Reality Check

September 24, 2012 — Mitul Kotecha

Markets face a reality check going into this week. The euphoria emanating from recent Fed, ECB and BoJ actions is fading quickly. The reality of weak growth and underlying structural tensions is coming back to haunt markets, suggesting much more limited upside for risk assets over coming weeks.

While there are some positive indications that the growth outlook may not have much further to deteriorate, such as the bounce in the Baltic Dry Index, scepticism about the ability of central banks to reflate economies is growing. In this respect, its worth highlighting that the rally in gold prices failed to extent much further last week although in part this may be due to an options expiry tomorrow.

Renewed tensions are creeping back into the market psyche, especially with regard to Europe. Procrastination from Spain about a formal bailout threatens to weigh on markets in the days ahead as some officials suggest that the EUR 100 billion received for Spanish banks will be sufficient for the country to avoid needing further aid. Bank stress test results, a Moody’s review on Spanish ratings and the country’s 2013 budget will all be scrutinised over coming days.

Meanwhile, disagreement between Germany and France over the timing of introducing banking union and supervision is accentuating tensions in the region. Greece remains in the limelight too, as the government continued to find further budget cuts in order to receive the next tranche of loans. The only good news appeared to come from a German press report that the ESM permanent bailout fund’s firepower will be leveraged up to EUR 2 trillion.

The EUR has lost momentum following its initial surge higher and looks constrained on any move above 1.3000. While EUR short positions have continued to be pared back according to IMM data the scope for short covering is becoming more limited. Developments in Spain and Greece will provide further guidance for the currency, but any upside in EUR/USD will be limited to resistance around 1.3180. It seems more likely that having failed to sustain gains, the EUR will continue to drift lower.

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So much in the price

September 10, 2012 — Mitul Kotecha

The weaker than expected US August non farm payrolls data at the end of last week punished the USD and reinforced expectations that the Federal Reserve will announce a fresh round of quantitative easing at this week’s FOMC policy meeting. The shift in expectations for QE has been rapid over recent weeks and the jobs data acted as the icing on the cake. In part USD weakness reflects both QE expectations and the positive reaction to the European Central Bank’s bond buying plan announced last week. In this respect a lot is already priced in to currency markets and EUR/USD will struggle to sustain a move above 1.28 in the short term.

From a risk / reward perspective there are potentially plenty of stumbling blocks this week aside from the FOMC meeting that could skew market direction towards risk rather than reward. These include the German constitutional court decision on the ESM permanent bailout fund and Dutch elections both of which take place on Wednesday. The German court decision is the last needed before the ESM comes into force. Legal experts expect the court to approve the ESM but with tough conditionality. Should the ESM not be approved it would leave any more bailout funds to come only from the cash left in the temporary and dwindling EFSF. Separately the Dutch elections look set to end in weeks if not months of coalition building. These events occur gainst the backdrop of talks between the Greek government and its creditors following failure to agree on spending cuts between Greece’s coalition partners.

Ahead of these events the European Commission will reveal details of plans towards a single banking supervision mechanism. The G20 meeting in Mexico and Ecofin meeting at the end of the week will also garner attention, with any discussion on a European banking union of interest. Meanwhile, following the ECB’s announcement last week the ball is in the court of Spain and Italy to formally request An EU bailout and in turn accept various conditions and targets necessary to receive a bailout. Only then will the ECB commence its ‘unlimited’ bond buying. No date or deadline has been set for such requests for a bailout but given the sharp drop in peripheral Eurozone bond yields over recent weeks in anticipation of ECB bond purchases there is certainly scope for disappointment, with market patience likely to run thin.

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Euro relief, but will it last?

September 8, 2012 — Mitul Kotecha

The European Central Bank (ECB) decision to embark on outright monetary transactions helped to provide a major lift to markets but did not spur the EUR onto major greater gains. The program of conditional albeit unlimited bond purchases was much anticipated and well received (except by the German Bundesbank) despite many of the details being leaked in advance. The lack of EUR reaction in part reflected this.

In fact, the EUR appeared to rally more in the wake of aggressive buying of EUR/CHF, which finally moved away from its 1.2000 floor, possibly with some official help. Markets will now await the decisions of Spain and Italy which would have to formally request aid for the bond buying plan to be put into action and perhaps there will be some hesitation on the part of the EUR to push higher.

Although there could be some nervousness ahead of the decision by the German constitutional court on the ESM permanent bailout fund and Dutch elections on 12 September the ECB’s move has provided a floor under risks assets over the short term. Given the EUR’s strong relationship with peripheral Eurozone bond yields, the implication is that the drop in the yields will provide some support for the EUR.

Before everyone becomes too excited it should be noted that there is still a long way to go before the Eurozone crisis will be resolved given the many structural and growth issues that need to be overcome. Nonetheless, the downside risks for the EUR are clearly diminishing, leaving the currency in better shape than it has been for a long while.

The fact that EUR/USD is back above its 100-day moving average is a positive signal. Moreover, despite some short covering the market is still very short EUR. However, we would be cautious about becoming overly bullish. Further gains in the EUR will be difficult to achieve given the constant drag on the currency due to relatively weaker growth and the simple fact that many of the underlying issues in the Eurozone remain unresolved.

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Bernanke eyed for QE clues

July 17, 2012 — Mitul Kotecha

Range trading is likely to dominate. However, the news flow remains negative, with disappointing retail sales data in the US combined with more the decision by the German constitutional court to delay its decision on the ESM bailout fund until September 12, highlighting the lack of potential for any rally in risk assets in the near term.

The International Monetary Fund (IMF) provided markets with a further dose of caution, with its warning that risks to global growth “loom large” as it cut its forecasts for global growth. Pressure on policy makers to provide more stimulus will grow, but the room for and efficacy of such stimulus is questionable.

The weaker than expected June US retail sales report released yesterday has resulted in fuelling expectations that Fed Chairman Bernanke will announce a shift towards more quantitative easing later today. Consequently the USD has come under pressure losing ground so far this week.

While the USD is set to be restrained ahead of Bernanke’s speech to the Senate we do not believe he will announce a change in stance. Therefore, any USD weakness is likely to prove temporary in the short term. The inability of risk appetite to improve further and the ongoing uncertainties in the Eurozone reinforce the view that the USD’s downside will be limited.

Today’s US releases are likely to reveal gains in June industrial production, and a likely strengthening in long term capital flows in May, factors that will help to provide the USD with further support.

Although the EUR has bounced this week data today will only serve to reinforce its overall downward trajectory. The July German ZEW survey is set to decline further. The range of forecasts for this volatile survey is wide between -10 to -30, with our forecast towards the lower end.

The plethora of negative news in terms of policy progress continues to dampen sentiment and hamper the EUR’s ability to recover. Whether its persistent downgrades of economic growth across Eurozone countries, stalling of reforms and austerity plans, or delays in implementing agreed upon measures, the news is unambiguously bad.

Dashed hopes of progress towards finding and implementing solutions have led to a renewed deterioration in speculative appetite for EUR. Although the potential for short covering remains high, the trigger for any short covering is decidedly absent. We maintain the view that EUR/USD will test 1.2000 over coming weeks.

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Plenty of event risk

July 3, 2012 — Mitul Kotecha

In the wake of the EU Summit at the end of last week sentiment has stabilised, with risk indicators such as the VIX ‘fear gauge’ reflecting a firmer tone to risk appetite. Although a few stumbling blocks have arisen such as the objections by both Finland and Holland to bond purchases by the ESM bailout fund they may not be sufficient to derail the project. The euphoria is likely to fade in the days ahead but the US Independence day holiday tomorrow may keep trading somewhat subdued.

There are plenty of events this week including central bank decisions by the RBA (Australia), Riksbank (Sweden), ECB (Eurozone) and BoE (UK), to provoke some excitement. A likely rate cut from the ECB and an extension of asset purchases by the BoE will give markets plenty to chew on. Finally, at the end of the week the US June jobs report will also be closely watched. We forecast a 100k increase in payrolls but will look for clues from tomorrow’s ADP jobs report.

The disappointing US June ISM manufacturing survey released yesterday highlighted that growth risks will remain a key weight on the market dampening any improvement in risk appetite over coming weeks. Moreover, weaker growth in Europe will make it more difficult to achieve budget targets, while adding to pressure to ease bailout terms. Undoubtedly the European summit was a step in the right direction but with plenty of details still needing to be thrashed out and growth concerns intensifying it would be highly optimistic to expect a fully fledged ‘risk on’ to ensue.

Notably the EUR has given back some of its gains after failing to break above 1.2700 against the USD. Further downside is likely but the EU Summit outcome has meant that the risk of a sharp drop lower has receded. Although there is likely to have been some short covering following the summit outcome EUR short positions remain significant, a factor that may also limit downside in the currency. EUR/USD will find some short term support around 1.2553 but will likely edge down to around 1.2500 over coming sessions.

Posted in Australia, eurozone, Sweden, US. Tags: , , , , . Leave a Comment »
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