USD finding support, AUD slipping

March 6, 2012 — Mitul Kotecha

US bond yields look relatively well supported and in turn this is providing a degree of support for the USD. In this respect the firmer than consensus reading in a gauge of service sector activity, the February US ISM non-manufacturing survey (57.3 versus 56.8 in January) which contrasted with relatively weak service sector purchasing managers’ indices (PMI) in Europe, helped to maintain the healthy yield differential between the US and German bunds.

Combined with the generally ‘risk off’ sentiment pervading markets, in part due to the weaker PMI data, the USD looks to be in good form early in the week. The next market mover will be Wednesday’s ADP jobs report (a measure of jobs growth in the services sector), which will provide clues to Friday’s February non-farm payrolls outcome. In the meantime the fact that the speculative market (IMM) is positioned short USD (for the first time since September 2011) suggests that the room for further USD selling looks limited, with the USD index looking well supported above 79.00.

AUD and other high beta currencies lost more ground in the wake of the drop in the Chinese non-manufacturing PMI in February. AUD remains highly reactive to Chinese data releases given the high and growing exposure of Australia’s economy to China. Given the likelihood of a soft landing in China this year, the medium term damage to the AUD will be limited and I stil look for AUD/USD to reach 1.10 by year-end.

Over the near term however, there is scope for more AUD downside but much will depend on the outcome of the Reserve Bank of Australia (RBA) policy meeting. Expectations of rate cuts have diminished following recently better data and a less dovish statement at the last RBA meeting. A relatively benign statement will offer the AUD little support, leaving AUD exposed to a drop to technical support to just under 1.06 versus the USD.

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Risk currencies buoyed

February 29, 2012 — Mitul Kotecha

Positive developments helped to buoy markets. Although US durable goods orders were weaker than forecast a jump in US consumer confidence to its highest since February 2011 gave equity markets and risk assets in general a lift. Even in Europe the news was encouraging as Italy managed to auction 10-year debt at a cheaper rate than previously while Portugal passed a third review of its bailout programme and noted that unlike Greece it would need a second bailout.

There was some negative news however, with the European Central Bank (ECB) temporarily suspending the eligibility of Greek bonds as collateral for its funding operations and Ireland calling a referendum on the European fiscal compact. Nonetheless, hopes of a healthy take up at today’s ECB second 3-year Long term refinancing operation (LTRO) will keep markets in positive mood in the short term.

The USD index continues to look restrained when risk assets are rallying. Given the positive equity market mood overnight it is no surprise that the USD came under further pressure while the EUR looks firm ahead of today’s 3-year LTRO by the ECB. Fed Chairman Bernanke’s testimony will give the USD some direction but we do not expect him to deliver any big surprises. EUR/USD will continue to rally if we are correct about a strong EUR 600-700 billion take up at the LTRO but the currency pair will meet resistance around 1.3550.

JPY has lost ground against various cross including USD, EUR and AUD. Much of its weakness is related to widening yield differentials but our models reveal that USD/JPY in particular has overshot its implied value. Unless US yields widen further versus Japan, JPY could even rebound over coming days. EUR/JPY has breached its 200 day moving however, which is a bullish signal for the currency pair. A generally firm EUR tone likely to be maintained in the short term will also be exhibited versus JPY.

Warnings by Swiss National Bank head Jordan reiterating his stance of defending the EUR/CHF floor of 1.20 has done little to push the currency pair higher. EUR/CHF has enjoyed a strong relationship with movements in interest rate differentials. This implies that it will take a relative rise in German yields versus Swiss yields for EUR/CHF to move higher. This is certainly viable given the deterioration in Swiss economic data over recent months. Eventually EUR/CHF will move higher but over the short term it is unlikely to move far from the 1.20 level.

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FX outlook this week

February 19, 2012 — Mitul Kotecha

Direction in FX markets will largely hinge on developments at the beginning of the week in Europe but a US holiday (Presidents’ Day) will mean a subdued start. US data has continued to beat expectations as revealed by the recent gains in core retail sales, manufacturing surveys, jobless claims and industrial production. US recovery is taking shape and the USD is finally showing some signs of perking up on the news.

Rising US bond yields have provided the USD with some support although the impact has been muted by higher bond yields elsewhere. Nonetheless, despite ongoing speculation of more Fed quantitative easing the USD looks set to be on a slightly firmer footing over coming days. In a relatively light week of data releases housing data will be the major focus of attention.

Assuming approval for a second Greek bailout goes ahead (after much procrastination) the week will at least begin on a positive note for the EUR. Whether the EUR will extend gains will partly be determined by the release of flash February purchasing managers’ indices (PMI) and the German IFO business confidence survey. Our forecasts of weak service sector readings but firm manufacturing indices will be a mixed blessing for the EUR but overall data will remain consistent with mild recession.

Failure of EUR/USD to sustain a move below the psychologically important 1.30 level suggests a bit more resilience over coming days. Nonetheless, speculation of a Greek euro exit will not fade quickly and markets will likely gyrate between ‘risk on’ and ‘risk off’ depending on the latest comments from Greek or European officials. All in all, the EUR will continue to struggle to move higher.

For a change one of the bigger movers in currency markets over recent days has been the JPY. Its decline following more aggressive monetary policy action by the Bank of Japan has extended further. The move by the BoJ helped to suppress Japanese government bond yields (JGBs) allowing USD/JPY to move higher in line with relatively higher US yields. This week’s release of January trade data will support the case for more JPY weakness given the deteriorating trend.

The data will also strengthen the resolve of the Japanese authorities to intervene in FX markets should the JPY strengthen anew. Immediate focus will be whether USD/JPY can break through the psychologically important 80 level where JPY weakness will be met by plenty of exporters offloading USDs. I suspect the upside momentum in USD/JPY will fade over coming days unless US bond yields continue their ascent.

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Euro and yen downside risks

February 15, 2012 — Mitul Kotecha

The lack of progress on a second bailout for Greece will keep markets nervous, leaving risk assets vulnerable to further slippage. The USD will be a beneficiary in this environment. Weak Eurozone GDP data for Q4 2011 released today will contrast with relatively firm data including industrial production and the Empire manufacturing survey in the US, leaving the story of US economic outperformance intact.

EUR has lost steam and looks vulnerable to a further correction lower. The fact that EU finance ministers have cancelled a meeting due to be held today means that markets will have to prolong their wait for an agreement on a second bailout package for Greece.

News that Greece’s political leaders will send a commitment to European officials today that they will implement further austerity measures will give some reassurance that things are moving in the right direction but a looming deadline for debt redemption in March will mean heightened nervousness.

Admittedly the market is still short EUR but positioning has moved close to its 3-month average suggesting a less potential for aggressive short covering. Following the downgrade of ratings of several Eurozone countries yesterday and a likely drop in Q4 2011 Eurozone GDP today, caution will be the prevalent theme today, leaving EUR/USD on the back foot and opening the door for a test of technical support around 1.3026.

The Bank of Japan’s decision to increase its asset purchase program and set an inflation goal had an immediate negative impact on the JPY. A sharp drop in GDP growth in Q4 last year, persistent deflation pressures and more aggressive action from other central banks pushed the BoJ into action.

Will there be any follow through on the JPY? USD/JPY had already been under some upward pressure in the wake of the widening in US bond yields versus Japan. The move by the BoJ will result in even more of a widening in yield differentials especially given that the BoJ actions means there will be an increase in official purchases of Japanese government bonds, helping to suppress JGB yields.

In the near term USD/JPY has broken above its 200 day moving average level, paving the way for a test of the 31 October 2011 high around 79.55. Further out, our bond forecasts show that both US and Eurozone 2-year bond yields will increase relative to Japanese yields over the coming months, supporting our forecasts of USD and EUR appreciation versus JPY.

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USD in a lose-lose situation, AUD caution

February 14, 2012 — Mitul Kotecha

News that Moody’s Investor service cut the debt ratings on six European countries while revising its outlook on the UK’s and France’s AAA rating to “negative” dampened sentiment for the EUR. Markets will likely trade cautiously ahead of tomorrow’s meeting of European Union Finance Ministers especially as it appears that at least Germany and Netherlands remain sceptical of Greece’s austerity plans, which could frustrate the approval of a second EUR 130 billion bailout package.

The USD is firmer overnight but still struggling to make headway in an environment of improving risk appetite. The fact that USD speculative positioning has dropped sharply to its lowest level since September last year highlights a major shift in USD sentiment. The USD is currently in a lose-lose situation helped neither by economic data or risk appetite. For example a healthy gain in January retail sales expected today, will help to boost risk appetite which in turn will help maintain pressure on the USD.

Encouragingly for the USD, 2 year bond yields have been rising since the start of February in line with firmer economic data. However, rather than giving the USD a boost (except vs. JPY) it has been outweighed by the fact that bond yields elsewhere have risen even more aggressively. The net result is that the prospects for the USD to strengthen further look somewhat restrained over the short term.

AUD has benefited from a firmer tone to risk appetite at the start of the week but for a currency in which speculative positioning is fast approaching all time highs I would be cautious of adding to long positions at current levels. Remaining one of the most sensitive currencies to gyrations in risk appetite the AUD will continue to be mainly driven by global events especially the Greek saga.

Nonetheless, there a few data releases at home that will capture market attention, in particular the January jobs report on Thursday. After a surprisingly large 29.3k fall in December a bounce is expected in January, with around a 15k increase likely. The report will provide clues to just how long the RBA will pause in its rate cutting cycle. I suspect that even a positive outcome will have a briefly positive impact on AUD, with the currency set to struggle to break above resistance around its 2012 high at 1.0845 versus USD.

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