FX Tension

September 27, 2010 — Mitul Kotecha

On September 22 1985 the governments of France, West Germany, Japan, US and UK signed the Plaza Accord which agreed to sharply weaken the USD. At this time it was widely agreed that the USD was overly strong and needed to fall sharply and consequently these countries engineered a significant depreciation of the USD.

It is ironic that 25 years later governments are once again intervening in various ways and that the USD is once again facing a precipitous decline as the Fed moves towards implementing further quantitative easing. This time central banks are acting unilaterally, however, and there is little agreement between countries. For instance Japan’s authorities found no help from the Fed or any other central bank in its recent actions to buy USD/JPY.

So far Japan’s FX interventions have been discreet after the initial USD/JPY buying on 15 September. The fact that Japan is less inclined to advertise its FX intervention comes as little surprise given the intensifying pressure from the US Congress on China for not allowing its currency, the CNY to strengthen. Tensions have deepened over recent weeks and the backing of a bill last week by an important Congressional committee to allow US companies to seek tariffs on Chinese imports suggests that the situation has taken a turn for the worse.

The softly softly approach to Japan’s FX intervention and US/China friction reflects the fact that unlike in 1985 we may be entering a period in which currency and in turn trade tensions are on the verge of intensifying sharply against the background of subdued global economic recovery.

The Fed’s revelation that it is moving closer to implementing further quantitative easing has shifted the debate to when QE2 occurs rather than if, with a November move moving into focus. Clearly the USD took the news negatively and will likely remain under pressure for a prolonged period as the simple fact of more USD supply weighs heavily on the currency. Markets will be able to garner more clues to the timing of QE2, with a plethora of Fed speakers on tap over coming days.

This week the US economic news will be downbeat, with September consumer and manufacturing confidence surveys likely to register declines, with consumer sentiment weighed down by the weakness in job market conditions. Personal income and spending will also be of interest and gains are expected for both. There will be plenty of attention on the core PCE deflator given that further declines could give clues to the timing of QE2.

Attention in Europe will centre on Wednesday’s recommendations for legislation on “economic governance” from the European Commission. Proposed penalties for fiscal indiscipline may include withholding of funding and/or voting restrictions but such measures would be politically contentious. Measures to enforce fiscal discipline ought to be positive for markets given the renewed tensions in peripheral bond markets in the eurozone.

The EUR was a major outperformer last week benefiting from intensifying US QE speculation and will set its sights on technical resistance (20 April high) around 1.3523 in the short-term. Notably EUR speculative positioning has turned positive for the first time this year according to the CFTC IMM data, reflecting the sharp shift in speculative appetite for the currency over recent weeks. The EUR has been surprisingly resilient to renewed sovereign debt concerns and similarly softer data will not inflict much damage to the currency this week.

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No Let Up in USD Pressure

September 17, 2010 — Mitul Kotecha

At the end of a momentous week for currency markets it’s worth taking stock of how things stand. Much uncertainty remains about the global growth outlook, especially with regard to the US economy, potential for a double-dip and further Fed quantitative easing. Although there is little chance of QE2 being implemented at next week’s Fed FOMC meeting speculation will likely remain rife until there is clearer direction about the path of the US economy.

In Europe, sovereign debt concerns have eased as reflected in the positive reception to debt auctions this week. Nonetheless, after a strong H1 2010 in terms of eurozone economic growth the outlook over the rest of the year is clouded. Such uncertainty means that markets will also find it difficult to find a clear direction leaving asset markets at the whim of day to day data releases and official comments.

The added element of uncertainty has been provided by Japan following its FX intervention this week. Whilst Japanese officials continue to threaten more intervention this will not only keep the JPY on the back foot but will provide a much needed prop for the USD in general. Indeed Japan’s intervention has had the inadvertent effect of slowing but not quite stopping the decline in the USD, at least for the present.

The fact that Japanese officials continue to threaten more intervention suggests that markets will be wary of selling the USD aggressively in the short term. The headwinds on the USD are likely to persist for sometime however, regardless of intervention by Japan and/or other Asian central banks across Asia, until the uncertainty over the economy and QE2 clears.

Japan’s intervention has not gone down well with the US or European authorities judging by comments made by various officials. In particular, the FX intervention comes at a rather sensitive time just as the US is piling on pressure on China to allow its currency the CNY to strengthen further. Although US Treasury Secretary Geithner didn’t go as far as proposing trade and legal measures in his appearance before Congress yesterday there is plenty of pressure from US lawmakers for the administration to take a more aggressive stance, especially ahead of mid-term Congressional elections in November. Ironically, the pressure has intensified just as China has allowed a more rapid pace of CNY nominal appreciation over recent days although it is still weaker against its basket according to our calculations.

Another country that has seen its central bank intervening over many months is Switzerland, with the SNB having been aggressively intervening to prevent the CHF climbing too rapidly. However, in contrast to Japan the SNB is gradually stepping back from its intervention policy stating yesterday that it would only intervene if the risk of deflation increased. Even so, Japan may have lent the Swiss authorities a hand, with EUR/CHF climbing over recent days following Japan’s intervention.

The move in EUR/CHF accelerated following yesterday’s SNB policy meeting in which the Bank cut its inflation forecasts through 2013, whilst stating that the current policy stance in “appropriate”. Moreover, forecasts of “marked” slowdown in growth over the rest of the year highlight the now slim chance of policy rates rising anytime soon. Markets will eye technical resistance around 1.3459 as a near term target but eventually the CHF will likely resume its appreciation trend, with a move back below EUR/CHF 1.3000 on the cards.

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Resisting Asian FX Appreciation

September 7, 2010 — Mitul Kotecha

The upward momentum in Asian currencies has continued unabated over recent weeks the gyrations in risk appetite. Most Asian currencies have registered gains against the USD over 2010 with the notable exception of one of last year’s star performers, KRW which after gaining by close to 9% last year has weakened slightly this year. Last year’s best performer the IDR which raked in close to 20% gains over 2009 versus USD has continued to strengthen this year, albeit to a smaller degree. Another currency that has extended gains this year has been the THB, which is on track to beat last year’s 4% appreciation against the USD.

The strength in Asian currencies has in part reflected robust inflows into Asian equity markets. For example Indonesia has been the recipient of around $1.7 billion in equity inflows so far this year. However, India and Korea have registered even larger inflows into their respective equity markets, at around $13 billion and $7.7, respectively, yet both the INR and KRW have underperformed other Asian currencies. The explanation for this is largely due to deteriorating current account positions in both countries. Further deterioration is likely.

The fact that equity flows have had only a small impact on the INR and KRW is reflected in their low correlations with their respective equity market performance. For most other Asian currencies the correlation with equity performance has been quite high, with the THB and MYR having the strongest correlations with their respective equity market indices over the past 3-months although the SGD, PHP and IDR have also maintained statistically significant correlations.

Clearly, for many but not all Asian currencies equity market gyrations are important drivers but at a time when growth is slowing more than many had expected in the US and governments in the eurozone are implementing austerity measures which will likely result in slowing growth and a worsening trade picture in the region, central banks in Asia will become increasingly wary of allowing their currencies from strengthening too quickly.

Increasingly Asian currency strength is being met with intervention by central banks in the region buying USDs against a host of Asian currencies. Over recent weeks this intervention appears to have become more aggressive. Nonetheless, any FX intervention led weakness in Asian FX is likely to prove short lived, with renewed appreciation likely over the coming months unless risk aversion increases dramatically. In other words a drop in Asian currencies will provide better opportunities to go long.

The CNY will play an important role on the pace and pattern of Asian currency movements. Investors in the region will also have one eye on developments on the visit of US National Economic Council director Larry Summers to Beijing. The CNY has firmed over recent days but this appears to be the usual pattern when a senior US official is in town and ahead of a G20 meeting. The fact is however, that the lack of CNY appreciation since the June CNY de-pegging remains a highly sensitive issue.

China is unlikely to yield to US pressure and is set to continue to act at its own pace and comments from officials in China over the past couple of days suggest no shift in FX stance. Although the CNY has not appreciated by as much as many had hoped for or expected since the June de-pegging the path is likely to be upwards, albeit at a gradual pace. For Asian currencies a slow pace of CNY appreciation implies further reluctance to allow a fast pace of appreciation so expect plenty of FX intervention in the weeks and months ahead.

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US Dollar Tensions

September 6, 2010 — Mitul Kotecha

There was considerable relief, most acutely in the US administration, that the US August jobs report revealed a better than expected outcome. To recap, private sector payrolls increased by 67k vs. an upwardly revised 107k in July whilst total non farm payrolls dropped 54k. The data sets the market up for a positive start to the week in terms of risk appetite despite Friday’s drop in the August US non-manufacturing ISM index, deflating some of the market’s upbeat mood.

Once again I wonder how long positive sentiment can be sustained with so many doubts about recovery prospects and limited ammunition on the fiscal front as well as some reluctance on the monetary front, to provide further stimulus should a double dip become a reality.

Markets will be treated to several major central bank decisions including from the Bank of Japan, Bank of England, Bank of Canada and Reserve Bank of Australia this week. These meetings are set to prove uneventful, with unchanged decisions across the board expected although the Bank of Canada decision is a tough call.

The main US release this week is the Fed’s Beige Book on Wednesday, a report which will help the Fed to prepare for the FOMC meeting on September 21. The evidence contained within it is unlikely to be positive reading, with consumer spending set to be relatively soft and evidence of recovery likely to remain patchy.

On Thursday the US July trade deficit is set to reveal some narrowing and as usual the deficit with China will be of interest given the renewed tensions over FX policy. FX tension seems to be intensifying once again due to the relatively slow pace of CNY appreciation since the June de-pegging as well as political posturing ahead of November US mid-term elections. A deterioration in US trade data, a factor that largely contributed to the soft Q2 GDP outcome in contrast to a strengthening in China’s trade surplus will have added fuel to the fire.

The firmer risk backdrop has put the USD on the back foot, with the USD index dropping sharply overnight. Nonetheless, speculative USD positioning as reflected in the CFTC IMM data reveals further short covering up to the end of August, implying USD speculative sentiment is actually turning less negative.

Another country which has a different sort of tension regarding the USD is Japan. Improving risk appetite will likely prevent the JPY from visiting previous highs against the USD but will do little to reduce FX intervention speculation. Indeed, there was more jawboning over the weekend on the subject, with Japan’s finance minister Noda reiterating that Japan would take decisive action to stem the JPY’s appreciation but adding that coordinated FX intervention was a difficult option. Clearly Japan us unlikely to succeed with unilateral FX intervention.

Political events have added to the debate on FX policy as focus turns to the election for leader of the ruling DPJ party next week, with a battle looming between current Prime Minister Kan and challenger Ozawa. Although Ozawa is unpopular with the electorate he yields plenty of political power, and appea rs to be more inclined towards FX intervention. Having failed to sustain a move above 85.00 the pull back in USD/JPY suggests little appetite to extend gains, likely leaving USD/JPY in a relatively tight range, with strong support around 83.55 and resistance around 85.23.

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Follow The Oracle

July 12, 2010 — Mitul Kotecha

Many investors are probably wishing they had the psychic abilities of Paul the octopus. The mollusc once again gave the correct prediction, by picking Spain to beat the Netherlands to become the winner of the World Cup. This ability would have been particularly useful for currency forecasters, many of which have been wrong footed by the move higher in EUR/USD over recent weeks.

Confidence appeared to return to markets over the past week helped by a string of rate hikes in Asia from India, South Korea and Malaysia, and firm data including yet another consensus beating jobs report in Australia. An upward revision to global growth forecasts by the International Monetary Fund (IMF) also helped, with the net result being an easing in double-dip growth concerns.

The good news culminated in a much stronger than forecast June trade surplus in China. However, China’s trade numbers will likely keep the pressure on for further CNY appreciation, and notably US Senators are still pushing ahead with legislation on China’s FX policy despite the US Treasury decision not to name China as a currency manipulator.

Political uncertainty on the rise again in Japan following the loss of control of the upper house of parliament by the ruling DPJ party. The JPY has taken a softer tone following the election and will likely remain under pressure. CFTC IMM speculative JPY positioning has increased but this has been met with significant selling interest by Japanese margin accounts who hold their biggest net long USD/JPY position since October 2009 according to Tokyo Financial Exchange (TFX) data.

In the absence of the prodigious abilities of an “oracle octopus” data and events this week will continue to show slowing momentum in G3 country growth indicators but not enough to warrant renewed double-dip concerns. Direction will be largely driven by US Q2 earnings. S&P 500 company earnings are expected to have increased 27% from a year ago according to Thomson Reuters.

There are several data releases of interest in the US this week but the main release is the retail sales report for June which is likely to record another drop over the month. Data and events in Europe include the Eurogroup finance ministers meeting, with markets looking for further insight into bank stress tests across the region. Early indications are positive but the scope of the tests remains the main concern. The July German ZEW survey will garner some interest and is likely to show a further slight decline in economic sentiment.

EUR/USD gains looked increasingly stretched towards the end of last week, as it slipped back from a high of around 1.2722. Technical resistance around 1.2740 will prove to be tough level to crack over coming days, with a pullback to support around 1.2479 more likely. CFTC IMM data reveals that short covering in EUR has been particularly sharp in the last week, with net short positions cut by over half, highlighting that the scope for further short covering is becoming more limited.

Conversely aggregate net USD long positions have fallen by over half in the last week as USD sentiment has soured, with longs at close to a three-month low. The scope for a further reduction in USD positioning is less significant, suggesting that selling pressure may abate.

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