Euro weaker despite hawkish ECB

June 10, 2011 — Mitul Kotecha

The bounce in EUR/USD following the European Central Bank (ECB) press statement following its unchanged rate decision proved short-lived with the currency dropping sharply as longs were quickly unwound, with EUR/USD hitting a low around 1.4478. The sell off occurred despite the fact that the ECB delivered on expectations that it would flag a July rate hike, with the insertion of “strong vigilance” in the press statement.

The reaction was a classic ‘buy on rumour, sell on fact’ outcome and highlights just how long EUR the market was ahead of the ECB meeting. Interestingly the interest rate differential (2nd futures contract) has not widened versus the USD despite the hawkish ECB message and in any case interest rate differentials are not driving EUR/USD at present as reflected in low correlations.

This leaves the EUR susceptible to Greek developments and the news on this front is less positive. ECB President Trichet ruled out any direct participation (ie no rollover of ECB Greek debt holdings) in a second Greek bailout whilst potentially accepting a plan of voluntary private participation in any debt rollover. The ECB’s stance is at odds with that put forward by German Finance Minister Schaeuble pressuring investors to accept longer maturities on their Greek debt holdings.

In contrast the USD appears to be finding growing relief from the fact that the Federal Reserve is putting up a high hurdle before QE3 is considered. As highlighted by Fed Chairman Bernanke earlier this week the Fed is not considering QE3 despite a spate of weak US data. This was echoed overnight by the Fed’s Lockhart and Plosser, with the former noting that there would need to be a substantially weaker economy and the latter noting that there would have to be a “pretty extraordinary” deterioration in the economy to support QE3.

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EUR Supported, AUD dives, NZD jumps

June 9, 2011 — Mitul Kotecha

Today is probably not the best day to sell EUR given that the ECB policy decision looms on the horizon. Whilst there is a risk of a ‘buy on rumour, sell on fact’ impact on the EUR following the European Central Bank (ECB) decision later today the relatively high probability that the ECB flags a rate hike in July will likely give further support to the EUR especially as it is not fully priced in by the market.

Of course should ECB President Trichet fail to mention “strong vigilance” in his press conference the EUR could suffer but this is likely to be a lower probability event. Some justification for higher rates will come from an upward revision in the ECB’s inflation forecasts. Consequently EUR/USD looks well supported around 1.4450.

The Bank of England is unlikely to deliver any surprises today, with an unchanged policy rate outcome and asset purchases target likely. The outcome will keep GBP restrained versus USD but given the likely contrast with the ECB, EUR/GBP could head higher as the currency pair continues to set its sights on the 0.90 level.

Even against the USD, GBP is unlikely to extend its gains, with 1.6474 likely providing a near term technical cap. The dichotomy of weaker activity and higher inflation is clearly causing a problem for policy makers but we still believe a rate hike is likely later in the year. In the meantime GBP remains vulnerable to further data disappointments over coming weeks.

There was more bad news for the AUD today in the form of a weak than forecast May employment report. The data will reinforce expectations that the RBA will not hike interest rates over coming months, with July and August effectively ruled out, though a hike in September remains probable.

The data had major impact on AUD which dropped sharply below the 1.0600 handle versus USD. Clearly the combination of the RBA statement and weak jobs data has resulted in a major headwind against further near term AUD appreciation. AUD will remain under downward pressure in the short-term, with technical support seen at 1.0440.

Unlike the RBA the Reserve Bank of New Zealand (RBNZ) opened the door for higher interest rates following its unchanged policy decision today, with the Bank stating that “a gradual increase in the overnight cash rate over the next two years will be required”. Despite noting some caution about the strength of the NZD and its impact on the economy the Kiwi strengthened versus the USD

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EUR Becomes The Anti USD

June 8, 2011 — Mitul Kotecha

The USD is close to giving back the full extent of the gains it made during May. The USD index hit a low of around 72.696 on 4th May and looks on track to re-test this level.

It would be easy to say that the USD is being undermined by low US bond yields but whilst this is partly true only USD/JPY has had a significant correlation with bond yield differentials over the past 3-months.

The reality is that the EUR has become the anti USD at present. Whilst the EUR composes 57.6% of the USD index which would imply a high correlation between the USD index and EUR, it does not explain the fact that the correlation over the past 3-months is at an extremely high 0.98.

It is probably a relief for USD bulls that the currency is not being particularly influenced by yield differentials at present as it would be even weaker if it was so. US bond yields continue to be depressed by growth concerns, following a spate of weaker US data releases, culminating in the May jobs report last week.

Speculation about QE3 is similarly unhelpful for the USD but the prospects of this occurring are still very slim and notably whilst Bernanke highlighted the “frustrating slow” economic recovery in a speech last night he did not indicate a desire to embark on QE3.

Nonetheless, any clues about Fed policy will be closely scrutinised and this includes today’s Beige Book of regional economic conditions. Our expectation of a relatively downbeat report suggests that the USD will find no support from this source.

Ultimately USD recovery will require EUR weakness but the European currency appears to have regained its ‘Teflon’ coating as its resistance to bad news grows once again. The EUR was helped yesterday by a stronger than expected April retail sales report and will undoubtedly find further solace from confirmation of a strong start to the year in terms of Q1 GDP today.

Overall direction continues to come from news in the eurozone periphery, however. The fact that officials appear to be inching towards an agreement in Greece has clearly been appreciated by the EUR. Moreover, potential ECB backing for debt rollovers by private investors will alleviate some concerns.

Nonetheless, at current levels, with EUR/USD on the path to its 4th May high around 1.4940 it appears that a lot is already priced in and the scope for disappointment is high.

Posted in Bond markets, Currencies, ECB, Economics, Economy, Europe, eurozone, Federal Reserve, FX, Greece, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , . 4 Comments »

Euro Resilience To Fade

May 31, 2011 — Mitul Kotecha

There will at least be a little more liquidity in FX markets today following yesterday’s public holidays in the US and UK. Whether this means that there will be a break out of recent ranges is another matter. Clearly global growth worries as well as eurozone peripheral debt concerns are having an important impact on market dynamics but are also providing conflicting signals.

On the one hand the USD ought to garner support from Europe’s problems but on the other, safe haven demand and growth concerns is bolstering demand for US Treasuries keeping US bond yields at very low levels despite the lack of progress on increasing the US debt ceiling and agreeing on medium to long term deficit reduction.

In the wake of a run of US data disappointments including April durable goods orders, Q1 GDP and weekly jobless claims last week, fears of a loss of momentum in the US economy have intensified. Manufacturing and consumer confidence surveys in the form of the May Chicago PMI and Conference Board consumer confidence survey today will be closely scrutinised to determine whether the ‘soft patch’ in the US economy will persist.

This will have important implications for the USD as worries about growth may feed into expectations that the Fed’s ultra loose monetary policy will be sustained for longer. As it is US 2-year bond yields have dropped to their lowest level this year.

Fortunately for the USD only USD/JPY and USD/CHF have maintained a statistically strong correlation with bond yield differentials although we expect the break in relationship for other currencies to prove temporary. In the case of USD/JPY, yield differentials have narrowed between the US and Japan, a factor playing for JPY appreciation.

Perhaps the fact that unlike the US Japanese data has on balance been beating expectations notwithstanding disappointing April household spending and industrial output data has helped to narrow the yield gap with the US. One explanation is that that worst fears of post earthquake weakness have not been borne out, suggesting that economic expectations have been overly pessimistic. In any case, USD/JPY 80 is still a major line in the sand for the currency pair.

The EUR continues to show impressive resistance, with EUR/USD breaking technical resistance around 1.4345, which opens up a test of 1.4423. Reports that Greece had failed to meet any of its fiscal targets and of harsh conditions set by European officials for further aid have failed to dent the EUR. Whether the market is simply becoming fatigued or complacent will be important to determine if the EUR can gain further.

A report in the WSJ that Germany is considering dropping its push for early rescheduling of Greek debt has given some support to the EUR too. Ongoing discussions this week are unlikely to prove conclusive however, with attention turning to meetings of European officials on 20th and 24th June. I still believe EUR gains will limited, with the break above 1.4345 likely to prove shortlived.

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Greece’s trials and tribulations

May 30, 2011 — Mitul Kotecha

Two main influences on markets continue to weigh on sentiment. Firstly the trials and tribulations of the eurozone periphery remain centre of attention. The failure of Greek Prime Minister Papandreou to win cross party support for austerity measures at the end of last week highlights the problems Greece is facing both domestically and externally.

Reports that European officials are negotiating tough bailout conditions including major external intervention in terms of tax collection and privatisation suggest that gaining further aid will not be easy. The second weight on market sentiment is global growth concerns, with a string of disappointing data releases over recent weeks leading to an intensification of concerns about the pace of recovery.

Markets will likely remain nervous in this environment and it is difficult to see risk appetite improving to any major degree. This has proven bullish for bond markets, with the tone set to continue this week. Currencies remain in ranges and holidays today in the US and UK will likely result in thin trading. The resilience of the EUR to peripheral concerns has been impressive but at the same time Greek concerns will limit any gains. Meanwhile, gold and precious metals look to remain well supported, with gold’s safe haven bid remaining solid.

USD sentiment has improved sharply according to the latest CFTC IMM report which reveals that net USD short positions have been cut in half over the last two weeks with positioning well above the 3-month average. Conversely net EUR longs continue to shrink as speculative investors off load the currency. The fact that the EUR is not weaker than it is points to the influence of official demand for the currency, especially from Asia.

This week will likely be dominated by ongoing discussions about Greece and given the opposition to austerity measures and potentially strict bailout terms, forging an agreement will not be easy. Reports suggest that around half of Greece’s financing needs until the end of 2013 could be accounted for without new loans via privatisation and changes in terms for private bondholders, with Europe and the IMF needed to lend an additional EUR 30-35 billion on top of the EUR 110 already slated.

Data releases are likely to take a back seat but there will still be plenty of attention on the key release of the week, namely the May US jobs report. The market looks for a 185k increase in payrolls, with the unemployment rate edging lower to 8.9%. This would mark the lowest payrolls reading in 4 months. Clues to the jobs data will be garnered from the May ADP jobs report, ISM manufacturing survey and consumer confidence data earlier in the week.

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