Edging away from the cliff

November 20, 2012 — Mitul Kotecha

Risk appetite was decidedly firmer overnight as hopes of a US budget deal grew. Talks between President Obama and Congressional leaders have been labelled as ‘constructive’ implying some sign of compromise although there is a long way to go before a deal is likely. Sentiment was boosted further by encouraging housing news out the US, with home builders’ confidence and existing home sales beating expectations. Unfortunately housing starts data today will not be as upbeat.

News that France’s credit ratings were cut by Moody’s dampened the mood, ahead of a meeting by Eurozone officials to decide on the fate of Greece’s EUR 31.5 billion loan tranche. The French downgrade may cast a shadow over markets this morning but hopes of progress towards a solution to the fiscal cliff will keep markets buoyed.

Data releases in the Eurozone will do little to help the EUR given expectations of weak purchasing managers’ indices and a yet another drop in the German IFO business confidence survey over coming days. News on the Greek front might be a little better if the country’s loan tranche is approved today. However, any boost to EUR sentiment will be short lived as discussions about Greece’s sustainability and disagreements among its creditors hog the limelight.

My quantitative models suggest little directional bias, with EUR/USD close to its short term fair value. While all of this suggests that the EUR will fail to find much momentum its worth highlighting that EUR short speculative positioning is at its highest since 11 September and a great deal of bad news is already priced in.

While the Bank of Japan is set to deliver more easing over coming months today’s meeting will likely mark a pause in policy. I do not expect any surprises from the Bank of Japan today but the JPY remains on the back foot in the wake of calls for “unlimited easing” by the opposition LDP party. However, the outcome of elections is by no means clear cut and although the LDP will likely garner the lion’s share of the vote its policies may be constrained by coalition partners.

I remain cautious of calling the JPY higher from current levels, especially given that USD/JPY will be undermined somewhat by the drop in US bond yields. Moreover, my quantitative model shows a sell signal for USD/JPY. Technical resistance around 87.78 will likely cap any up move in the currency in the neat term.

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Sell into the USD/JPY rally, EUR bottoming out, GBP vulnerable

November 19, 2012 — Mitul Kotecha

Following a week when risk measures continued to worsen there may not be much respite over coming days. The usual suspects will continue to direct sentiment including US fiscal cliff discussions, Greece’s next loan tranche and debt sustainability, the timing of any possible Spanish bailout request, and the conflict between Israel and Hamas in the Gaza strip. Added to this list are worries about economic growth.

Data releases this week are expected to be soft in general, with US existing home sales set to slip in October, weak readings for Eurozone flash purchasing managers’ indices and an eight consecutive drop in the German IFO business climate survey in November. Trading conditions will likely thin over coming days as the US Thanksgiving holiday on Thursday approaches.

Events over coming days will at least give further clues on the monetary policy front, with Fed Chairman Bernanke scheduled to give a speech at the Economics Club of New York, an event which may shed some light on Fed policy once Operation Twist ends. In the UK Bank of England minutes will also be scrutinised for clues on more QE, with a likely split decision set to be revealed. GBP continues to suffer from a bad combination of weak activity and higher inflation, leaving the currency vulnerable to further selling, especially against EUR.

Additionally, the Bank of Japan will decide on policy although a pause is expected this week given that easing measures were only announced at the last meeting at the end of October. The general election on December 16 may also complicate BoJ policy. USD/JPY’s upside potential looks limited from current levels and a lack of action from the BoJ tomorrow will likely undermine the current pair further. USD/JPY will find strong resistance around 81.78.

In Europe policy decisions will focus on developments in Greece, with the next loan tranche for the country to be decided and discussions on the 2014-2015 EU budget set to take place. The loan Greek aid discussions tomorrow ought to lead to an agreement to distribute EUR 31.5 billion in aid to Greece. The decision may help the EUR to edge higher, although EUR/USD will need to break above its 200 day moving average around 1.2807 before it can register more concrete signs of recovery.

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Peering over the cliff

November 16, 2012 — Mitul Kotecha

As the US edges closer to falling off the fiscal cliff budget discussions between US President Obama and Congressional leaders commencing today will garner most attention. Conciliatory signs from both sides suggest some attempt at compromise but tough starting points mean that it will not be easy to match rhetoric with reality.

Markets are clearly in nervous mood, with US stocks closing lower as risk aversion edged higher. Disappointing earnings from Wal-Mart Stores taken together with a weaker than anticipated Philly Fed survey in November and weekly jobless claims added another layer of negativity to the market. Despite the US-centric fiscal cliff risks the USD remains firm although notably its pace of appreciation has slowed, with the currency likely to make little headway in the near term.

Although unsurprising, data in Europe confirmed that the region fell back into recession, an outcome that will do little to ease tensions. Hopes of a final agreement on Greece’s loan tranche at next week’s Eurogroup meeting may however, limit any damage to Eurozone markets. The EUR has shown signs of bottoming out and may take further advantage of the respite from a more restrained USD. There is little of interest on the data front today, with Eurozone current account data, US industrial production and TICS flows the main highlights.

On the political front the dissolution of parliament in Japan is the highlight, with markets continuing to push the JPY lower as expectations of more aggressive action after elections to the weaken the currency grow. The fourth consecutive downgrade of Japan’s economic assessment by the government highlights the urgency for such action.

Asian currencies are finding a little more resistance to further gains as the appreciation of the CNY has stalled over recent days. The most sensitive currencies to the CNY including KRW and TWD will likely face most resistance to further gains. In contrast those currencies that are more USD sensitive including INR and MYR could take advantage of any pause in USD index gains.

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USD clambering up the fiscal cliff

November 12, 2012 — Mitul Kotecha

Following US elections the reality of the task ahead to resolve the looming fiscal cliff has cast a long shadow of markets, leaving risk assets under pressure. Despite comments from the US administration and Congressional leaders of a willingness to compromise, markets remain unconvinced, especially given the unchanged underling stance of both Democrats and Republicans, the former towards taxing the wealthiest and the latter towards no tax hikes.

US data and events will not help risk appetite, with a drop in retail sales, moderate gains in manufacturing surveys and a small gain in October industrial production expected. The main highlight will be the FOMC minutes. Perversely the USD will continue to benefit even though much of the rise in risk aversion and subsequent safe haven demand is US orientated.

News that Greece passed its 2013 budget over the weekend will do little to assuage concerns over the country’s precarious financing position. It will also not guarantee that the Eurogroup meeting will approve Greece’s next loan tranche today given disagreements over the country’s debt sustainability, with a decision only likely by the end of the month.

Greece’s ability to handle a EUR 5 billion debt repayment this week via a treasury bill auction tomorrow will be the immediate focal point for markets given the difficulty for the country to obtain financing. At least economic data in the Eurozone will be slightly less negative, with upside risks to preliminary Q3 GDP and a likely third straight gain in the German ZEW investor confidence index expected in October. None of this will offer much respite for the EUR which looks set to slip further on its way towards its 100 day moving average around 1.2639.

In Japan the release of Q3 GDP data this morning which revealed the first negative reading in 3 quarters and broad based weakness in GDP components adds to the pressure on Japanese officials, in particular the Bank of Japan to intensify its stimulus efforts. The likelihood of another negative reading in Q4 and therefore a technical recession also highlights the need to weaken the JPY in such efforts. However, as we have been warning the move in USD/JPY above the 80 level proved short lived, with the currency pair undermined by a drop in US bond yields and to a lesser extent higher risk aversion. We see little chance of USD/JPY sustaining a break back above 80 in the current environment.

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Negative yields hit the euro

November 6, 2012 — Mitul Kotecha

Market participants will be distracted by today’s US Presidential election and Thursday’s transfer of leadership in China. The USD seems to be enjoying strength despite a slight lead in the polls by President Obama. The consensus view is that a Romney win would be USD positive given that it may imply a more restrictive Fed in the form of less QE but the USD appears to be ignoring such polls.

The EUR is the worst performing currency so far this month after the CHF. Greek and Spanish concerns are placing a growing weight on the EUR the former due to tomorrow’s vote on austerity measures and the latter due to worsening economic data and a lack of traction towards requesting a bailout and thus activating the European Central Bank’s bond purchase program.

A massive weight on the EUR is the fact that Germany 2 year bond yields have turned negative, leading a widening US yield advantage and in turn a weaker EUR/USD. Indeed, the correlation between 2 year US – German yield differentials is very high, implying that the EUR will struggle below its 200 day moving average around 1.2828 until German yields push higher.

A generally firmer USD has also dealt a blow GBP, with the currency slipping below 1.6000. Notably GBP is holding up well against the EUR. Industrial and manufacturing production data today will give some direction to the currency but the news is unlikely to be positive, with a further sharp decline expected in September.

Thereafter attention will swiftly turn to the Bank of England policy decision on Thursday, where the decision will be a close call but we look for an additional GBP 25 billion in asset purchases to be announced. GBP could face some pressure in this event but given that the currency not been particularly impacted from QE in the past, we doubt that it will suffer a severe blow. However, the BoE action may help to stem the decline in EUR/GBP, with support seen around 0.7956.

AUD has lost some steam this week as speculative longs have been cut back ahead of the RBA policy decision. The pull back has largely to do with a generally firmer USD, some deterioration in risk appetite and lower commodity prices than any shift in policy expectations, however.

The market is pricing in around a 50% probability of a rate cut today Given that this is not fully priced in, the AUD is vulnerable in the wake of a rate cut. However, much will depend on the accompanying statement. Given that recent domestic and Chinese data have been a bit more encouraging we doubt that the statement will be particularly dovish, suggesting that downside risks to AUD will be limited to technical support around 1.0305 versus USD.

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