USD and JPY on the back foot

December 17, 2012 — Mitul Kotecha

Running into the end of the year it is clear that the USD is turning into the biggest loser. In part this reflects year end flows but also the dovish Fed stance and uncertainty about a resolution of the fiscal cliff. Indeed, with the Fed FOMC meeting out of the way the lack of progress on averting the fiscal cliff is quite disconcerting. Market confidence of an agreement appears to be slipping judging by the weakness in risk assets at the end of the week.

The USD is unlikely to make up much ground in the days ahead despite some likely positive data releases including yet more data showing housing market recovery, gradually improving manufacturing confidence gauges as well as a revision higher to Q3 GDP.

The EUR is on the verge of ending the year in strong form (too strong for Eurozone economies) as news of agreements on Greece’s loan tranche and banking supervision have given the currency even more support. Much of the rally in the EUR is likely to come from position adjustment into year end and could reverse quickly into new year, however.

Nonetheless, there is no doubt that receding tail risk due in large part due to continued support from expected eventual ECB asset purchases (OMT) activation will limit any downside in the EUR. In the near term the EUR may still take some direction from the German IFO survey on Wednesday but assuming that this survey continues its stabilisation, EUR/USD will likely maintain gains above technical support around 1.2880.

Japan faces a new reality following elections following Shinzo Abe’s Liberal Demoractic Part (LDP) victory in lower house elections. In particular, pressure for more aggressive policy will be sustained given the two thirds majority obtained. Nonetheless, it is not obvious that coalition parties will be as welcoming while some of the rhetoric from LDP leader Abe has already softened.

As the deterioration in the Tankan survey revealed the economic picture is clearly worryingly weak. Trade data over the coming week will be scrutinised to determine the lingering impact of frictions with China as well as the strength of the JPY. On this note, a further increase in asset purchases by the BoJ this week will mean that the JPY is unlikely to retrace its losses very quickly. Nonetheless, USD/JPY will face strong resistance around 84.60.

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USD underperforms

December 13, 2012 — Mitul Kotecha

The Fed expanded its asset purchases by buying $45 billion in longer dated Treasuries following the end of Operation Twist, with total purchases at USD 85 billion per month. The Fed went a step further by changing the guidance, now anticipating that policy will be maintained at an “exceptionally low range for the Fed Funds rate” as long as the unemployment rate remains above 6 ½ % and inflation no more than ½ % above the Fed 2% goal.

Equity market reaction was limited, with any positive boost dampened by the recognition that the Fed will not be able to offset the blow to the economy from the fiscal cliff. On this front, progress has been limited as the likelihood of a deal by the end of the year is diminishing by the day.

In Europe sentiment is somewhat better as hopes that the EU Council meeting today will yield an agreement on banking union and supervision. Final approval for the delayed Greek loan tranche is likely to be delivered following the completion of Greece’s debt buyback. The better news in Europe will be reflected in a decent reception to the Spanish and Italian bond offerings today.

The USD did not take too kindly to the latest efforts by the Fed to boost the economy although there are clearly diminishing returns as far as FX markets are concerned with regard to Fed QE. Nonetheless, the USD is coming under growing pressure into year end.

Next year assuming that the fiscal cliff in the US is resolved, with a limited fiscal drag on the economy, a relatively positive growth trajectory for the US alongside an expected increase in US bond yields will mean that the USD will still enjoy gains against currencies with weaker growth paths namely the EUR and JPY.

My forecasts for the USD index based on forecasts for its constituents show a gradual strengthening over the course of the next couple of years (82.4 and 85.7 by end-2013 and -2014, respectively) largely due to the USD’s expected appreciation versus EUR and JPY. In reality, this is misleading as improving risk appetite and continued capital inflows to EM and commodity currencies will mean that the USD will underperform.

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EUR sell on rallies, weaker CNY

December 11, 2012 — Mitul Kotecha

Ahead of several major events over coming days including the Fed FOMC meeting, EU Summit and Japanese elections the market will continue to appear directionless. Indeed, there was little influence overnight, as markets digested news of Italian Prime Minister Monti’s resignation, with the reality that this merely took place earlier than expected limited any damage. Discussions on the fiscal cliff were ongoing but with no sign of breakthrough as officials noted that the lines of communication remain open.

On the data front the German ZEW survey will be the main highlight for Eurozone markets today, with a likely small improvement set to provide marginal relief to the markets. A conference call by the Eurogroup to discuss Greece is also on tap as any news about the progress of Greece’s debt buyback and aid tranche is awaited. In the US a small narrowing in the October trade deficit is expected but small business optimism is likely to have deteriorated in November. The data and events today will leave markets largely unperturbed.

EUR managed to recoup some of its losses after dropping to a low around 1.2880 versus USD which is a strong support level. EUR/USD continues to look like a sell on rallies, with any break above 1.3000 likely to find strong selling interest. A slightly firmer ZEW survey and potentially positive comments about Greece may help limit any pressure, however. USD/JPY continues to look stretched to the topside as indicated by extreme short JPY market positioning although reports that the Bank of Japan are preparing further monetary stimulus at its meeting next week will limit any retracement.

Asian currencies remain supported although the weaker CNY over recent days will likely undermine closely correlated currencies including KRW and TWD. Nonetheless USD/KRW dropped below the psychologically important 1080 level, with the Bank of Korea smoothing rather than stemming any appreciation in KRW. Markets remain wary of more regulations on the KRW while the weaker CNY will also contribute to acting to resist further KRW appreciation in the near term. The IDR was the major underperformer in the region but comments by the central bank governor about guarding the currency will fuel caution about further selling.

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Bullish INR but other Asian currencies held back

December 7, 2012 — Mitul Kotecha

Although the European Central Bank (ECB) left policy rates unchanged the post meeting press conference effectively opened the door to a rate cut in Q1 next year following sharp downward revisions to growth projections and well below target inflation projected over the medium term. A major casualty of the shift in ECB tone was the EUR which dropped over one big figure from a high of around 1.3089. Technical support for EUR/USD is now seen around 1.2885.

The Baltic Dry Index has continued to decline over recent days sending an ominous signal for growth ahead. Meanwhile, once again politics cast a shadow over European markets as Italy’s government overcame a confidence motion, with ex Prime Minister Berlusconi’s PDL party threatening to withdraw support and bring down the government.

Trading is likely to remain thin today as markets await the US November jobs report. The report will undoubtedly be soft (consensus is for an 85k increase in November payrolls) but as much of the weakness in jobs growth will be due to Hurricane Sandy the market impact is likely to be muted leaving a likely constructive tone to risk appetite going into next week.

Asian currencies continue to take direction from the CNY, with the lack of upside traction in this currency leaving most Asian currencies within ranges despite the fact that equity flows to Asia have been very strong over recent days, with inflows of over $2 billion registered this week alone. The implication is that central banks in the region have become increasingly active in preventing Asian currency strength.

One currency that has a limited influence from the CNY is the INR and this currency continues to outperform on reform hopes. The passage through India’s lower house of parliament allowing foreign investment into retailers was encouraging and hopes have grown that it will be followed by passage in the upper house. Further gains in the INR are seen over coming sessions, with a short term break below USD/INR 54.00 looming.

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SEK weaker, Asian FX still following CNY

November 28, 2012 — Mitul Kotecha

Despite a series of better than expected data releases in the US including October durable goods orders, Case Shiller house prices and consumer confidence the lack of progress towards resolving the fiscal cliff is weighing on risk appetite. Comments by Senate Majority leader Reid of little progress in budget talks hit equity markets and will cast a shadow over risk appetite today.

News that the US did not label China a currency manipulator did little to help as such an outcome was expected in the US Treasury’s semi-annual currency report, especially given the recent appreciation of the CNY. Any positive boost from the Greek aid deal also proved short lived. The lack of major data releases or events today will likely most asset classes within recent ranges.

The EUR has failed to hold onto Greek debt deal inspired gains but looks well supported above 1.2900. The realisation that any aid to Greece will still be subject to several parliamentary approvals, ongoing reforms and a successful debt buy back may have dampened sentiment or more likely the deal was already priced in.

Looking ahead there is little on the economic front to provide any directional impetus for EUR/USD aside from M3 money supply data where a modest increase is expected in October. In contrast the run of better US economic data is set to continue, with October new home sales and the Beige Book likely to provide encouraging reading. The difficulty in reaching agreement on the fiscal cliff may perversely play negatively for the EUR as risk aversion pushes higher.

My quantitative models have continued to point to EUR/SEK upside. Economic data yesterday provided more negative news for the currency, with business and consumer confidence for November recording bigger than expected declines. Q3 GDP data tomorrow will confirm the slowing in the economy, while retail sales are set to record a decline.

However, while the SEK remains vulnerable it is already pricing in some bad news. I suspect that the 26 October high around EUR/SEK 8.7194 will be difficult to break through. I prefer to play SEK weakness versus NOK at current levels.

Asian currencies remain relatively well supported and continue to track movements in the CNY rather than the USD although slightly higher risk aversion will weigh limit the ability of Asian FX to strengthen. USD/KRW looks likely to continue to struggle to break below the 1080 level as markets remain wary of official action to weaken the currency. A likely unchanged rate decision from the Bank of Thailand ought to leave the THB to trade within its tight range.

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