Euro looking rich at current levels

October 21, 2011 — Mitul Kotecha

Markets continue to be rumour driven with little concrete news to provide direction. The news that a comprehensive deal by European officials at this Sunday’s EU Summit is now very unlikely has come as a further blow to hopes of a swift resolution to the crisis.

So it seems that Sunday’s meeting will provide a forum to thrash out ideas before a second summit next Wednesday. As a reminder the issues at hand are leveraging the EFSF, banking sector recapitalisation and the extent of private sector participation in Greek debt write downs.

The main disagreement appears to be between Germany and France on method of additional funding the EFSF bailout fund (which has EUR 280billion of firepower left), with Germany and the European Central Bank (ECB) opposed to French demands to utilise the ECB to help back the EFSF with France wanting the facility being turned in a bank. In terms of write downs for Greek bond holders there is a push for at least a 50% reduction compared to the 21% agreed in July.

Separately speculation of the amount of new capital needed for banking sector recapitalisation now revolves around a figure of EUR 80 billion. One spanner in the works is that Chancellor Merkel will have to gain approval from the German parliament before agreeing on further changes to the EFSF, which may delay the process further.

Clearly as this week has gone on the air has continued to seep out of the balloon as the market braces for disappointment. Surprisingly the EUR has held up well and while it has failed to extend gains, hitting a high earlier in the week around 1.3915 but still pricing in some scope for success, at current levels.

Helping the EUR was the fact that the market was very short, and while it could still move higher next week if European officials agree on a plan it still looks like a sell on rallies, with the scope for further gains limited from current rich levels. Good news from Europe next week could see a test of EUR/USD 1.40 but this will prove to be a good selling area further out.

At least there was some good news from Greece for a change as the Prime Minister won a vote to pass further austerity measures to help secure the next tranche (delayed from September) of the bailout despite ongoing protests in the country. The near term focus will be on a meeting of Finance Ministers today ahead of Sunday’s summit.

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Euro supported by hope

September 27, 2011 — Mitul Kotecha

Hope appears to be the overriding sentiment filtering through markets at present. Such hope includes expectations that the European authorities will be able to ring fence Greece and avoid much deeper and wider comtagion to other eurozone peripheral countries than has already taken place. This may involve a European version of the US Troubled Asset Relief Program (TARP). Various other measures are being speculated on including covered bond purchases from the ECB, provision of 12 month liquidity by the ECB, a policy rate cut, banking sector recapitalization and a beefing up of the EFSF bailout fund.

The result of such speculation has been to provide some stability to the EUR and asset markets but there is a long way to go before hopes turn into action. The next few weeks will be critical to determine whether a firmer base to sentiment and the EUR can be established and markets will turn their attention to a meeting of eurozone finance ministers on October 3 and the European Central Bank on October 6. Meanwhile national votes on changes to the EFSF bailout fund will continue this week including Germany’s vote on Thursday. While the vote is likely to pass it may draw attention to divisions within Chancellor Merkel’s party.

One thing is certain. There is no room for any more disappointment especially given that the plans agreed by European officials in July have yet to be implemented. If there is no concrete action over coming weeks the EUR will come under renewed pressure and indeed the risk is still heavily skewed towards more EUR weakness given the various disagreements between officials. Nonetheless, the improved mood in the short term will likely help prevent the currency from sliding further for now and a base appears to be forming just under 1.35 against the USD.

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US Dollar Under Broad Based Pressure

July 27, 2011 — Mitul Kotecha

ThE USD has registered broad based losses over recent days and the longer the stalemate with regard to extending the US debt ceiling the bigger the problem for the currency. Indeed, it appears that the USD is taking the brunt of the pressure compared to other assets. For example, although US treasury yields have edged higher there is still no sense of panic in US bond markets.

Failure to raise the debt ceiling does not automatically imply a debt default but it will raise the prospect should an agreement not be reached in the weeks after. However, the impact on US bonds maybe countered by the increased potential for QE3 or safe haven flows in the event that no agreement is reached.

The worst case scenario for the USD remains no agreement on the debt ceiling ahead of the August 2 deadline but a short term solution that appears to be favored by some in the US Congress may not be that much better as it would effectively be seen as ‘kicking the can down the road’.

The better than hoped for agreement to help resolve Greece’s debt problems at the end of last week came as a blow to the USD given the almost perfect negative correlation between the USD and EUR over recent months. Moreover, the debt ceiling stalemeate is pouring salt into the wound. However, the situation is highly fluid and should officials pull a rabbit out of the hat and find agreement the USD could rally sharply.

All is not rosy for the EUR either and its gains have largely come by courtesy of a weaker USD rather than positive EUR sentiment. Economic news hardly bodes well for the EUR, with data in the eurozone looking somewhat downbeat. For instance, the Belgian July business confidence indicator dropped to a 9-month low in line with the weaker than expected outcome of the July German IFO survey last week.

Moreover, there are still several questions about last week’s second Greek bailout agreement and contagion containment measures including parliamentary approvals and lack of enlargement of the EFSF which could keep markets nervous until there are clear signs that implementation is taking place successfully.

A clear sign that the EU agreement has failed to inspire as much confidence as officials had hoped for is the lack of traction in terms of narrowing peripheral bond spreads, with the exception of Greece. This partly reflects a renewed ‘risk off’ tone to markets but this is not the sole reason.

EUR/USD has extended gains benefiting from USD weakness rather than any positive sentiment towards EUR, breaking above 1.4446, the strong multi-month corrective channel resistance, signalling a bullish move. The next level of technical resistance is around 1.4568 but direction will continue to come from the debt ceiling talks.

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Edging Towards A European Deal For Greece

July 21, 2011 — Mitul Kotecha

The momentum towards some form of agreement at the Special EU Summit today is growing, with French and German leaders reaching a “joint position on Greece’s debt situation”. Details of this position are still unknown, however. EUR has found support as expectations of a positive outcome intensify.

However, given that positive news is increasingly being priced in, and the market is becoming increasingly long, upside EUR potential will be limited even in the wake of a comprehensive agreement. A break above EUR/USD resistance around 1.4282 would bring in sight the next key resistance level around 1.4375 but this where the rally in EUR/USD is set to be capped.

Prospects of a major US debt default or at the least a government shutdown appear to be receding as the US administration has indicated some willingness to opt for a short term increase in the US borrowing limit to give more time for a bigger deficit reduction deal to be passed by Congress. Meanwhile, there will be further news on the deficit reduction plans put forward by the “gang of six” US senators, with a press conference scheduled for later today.

Debt ceiling negotiations are likely to be the main focus of market attention, with the Philly Fed manufacturing survey and weekly jobless claims relegated to the background. A speech by Fed Chairman Bernanke is unlikely to deliver anything new today. The USD is likely to be on the back foot given expectations of a deal in Europe and improved risk appetite but we expect losses to be limited.

The JPY continues to defy my bearish expectations. Over recent days the US yield advantage over Japan in terms of 2Y bonds dropped to multi-year lows below 20bps. Given the high correlation between USD/JPY and yield differentials, this has corresponded with the fall below 80.00.

Expectations of JPY weakness versus USD is highly dependent on the US – Japan yield gap widening over coming months. For this to happen it will need concerns about the US economy and expectations of more Fed asset purchases to dissipate, something that may not happen quickly given the rash of disappointing US data releases lately.

GBP found itself on the front foot following the release of the Bank of England Monetary Policy Committee minutes, which were less dovish than anticipated. They also revealed that the BoE expects inflation to peak higher and sooner than previously expected. However, the fact that the overall tone was similar to the last set of minutes meant there was little follow through in terms of GBP.

Further direction will come from June retail sales data today and forecasts of a bounce in sales will likely help allay concerns about a downturn in consumer spending. Nonetheless, GBP is still likely to struggle to break through resistance around 1.6230 versus USD.

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Euro crisis intensifies

July 12, 2011 — Mitul Kotecha

The blowout in eurozone non-core debt has intensified and unlike in past months the EUR has been a clear casualty. The lack of a concrete agreement over a solution given divergent views of EU officials, the European Central Bank (ECB) and private sector participants threatens a further ratcheting higher of pressure on markets over coming weeks.

The only real progress overnight as revealed in the Eurogroup statement appeared to be in the renewing the option of buying back Greek debt via the eurozone bailout fund, extending maturities and lowering interest rates on loans. This will be insufficient to stem the pressure on the EUR, with the currency verging on a sharp drop below 1.40.

The USD continues to take advantage of the EUR’s woes and has actually staged a break above its 100-day moving average yesterday after several attempts previously. This sends a bullish signal and the USD is set to remain supported given that there is little in sight of a resolution to the problems festering in the eurozone.

Today’s release of the June 22 Fed FOMC minutes will give some clues to Fed Chairman Bernanke’s testimony to the House of Representatives tomorrow, but as long as the minutes do not indicate a greater willingness to embark on more asset purchases, the USD is set to remain resilient.

GBP has also benefitted from the EUR’s weakness, and unlike the EUR has only drifted rather than dived versus the USD. However, the UK economy is not without its own problems as revealed in a further drop in retail sales overnight, albeit less negative than feared, with the British Retail Consortium (BRC) like for like sales falling 0.6% in June.

A likely increase in June CPI inflation in data today to a 4.8% annual rate will once again highlight the dichotomy between weak growth and high inflation. In turn, such data will only provoke further divisions within the Bank of England MPC. While further gains against the beleaguered EUR are likely, with a test of EUR/GBP 0.8721 on the cards in the short term, GBP will struggle to sustain any gain above 1.6000 versus USD.

Both AUD and NZD are vulnerable against the background of rising risk aversion and a firmer USD in general. However, both currencies are not particularly sensitive to risk aversion. Interestingly the major currency most sensitive to higher risk aversion in the past 3-months is the CAD and in this respect it may be worth considering playing relative CAD underperformance versus other currencies.

As for the AUD it is more sensitive to general USD strength, suggesting that it will be restrained over coming sessions too and given that market positioning is still very long AUD, there is scope for further downside pressure to around 1.0520 versus USD.

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