Risk assets to slip ahead of ECB and US payrolls

September 3, 2012 — Mitul Kotecha

Although Federal Reserve Chairman Bernanke did not categorically state that a third round of quantitative easing or QE3 is on the cards his stoic defence of past QE while playing down of the risks emanating from such actions, highlight that the prospects are more likely than not for more Fed balance sheet expansion.

Markets clearly liked what they heard, with risk assets finishing off the week on a positive note. Notably commodities continue to outperform and the prospects of more currency debasing by the Fed and European Central Bank suggest that gold in particular, will continue to look attractive. However, the weaker than expected Chinese manufacturing purchasing managers index (PMI) in August, with the index dropping below the 50 boom/bust level, will put a dampener on markets.

The main impediment to QE3 would be a major improvement in job market conditions and in this respect markets will have the August jobs report to digest at the end of this week. Preliminary estimates of an 125k increase in payrolls and an unemployment rate stuck at 8.3% suggests that it should be no hindrance to more QE.

The other key event of the week is the European Central Bank meeting although markets will eye events in Greece ahead of this, with the Troika set to revisit the country mid week. The ECB continues to play its game of brinkmanship with governments, and while they Bank will likely commit to a bond buying programme it is unlikely to announce the onset of a new round of bond purchases until governments in particular Spain formally request aid from the EFSF / ESM bailout funds. Although there is some scope for disappointment expectations of major ECB action have already been pared back.

Other central banks in the frame include the Reserve Bank of Australia and Bank of Canada but unlike the ECB policy easing is unlikely from either of these central banks. Overall, risk assets to trade with a heavy tone and the USD will recoup some of its losses over coming days, especially against the EUR.

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EUR to drift lower, AUD supported, JPY flatlines

August 7, 2012 — Mitul Kotecha

EUR/USD has failed to retake the 1.2400 handle and as noted yesterday looks set to gradually make its way lower again. News that the German government lent its support to the European Central Bank (ECB) bond buying plan helped to limit losses overnight, but there is likely to be little news on the policy front over coming weeks as Europe moves into full blown summer holiday mode.

No news is perhaps good news, but market patience continues to run thin and the EUR will eventually be punished should policy makers fail to deliver which has been so often the case. With only German factory orders in terms of data releases of note today, EUR/USD is set to settle into a range, but with a downside bias.

The RBA meeting today is likely to prove relatively uneventful. Almost all analysts polled expect a no change outcome from the Reserve Bank. As this is the largely priced in, the main influence on AUD will be the accompanying statement. The market is overly aggressive in pricing in 75 basis points of policy rate cuts over the coming months and in this respect it will require a particularly dovish statement to validate these expectations.

More likely, the RBA will sound neutral reflecting on relatively firm data (except the June jobs report) releases since the last meeting and a better global environment. Combined with strong attraction to ‘carry’ trades and a firmer tone to risk appetite, AUD looks well supported, with technical support seen around 1.0437.

USD/JPY continues to flat line just above the 78.00 level ahead of this week’s Bank of Japan meeting. There is unlikely to be much excitement from the BoJ meeting but the pressure to take more aggressive steps to reach their 1% inflation goal as well as to weaken the JPY remains strong. The 78.00 level appears to be an uncomfortable equilibrium for markets and Japanese policymakers.

Although low implied FX volatility suggests that there is little expectation of a move in either direction Japanese officials continue to remain concerned about the strength of the JPY. Similarly, the US Treasury bond versus Japanese JGB yield differential (2 year) remains relatively steady, suggesting little directional impetus in the short term. Given hopes / expectations of more Fed quantitative easing it seems unlikely that USD/JPY will make much traction on the upside over coming weeks.

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Risk currencies rally

August 6, 2012 — Mitul Kotecha

Following the disappointment from the lack of US Federal Reserve and European Central Bank (ECB) action last week, the US July jobs report provided a fillip for markets. The stronger than expected jump in payrolls (163k) dampened worries about the pace of jobs recovery while the increase in the unemployment rate (to 8.3%) kept alive hopes of more Fed quantitative easing.

Indeed, even the ECB’s decision and statement last week have been interpreted as merely delaying the inevitable, with stronger action expected from the central bank over coming weeks. Against this backdrop, markets will begin the week in positive tone and risk assets are likely to extend gains early in the week.

The highlights on the data calendar this week include two central bank meetings, Bank of Japan (BoJ) and Reserve Bank of Australia (RBA), and the Bannk of England (BoE) Quarterly Inflation Report (QIR). Major policy changes from the former two central banks are unlikely although the BoJ may decide to abolish the 0.1% minimum bidding rate on JGB operations.

As for the BoE QIR a dovish reading is likely which will help to support expectations of further policy action in the UK, which in turn will mean that GBP will underperform. Data releases are fairly thin on the ground, with US trade data, Q2 non farm productivity, German factory orders and industrial production releases across Europe. Overall, we see little to detract from the positive tone to asset markets.

Risk currencies begin the week on the front foot. The EUR/USD reaction to the US jobs data was particularly interesting, hitting a high of 1.2444 as stop losses were triggered on the upside. Further EUR gains will be difficult to achieve, however. Speculative market positioning reveals that EUR short positions have dropped to their lowest level in several weeks, suggesting less scope for further short covering.

The lack of major data releases over coming days within the Eurozone mean that direction will come from Spain and whether the country formally asks for financial support from the EFSF. In the meantime, EUR/USD is likely to edge back to around technical support around 1.2218.

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Fed passes the baton to the ECB. EUR and GBP downside risks

August 2, 2012 — Mitul Kotecha

Although the Fed’s inaction overnight was perhaps a little disappointing for markets the FOMC did note that it “will” provide further stimulus to the economy if needed. The USD rallied but risk currencies came under pressure. However, any sell off in risk assets will be limited as markets look to the FOMC meeting on September 13 for more action. This will also coincide with updates of the Fed’s economic forecasts. The below consensus reading for the ISM manufacturing index in July which came in at 49.8 added to the slight disappointment, with the data consistent with flat growth in manufacturing.

Attention now turns to the European Central Bank (ECB). Warnings by the Bundesbank President Weidmann for the ECB not to overstep its remit sets the scene for a stressful policy meeting today. Although markets have pared back their overly bullish expectations from the end of last week a lack of action by the ECB to reduce peripheral bond yields will disappoint and lead to a sell of in risk assets and EUR/USD but support around 1.2150 is likely to hold. Even a restart of Securities Market Purchases on its own would not be a game changer.

The Bank of England also decides on policy today but unlike the ECB there is little expectation of any action from the MPC. Inaction by the BoE today will highlight that after a GBP 375 billion in asset purchases there is limited room in the tool kit aside from lowering interest rates further. A weaker than expected reading for UK July manufacturing confidence weighed on GBP, with the data following a rash of disappointing data releases over recent weeks. I continue to see downside risks to GBP both against the EUR and USD, however. Indeed, my quantitative models reveal that GBP/USD should be trading around 1.5144 while EUR/GBP should be around 0.8242.

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USD under pressure, AUD well supported

August 1, 2012 — Mitul Kotecha

Despite comments by the German Finance Ministry that it sees no need to give the ESM bail out fund a banking license, market hopes of European Central Bank (ECB) action tomorrow remain in place, helping to give some support to markets and the EUR. However, the Fed is unlikely to deliver fresh stimulus measures following the conclusion of its two day meeting today.

Sentiment slipped slightly overnight although any weakness was limited by stronger than expected data releases in the US in the form of July consumer confidence and Chicago PMI. US and European equities ended lower but overall its appears to be a case of treading water until the policy decisions over coming days as well as Friday’s US jobs report.

There is perhaps less expectation of Fed action than the ECB but nonetheless, recent press reports suggest that the Fed is shifting closer to pulling the trigger for more balance sheet expansion. This in turn has put some restraint on the USD.

Although it is more likely that the Fed will want to wait to assess more economic data (the Fed will not be privy to the July jobs report before its release on Friday) there is a chance that the Fed could extend its guidance tonight. This will be less important from a USD perspective but if the Fed opens the door even wider to a third round of quantitative easing the USD will find little solace from a lack of QE today as the Fed will merely be seen to delay such a move until September.

Combined with the impact of firmer risk appetite over recent days and consequently reduced safe haven demand the USD will struggle to make any headway in the near term, with the USD index to find it difficult to break above 83.000.

AUD has been the best performing major currency in July. Yield attraction has increased and the AUD has been a key beneficiary. While my forecasts remain among the most bullish this year (1.08 by year end) I am cognisant of the risks of a pull back in the interim.

AUD has benefited to some extent from expectations of further policy stimulus in China as well as a generally more favourable tone to risk appetite. Reports that China is interested in buying Australian regional government bonds will also help buoy AUD.

While external conditions hold various risks to the AUD the domestic picture does not look too adverse and various domestic economic indicators have beaten expectations. Consequently I believe that market expectations for a bigger 75bp of Reserve Bank of Australia (RBA) policy easing are overdone and an eventual correction in the markets’ overly dovish stance will help to support the AUD.

Meanwhile, speculative AUD positioning is well below the all time high reached in April 2011, suggesting scope for more gains. AUD/USD looks well supported around 1.0374.

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