China’s gradual renminbi move

June 21, 2010 — Mitul Kotecha

China’s decision to “proceed further with reform” of the CNY exchange rate regime will dictate market activity at the turn of the week. The decision to act now reflects the fact that China is no longer in crisis mode policy. Although the eurozone sovereign crisis may have delayed China’s move, the authorities in China clearly felt that conditions had improved sufficiently enough to act. The decision will pre-empt some of the criticism that China would have faced at the G20 meeting next weekend, leaving attention firmly on Europe.

Before we all get too excited it should be noted that it is unlikely that China’s announcement presages aggressive action on the CNY. Stability appears to be the name of the game, a fact that has already drawn criticism from some in the US Senate who may still push for legislation over China’s exchange rate.

China will likely allow some, albeit gradual appreciation of the CNY. In this respect, it’s worth noting that the CNY appreciated by around 6.6% against the USD during 2007 and around the same amount in 2008 prior to the formal peg with the USD. Appreciation at a similar pace of coming months is unlikely.

The initial impact on the USD was an echo of the July 2005 move but to a far smaller degree. The USD was sold off across the board as market players reacted to the likelihood of the USD playing a less important role in China’s exchange rate mechanism. The USD rallied when China maintained its CNY fixing but lost ground as the CNY appreciated against the fixing.

The fact that net USD speculative positions halved over the past week according to the CFTC IMM data, suggest that the USD is far less vulnerable this week to selling pressure from a positioning perspective. In other words there will be no repeat of the sharp FX moves that were seen post the July 2005 CNY revaluation. Whilst the major currency impact is likely to prove muted, Asian currencies are set to benefit more significantly, with further strengthening likely this week.

China’s announcement will play into the tone of firmer risk appetite at the beginning of the week but the move in some risk currencies, especially the EUR is looking increasingly stretched. The EUR and risk appetite may have benefited from recent positive news flow including the announcement of European bank stress tests and the relatively positive reception to Spain’s bond auction, but speculative positioning (IMM) data reveals that there was already a strong short-covering rally over the past week, which saw net EUR short positions almost halve.

Further EUR/USD gains will be harder to come by, with an immediate obstacle around 1.2500. Perhaps another reason for China to be cautious about the pace of CNY appreciation is the likelihood of further EUR weakness and the impact that this would have on China’s trade with Europe. As it is EUR/CNY has already dropped by over 13% so far this year and China will not want to enact measures that will accelerate the pace of the move in the currency pair.

Posted in Asia, central banks, China, Currencies, Economics, Economy, emerging markets, Europe, eurozone, Fiscal/Budget, FX, Monetary Policy, US, US administration. Tags: , , , , , , , , , , , , , . 1 Comment »

Euro Rally To Fade

June 17, 2010 — Mitul Kotecha

It is not an easy time to forecast currencies. Just as many forecasters fought for the accolade of being the most bearish on the EUR and many others were forced to capitulate or risk falling behind the curve, EUR/USD has started to perk up. Similarly, commodity currencies and many emerging market currencies have bounced.

Perhaps the explanation of these moves is merely position adjustments as traders and investors square positions as they keep one eye on the World Cup or maybe its just fatigue after weeks of selling pressure. Either way, the fact that speculative USD market positioning is at a very high level, suggests there is plenty of scope to take profits on long USD positions.

There are various reasons to expect the calm to give way to renewed tensions, however. Public opposition to austerity plans in Europe, added to the prospects for slowing growth as the plans are implemented, in addition to banking sector concerns, suggest that the outlook for the EUR remains downbeat. These factors also point to the prospects of risk aversion rising over the coming weeks, reversing the recent rally in risk currencies.

Further out, the EUR’s travails will not be over quickly and in the wake of the implementation of austerity plans the EUR will struggle from the impact of relatively slower growth in the eurozone compared to the US and other countries. The EUR will continue to remain under pressure even as risk appetite improves and many risk currencies appreciate.

The interruption of risk as an FX determinant is likely to fade towards the end of the year and investors will then go back to differentiating on the basis of relative growth and interest rate dynamics, which will play well for the USD as US growth strengthens.

Relative growth differentials will also bode well for commodity currencies and there will be scope for plenty of upside in the AUD and NZD as growth strengthens. Both countries have benefited from firm demand in Asia and China in particular and this source of support will likely continue to be beneficial.

Funding currencies including JPY and CHF will likely weaken this year against the USD based on the likely improvement in risk appetite later this year. The outlook for the JPY will be particularly interesting in the wake of the change in Prime Minister in Japan, especially given the new PM’s preference for a weaker JPY and reflationary policies. USD/JPY will likely reach 100 by the end of the year.

GBP should not be seen in the same context as the EUR. Although the UK has got its own share of fiscal problems the new government appears to be moving quickly to mollify both investor and ratings agency concerns. The test will come with the reaction of the emergency budget on June 22nd but I suspect that the downside risk to GBP will be limited.

Unlike the EUR which is trading around “fair value”, GBP is highly undervalued. Arguably past GBP weakness puts the UK economy on a stronger recovery footing. Moreover, problems that Europe will face in implementing multi country austerity plans and widening growth divergence, will not be repeated in the UK. Overall, there is likely to be significant outperformance of GBP versus EUR over coming months

Posted in China, Commodities, Currencies, Economics, Economy, emerging markets, Europe, eurozone, Financial crisis, Fiscal/Budget, FX, Greece, Interest rates, Japan, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Sell Risk Trades On Rallies

June 8, 2010 — Mitul Kotecha

It seems that every time there is a bounce in risk appetite it quickly dissipates as worries about growth, fiscal deficits, sovereign debt, etc, return to dent sentiment. This was again the case overnight as markets sold off late in the US session, with an early bounce in sentiment proving too fragile to last. This pattern of trading is set to persist for a long while yet, with the overall tone of selling risk trades on rallies remaining in place.

Fears over a double dip global recession have increased since the release of Friday’s disappointing US jobs report even if it is too early to pass judgment based on the basis of one month’s data. Coupled with worries about slowing growth momentum in China, hopes that slower growth in the eurozone could be counterbalanced by firm growth elsewhere are being dashed. The problem is that despite a strong quarter of growth for most economies in Q2 2010 the outlook for the second half of the year is far more uncertain.

European Union officials sought to calm worries about the potential for renewed fiscal crises in the future by agreeing to monitor national budgets more closely and at an earlier stage whilst introducing a wider range of sanctions on excessive deficits. Unfortunately this is akin to the idiom about closing the stable door after the horse has bolted. The steps aren’t going to help resolve the current crisis. Evidence of implementation, execution and results on the deficit cutting front will help however, but this is a process that will take months rather than days or weeks.

A couple of factors may have prevented the EUR from extending losses overnight. 1) Germany announced EUR 80 billion in spending cuts along with 15,000 public sector job cuts. Germany also is pushing for a financial transactions tax on tap of the bank levy. 2) European finance ministers finalised details of the EUR 440 bn Financial Stability Facility which aims to sell AAA rated bonds to make loans to eurozone countries. The only question is the approval process. The statement on the funds operations only said that “national legal procedures to participate in the facility are well on track”. EUR/USD is likely to range between 1.1826 and 1.2110 over the short-term.

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Renewed concerns

June 2, 2010 — Mitul Kotecha

Despite some positive US data, with both the May ISM manufacturing index and April construction spending coming in stronger than forecast, market sentiment soured. The relative calm that was exhibited at the end of May is giving way to renewed fears as equity markets weaken, volatility increases and risk aversion intensifies. Risk trades are set to remain on the back foot, with the EUR likely to remain the weakest link. After testing support close to 1.2110 EUR/USD bounced but remains vulnerable to a fresh test of this level in the short-term.

A combination of concerns including rumours of ratings downgrades, with France the new target, Middle East tensions, weaker Chinese manufacturing activity and worries about increasing bank writedowns in Europe, have conspired to drag markets lower. The failure to stem the hue oil-leak in the US contributed to the malaise as the US government announced a criminal probe.

For the most part, data releases were unhelpful to risk appetite as the majority of global purchasing managers indices (PMIs) slipped in May, led by China. Only a few increased, including India and notably Ireland, whilst the Spanish and Greek PMIs fell. Although the US ISM index slipped the components looked positive, especially the employment component which moved higher, suggesting some upside potential for Friday’s May payrolls data for which we look for a 500k increase.

A picture of divergence appears to be growing in the eurozone, which will act as another source of pressure on the EUR. Germany’s outperformance is widening as reflected by the fact the German unemployment dropped to 7.7% in May in contrast to a rise in eurozone unemployment, to 10.1%. Moreover, Germany was the only country where its PMI was actually revised higher relative to the flash reading. There are also growing divisions within the European Central Bank (ECB), in particular towards the purchase of government bonds, with German ECB members particularly critical.

Posted in central banks, China, Currencies, Economics, equity markets, Europe, eurozone, Financial crisis, Fiscal/Budget, FX, Germany, Greece, India, Monetary Policy, Spain, US. Tags: , , , , , , , , , , , , , , . Leave a Comment »

Capital Flowing Out of Europe

May 18, 2010 — Mitul Kotecha

When investors’ concerns shift from how low will the EUR go to whether the currency will even exist in its current form, it is blatantly evident that there is a very long way to go to solve the eurozone’s many and varied problems. As many analysts scramble to revise forecasts to catch up with the declining EUR, the question of the long term future of the single currency has become the bigger issue. Although the EUR 750 billion support package was hailed by EU leaders as the means to prevent further damage to the credibility of the EUR, it has failed to prevent a further decline, but instead revealed even deeper splits amongst eurozone countries.

Although the European Central Bank (ECB) confirmed that it bought EUR 16.5 billion in eurozone government bonds in just over a week, with the buying providing major prop to the market, private buyers remain reluctant to renter the market. As a result of the ECB’s sterilised interventions bond markets have stabilised but the EUR is now taking the brunt of the pressure, a reversal of the situation at the beginning of the Greek crisis, when the EUR proved to be far more resilient. Reports that some large institutional investors have exited from Greek and Portuguese debt markets whilst others are positioning for a eurozone without Greece, Portugal and Spain, suggest that the ECB may have taken on more than it has bargained for in its attempts to prop up peripheral eurozone bond markets.

As was evident in the US March Treasury TICS report it appears that a lot of the outflows from Europe are finding their way into US markets. The data revealed that net long-term TIC flows (net US securities purchases by foreign investors) surged to $140.5 billion in March. The bulk of this flow consisted of safe haven buying of US Treasuries ($108.5 billion), although it was notable that securities flows into other asset classes were also strong especially agencies and corporate bonds, which recorded their biggest capital inflow since May 2008. Asian central banks also reversed their net selling of US Treasuries, with China investing the most into Treasuries since September 2009. Anecdotal evidence corroborates this, with central banks in Asia diversifying far less than they were just a few months ago.

This reversal of flows is unlikely to stop anytime soon. It is clear that enhanced austerity measures in the eurozone will result in weaker growth and earnings potential. This will play negatively on the EUR especially given expectations of a superior growth and earnings profile in the US. Evidence of implementation, action and a measure of success on the fiscal front will be necessary to begin the likely long process of turning confidence in the EUR around. This will likely take a long time to be forthcoming. EUR/USD has managed to recover after hitting a low of around 1.2235 but remains vulnerable to further weakness. The big psychological barrier of 1.20 looms followed by the EUR launch rate of around 1.1830.

Posted in Asia, Bond markets, central banks, China, Currencies, Economics, Economy, eurozone, Financial crisis, Fiscal/Budget, FX, Germany, Greece, IMF, US. Tags: , , , , , , , , , , , , , , , , , . 1 Comment »
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