Position Unwinding Boosts USD

May 9, 2011 — Mitul Kotecha

The USD’s multi-month fall has come to an abrupt halt, with the currency registering gains in reaction to what appears to be a major position unwinding across asset markets, led by a drop in commodity prices.

Will it continue? Whilst I am amongst the more bullish forecasters on the USD over the medium term, the current rally could prove to be short-lived in the absence of a shift in Federal Reserve rhetoric or end to quantitative easing (QE2). Nonetheless, the market had got itself very short USDs (as reflected in the CFTC IMM data as of early last week which showed an increase in net short positions) and the rally in the USD last week was likely spurred by major short-covering which could extend further into this week.

The move in the USD gained momentum as European Central Bank (ECB) President Trichet proved to be less hawkish than many expected in the press conference following last Thursday’s ECB meeting. Moreover, renewed worries about Greece at the end of last week, with a report in the German Der Spiegel, later denied by Greek officials, that the country was planning to leave the Eurozone dented the EUR,

Taken together with the improving trend in US April non-farm payrolls (April registered +244k increase, with private payrolls 268k), these factors colluded to provide further positive stimulus to the USD and negative fallout on the EUR. The room for EUR downside is evident in the net long EUR speculative position, which rose to its highest since December 2007 as of 3rd May.

This week’s batch of US releases including March trade data, April retail sales and CPI, are unlikely to result in a reversal in last week’s trend though a trend like reading for core CPI, with the annual rate below the Fed’s comfort zone will reinforce expectations of dovish Fed policy being maintained, which could inject a dose of caution into the USD’s rally.

Against the background of a likely widening in the US trade deficit in March there will plenty of attention on the annual strategic and economic dialogue beginning today, with markets interested in discussions on Chinese worries about the gaping US fiscal deficit and US concerns about China’s exchange rate policy.

Greece’s denial of plans to leave the eurozone and discussions over a further adjustment to Greece’s bail out package, may help limit any drop in the EUR this week though it will by no means mark the end of such speculation about the periphery especially with this weeks’ Q1 GDP data releases across the eurozone likely to further highlight the divergence between the core and the periphery even if the headline eurozone reading rebounds strongly as we expect.

In the UK the Bank of England Quarterly Inflation Report will be the main influence on GBP. Downward growth revisions will play into the view that inflation will eventually moderate, capping expectation of higher interest rates over the coming months. However, the likely upward revision to near term inflation forecasts will help limit any damage to GBP.

GBP has lost ground to the USD but it should be noted that it has outperformed the EUR over recent days, reversing some of the recent run up in EUR/GBP. Given that EUR sentiment is likely to remain fragile this week, GBP may continue to capitalise, with a test of EUR/GBP 0.8672 on the cards.

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Risk Aversion Creeps Higher

May 4, 2011 — Mitul Kotecha

The USD index has dropped by around 17% since June 2010 high and despite a slight bounce this week it is unlikely to mark the beginning of a sustained turnaround. Nonetheless, I would caution about getting carried away with positioning for USD weakness. Whilst an imminent recovery looks unlikely the risk/reward of shorting the USD is becoming increasingly unfavourable.

Until then Federal Reserve comments will be watched closely for clues on policy and there are plenty of Fed speakers this week including a speech by Boston Fed’s Rosengren today and Fed Chairman Bernanke tomorrow. The USD will also gain some direction from jobs data and markets will be able to gauge more clues for Friday’s non-farm payrolls data , with the release of the April ADP employment report today.

The EUR is one currency that has suffered this week. News that Portugal’s caretaker government has reached an agreement with the European Union / International Monetary Fund on a bailout of as much as EUR 78 billion has so far been greeted with a muted response. EUR attention is still very much focussed on the ECB meeting tomorrow and prospects of a hawkish press statement suggest that EUR/USD downside will be limited, with support seen around 1.4755.

The JPY has strengthened by around 5% versus USD since its 6th April USD/JPY high around 85.53, confounding expectations that Japan’s FX intervention following the county’s devastating earthquake marked a major turning point in the currency. A combination of narrowing interest rate differentials with the US (2 year US/Japan yield differentials have narrowed by around 20bps in the past month), strong capital inflows to Japan (net bond and equity flows in the last four weeks have increased to their highest this year), and rising risk aversion have all played their part in driving the JPY higher.

As a result USD/JPY is fast approaching the psychologically important level of 80, a level that if breached will likely lead to FX intervention. Although Golden Week holidays in Japan this week suggest that JPY liquidity may be quite thin, Japanese authorities are likely to remain resistant to further gains in the JPY, likely using thinning liquidity to their advantage.

Despite the JPY’s recent strength speculative positioning over the past four weeks has remained net short JPY, whilst Japanese margin traders have also increased their long USD/JPY bets, suggesting that these classes of investors are not to blame for the JPY’s appreciation. This suggests that FX intervention may not be as successful given that the market is already short JPY.

Given the risk of intervention on USD/JPY, the CHF appears to be an easier choice for safe haven demand against the background of rising risk aversion. The currency has risen to a record high against the USD, gaining around 8.3% so far this year. Given the hints of higher interest rates by the Swiss National Bank (SNB) and resilience economic performance, downside risks for CHF are limited at present unless risk appetite improves sharply. Further gains are likely with USD/CHF likely to test the 0.8570 support level over the short-term.

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RBA on hold, RBI hikes rates

May 3, 2011 — Mitul Kotecha

News of the death of Osama Bin Laden gave the USD a lift and its gains have extended for a second day. Extreme short market positioning as well as increasing risk aversion (perhaps due to worries about retaliation following Bin Laden’s death) have helped the USD.

However, the boost to the USD could be short-lived in the current environment in which it remains the preferred global funding currency. Indeed, the fact that US bond yields have dropped sharply over recent weeks continues to undermine the USD against various currencies.

The USD firmed despite the US ISM manufacturing index dropping slightly, albeit from a high level. The survey provided some useful clues to Friday’s US jobs report, with the slight decline in the employment component of the ISM survey to 62.7 consistent with a 200k forecast for April payrolls.

Ahead of the European Central Bank (ECB) meeting on Thursday hawkish rhetoric from new Council member and Bundesbank chief Weidmann (replacing Weber) and more reassurances from Greek and EU officials that there will be no debt restructuring or haircut on the country’s debt has helped the EUR although it is notable that it could not sustain a foot hold above 1.49. Eurozone bond yields have risen by around 20bps compared to US yields over the past month, a fact that suggests that the EUR may not fall far in the short-term.

USD/JPY is trading dangerously close to levels that may provoke FX intervention by the Japanese authorities. General USD weakness fuelled a drop in USD/JPY which has been exacerbated by a rise in risk aversion over recent days (higher risk aversion usually plays in favour of a stronger JPY). The biggest determinant of the drop in USD/JPY appears to a narrowing in bond yields (2-year bond yields have narrowed by around 20bps over the past month) largely due to a rally in US bonds.

Unsurprisingly the Reserve Bank of Australia (RBA) left its cash rate on hold at 4.75%. The accompanying statement showed little inclination to hike rates anytime soon, with credit growth noted as modest, pressure from a stronger exchange rate on the traded sector and temporary prices shocks which are expected to dissipate. The only indication that rates will eventually increase is the view that longer term inflation is expected to move higher.

I look for further rate hikes over coming months even with the AUD at such a high level. AUD has lost a bit of ground after hitting a high just above 1.10 against the USD and on the margin the statement is slightly negative for AUD. A slightly firmer USD overall and stretched speculative positioning, with IMM AUD positions close to their all time high, points to some downside risks in the short-term.

In contrast India’s central bank the RBI hiked interest rates by more than many expected. Both the repo and reverse repo rates were raised by 50bps, with the central bank governor highlighting renewed inflation risks in his statement. The decision reveals a shift in RBI rhetoric to an even more hawkish bias in the wake of rising inflation pressures, which should be beneficial to the rupee.

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Central bank decisions and US payrolls in focus

May 1, 2011 — Mitul Kotecha

The USD’s troubles are far from over. Data and events this week will do little to stop the rot. As US Federal Reserve Chairman Bernanke made clear last week the Fed is committed to completing its asset purchase programme by the end of June though there is plenty of debate about what comes after. Reduced growth forecasts and the Fed’s view that price pressures are “transitory” have been sufficient to keep the USD on its knees.

The weaker than expected reading for Q1 US GDP growth at 1.8% QoQ clearly did nothing to alleviate pressure on the USD even though it is widely believed that the soft growth outcome will prove fleeting, with recovery set to pick up pace over the coming months. In truth much will depend on the trajectory for oil prices, especially as petrol prices in the US verge on the psychologically important $4 per gallon mark. Even higher energy prices could dent growth further but lower or stable prices will keep the recovery on track.

The highlight in this holiday shortened week for many countries this week is the US April jobs report at the tail end of the week. Estimates centre on around a 200k gain in payrolls but forecasts will be refined with the release of the ADP private sector jobs report and ISM manufacturing survey earlier in the week. The unemployment rate may prove sticky and will likely remain at 8.8%, a disappointment to those looking for a quicker recovery. The elevated unemployment rate will only reinforce expectations that the Fed will not be quick to reverse policy, with the USD continuing to suffer as a result.

Central bank meetings will be plentiful this week, with the European Central Bank (ECB) and Bank of England (BoE) likely to garner most attention. Recent data in the Eurozone has provided further evidence of growth divergence between North and South, but the EUR has remained resilient to this as well as to increased concerns about the periphery. This make the ECB’s job even tougher than usual when it meets this week and it is unlikely that the Bank will hike rates again so soon, especially given the strength of the EUR. Nonetheless, Trichet will continue to sound hawkish, limiting any damage to the EUR (if any) of no move in policy rates.

Similarly the Bank of England will also remain on the sidelines though this should come as little surprise in the wake of disappointing data recently and a surprise drop in inflation, albeit to still well above the BoE’s target. GBP has made up ground against a generally weak USD but judged against other currencies it has been an underperformer as expectations of monetary tightening have been pared back. Finally, the Reserve Bank of Australia (RBA) is set to remain on hold, but a hike over coming months remains likely even with the AUD at such a high level. Quite frankly although the USD is looking increasingly oversold there is nothing this week that would suggest it will recover quickly.

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Australian Dollar Looking Stretched

April 7, 2011 — Mitul Kotecha

Central bank decisions in Japan, Europe and UK will dictate FX market direction today. No surprises are expected by the Bank of Japan (BoJ) and Bank of England (BoE) leaving the European Central Bank (ECB) decision and press conference to provide the main market impetus. Although a hawkish message from ECB President Trichet is likely the market has already priced in a total of 75 basis points of tightening this year. We retain some caution about whether the EUR will be able to make further headway following the ECB meeting unless the central bank is even more hawkish than already priced in.

EUR/USD easily breached the 1.4250 resistance level and will now eye resistance around 1.4500. News that Portugal formally requested European Union (EU) aid came as no surprise whilst strong German factory orders provided further support to the EUR. The data highlights upside risks to today’s February German industrial production data. The EUR will find further support versus the USD from comments by Atlanta Fed’s Lockhart who noted that he doesn’t expect the Fed to hike interest rates by year end.

USD/JPY is now around 7.5% higher than its post earthquake lows. Japanese authorities will undoubtedly see a measure of success from their joint FX intervention. To a large degree they have been helped by a shift in relative bond yields (2-year US / Japan yield differentials have widened by close to 30 basis points since mid March, and are finally having some impact on USD/JPY as reflected in the strengthening in short-term correlations. Whilst the BoJ is unlikely to alter its policy settings today the fact that it is providing plenty of liquidity to money markets, having injected around JPY 23 trillion or about 5% of nominal GDP since the earthquake, is likely playing a role in dampening JPY demand.

AUD/USD has appreciated by close to 6% since mid March and whilst I would not recommend selling as yet I would be cautious about adding to long positions. My quantitative model based on interest rate / yield differentials, commodity prices and risk aversion reveals a major divergence between AUD/USD and its regression estimate. Clearly the AUD has benefitted from diversification flows as Asian central banks intervene and recycle intervention USDs. However, at current levels I question the value of such diversification into AUD.

Speculative AUD/USD positioning as indicated by the CFTC IMM data reveals that net long positions are verging on all time highs, suggesting plenty of scope for profit taking / position squaring in the event of a turn in sentiment. Moreover, AUD gains do not match the performance of economic data, which have been coming in worse than expected over recent weeks. Consequently the risks of a correction have increased.

Posted in Australia, central banks, Currencies, ECB, Economics, Economy, Europe, eurozone, Federal Reserve, FX, Germany, Interest rates, Japan, Monetary Policy, Portugal, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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