterday and is likely to remain vulnerable to further slippage. CAD was further undermined by a relatively dovish Bank of Canada statement following the decision overnight to leave policy rates unchanged.

Given that US Treasury yields have risen by around 33bps since the end of October it is worth looking at which currencies are most sensitive to rising yields. In Asia the most correlated currencies with 10 year US Treasury yields over the last 3 months and therefore most vulnerable currencies are the SGD, THB, and MYR. The least sensitive have been CNY, IDR and KRW. Playing long KRW / short SGD appears to be a good way of playing an environment of rising US yields, especially given that yields are set to continue to rise over the coming months.

It’s all about communication

Calm has settled over markets as anticipation builds ahead of tomorrow’s Fed FOMC outcome. Equity markets registered broad based gains globally while US yields rose and the USD stabilized. It’s worth reiterating that effective Fed communication is the key to ensure that this calm continues otherwise market volatility will quite easily return.

Yesterday’s mixed data releases did not offer much to the debate on Fed policy as the Empire manufacturing survey rose more than expected but disappointed on the detail, while home builders’ confidence jumped. May CPI inflation data will perhaps offer more clues today, with a benign reading likely to ensure that markets do not get carried away in expecting any major shift in Fed policy. In Europe, a likely decline in the German ZEW investor confidence survey in June will do little to boost confidence in recovery.

GBP/USD has rallied impressively over recent weeks although much of its gain has been spurred largely by USD weakness rather than inherent GBP strength. Nonetheless, UK data has looked somewhat more encouraging, a fact that has played some role in reinforcing GBP gains. Whether this continues will depend on a slate of data releases this week including retail sales on Thursday. CPI inflation data (today) and Bank of England MPC minutes (tomorrow).

On balance, I look for UK data to continue to paint an encouraging picture of recovery, which ought to provide further support for GBP. However, the risk / reward does not favor shorting the USD at present and I suggest playing further GBP upside versus EUR.

CHF has strengthened as risk aversion has flared up. While I remain bearish CHF over the medium term the near term outlook will be driven by risk gyrations (given the strong correlation between CHF and our risk barometer). Both EUR/CHF and USD/CHF have already fallen sharply having priced in higher risk aversion.

Obviously much in terms of risk appetite will depend on the Fed FOMC outcome tomorrow and I would suggest caution about shorting the CHF just yet. Additionally Swiss data in the form of May trade data and more importantly the SNB policy decision this week will be watched closely, especially given the threat by SNB Jordan of implementing negative interest rates. I don’t expect any shift in policy on Thursday, however, leaving USD/CHF firmly supported around 0.9130.

Since Fed Chairman Bernanke highlighted the prospects of Fed “tapering” during his testimony on May 22 commodity currencies have performed poorly. The notable exception has been the CAD which has eked out gains over recent weeks. Like GBP, the CAD has been helped by relatively positive data releases, which in turn have prompted growing expectations of policy rates hikes from the Bank of Canada. Market positioning in CAD remains relatively short, suggesting more scope for gains over coming weeks. Meanwhile, data this week including May CPI and April retail sales will be scrutinized for clues as to the next move from the BoC and in turn whether gains in CAD are justified.

Catching a falling knife

USD/JPY’s pull back is proving short lived as Japanese Economy Minister Amari attempted to backtrack from his earlier comments that warned about the negative impact of a weaker JPY on “people’s lives”. His comments today suggest that Japan’s stance on a weaker JPY has not changed.

Nonetheless, there may be some consolidation in the near term as likely inaction from the Bank of Japan at it policy meeting this week will mean no new stimulus. While no policy change ought to be unsurprising given recent aggressive actions it appears that the market has become addicted to stimulus.

In any case US Treasury yields will need to be eyed for further USD/JPY direction, with a break of the psychologically important 2% level in the 10 year Treasury a likely trigger for a further up move in the currency pair.

GBP has held up well on the crosses while like many other currencies has faced a resurgent USD. Little impact on GBP is expected from today’s April CPI inflation data especially given that any expected decline is set to prove temporary (Bloomberg consensus 2.6% YoY).

More importantly a likely more optimistic set of Bank of England MPC minutes on Wednesday and rebound in April UK April retail sales on Thursday will provide GBP will further support although we suggest looking for any upside on the crosses rather than versus USD.

Is it time to buy AUD? While I don’t want to be accused of catching a falling knife AUD looks reasonably good value especially against other commodity currencies, especially NZD and CAD. While there have been plenty of negative factors pressuring the currency including prospects for more RBA rate cuts, weaker commodity prices, and softer domestic and Chinese data, much of this is in the price.

My AUD/USD quantitative model estimate based shows that it is oversold relative to its short term fair value estimate. Moreover, speculative positioning according to the CFTC IMM data has turned negative for the first time in almost a year. The RBA May meeting minutes (the meeting during the RBA surprisingly cut its cash rate to 2.75) reelased today did not change this perspective given that markets have already priced in one more rate cut in the cycle.

Asian currencies will likely continue to retrace some of their recent losses in the near term. However, domestic factors and growth worries will provide an importance influence, with the IDR for instance failing to benefit from any USD pull back as the government continues to wrestle with a fuel subsidy cut. Meanwhile, weaker than expected growth in Thailand in Q1 2013 cast a shadow over many Asian currencies as concerns of a wider growth slowdown in Asian intensify.

EUR rallies, AUD and CAD eye rate meetings

Some consolidation and even slightly more upbeat tone have helped risks assets to settle and the outlook today is for more of the same. The respite looks temporary unless followed by concrete measures out of the Eurozone to stem the crisis, however. Attention will focus on today’s emergency teleconference between G7 leaders in which they are expected to put more pressure on European leaders to act.

However, continuing stalemate in Europe, with Spain’s push for an injection of funds from the Eurozone bailout fund into its banks facing resistance from Germany who believe that any funding should come as part of a formal bailout package. Despite the lack of traction in Europe, the EUR has managed to eek out further gains, with the rebound from the lows around 1.2287 versus USD gaining traction. Near term resistance is seen around 1.2625.

There has been a change of heart by many ahead of today’s Reserve Bank of Australia (RBA) meeting. Weaker global data in particular in China, with both the manufacturing and non manufacturing purchasing managers indices (PMI) coming in weaker than expected, have added to worries about the path of the Australian economy.

Taken together with some deterioration in Australian money market conditions, weaker commodity prices and growing European contagion risks, the RBA will probably want to shield the domestic economy, with another 25bps rate cut. Talk of a 50bps easing today has done the rounds but this seems excessive given that it would fall hot on the heels of 50bps rate cut at the beginning of May.

The AUD has priced in some easing and a likely 25bps rate cut is unlikely to put much pressure on the currency but much will depend on the accompanying statement. In any case, downside risks remain in the current environment.

The Bank of Canada also meets today to decide on its policy rate settings. Unlike in Australia there has been no change of heart ahead of the meeting, with the BoC set to keep its policy rate on hold at 1%. The central bank has sounded more upbeat than most and the drop in the CAD over recent weeks has in any case acted to loosen monetary conditions.

Although somewhat resilient compared to its commodity counterparts such as AUD and NZD, the CAD is playing catch up, having been the worst performing currency so far this month. Speculative positioning has drifted lower too, although it is still close its three month average. This implies room for a further reduction in long positions as the CAD fails to outperform.

Recent weakness in US economic data highlights the risks ahead for Canada and the CAD, suggesting that investors will continue to take a cautious tone towards the currency over coming weeks. A more neutral statement from the BoC will likely keep CAD sentiment subdued.

AUD risks, CHF speculation, CAD upside

News that the IMF revised up its global growth forecasts, decent demand for a Spanish bill auction and a stronger than expected reading in the April German ZEW investor confidence survey helped to calm market nerves overnight. Some solid US Q1 earnings also supported equities too.

Weaker readings for US industrial production and housing starts were largely ignored. Hopes of an expansion of IMF funds were boosted by the news that Japan will be provide an extra $60 billion. High beta currencies rallied overnight but notably the EUR failed to register gains despite a narrowing in peripheral Eurozone bond yields.

AUD has undergone some major gyrations. The boost from by a strong jobs report last week was quickly undone by a relatively dovish set of RBA minutes, which appeared to confirm the view that a rate cut would take place in May. Of course, as the RBA pointed out the April 24 Q1 inflation report would be essential to provide the final clues to the rate decision.

As a rate cut is already priced in, an upside inflation surprise may actually result in a bounce in the AUD but any positive impetus will have to contend with a more fragile risk environment, yesterday’s risk rally not withstanding. AUD is one of the most highly sensitive currencies to risk aversion and bounced overnight as risk appetite improved but we suspect the risk rally will fade in the short term putting the AUD under renewed downward pressure.

EUR/CHF continues to track the 1.20 ‘line in the sand’ closely, but rumours of a shift in the floor continue to do the rounds. Swiss officials have not confirmed such speculation but have highlighted the impact of a strong CHF in fuelling deflation pressures. The case for a move higher in the CHF ceiling is therefore quite high, but the cost could also be high if speculators test the resolve of the Swiss authorities.

Although the Swiss economy continues to suffer it appears that the pain of a strong CHF is lessening slightly although not enough to ease concerns about the strength of the currency. The March KoF Swiss leading indicator revealed a second straight increase, albeit from a low level. Further gains may be limited however, given the ongoing downward pressure emanating from weaker growth in the Eurozone.

The Bank of Canada left policy rates unchanged at 1% but the accompanying statement appeared to pave the way for higher interest rates. Consequently expectations of rate hikes have been brought forward, with the CAD rallying due to its strong correlation with interest rate differentials. Firmer commodity prices also helped to boost CAD.

Our quantitative models show scope for further CAD gains over the short term, suggesting more gains ahead. Further direction will come from the BoC Monetary Policy Report today, with USD/CAD setting its sights on a test of technical support around 0.9766 in the near term.

EUR range, CAD looks good versus AUD

Ahead of the European Central Bank (ECB) meeting and outcome of the Greek private sector involvement (PSI) debt swap it is very difficult to see the EUR moving out of ranges. I expect no surprises from the ECB and therefore little FX impact. Downward revisions to ECB growth forecasts will however, underpin the more negative tone to the EUR exhibited over recent days.

The bigger risk is the outcome of the PSI. Reports that Greece is nearing the minimum level of PSI participation of 66% will help erase market concerns of a complete collapse of the debt deal, but the risk of forcing a collection action clause and triggering credit default swaps (CDS) remains very much alive. EUR/USD is unlikely to recoup much of its recent losses against this background but will also not sustain any drop below technical support around 1.3055.

The CAD has pivoted around the parity level with the USD over recent weeks, showing little inclination to undertake a significant move in either direction. Notably USD/CAD has failed to sustain gains above its 200-day moving average level around 0.9997. Nonetheless, the CAD has held up relatively well compared to its commodity currency peers, specifically the AUD and NZD, which have both fallen over recent days.

The breakdown in correlation highlights the fact that CAD is regaining some of its old allure as a ‘turbo dollar’. My quantitative estimates show that USD/CAD has some further downward potential but I prefer to play potential CAD upside versus the AUD. The Bank of Canada (BoC) meeting today will do little to derail the CAD, with an unchanged policy decision in prospect, leaving the CAD to maintain gains against AUD.

Plenty of event risk

This week is heavy with event risk, with a lot expected from EU leaders. So far the risk on tone to markets has held up, with for example the VIX fear gauge resting below the key 30.0. The G20 meeting over the weekend set the deadline for action for concrete solutions to the eurozone debt crisis for the October 23 EU Summit.

However, there will be little detail on issues such as banking sector recapitalisation, private sector involvement in any debt restructuring or ‘leveraging’ the EFSF bailout fund until the report on Wednesday night by the Troika on Greece. The reward to EU leaders would be the potential for more aid from the IMF but even now it seems that a German government official has poured cold water of a plan being announced at the EU Summit which will disappoint markets.

There are also plenty of data releases for markets to digest over coming days including inflation releases, manufacturing surveys and industrial production data in the US while in Europe the German IFO and ZEW surveys are scheduled for release. The data will follow on from the better than expected September US retail sales releases at the end of last week continuing to dampen expectations that the global economy is falling in recession though there will be a marked deceleration in European data.

Meanwhile the US Q3 earnings season rolls. The risk on tone will likely continue to weigh on the USD and weigh on bonds but unlike a few weeks ago when a lot of bad news was priced in, the scope for disappointment is becoming increasingly high.

Many currencies remain highly correlated with gyrations in risk and in this respect the improvement in risk appetite is good news for high beta / commodity. AUD, NZD, CAD and JPY are amongst the most sensitive currencies and therefore prone to a bigger reaction as risk improves, with the former three strengthening and the JPY weakening. Asian currencies poised to benefit from firmer risk appetite include INR and KRW, both with relatively high correlations with risk.

EUR/USD has made a solid recovery over recent days from its lows around 1.3146 spurred by hopes of action by European officials. Such hopes may yet be dashed but the EUR looks supported over coming days ahead of the EU summit Speculative positioning also reflects a slight improvement in EUR sentiment as IMM short positions have declined in the last week but its worth noting that this week’s European data are unlikely to be supportive for the EUR.

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