Strengthening risk appetite hitting the dollar

October 13, 2011 — Mitul Kotecha

Strengthening risk appetite is taking its toll on the USD, with the USD index now down around 3.5% from its 4 October peak. Although equity markets probably liked the news the USD was dealt another blow from the FOMC minutes which revealed that some Fed officials were keen on embarking on further large-scale asset purchases after recognizing that the impact of Operation Twist will not be so potent.

Earnings will have some impact on risk and in turn the USD, with Q3 earnings from JP Morgan and Google on tap today. However, risk appetite looks well supported and in a market that became long USDs very quickly, this suggests some scope for squaring long positions in the short term.

What comes next for the EUR? The currency has bounced from its lows and has made considerable ground against the USD over recent sessions. Markets quickly got over Slovakia’s initial rejection of the EFSF’s enhancement as agreement was reached by officials in the country to approve the mechanism in a second vote. However, there is not much news on the progress on issues such as European banking sector recapitalisation, ‘leveraging’ the EFSF or the any change in creditor participation in any Greek debt restructuring.

Although European Commission President Barroso gave some broad outlines of what should be done to recapitalise banks disagreement among officials meant that there was little detail. Perhaps no news is good news and in any case markets will have to wait for the delayed EU Summit for further news, but the longer the wait the greater the scepticism and attendant downside risks to EUR.

The Swiss National Bank must be content with their stance on the CHF. Since the imposition of a ceiling for CHF versus EUR at 1.2000, and after an initial sharp jump higher the currency pair has continued to edge upwards. Meanwhile, speculation that the SNB may even raise the ceiling to 1.30 has grown as domestic complaints such as those from the country’s largest telecoms operator yesterday about the ongoing strength in the currency, continue.

The SNB has not indicated that it favors such a move and may be content with a gradual decline in the CHF as is taking place now, but should the fragile market calm at present disintegrate the SNB may have another battle on their hands as appetite for the currency strengthens anew. On the top side resistance is seen around 1.2469 for EUR/CHF.

Like many other high beta currencies AUD is being influenced less by domestic factors and more by risk aversion. Even more influential to the direction of AUD/USD is the movement in commodity prices and like risk aversion this had a negative influence on AUD as commodity prices dropped sharply over September.

Due to a bounce in both risk and commodities AUD has bounced sharply from its recent lows back above parity with the USD. AUD will have found further support from the firm September jobs report today. It is difficult to go against rising risk appetite at present but there is still a significant risk that hopes of a solution to the eurozone’s woes do not materialise while growth expectations are pared back further. Against this background the AUD will remain susceptible to sharp

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Risk appetite remains fragile

October 10, 2011 — Mitul Kotecha

The stabilisation in risk appetite over recent days looks highly fragile and markets will look to upcoming events in Europe and data releases to determine whether a rally in risk assets is justified. Discussions over the weekend between German Chancellor Merkel and French President Sarkozy delivered little in substance apart from a promise that a concrete response to the crisis will be delivered by the end of the month ahead of the 3 November G20 summit.

Both leaders agreed on the need for European banking sector recapitalisation and this issue along with whether or how to leverage the EFSF bailout fund and the extent of private sector participation in any Greek bailout is likely to take growing prominence for markets over coming weeks ahead of the EU summit on 17-18 October. In the meantime, markets may give Eurozone officials the benefit of the doubt but patience will run thin if no progress is made on these fronts.

The US jobs report at the end of last week which revealed a bigger than expected 103k increase in payrolls and upward revisions to previous months will have helped to allay fears about a renewed recession in the US and global economy. Indeed, recent surveys reveal that analysts expected weak US growth rather than recession. This week’s data will help to shore up such expectations with US data including retail sales and consumer confidence likely to outshine European data, including likely declines in industrial production in the region.

Overall, this will help to buoy risk appetite which may leave the USD with less of a safe haven bid but at the same time it will also reduce expectations of more quantitative easing (QE3) in the US, something that will bode well for the USD. Markets are set to begin the week in relatively positive mood but we remain cautious about the ability of risk appetite to be sustained. On balance, firmer risk appetite will play negatively for the USD early in the week but any drop in the USD will be limited by the fragility of risk appetite and potential for risk aversion to intensify again.

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Waiting for a solution to Europe’s crisis

September 30, 2011 — Mitul Kotecha

The boost to sentiment following Germany’s approval of changes to the EFSF bailout fund was brief. Although the outcome of the vote was not particularly surprising political concerns were assuaged by the fact that Chancellor Merkel secured support from within her coalition. Markets were also helped by a bigger than expected drop in weekly US jobless claims but this also failed to provide a lasting impact.

The bottom line is that there is still a huge degree of scepticism on the ability of policymakers to resolve the crisis in the eurozone periphery while growth worries have not receded. Even the approved changed to the EFSF bailout fund are increasingly being seen as old news given the view that it will need deeper changes including ‘leveraging’ it up.

Consequently risk aversion remains at a highly elevated level and is showing no sign of easing. It may be difficult to turn sentiment around as we go into the final quarter of the year, especially as those investors registering profits for the year may want to capitalise on these profits rather than sit through continued volatility in the weeks ahead. Indeed the sharp drop in gold prices over the last couple of weeks even in an environment of elevated risk aversion may reflect this.

Similarly risk assets may struggle to recover over coming weeks unless there is a major improvement in the situation in Europe or in growth data. Markets will go into the end of this week looking ahead to key events next week including an Ecofin meeting at the beginning of next week, a European Central Bank (ECB) meeting and the US September jobs report.

There will be plenty of attention on the Ecofin meeting of European Finance Ministers on Monday especially given that much of the reason for the stability in markets recently is the hope of concrete measures to resolve the crisis in the region. In this respect the scope for disappointment is high, suggesting that the EUR is vulnerable to a further drop.

While the extent of short market positioning at the beginning of week left open some scope for EUR short covering the absence of any good news will mean the impetus for short covering diminishes. Unless the Ecofin meeting delivers on expectations EUR/USD will likely re-test the 26 September low around 1.3363.

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Euro supported by hope

September 27, 2011 — Mitul Kotecha

Hope appears to be the overriding sentiment filtering through markets at present. Such hope includes expectations that the European authorities will be able to ring fence Greece and avoid much deeper and wider comtagion to other eurozone peripheral countries than has already taken place. This may involve a European version of the US Troubled Asset Relief Program (TARP). Various other measures are being speculated on including covered bond purchases from the ECB, provision of 12 month liquidity by the ECB, a policy rate cut, banking sector recapitalization and a beefing up of the EFSF bailout fund.

The result of such speculation has been to provide some stability to the EUR and asset markets but there is a long way to go before hopes turn into action. The next few weeks will be critical to determine whether a firmer base to sentiment and the EUR can be established and markets will turn their attention to a meeting of eurozone finance ministers on October 3 and the European Central Bank on October 6. Meanwhile national votes on changes to the EFSF bailout fund will continue this week including Germany’s vote on Thursday. While the vote is likely to pass it may draw attention to divisions within Chancellor Merkel’s party.

One thing is certain. There is no room for any more disappointment especially given that the plans agreed by European officials in July have yet to be implemented. If there is no concrete action over coming weeks the EUR will come under renewed pressure and indeed the risk is still heavily skewed towards more EUR weakness given the various disagreements between officials. Nonetheless, the improved mood in the short term will likely help prevent the currency from sliding further for now and a base appears to be forming just under 1.35 against the USD.

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Euro vulnerable to event risk

September 26, 2011 — Mitul Kotecha

The USD is benefitting in the current environment of elevated risk aversion reflected in a jump in USD speculative positioning over recent weeks, with current IMM positioning currently at its highest since June 2010.

Admittedly there is still plenty of scope for risk aversion to intensify but what does this mean for the USD? The USD index is currently trading just over 78 but during the height of the financial crisis it rose to around 89, a further gain from current levels of around of around 14%.

The main obstacle to further USD strength in the event of the current crisis intensifying is if the Fed implements QE3 but as the Fed has indicated this is unlikely to happen anytime soon, as “Operation Twist” gets underway.

Now that the Fed FOMC meeting is out of the way markets will also be less wary of buying USDs as the prospect of more QE has diminished for now. Data this week will likely be USD supportive too, with increases in consumer confidence, durable goods orders, an upward revision to Q2 GDP expected.

The EUR remains highly vulnerable to event risk this week. Various votes in eurozone countries to approve changes to the EFSF bailout fund will garner most attention in FX markets, with the German vote of particular interest although this should pass at the cost of opposition from within Chancellor Merkel’s own party.

The EUR may garner some support if there is some traction on reports of a three pronged approach to help solve the crisis which includes ‘leveraging’ the EFSF fund, large scale European bank recapitalisation and a managed default in Greece, but there has been no confirmation of such measures.

Meanwhile, the potential for negotiations between the Troika (EC, IMF, ECB) and the Greek government to deliver an agreement on the next loan tranche for the country has increased, which could also offer the EUR a boost this week, albeit a short lived one.

Speculation of a potential European Central Bank (ECB) rate cut has increased a factor that could undermine the EUR depending on whether markets see it as growth positive and thus EUR positive or as a factor that reduced the EUR’s yield attraction. There is also more speculation that the ECB will offer more liquidity in the form of a 1-year operation but once again there has been no confirmation.

A likely sharp drop in the German IFO survey today and weakness in business and economic confidence surveys on Thursday will support the case for a rate cut, while helping to maintain the downward pressure on the EUR.

Given the potential for rumours and events to result in sharp shifts in sentiment look for EUR/USD to remain volatile, with support seen around 1.3384 and resistance around 1.3605.

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