Markets taking their cue from China data and Bernanke

July 15, 2013 — Mitul Kotecha

After having been on the road visiting clients across Asia over the last two weeks the overall tone to markets feels slightly better than when I left. Risk appetite is improving as central banks attempt to dampen the spike in yields, by initiating “forward guidance”. On balance, markets appear to be making the volatile transition to Fed tapering with less angst than a couple of weeks back.

Despite the confusion over China’s GDP growth target the tone at the start of the week is positive. China’s Q2 GDP slowed compared to Q1 coming in at 7.5% YoY from 7.7% previously but arguably last week’s comments by China’s Finance Minister that China was targeting growth of 7% (later revised in to 7.5%) had arguably done a good job in guiding market expectations lower. In the event the market reaction to the Q2 GDP release was limited.

Aside from China’s data, markets have taken their cue from Fed Chairman Bernanke’s dovish comments last week when he noted that policy will remain “highly accommodative” for the “foreseeable future”. Discomfort at the sharp rise in US Treasury yields will have played a part in spurring such comments, with the net impact being one of improved risk appetite.

Further clarification from Bernanke will be sought during his semi-annual monetary policy report to Congress mid week although he is unlikely to diverge from his recent comments. Nonetheless, US yields and the USD will likely creep higher over coming days helped by firmer data including the June retail sales report today.

Eurozone markets will have little on the data front to digest aside from the German July ZEW survey this week, leaving the fragile state of Portuguese politics in the spotlight. Potential for fresh elections remains a distinct possibility although discussions over forming a new government will continue this week. Overall, this would suggest some underperformance of Eurozone markets and the EUR over the coming days.

In the UK the release of CPI inflation data in June and Bank of England MPC minutes will garner most attention. Inflation is likely to have pushed through the 3% threshold, requiring new governor Carney to write a letter to the UK Chancellor Osborne explaining the reasons for the rise in inflation pressures. Meanwhile the MPC minutes will take a slightly more hawkish stance, with a 7-2 vote expected as Carney will most likely have sided with the majority unlike his predecessor. Against this background GBP is set to gain some ground, especially against the EUR.

Asian currencies made up some ground following the Bernanke inspired drop in the USD last week but given that the region continues to suffer from equity portfolio outflows gains will be difficult to hold over coming days. Nonetheless, the good news is that the haemorrhaging in capital flows to the region has diminished, with only USD 73.6 million in equity outflows from Asia registered month to date.

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US dollar buoyed by higher yields, Asian currencies hit

July 8, 2013 — Mitul Kotecha

Efforts by the European Central Bank and Bank of England to disassociate themselves from Fed policy actions were overwhelmed by the US June jobs report which revealed a bigger than consensus 195k increase in payrolls and upward revisions to previous months. The data reinforced expectations that the Federal Reserve would begin tapering in September while the data also pushed US yields sharply higher (close to 23 basis points increase in US 10 year yields following the data) and fuelling further USD strength.

In fairness attempts by the ECB and BoE to introduce ‘forward guidance” may eventually garner some success but US yields will continue to dictate market direction, at least until the markets successfully transition to the reality of Fed tapering, which could take several weeks. During the interim expect transitional volatility to continue, with risk assets globally remaining under pressure.

Further detail on Fed policy will be looked for from within the minutes of the June FOMC meeting to be released on Wednesday although it is unlikely that there will be any real divergence from the message delivered by Fed Chairman Bernanke and a host of other Fed officials over recent weeks. Consequently the USD is likely to retain a broadly firm tone as it reacts to the sharp move higher in US yields at the end of last week.

The Bank of Japan will likely be emboldened in its ultra easy monetary policy stance following last week’s ECB and BoE announcements although no further policy action is likely at this week’s meeting as attention shifts to Japan’s Upper House elections on 21 July. The JPY in particular will remain susceptible to USD strength and widening yield differentials, with potential to test USD/JPY resistance around 102.45 this week.

European attention will centre on Greece and Portugal as the former will be the focus of discussions at the Eurogroup / Ecofin meetings today and tomorrow, with officials set to deliberate Greece’s bailout. Attempts in Portugal to resolve political differences between the main coalition parties appears to have garnered some success in a deal which could stave off fresh elections. None of this will help the EUR which is set to remain under pressure as it edges towards support levels at 1.2744 versus USD.

USD strength will also continue to be exhibited versus Asian currencies this week. Equity fund outflows continue to damage regional currencies lower. Since the end of May Asia has recorded around USD 15.4 billion in equity outflows. Total inflows this year have dropped to only around USD 3.6 billion. A renewed fall in the JPY will added pressure to more JPY sensitive currencies such as TWD and KRW but the overwhelming influence is higher US yields and capital outflows which will continue to have particularly negative impact on currencies with external funding needs, especially the INR and IDR.

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“Feral hogs” beware

June 25, 2013 — Mitul Kotecha

Bond and equity selling has been sustained as worries both about Federal Reserve tapering and liquidity in China’s banking sector continues to roil markets. Fed comments overnight did little to soothe market angst, with the Fed’s Fisher and Kocherlakota both revealing little concern about the market reaction to prospects of Fed tapering. However, both Fed officials were keen to point out that policy will remain accommodative even after the end of quantitative easing which helped to allay some of the pain on markets in overnight trading.

Reinforcing market volatility is the approach of month and quarter end. Several other Fed speakers will be on tap over coming days while 2, 5 and 7 year Treasury auctions will also be under scrutiny but ahead of the speeches and auctions markets will look to today’s US data releases including May durable goods orders, June consumer confidence and May new home sales for further direction.

EUR/USD failed to get much of lift from the rise in the German IFO business confidence survey in June and looks set to extend declines over coming sessions. Despite its drop from its high around 1.3420 EUR/USD has not been particularly sensitive to higher US yields over recent weeks but this may be changing. As revealed in the latest CFTC IMM report net speculative positioning in EUR/USD became positive for the first time in four months.

Now that the room for EUR short covering has disappeared EUR’s sensitivity to yield is likely to grow. The fact that the 10 year US Treasury yield differential with bunds has widened sharply will be difficult for EUR/USD to ignore, with attendant negative consequences for the currency. The lack of key Eurozone data releases over coming days will leave the EUR/USD increasingly at the mercy of US yield movements.

Another currency having to deal with a relatively thin data slate is GBP. Only the government’s Spending Review, Bank of England Financial Stability Report and second estimate of Q1 GDP are scheduled for release this week but none of these are likely to prove to be market movers. Having been hit by a firmer USD, GBP/USD has fallen well off its recent highs around 1.5752. On the crosses GBP looks a little healthier but is notably failing to make any headway against the EUR.

While the USD has rallied on higher US yields markets are not looking for a similar policy moves in the UK, especially given that some BoE MPC members are still inclined to increase asset purchases. Indeed, the recent rise in UK gilt yields may embolden the doves on the MPC. Although net speculative short GBP positions have not fully evaporated, the room for GBP upside is now very limited, with a firm USD in general set to continue to push GBP lower.

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US dollar running rampant

June 24, 2013 — Mitul Kotecha

A calmer tone looks like it will settle over markets today after recent sharp volatility. However, little relief to the pain inflicted on markets from tapering fears is likely this week. Weaker growth and funding concerns in China added another layer of uncertainty to the market psyche although comments from China’s central bank the PBoC about “fine tuning” may help to allay fears of a wider credit crunch.

Meanwhile across the pond Fed officials are probably quite frustrated by the market reaction to last week’s FOMC statement. There will be plenty of Fed speakers on tap this week to provide clarification, with markets looking for some soothing comments. Given the varying and diverse views among Fed officials such hopes may be dashed.

Data releases both in the US and Europe will be encouraging in terms of recovery expectations but will do little to ease the angst over tapering. In the US durable goods orders and new homes sales will record gains in May while June consumer sentiment indices will remain at relatively high levels.

In Europe, aside from the European council meeting this week the German IFO business confidence survey today and economic sentiment gauges later in the week are set to rise in June. In Japan the main CPI inflation gauge will stabilize in May although reaching the 2% inflation targets remains as difficult as ever while industrial production is set to decline in May due to still fragile foreign demand.

Most asset markets will continue to track bonds, with equities, and commodities remaining under pressure and the USD supported by higher US yields. Notably 10 year Treasury yields spiked to over 2.5%, a sharp increase over the week. Consequently the USD’s firm tone was expressed across a broad swathe of currencies, with Scandinavian, Latam and commodity currencies among the worst performers.

Emerging market and commodity currencies are set to suffer from continued capital outflows while the USD runs rampant. However, many currencies look oversold and over the near term some stabilisation is likely as they benefit from a slightly better risk tone at the turn of the week. As indicated by the latest CTFC IMM data, the USD long positioning has been cut back, suggesting scope for further gains. EUR positioning has turned net long for the first time in four months implying no further room for short covering.

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Bernanke awaited, RBI stays on hold

June 17, 2013 — Mitul Kotecha

Central banks are very much in the spotlight. Whether it’s poor communication or disappointment over the lack of fresh stimulus measures in Japan or opposition to the European Central Banks’ (ECB) OMT policy being debated in the German constitutional court there is much to focus on. Against the background of heightened volatility and elevated risk aversion the Fed FOMC meeting on Wednesday will garner even more attention than usual.

Although no change in policy settings is expected the ability of Fed Chairman Bernanke to communicate effectively the Fed’s strategy over ‘tapering’ will be crucial to determine whether market volatility persists or lessens. Ultimately markets are likely to successfully transition to a world of reduced Fed asset purchases but this may take a while. In the meantime market stress is set to remain elevated.

Aside from the Fed FOMC meeting US data releases are likely to continue to show encouraging signs of housing market recovery, with US May housing starts and April existing home set to reveal gains. Meanwhile, CPI inflation will remain benign in May while the June Empire manufacturing survey today will reveal a slight improvement.

In Europe, there will be attention on a Eurogroup meeting on Wednesday where banking union will be discussed while data releases include the June German ZEW investor confidence survey (slight drop likely) and the flash estimates of June purchasing managers’ indices. These are likely to look less negative although they are set to remain in contraction territory. In Japan, May trade data will likely show a widening in deficit as weaker external demand outweighs the impact of a weaker JPY.

In FX markets USD selling against major currencies is likely to slow. The 4.4% drop in the USD index from its highs in late May has been rapid but it has led to a major shift in positioning. Speculative USD long positions have been cut back significantly, while EUR positioning is almost back to flat after being extremely short in previous weeks. Similarly JPY short positions are beginning to be pared back. I suspect that the EUR in particular will struggle to make much more headway.

Weakness of the USD against major currencies has contrasted sharply with USD strength against emerging market currencies. The sell off in Asian currencies has been particularly sharp although there was some tentative recovery towards the end of last week. The INR followed by the most risk sensitive currencies including PHP and THB have suffered the most over recent weeks.

The INR’s vulnerability has been particular high due to its external funding requirements although it may show some tentative signs of recovery over coming days as its sell off has looked overdone. The Reserve Bank of India policy meeting today offered no help for the INR. Although it was a close call there was a significant minority looking for a rate cut to boost growth. The lack of action will weigh on the INR in the short term.

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