Respite for the dollar

October 27, 2009 — Mitul Kotecha

Markets are increasingly discounting stronger than expected Q3 earnings.  Further gains in equities and risk appetite may be harder to achieve even if profits continue to be beat expectations, which so far around 80% of Q3 earnings have managed to do. Measures of risk such as the VIX “fear gauge” have highlighted an increasingly risk averse environment into this week.  The negative market tone could continue in the short term.

The USD has found some tentative relief, helped by the drop in equities and profit taking on risk trades.  The fact that the market had become increasingly short USDs as reflected in the latest CFTC Commitment of Traders’ (IMM) report in which aggregate short USD positions increased in the latest week (short USD positions numbered roughly twice the number of long positions), has given plenty of scope for some short covering this week.

The USD has even managed quite convincingly to shake off yet another article on the diversification of USD reserves in China.  The USD index looks set to consolidate its gains over the short term against the background of an up tick in risk aversion.  The USD index will likely remain supported ahead of the main US release this week, Q3 GDP on Thursday, but any rally in the USD is unlikely to be sustainable and will only provide better levels to short the currency.

Given the broad based nature of the reversal in risk sentiment with not only equities dropping but commodities sliding too, it suggests that high beta currencies, those with the highest sensitivity to risk will suffer in the short term.  These include in order of correlation with the VIX index over the past month, from the most to the least sensitive, MXN, AUD, MYR, SGD, NOK, EUR, CAD, INR, ZAR, BRL, TRY and NZD. The main beneficiary according to recent correlation is the USD.

EUR sentiment in particular appears to be weakening at least on the margin as reflected in the latest IMM report which revealed that net long EUR speculative positions have fallen to their lowest level in 6-weeks.  Whether this is due to profit taking as EUR/USD hit 1.50 or realisation that the currency appeared to have gone too far too quickly, the EUR stands on shakier ground this week.  EUR/USD may pull back to near term technical support around 1.4840 and then 1.4725 before long positions are re-established.

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EUR/USD takes a crack at 1.50, where now?

October 22, 2009 — Mitul Kotecha

It seemed inevitable and finally after flirting with the 1.50 level, EUR/USD managed to break through although there seems to be little momentum in the move, with the currency pair dipping back below 1.50 in the Asian trading session. Contrary to expectations the break above 1.50 did not lead to a sharp stop loss driven move higher. 

Even the break through 1.50 only provoked a limited reaction in the FX options market where implied EUR/USD volatility only moved slightly higher. In fact despite the warnings by ECB President Trichet about “excessive currency volatility” FX options volatility for most currency pairs has been on a downward trajectory over the past few months, implying that the move in EUR/USD and the USD itself has been quite orderly. 

Trichet’s warning is more likely a veiled threat on the level of EUR/USD rather than its volatility, unless of course the ECB chief is seeing something that the FX options market is not. Assuming that EUR/USD closes above 1.50 this week it technically has plenty of open ground on the run up to the record high of 1.6038 hit in July 2008 but there will also be plenty of official resistance to limit its appreciation. Such resistance is limited to rhetoric but it will not be long before markets begin discussing the prospects of actual FX intervention.  

Perhaps the reason that EUR/USD did not move sharply higher following the break of 1.50 was the late sell off in US stocks on Wednesday which helped to fuel some USD short covering.  The USD index is holding just above the 75.00 level but it’s not a big stretch from here to move down to the March 2008 low around 70.698, with the overall tone of broad USD weakness remaining intact and ongoing. 

GBP was helped by relief that the minutes of the BoE meeting showed no inclination to increase the level of quantitative easing despite the ongoing debate within the MPC.   The minutes even sounded slightly upbeat about economic prospects. GBP/USD hit a high of 1.6638 in the wake of these developments due in large part to more short covering whilst EUR/GBP briefly dipped below 0.90.  GBP/USD may find it tough going to make much headway above 1.66 as has been the case over recent months, with strong resistance seen around 1.6661.

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Risk On / Risk Off

October 16, 2009 — Mitul Kotecha

Risk was firmly back on over the past few days as the majority of earnings came in stronger than expected; around 80% of S&P 500 companies have beaten expectations so far. Data releases in the US have also continued to beat forecasts, the latest of which was the September industrial production report. The dollar stood little chance of a recovering against this background and continues to languish around 14-month lows.

Sterling has been the star performer, perhaps a reflection of the fact that the market was extremely short (CTFC IMM data revealed record net short sterling positions last week) and some hints that the Bank of England may not extend quantitative easing was sufficient to provoke a short covering rally. Still the pound’s gains may prove short-lived until there are clearer signs of economic recovery and of a turn in the interest rate cycle.

There will be some key events and data over the coming week that will give further direction to sterling including a speech by BoE Governor King, MPC minutes, retail sales and preliminary Q3 GDP data. Overall, the data are unlikely to deliver much of a boost to the pound even though both retail sales and GDP are likely to deliver positive readings. Sentiment for the pound continues to swing in a wide range and though a lot of negativity was in the price a sustained recovery is far off. The risks remain that GBP/USD will push back towards support around 1.5902.

I still believe that there is little positive to be said for the euro too. The currency benefits from a weaker dollar but is hardly supported by fundamentals especially as a stronger euro damages one of the main engines of eurozone growth, namely exports. EUR/USD will struggle to make headway through 1.50 though once through here it could easily be carried higher. The most positive factor supporting the euro is the continued recycling of central bank intervention flows here in Asia and this may be sufficient to propel EUR/USD through 1.50 before hitting a wall of resistance around 1.5084.

The dollar itself may be given a lifeline from what looks like a softer tone to markets at the end of the week but overall sentiment remains very bearish despite attempts by various US officials to talk the dollar higher this week. The Fed’s Fisher hit the nail on the head when he said that the dollar’s long term value depends on policymakers “getting it right”. In the short term however, it’s all about risk and increasingly it will be about interest rate differentials, both of which will play negatively for the dollar.

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No relief for Sterling

October 13, 2009 — Mitul Kotecha

Anybody in the UK thinking of taking a holiday overseas has had to think twice over recent months given the precipitous drop in the pound (GBP) that took place since the beginning of August 2008. At the lowest point around six months after the British pound began its decline it had lost around a third of its value against the US dollar. Against the euro, sterling has fared even more poorly over a longer period, with GBP losing around 45% of its value from the beginning of 2007.

Since then GBP has recovered but has given back some of its gains over recent weeks against the dollar but has continued to weaken against the EUR. The worsening in GBP sentiment has been particularly well reflected in CFTC data on speculative positioning which revealed a drop to an all time low in GBP speculative contracts in contrast to EUR speculative contracts reaching close to the year high.

GBP faces headwinds from expectations that the Bank of England will extend its quantitative easing especially in the wake of recent data whilst news that the Center for Economics and Business Research (CEBR) predicted that the Bank of England (BoE) will keep its base rate unchanged until at least the end of 2011 came as another blow.

Although currencies are not particularly sensitive to interest rate movements at present it is unlikely to be long before the historically strong FX/interest rate relationship re-exerts itself and if UK policy is likely to remain accommodative for a prolonged period this could be detrimental to GBP’s recovery prospects. It seems unlikely that the BoE will wait as long as the CEBR predict before raising interest rates although a rate hike anytime in 2010 also looks unlikely.

There is at least some hope that aggressive UK monetary policy will deliver a relatively quicker economic recovery than in the eurozone where policy has arguably been much less aggressive and this relatively more positive cyclical picture will eventually result in some strengthening in GBP.

Nonetheless, the interim outlook continues to look bleak and sentiment is likely to continue to deteriorate over the short term. EUR/GBP now looks on path to retest its high reached at the end of 2008 at just over 0.98 (or around 1.02 for those that prefer to look at GBP/EUR) whilst GBP/USD appears to be heading for a move back below 1.55 and back to around 1.50.

Perhaps one of the only positive things that GBP has going for it at present is that looks very undervalued and when recovery does happen it could bounce back quite quickly and aggressively as markets cover their short positions. In the meantime, the good news of low interest rates will at least benefit borrowers and mortgage holders holding GBP denominated loans but not anyone in the UK wanting to take a holiday overseas.

Posted in Currencies, Economics, Interest rates, Monetary Policy, UK. Tags: , , , , , , , , , , , , , , . 2 Comments »

What to watch this week

October 12, 2009 — Mitul Kotecha

Over recent days trading has been characterised by dollar weakness, stronger equities, rising commodity prices and most recently an increase in US bond yields, the latter driven by some slightly hawkish Fed comments. Whether the tone of stronger attraction to risk trades continues will largely depend on US Q3 earnings however, with many earnings reports scheduled this week.

Given the plethora of Fed officials on the wires over recent days and the mixed comments from these officials there may more attention on US CPI on Thursday than usual but the data is unlikely to fuel any concern about inflation risks. Instead there will be more interest on the Fed FOMC minutes on Wednesday which will once again be scrutinised for the timing of an exit strategy.

Over the week there is plenty for markets to digest aside from earnings reports. US consumer and manufacturing reports will garner most attention. The key release is US September retail sales (Wed) where some payback for the “cash for clunkers” related surge in sales over the last month is likely to result in a drop in headline retail sales, though underlying sales will likely post a modest rise.

Fed speeches will also be monitored and speakers include Kohn, Dudley, Tarullo and Bullard this week. Recent comments have hinted that some Fed members are becoming increasingly concerned about the timing of policy reversal and further signs of this in this week’s speeches may give the dollar some comfort but this will prove limited given that the Fed is still a long way off from reversing policy.

Even if the market believes the Fed is starting to contemplate the timing of reversing its current policy setting it is unclear that the dollar will benefit much in the current environment. Sentiment remains bearish; speculative dollar sentiment deteriorated sharply over the past week according to the CFTC Commitment of Traders (IMM) data, to levels close to the lowest for the year.

Moreover, the correlation between interest rate differentials and currencies is still insignificant in most cases suggesting that even a jump in yields such as the move prompted by last week’s comments by Fed Chairman Bernanke should not automatically be expected to boost the dollar. Once markets become more aggressive in pricing in higher US interest rates this may change but there is little sign of this yet

In contrast the euro continues to benefit from recycling of central bank reserves and recorded a jump in speculative appetite close to its highest level this year according to the IMM data. Reserve flows from central banks may contribute to EUR/USD taking aim at its year high around 1.4844 (last tested on 24 September 09) over coming days.

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