Euro support unwinding

December 16, 2010 — Mitul Kotecha

The USD is set to end the year in firm form aided by rising US bond yields. Yesterday’s data supported this trend. The Empire manufacturing survey beat expectations rebounding nearly 22 points in December and industrial production rose 0.4% in November although there was a downward revision to the previous month. This was against the background of soft inflation, with headline and core CPI rising 0.1%, indicating that the Fed will remain committed to its $600 billion program of asset purchases.

EUR/USD dropped below support around 1.3280, weighed down by various pieces of negative news. Moodys downgrade of Spain’s credit ratings outlook dented sentiment but the bigger sell off in EUR followed the move in US bond yields. The prospect of EUR recovery over the short term looks limited. The issue of finding agreement on a permanent debt resolution fund continues to fuel uncertainty and will likely come to a head at the EU summit starting today.

Added to this Ireland’s main opposition party which will likely play a part in forming a new government early next year wants some of the debt burden shared with senior bank debt holders. The good news in Europe was few and far between but at least Ireland’s parliament backed the EU/IMF bailout for the country. Of course the backing could be derailed following elections in January. Perhaps the most surprising aspect of the move in EUR is that it’s not weaker. The next support level for EUR/USD is around 1.3160.

The divergence between the US and Europe on policy is stark, with loose fiscal and monetary policy in the US providing a significant prop to the US economy, whilst the much tighter fiscal stance and less loose monetary policy threatens to result in more pressure on eurozone growth especially against the background of an overvalued EUR. This divergence will manifest itself next year in the form of US growth outperformance and stronger USD vs. EUR.

The resilience of the UK consumer continues to surprise, with the CBI distributive trades survey coming in strong and rising further to +56 in December. The only problem with the survey data is that is has not tracked official data. November retail sales data today will give further clues to the strength of spending heading into Christmas. More worryingly from the Bank of England’s perspective is the fact that inflation continues to rise despite assurances that the increase in inflation is temporary. At the least the likelihood of more quantitative easing QE from the BoE has evaporated though it is still a long way off before interest rates are hiked. In the meantime GBP continues to underperform both EUR and USD though GBP/USD will find strong support around 1.5512.

Upward pressure on US yields and the USD us unlikely be derailed US data releases today. Housing starts are set to bounce back in November, with a 6% gain expected, whilst the trend in jobless claims will likely continue to move lower. The Philly Fed manufacturing survey is set to lose a little momentum reversing some of November’s sharp gain but will still remain at a healthy level.

Posted in Bond markets, central banks, Currencies, ECB, Economics, Economy, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Interest rates, Ireland, Monetary Policy, Spain, UK, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

US Dollar Back On Top As Yields Rise

March 26, 2010 — Mitul Kotecha

Two issues are driving markets and both are playing negatively for sentiment; the rise in G7 bond yields and the outcome of the EU summit. At a time when G7 bond yields have been pushing higher the poor response to the US $32 billion 7-year note sale contributed to a further increase in yield. The sale resulted in a yield of 3.374%, which was higher than expected, and a bid/cover ratio of 2.61. A combination of large US Treasury supply, medium term funding issues and signs of improving growth suggest no let up for US Treasuries.

The most reactive currency to yield differentials is currently USD/JPY. The 1-month correlation between USD/JPY and US/Japan bond yield differentials is a high 0.85. The spike in US 10-year Treasury yields especially relative to JGB yields (by around 21 basis points this week) is the main contributor to the jump in USD/JPY over recent days. Given the bearish outlook for US bonds in the near term, it suggests more upside for USD/JPY but also increasingly for other currencies against the USD as the importance of yield increases. Immediate USD/JPY technical resistance is seen around 93.21, with support at 91.87.

The other event of note yesterday was developments surrounding Greece in the European Union summit though in truth it was probably the strong comments by ECB President Trichet that had the bigger impact on EUR sentiment. The final EU communiqué noted the readiness for bilateral loans to Greece and substantial International Monetary Fund (IMF) financing in a Greek aid mechanism. Importantly and a likely sop to Germany, any aid will not contain a subsidy for Greece. Aid by the EU and IMF will only be provided in the event of “very serious difficulties”.

The EU agreement means that no money will be forthcoming immediately, but at least there will be a back stop should Greece have financing difficulties over coming weeks, which will act as an important safety net ahead of substantial Greek debt rollovers. This news was supplemented by the fact that ECB will not raise its minimum collateral requirements at the end of the year, which means that Greek debt will not be excluded in the event of a ratings downgrade. This is good news for Greece.

The combination of the fact that Greece will have to borrow money only at market rates, ongoing worries about other EU countries fiscal problems and European Central Bank (ECB) President Trichet putting somewhat of a dampener on sentiment by criticizing IMF involvement in the deal, will keep the EUR under pressure. Although Trichet later reversed his comments, the damage was already done and any relief to EUR/USD will be short-lived. The currency pair is increasingly poised for a further downside move, with the next target at 1.3213 on the path towards an eventual test of 1.3000.

Posted in Bond markets, central banks, Currencies, Economics, Economy, Europe, Financial crisis, Fiscal/Budget, FX, Greece, Interest rates, Japan, US. Tags: , , , , , , , , , , , , , , , . Leave a Comment »

Greek Confusion, India Tightening

March 22, 2010 — Mitul Kotecha

It is highly interesting that markets could take fright from a rate hike in India but this appears to be what has happened. India’s surprise 25bps rate hike has provoked another bout of risk aversion whilst the lack of any concrete agreement on a framework for a Greek bail out dealt a further blow to confidence. FX tensions between the US and China have not helped, with China threatening retaliation to any US move to name the country as a currency manipulator in the mid April US Treasury report.

Should we really be worried by a rate hike in India or China? Whilst the India rate move reflects the fact that emerging market central banks are moving far more aggressively to raise rates than their G7 counterparts, global fears that India’s move will dampen recovery prospects are unfounded. Monetary tightening in India and China and other economies is taking place against the backdrop of economic strength not weakness.

As such the global impact on growth should be limited. Rising inflation pressure in Asia is reflection of the much quicker economic recovery, relatively low rates and undervalued currencies in the region. Not only will central banks in Asia have to raise interest rates but will also have to allow further currency appreciation.

There is still plenty of confusion about a bail out for Greece ahead of the 25-26th March EU summit. German Chancellor Merkel dampened expectations of a bailout by stating that it was not even on the agenda for the summit. In contrast, EU President Barroso has pushed EU members to agree on an explicit stand-by aid agreement for Greece as soon as possible.

There is also disagreement about whether there should be any IMF involvement, with Germany favouring some help from the Fund whilst France opposes it. Meanwhile, the Greek Prime Minister has reportedly given an ultimatum that should no aid plan be forthcoming at the EU summit, Greece will turn to the IMF for assistance.

All of this suggests more downside for EUR/USD, with a test of support around 1.3422 looming. In the event that the EU summit offers good news for Greece, EUR/USD sentiment could turn quickly so a degree of caution is warranted. Speculative sentiment for the EUR has improved according to the latest CFTC Commitment of Traders (IMM) data for the week to 16th March, with net short EUR positions at their lowest since the beginning of February. Nonetheless, the short covering seen over the past week could come to an abrupt end should there be no aid package for Greece.

The most volatile currency over the past week was GBP/USD and after hitting a high of around 1.5382 it has slid all the way back to around the 1.5000 level. Much of this was related to the gyrations in EUR/USD but GBP took on a life of its own towards the end of the week and has not been helped by comments by BoE MPC member Sentence who highlighted the risk of a “double-dip” recession in the UK.

GBP is highly undervalued and market positioning is close to a record low but a sustainable recovery looks unachievable at present. Attention this week will centre on the 2010 UK Budget announcement and markets will scrutinise the details of how the government plans to cut the burgeoning budget deficit. Failure to restore some credibility to the government’s plans will dent GBP sentiment further and lead to a sharper decline against both the EUR and USD.

Posted in Asia, central banks, China, Currencies, Economics, Economy, emerging markets, Europe, Financial crisis, Fiscal/Budget, FX, Germany, Greece, India, Interest rates, Monetary Policy, UK. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »
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