High Hopes

October 11, 2011 — Mitul Kotecha

EUR/USD has rallied over recent days from a low around 1.3146 last week. Market hopes of a eurozone solution may fall flat but the pressure on officials has ratcheted higher, and the risks of failure are now too significant to jeopardize with half measures. Weekend promises of banking sector recapitalisation by Germany and France have helped but will not be enough should such promises prove empty. Markets will likely give the benefit of the doubt to eurozone officials ahead of the delayed October 23 EU Summit and the November 3 G20 meeting.

Consequently EUR will find some support over coming days and could extend gains as risk appetite improves; having broken above 1.3600 the next big resistance level for EUR/USD is 1.3800. The fact that EUR speculative positioning is very negative (biggest short position since June 2010 according to IMM data) highlights the potential for short covering.

Possible good news in Greece, with an announcement by the Troika (ECB, EU and IMF) on talks over the next tranche of the bailout will likely provide more EUR support. One stumbling block for the EUR could come from the Slovakian vote on EFSF bailout fund enhancement, which is by no means guaranteed to pass.

The JPY remains firm benefitting from higher risk aversion, registering one of the highest correlations with risk over recent months. However, the reason why the JPY is not even stronger is that bond yield differentials (especially 2-year) with the US have widened out in favour of the USD over recent days. If the recent improvement in risk appetite continues, combined with widening yield differentials it could push USD/JPY to finally move higher and sustain a break above 77.00.

GBP/USD has made an impressive bounce over recent days from a low around 1.5272 last week despite the Bank of England’s announcement of more quantitative easing last week and credit ratings downgrades of several UK banks. This resilience is impressive but it appears that GBP is caching onto the coat tails of a firmer EUR rather than benefitting from a domestically led improvement in sentiment. Nonetheless, there is scope for further gains in GBP given that speculative positioning in the currency moved close to its all time low early last week in anticipation of BoE QE.

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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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Edging Towards A European Deal For Greece

July 21, 2011 — Mitul Kotecha

The momentum towards some form of agreement at the Special EU Summit today is growing, with French and German leaders reaching a “joint position on Greece’s debt situation”. Details of this position are still unknown, however. EUR has found support as expectations of a positive outcome intensify.

However, given that positive news is increasingly being priced in, and the market is becoming increasingly long, upside EUR potential will be limited even in the wake of a comprehensive agreement. A break above EUR/USD resistance around 1.4282 would bring in sight the next key resistance level around 1.4375 but this where the rally in EUR/USD is set to be capped.

Prospects of a major US debt default or at the least a government shutdown appear to be receding as the US administration has indicated some willingness to opt for a short term increase in the US borrowing limit to give more time for a bigger deficit reduction deal to be passed by Congress. Meanwhile, there will be further news on the deficit reduction plans put forward by the “gang of six” US senators, with a press conference scheduled for later today.

Debt ceiling negotiations are likely to be the main focus of market attention, with the Philly Fed manufacturing survey and weekly jobless claims relegated to the background. A speech by Fed Chairman Bernanke is unlikely to deliver anything new today. The USD is likely to be on the back foot given expectations of a deal in Europe and improved risk appetite but we expect losses to be limited.

The JPY continues to defy my bearish expectations. Over recent days the US yield advantage over Japan in terms of 2Y bonds dropped to multi-year lows below 20bps. Given the high correlation between USD/JPY and yield differentials, this has corresponded with the fall below 80.00.

Expectations of JPY weakness versus USD is highly dependent on the US – Japan yield gap widening over coming months. For this to happen it will need concerns about the US economy and expectations of more Fed asset purchases to dissipate, something that may not happen quickly given the rash of disappointing US data releases lately.

GBP found itself on the front foot following the release of the Bank of England Monetary Policy Committee minutes, which were less dovish than anticipated. They also revealed that the BoE expects inflation to peak higher and sooner than previously expected. However, the fact that the overall tone was similar to the last set of minutes meant there was little follow through in terms of GBP.

Further direction will come from June retail sales data today and forecasts of a bounce in sales will likely help allay concerns about a downturn in consumer spending. Nonetheless, GBP is still likely to struggle to break through resistance around 1.6230 versus USD.

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Risk Aversion to remain elevated

July 18, 2011 — Mitul Kotecha

It remains a tumultuous time for markets, gripped by a cacophony of concerns ranging from the lack of resolution to the Eurozone debt crisis to the failure to reach agreement on raising the US debt ceiling and associated deficit reduction plans. Mingled among these is the growing evidence that economic growth is turning out weaker than expected. Meanwhile Europe’s crisis appears to be shifting from bad to worse, as reflected in a shift in attention towards the hitherto untouched Italy although Italian concerns have eased lately.

The release of the EU bank stress test results at the end of last week have not helped, with plenty of criticism about their severity and rigour following the failure of only 8 banks out of the 90 tested. Expectations centred on several more banks failing, with much more capital required than the EUR 2.5 billion shortfall revealed in the tests. Answering to this criticism officials note that there has already been a significant amount of capital raised over recent months by banks, but this will be insufficient to stem the growing disbelief over the results.

Attention is still very much focussed on Greece and reaching agreement on a second bailout for the country, with further discussions at the special EU summit on July 21. The contentious issue remains the extent of private sector participation in any debt restructuring. The decision to enhance the flexibility of the EFSF bailout fund to embark on debt buybacks has not helped. Consequently contagion risks to other countries in the Eurozone periphery are at a heightened state. Despite all of this the EUR has shown a degree of resilience, having failed to sustain its recent drop below 1.40 versus USD.

One explanation for the EUR’s ability to avoid a steeper decline is that the situation on the other side of the pond does not look much better. Hints of QE3 in the US and the impasse between Republicans and Democrats on budget deficit cutting measures tied to any increase in the debt ceiling are limiting the USD’s ability to benefit from Europe’s woes. Moreover, more weak data including a drop in the Empire manufacturing survey and a drop in the Michigan consumer sentiment index to a two-year low, have added to the worries about US recovery prospects.

Against this background risk aversion will remain elevated, supporting the likes of the CHF and JPY while the EUR and USD will continue to fight it out for the winner of the ugliest currency contest. Assuming that a deal will eventually be cobbled together to raise the US debt ceiling (albeit with less ambitious deficit cutting measures than initially hoped for) and that the Fed does not embark on QE3, the EUR will emerge as the most ugly currency, but there will be plenty of volatility in the meantime.

Data and events this week include more US Q2 earnings, June housing starts and existing home sales. While housing data are set to increase, the overall shape of the housing market remains very weak. In Europe, July business and investor surveys will be in focus, with a sharp fall in the German ZEW investor confidence survey likely and a further softening in July purchasing managers indices across the eurozone. The German IFO business confidence survey is also likely to decline in July but will still point to healthy growth in the country. In the UK Bank of England MPC minutes will confirm no bias for policy rate changes with a 7-2 vote likely, while June retail sales are likely to bounce back.

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Greek Decision Delayed

June 20, 2011 — Mitul Kotecha

European Union Finance Ministers have agreed that additional funding for Greece will come from both official and private investors, with the later likely through a voluntary rollover of existing Greek debt as per the ‘Vienna Initiative’ of 2009 applied at the time to Emerging Europe. Agreement was reached following the decision by Germany to ease its demands for private sector participation in a debt restructuring. The news brought some relief to markets on Friday.

However, the announcement today that a final decision on a further tranche of aid and a second bailout package will not take place until early July will come as a blow to markets and likely lead to a more cautious start to this week. The onus is now on Greek Prime Minister Papandreou to gain approval for further austerity measures following the recent government cabinet reshuffle and in the face of a no confidence vote tomorrow. Failure to pass the confidence motion could provoke a political crisis, leading to likely contagion across Europe.

Europe has given the Greek government until the end of this month to implement measures including budget cuts and asset sales, with failure to pass further austerity measures likely to lead to a delay of any further aid. There will be plenty of noise surrounding Greece over coming days, with the issue likely to dominate the EU summit in Brussels on June 23-24. In the meantime the EUR/USD looks like it will settle into a range over the short-term, with support around the 100 day moving average of 1.4165.

EUR speculative positioning is currently around its 3-month average, with the market continuing to hold a sizeable long position in EUR/USD according to the CFTC IMM data. The risks remain skewed to the downside as nervousness about a Greek deal grows. Should the Greek Prime Minister pass a no confidence motion there will be some short term relief but tensions are likely to persist for a long while yet. Moreover, other eurozone countries are not in the clear yet as reflected by Moody’s announcement that Italy’s AA2 government bond rating is on review for possible downgrade.

Posted in Currencies, ECB, Economics, Economy, Europe, eurozone, Financial crisis, Fiscal/Budget, FX, Germany, Greece. Tags: , , , , , , , , , , , , , , , . Leave a Comment »
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