USD weaker except versus JPY, EUR gains unsustainable

April 8, 2013 — Mitul Kotecha

Risk aversion is creeping higher whether due to weaker data and budget concerns in the US, political uncertainty in Europe or tensions in the Korean peninsular. Central banks continue however, to do their utmost to keep monetary conditions sufficiently easy to facilitate recovery.

The Bank of Japan was the latest to do its part under the helm of governor Kuroda, with new measures including a major increase in asset purchases, delivering a positive surprise to markets while pushing the JPY sharply weaker.

Only the ECB appears to lag in terms of central bank activism keeping policy on hold last week despite weak economic conditions are ongoing austerity pain. A series of industrial production releases across the Eurozone including German February IP scheduled for release today will not change the picture materially.

The much weaker than expected US March jobs report in which payrolls increased by only 88k, concern that economic activity is following a similar pattern to previous years ie strength in Q1 followed by weakness in Q2, has intensified. I do not believe this is the case but the jury is still out.

At the least the data will embolden Fed doves who will use the data as evidence that any tapering off in asset purchases should not occur quickly. A series of Fed speeches this week including one by Fed Chairman Bernanke tonight will be listened to very closely to determine whether the jobs report has provoked further caution from the Fed. Moreover, Fed FOMC minutes will be scrutinized to determine how the Fed will adjust the flow rate of asset purchases to the changing outlook.

The overall tone to FX markets is one of broad based USD weakness, with the notably exception of the JPY where the relatively aggressive BoJ stance has provoked a bigger reaction. The EUR has taken advantage of a softer USD but is unlikely to sustain gains around the EUR/USD 1.3000 level given the political problems across the Eurozone and relatively weaker economic conditions.

Indeed, news that Portugal’s constitutional court rejected austerity measures has put at risk the ability of the country to achieve its budget targets and regain access to international bond markets. Meanwhile Cyrpus’ bail in continues to leave a sour taste among depositors across the region while Italy continues to edge towards fresh elections.

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Cyprus deal reached but risk rally to fade

March 25, 2013 — Mitul Kotecha

A deal between Cyprus and the Troika has been reached “in principle”, an outcome that will be met with relief across markets, with the EUR and risk assets rallying. Most details have yet to emerge but it appears that only depositors above EUR 100k will be hit by a levy while the country’s second largest bank will be closed. However, the levy is likely to be fairly hefty.

The bailout deal will mean that the risks of Cyprus defaulting and leaving the Eurozone will have significantly diminished. Nonetheless, the deal will still involve a huge amount of work on Cyprus’ part to find the USD 5.8 billion needed to supplement the EUR 10 billion bailout and subsequently a lot of economic pain involved. The current risk rally is likely to fade quickly as markets begin to focus on the task at hand.

Elsewhere Italy begins the formal process of forming a government this week but the prospects of a quick resolution to the political impasse in the country looks very limited, with fresh elections still a very possible outcome. Reflecting the uncertainty both around Cyprus and Italy, economic sentiment gauges in Europe will likely decline in March.

Meanwhile in the US data releases will look more impressive, with Durable goods orders set to record an impressive gain in February and Q4 GDP likely to be revised sharply higher. Although consumer confidence and new home sales will slip, this will take place from healthy levels.

EUR/USD broke through 1.3000 following the Cyprus deal but will run into resistance around 1.3135 and we expect gains to fade in the short term as markets look past the headlines. Downside risks to EUR will remain in place due to relatively unfavourable data releases and ongoing political uncertainty in Italy.

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Cyprus vote awaited

March 19, 2013 — Mitul Kotecha

The big market mover overnight was the VIX ‘fear gauge’ spiking in the wake of increased risk aversion. Follow through looks limited, however. Markets look a bit calmer as the panic following the news of levy of bank deposits in Cyprus as part of a EUR 10 billion bailout for the country, eased. No sign of bank runs elsewhere in the Eurozone and the go ahead to make the deposit levy more progressive (ie a higher levy on bigger deposit holders) while maintaining the total amount at around EUR 5.8 billion, have helped to calm tensions.

Nonetheless, today’s delayed vote in Cyprus’ parliament to approve the levy could provoke more nervousness especially as the outcome is too close to call. Attention will therefore remain firmly fixed on developments in Cyprus, with economic data taking a back seat. The highlights on the data front include likely gains in the German March ZEW investor confidence survey and US February housing starts and building permits.

Currency movements look to be limited ahead of the Cyprus vote and then the Fed FOMC outcome tomorrow. The EUR remains the weakest link, with gains in the currency likely to be sold into although support around EUR/USD 1.2876 is likely to hold unless the Cyprus vote fails to endorse the deposit levy. If this is the case, expect further sharp pressure on the EUR and a much bigger drop in the currency and risk currencies in general. European and Cyprus officials would have to back to the table but in the meantime panic would ensue.

The RBA minutes released this morning maintained that the door remains open for further policy rate cuts although they did note that the economy is responding to previous cuts with the impact having further to run. There is little in the minutes to suggest further easing is imminent. The RBA minutes are unlikely to dent the AUD which remains resilient having managed to remain well supported even despite the Cyprus panic. AUD/USD is likely to consolidate around current levels just below 1.0400 before embarking on further gains over coming weeks.

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Cyprus hits EUR, GBP retracing lower, USD firm ahead of FOMC

March 18, 2013 — Mitul Kotecha

There are plenty of events and data to digest on both sides of the pond this week. In Europe, Cyprus’ bailout will be a key focus. The decision to ‘bail in’ in bank depositors aimed at raising EUR 5.8 billion by imposing a levy on deposits will be voted on today in Cyprus. While the EUR 10 billion bailout is small change compared to other Eurozone bailouts the deposit levy could have wide ranging repercussions on Eurozone bank deposits in other peripheral countries despite Cyprus’ case being labelled as “unique”.

Meanwhile, politics in Italy remains unpredictable, with discussions tomorrow between the President and political parties to try and form a government. There is little to suggest a deal is in the offing with the risk skewed towards protracted negotiations and fresh elections.

Data in the Eurozone is expected to a little more encouraging, with gains in Eurozone manufacturing confidence (albeit still in contraction territory), German ZEW investor confidence and IFO business confidence surveys likely. Also of note this week is the Bank of England MPC minutes and UK 2013 Budget and in particularly any change to the BoE’s mandate contained within the budget.

Markets likely to tread water ahead of Fed FOMC outcome. While no change to the USD 85 billion asset purchase program is likely the Fed may actually revise slightly lower their near term growth forecasts due mainly to fiscal policy developments despite recent encouraging data. It seems unlikely that the Fed will hint at any tapering off of QE but nonetheless, it will be difficult for the Fed to ignore recent positive data. On the data front, housing data in the form of housing starts and existing home sales will reinforce evidence of recovery in the housing market.

The EUR has already come under pressure as a result of Cyprus concerns and will struggle to reverse its losses. EUR/USD 1.2876 will offer some support in the near term and the fact that the speculative market has been short EUR over recent weeks may also limit some of the downside pressure. Nonetheless, any gains are likely to be sold into.

GBP/USD is also set to retrace lower, especially if the MPC minutes reveal a more dovish bias and/or any new mandate for the BoE is perceived to enable more policy easing. All of this leaves the USD in good form, with the USD index setting its sights on the psychologically important 83.00 level.

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USD buoyant

March 13, 2013 — Mitul Kotecha

After finally returning from a two week trip visiting clients across North America it appears that the USD continues to remain in buoyant mood. I have been highlighting the prospects for a stronger USD against major currencies for some time and this has been borne out by the strong USD performance since early February.

Despite a lackluster performance for US stocks overnight overall sentiment remains largely upbeat as reflected by the fact that my risk barometer has breached its lower threshold and has moved into risk loving territory. Similarly the VIX fear gauge is trading at multi year lows although it did move higher overnight.

The sharp drop in UK industrial production and a warning by the Bundesbank’s Weidmann that the Eurozone crisis was not over added a dose of caution to the market. On a more positive note the Baltic Dry Index is at its highest level so far this year, sending a positive signal for global growth expectations.

While there is still much wrangling in the US over budget proposals, and in Europe, Italian political uncertainty continues, markets remain focused on the positives of improving growth against the background of highly accommodative monetary policies. Nonetheless, the divergence between the US and Europe in terms of growth is set to continue. A likely bigger than forecast increase in US February retail sales in contrast to a bigger than forecast fall in Eurozone industrial production in January will attest to this.

EUR/USD has managed to garner a semblance of stability over recent days, with the currency pair finding it difficult to sustain any decline below the psychologically important 1.3000 level. The drop in EUR/USD over much of February has been more aggressive than implied by the performance of Eurozone peripheral bonds but this is no surprise given that this is not the biggest influence on the currency.

Instead the explanation for the EUR decline is found when viewing the move in US 2 year Treasury yields relative to 2 year bunds. The strong correlation with EUR/USD highlights this relationship, reflecting the impact of lower bund yields and higher Treasury yields. The EUR’s stability over recent days is therefore a function of a slight drop in the US yield advantage.

Given that the trend of firmer US data and weaker Eurozone data is set to continue, this stability is likely to be short lived. Our quantitative model suggests EUR/USD may rally in the short term but we suggest selling into it.

GBP/USD’s decline has continued unabated and there appear to be little to stand in the way of further weakness apart perhaps from the fact that a lot of bad news is priced in. Sentiment for GBP has clearly deteriorated as reflected in the CFTC IMM data revealing four straight weeks of negative positioning. The deviation with the 3 month average positioning has widened significantly, highlighting the pace of the move but also that the drop is beginning to look excessive.

Nonetheless, the bigger than expected drop in January industrial production data revealed yesterday has helped to compound the negativity towards the currency in the wake of deteriorating economic data and in turn heightened expectations of more BoE quantitative easing. Strong technical support around GBP/USD 1.4767 may hold in the short term but momentum indicators are showing no sign of a slowing in GBP selling pressure.

For GBP bulls (if there any left) there may be more value in looking to eventually re-enter long positions against EUR but we would not rush into this trade. .

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