Key events for FX markets this week

September 21, 2009 — Mitul Kotecha

Key events this week include the Fed FOMC and G20 meetings .  The G20 meeting is likely to be a non-event as far as markets are concerned.  There will be plenty of discussion about co-ordinating exit strategies but officials are set to repeat the commitment to maintain stimulus policies until recovery proves sustainable.  

There is likely to be little emphasis on currencies despite the fact that the dollar is trading around its lowest level in a year, except perhaps at the fringes of the meeting, with focus in particular on Japan’s new government’s pro yen policy.  

Regulation will also figure high amongst the topics debated but this will have little impact on markets over the short term.  Another topic that could be debated is protectionism, especially in light of the US decision to impose tariffs on Chinese tyres.

Ahead of the G20 meeting the Fed FOMC meeting is unlikely to result in any change in interest rates but the statement is likely to be cautiously upbeat in line with Fed Chairman Bernanke’s recent comments that the recession is “very likely over”.  The statement will be scrutinised for clues to the timing of policy reversal, especially given recent speculation that a couple of FOMC members were advocating an early exit.  Given that the dollar has suffered due to its funding currency appeal, any hint that some Fed officials are turning more hawkish could give the currency some much needed relief but we doubt this will last long. 

In contrast to speculation of a hawkish shift in thinking by some Fed members the Bank of England appears to be moving in the opposite direction.  The MPC minutes on Wednesday will be viewed to determine just how close the BoE was to extending quantitative easing and reducing interest rates on bank reserves at its last meeting. 

Sterling (GBP) has been a clear underperformer over recent weeks and a dovish tint to the minutes will act as another factor weighing on the currency as speculation over further action intensifies ahead of the next meeting.  

Sterling is also struggling against the euro having hit a five month low.  A combination of factors have hit the currency including concerns about quantitative easing expansion, the health of the banking system, and the latest blow coming from a the Bank of England in its Quarterly Bulletin where it states that GBP’s long run sustainable exchange rate may have fallen due to the financial crisis.   

Against this background it is not surprising that sterling was the only major currency against in which speculative positioning actually deteriorated versus the dollar last week (according to the latest CFTC Commitment of Traders report).   It is difficult to see any sterling recovery over the short term against this background, with a re-test of the 9 July low just under GBP/USD 1.60 in focus.

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Risk trades under pressure

July 11, 2009 — Mitul Kotecha

Having given presentations in Hong Kong, China and South Korea in the past week and preparing to do the same in Taiwan and Singapore this week it is clear that there is a lot of uncertainty and caution in the air.  

There can be no doubt now that risk aversion has forcibly made its way back into the markets psyche.  Government bonds, the US dollar and the Japanese yen have gained more ground against the background of higher risk aversion. 

Following a tough week in which global equity markets slumped, oil fell below $60 per barrel and risk currencies including many emerging market currencies weakened, the immediate outlook does not look particularly promising.

Data releases are not giving much for markets to be inspired about despite upgrades to economic growth forecasts by the IMF even if their outlook remains cautious.  US trade data revealed a bigger than expected narrowing in the deficit in May whilst US consumer confidence fell more than expected in July as rising unemployment took its toll on sentiment.   There was also some disappointment towards the end of the week as the Bank of England did not announce an increase in its asset purchase facility despite much speculation that it would do so.

Rising risk aversion is manifesting itself in the usual manner in currency markets.  The Japanese yen is grinding higher and having failed to weaken when risk appetite was improving it is exhibiting an asymmetric reaction to risk by strengthening when risk appetite is declining.  Its positive reaction to higher risk aversion should come as no surprise as it has been the most sensitive and positively correlated currency with risk aversion since the crisis began. 

Nonetheless, the Japanese authorities will likely step up their rhetoric attempting to direct the yen lower before it inflicts too much damage on recovery prospects.   The urgency to do so was made clear from another drop in domestic machinery orders last week as well as the poor performance of Japanese equities.  

The US dollar is also benefitting from higher risk aversion and is likely to continue to grind higher in the current environment.  Risk currencies such as the Canadian, Australian and New Zealand dollars, will be most vulnerable to a further sell off but will probably lose most ground against the yen over the coming days.   These currencies are facing a double whammy of pressure from both higher risk aversion and a sharp drop in commodity prices.    Sterling and the euro look less vulnerable but will remain under pressure too.   

There are some data releases that could provide direction this week in the US such as retail sales, housing starts, Empire and Philly Fed manufacturing surveys.  In addition there is an interest rate decision in Japan, and inflation data in various countries. The main direction for currencies will come from equity markets and Q2 earnings reports, however.  

So far the rise in risk aversion has not prompted big breaks out of recent ranges in FX markets.  However, unless earnings reports and perhaps more importantly guidance for the months ahead are very upbeat, there is likely to be more downside for risk currencies against the dollar but in particular against yen crosses where most of the FX action is set to take place.

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Dollar, Euro and Sterling Volatility Within Ranges

June 25, 2009 — Mitul Kotecha

Two steps forward, one step back appears to describe the movement of the US dollar over recent weeks.  Although the dollar is still off its lows registered at the beginning of June it has failed to make much of a recovery.  After a solid start to the week the dollar came under renewed pressure ahead of the FOMC decision but managed to register small gains following the lack of action from the Fed on Wednesday. Overall, the Fed showed slightly less concern about disinflation and became slightly less negative on the economic outlook but there was not much in the Fed statement to impact the dollar strongly.

Some comments by ECB officials noting that European interest rates are unlikely to be cut further and that further expansion of stimulus measures are not needed, likely explained some of the recent bounce in the euro versus dollar, but the massive ECB allocation of EUR 442 billion in its 1-year tender on Wednesday helped to push the euro lower once again.  The demand for funds from banks was extremely strong and the ECB responded by providing a huge amount of emergency credit.  The allocation drove down overnight and long term rates as well as weakening the euro. 

I still believe any gain in the euro will be limited especially as the Eurozone data flow continues to suggest that any recovery will be tepid.  Eurozone June PMIs this week revealed a small rise in the manufacturing index but a surprise fall in the services index. There was also some improvement in the French INSEE business confidence indicator but at most the data pointed to a slower pace of contraction and continue to lag the improvement in similar surveys in the US and UK.   EUR/USD appears to be trapped in a 1.38-1.43 range with little momentum to break either side of this. 

FX markets are set to remain volatile but within ranges.  The failure of the dollar to extend gains amidst thin data flow highlights the lack of direction in markets.  I am still biased towards some dollar upside over coming days but once again currencies will take their cue from equity markets.  The dollar may find some support if US equities continue to struggle; the S&P 500 is finding it difficult to sustain gains above its 200 day (897.2) and 50 day (900.54) moving averages, suggesting some scope for a downside move in US stocks an in turn a firmer dollar if the S&P 500 fails to hold above this level.   

GBP/USD looks resilient despite coming under pressure following comments by BoE Chief economist Spencer Dale that a weak currency was a “key channel” to spur growth.  Although GBP has recovered sharply from its low of 1.3549 touched on 26 January it is still looks undervalued and such comments do not necessarily justify a further drop in GBP.   Although GBP/USD is set to appreciate further over the coming months it could struggle to sustain a break above its 3 June high of 1.6663 over the near term.  The downgrade to UK growth forecasts by the OECD this week and comments by BoE governor King that UK recovery will be a “long, hard, slog” highlight the difficulties ahead.

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A set back for the pound

June 18, 2009 — Mitul Kotecha

The multi week rally in the pound (GBP) has hit a snag as the currency has failed to extend gains above its recent highs around 1.66 against the dollar (USD).  The surprising fall in UK retail sales, with sales dropping by 0.6% from April compared to expectations of a 0.3% increase, dealt GBP another blow.   Sales were down 1.6% from a year earlier.  This is bad news for those that had believed that the UK consumer was enduring the economic downturn with some resilience. 

The reality is that the recovery in the economy will be a bumpy ride.  Whilst there have been some signs of improvement in the economy it is by no means a broad based pattern.  I would warn at getting too carried away with recovery expectations.  There have been clear signs of strengthening in both manufacturing and service sector survey data but they still only point to a gradual recovery in the months ahead. 

Moreover, some UK housing market indicators have pointed to early signs of recovery but a lot of this is due to a lack of supply and at best the housing market is entering a period of stabilisation.   Despite the signs of economic stabilisation the British Chamber of Commerce (BCC) cut its forecasts for the UK economy to -3.8% this year compared to a previous forecast of -2.8%.  

Meanwhile, UK banks continue to restrain credit and may even need more equity capital on top of the $158 billion in capital already raised according to Bank of England governor Mervyn King in his Mansion House speech.  He also warned about a “protracted” economic recovery. The good news is that the BoE is in no rush to take back its aggressive monetary easing and £125 billion asset purchase plan, but unless banks pass the benefits of this onto borrowers the fledgling recovery could stall quite quickly.   

The desire not to act quickly to reverse monetary policy was echoed in the minutes of the June BoE meeting, which revealed a unanimous 9-0 vote to maintain the status quo on policy.  The minutes also noted that the near term risks to the economy had lessened but monetary policy committee members remained cautious about the medium term prospects.  It is likely that the BoE will take several more months to gauge how successful policy has been. 

All of this highlights that GBP will be vulnerable to periodic bouts of profit taking and reversal.  Its ascent from its lows against the USD below 1.40 has been dramatic and rapid.  I believe that much of its gain has been justified especially as it had fallen to extreme levels of undervaluation.  Moreover, aggressive policy actions, both on fiscal and monetary policy, suggest that UK economic recovery will come quicker than Europe. This implies that GBP will at the least continue to recover against the euro (EUR) despite the weak retail sales induced set back.   

I also look for GBP to extend gains against the USD over coming months, with GBP/USD likely to end the year in the 1.70-1.80 region rather than low 1.60s where it is now. Market positioning leaves plenty of scope for GBP short covering over coming weeks adding further potential for recovery.  GBP appreciation will not continue in a straight line however, but set backs going forward should be looked upon as providing opportunities to rebuild long positions.

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