Plenty of event risk

October 17, 2011 — Mitul Kotecha

This week is heavy with event risk, with a lot expected from EU leaders. So far the risk on tone to markets has held up, with for example the VIX fear gauge resting below the key 30.0. The G20 meeting over the weekend set the deadline for action for concrete solutions to the eurozone debt crisis for the October 23 EU Summit.

However, there will be little detail on issues such as banking sector recapitalisation, private sector involvement in any debt restructuring or ‘leveraging’ the EFSF bailout fund until the report on Wednesday night by the Troika on Greece. The reward to EU leaders would be the potential for more aid from the IMF but even now it seems that a German government official has poured cold water of a plan being announced at the EU Summit which will disappoint markets.

There are also plenty of data releases for markets to digest over coming days including inflation releases, manufacturing surveys and industrial production data in the US while in Europe the German IFO and ZEW surveys are scheduled for release. The data will follow on from the better than expected September US retail sales releases at the end of last week continuing to dampen expectations that the global economy is falling in recession though there will be a marked deceleration in European data.

Meanwhile the US Q3 earnings season rolls. The risk on tone will likely continue to weigh on the USD and weigh on bonds but unlike a few weeks ago when a lot of bad news was priced in, the scope for disappointment is becoming increasingly high.

Many currencies remain highly correlated with gyrations in risk and in this respect the improvement in risk appetite is good news for high beta / commodity. AUD, NZD, CAD and JPY are amongst the most sensitive currencies and therefore prone to a bigger reaction as risk improves, with the former three strengthening and the JPY weakening. Asian currencies poised to benefit from firmer risk appetite include INR and KRW, both with relatively high correlations with risk.

EUR/USD has made a solid recovery over recent days from its lows around 1.3146 spurred by hopes of action by European officials. Such hopes may yet be dashed but the EUR looks supported over coming days ahead of the EU summit Speculative positioning also reflects a slight improvement in EUR sentiment as IMM short positions have declined in the last week but its worth noting that this week’s European data are unlikely to be supportive for the EUR.

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High Hopes

October 11, 2011 — Mitul Kotecha

EUR/USD has rallied over recent days from a low around 1.3146 last week. Market hopes of a eurozone solution may fall flat but the pressure on officials has ratcheted higher, and the risks of failure are now too significant to jeopardize with half measures. Weekend promises of banking sector recapitalisation by Germany and France have helped but will not be enough should such promises prove empty. Markets will likely give the benefit of the doubt to eurozone officials ahead of the delayed October 23 EU Summit and the November 3 G20 meeting.

Consequently EUR will find some support over coming days and could extend gains as risk appetite improves; having broken above 1.3600 the next big resistance level for EUR/USD is 1.3800. The fact that EUR speculative positioning is very negative (biggest short position since June 2010 according to IMM data) highlights the potential for short covering.

Possible good news in Greece, with an announcement by the Troika (ECB, EU and IMF) on talks over the next tranche of the bailout will likely provide more EUR support. One stumbling block for the EUR could come from the Slovakian vote on EFSF bailout fund enhancement, which is by no means guaranteed to pass.

The JPY remains firm benefitting from higher risk aversion, registering one of the highest correlations with risk over recent months. However, the reason why the JPY is not even stronger is that bond yield differentials (especially 2-year) with the US have widened out in favour of the USD over recent days. If the recent improvement in risk appetite continues, combined with widening yield differentials it could push USD/JPY to finally move higher and sustain a break above 77.00.

GBP/USD has made an impressive bounce over recent days from a low around 1.5272 last week despite the Bank of England’s announcement of more quantitative easing last week and credit ratings downgrades of several UK banks. This resilience is impressive but it appears that GBP is caching onto the coat tails of a firmer EUR rather than benefitting from a domestically led improvement in sentiment. Nonetheless, there is scope for further gains in GBP given that speculative positioning in the currency moved close to its all time low early last week in anticipation of BoE QE.

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Waiting for a solution to Europe’s crisis

September 30, 2011 — Mitul Kotecha

The boost to sentiment following Germany’s approval of changes to the EFSF bailout fund was brief. Although the outcome of the vote was not particularly surprising political concerns were assuaged by the fact that Chancellor Merkel secured support from within her coalition. Markets were also helped by a bigger than expected drop in weekly US jobless claims but this also failed to provide a lasting impact.

The bottom line is that there is still a huge degree of scepticism on the ability of policymakers to resolve the crisis in the eurozone periphery while growth worries have not receded. Even the approved changed to the EFSF bailout fund are increasingly being seen as old news given the view that it will need deeper changes including ‘leveraging’ it up.

Consequently risk aversion remains at a highly elevated level and is showing no sign of easing. It may be difficult to turn sentiment around as we go into the final quarter of the year, especially as those investors registering profits for the year may want to capitalise on these profits rather than sit through continued volatility in the weeks ahead. Indeed the sharp drop in gold prices over the last couple of weeks even in an environment of elevated risk aversion may reflect this.

Similarly risk assets may struggle to recover over coming weeks unless there is a major improvement in the situation in Europe or in growth data. Markets will go into the end of this week looking ahead to key events next week including an Ecofin meeting at the beginning of next week, a European Central Bank (ECB) meeting and the US September jobs report.

There will be plenty of attention on the Ecofin meeting of European Finance Ministers on Monday especially given that much of the reason for the stability in markets recently is the hope of concrete measures to resolve the crisis in the region. In this respect the scope for disappointment is high, suggesting that the EUR is vulnerable to a further drop.

While the extent of short market positioning at the beginning of week left open some scope for EUR short covering the absence of any good news will mean the impetus for short covering diminishes. Unless the Ecofin meeting delivers on expectations EUR/USD will likely re-test the 26 September low around 1.3363.

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Euro vulnerable to event risk

September 26, 2011 — Mitul Kotecha

The USD is benefitting in the current environment of elevated risk aversion reflected in a jump in USD speculative positioning over recent weeks, with current IMM positioning currently at its highest since June 2010.

Admittedly there is still plenty of scope for risk aversion to intensify but what does this mean for the USD? The USD index is currently trading just over 78 but during the height of the financial crisis it rose to around 89, a further gain from current levels of around of around 14%.

The main obstacle to further USD strength in the event of the current crisis intensifying is if the Fed implements QE3 but as the Fed has indicated this is unlikely to happen anytime soon, as “Operation Twist” gets underway.

Now that the Fed FOMC meeting is out of the way markets will also be less wary of buying USDs as the prospect of more QE has diminished for now. Data this week will likely be USD supportive too, with increases in consumer confidence, durable goods orders, an upward revision to Q2 GDP expected.

The EUR remains highly vulnerable to event risk this week. Various votes in eurozone countries to approve changes to the EFSF bailout fund will garner most attention in FX markets, with the German vote of particular interest although this should pass at the cost of opposition from within Chancellor Merkel’s own party.

The EUR may garner some support if there is some traction on reports of a three pronged approach to help solve the crisis which includes ‘leveraging’ the EFSF fund, large scale European bank recapitalisation and a managed default in Greece, but there has been no confirmation of such measures.

Meanwhile, the potential for negotiations between the Troika (EC, IMF, ECB) and the Greek government to deliver an agreement on the next loan tranche for the country has increased, which could also offer the EUR a boost this week, albeit a short lived one.

Speculation of a potential European Central Bank (ECB) rate cut has increased a factor that could undermine the EUR depending on whether markets see it as growth positive and thus EUR positive or as a factor that reduced the EUR’s yield attraction. There is also more speculation that the ECB will offer more liquidity in the form of a 1-year operation but once again there has been no confirmation.

A likely sharp drop in the German IFO survey today and weakness in business and economic confidence surveys on Thursday will support the case for a rate cut, while helping to maintain the downward pressure on the EUR.

Given the potential for rumours and events to result in sharp shifts in sentiment look for EUR/USD to remain volatile, with support seen around 1.3384 and resistance around 1.3605.

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Euro fails too hold on to gains

September 19, 2011 — Mitul Kotecha

Any improvement in sentiment following the USD liquidity support announcement by various central banks last week is already filtering away against the background of European Union (EU) officials’ failure to make any headway at the Ecofin meeting over the weekend, a delay in the approval of the next bailout tranche for Greece and ongoing collateral dispute between Greece and Finland. On top of all of this German Chancellor Merkel suffered a further setback in regional elections over the weekend.

Greece will remain in focus this week and markets will look for signs that the country is back on track on its austerity plans and its next loan tranche. Prime Minister Papandreou cancelled a trip to the US while the Greek cabinet are apparently deciding on new fiscal measures. Attention will turn to a teleconference today from the Greek Finance Minister with EU and IMF officials.

Speculative sentiment for the EUR has already soured further and according to the latest CFTC IMM report, positioning in EUR is at its lowest since the end of June 2010. EUR/USD will continue to look very vulnerable having already dropped sharply from a high of around 1.3899 in Asian morning trading as the bad weekend news hit the currency. EUR/USD will find some technical support just below 1.3500 this week but any upside is set to prove limited unless some concrete announcements are delivered relating to Greece over coming days.

In contrast to the EUR, USD speculative appetite has turned net long for the first time since July 2010. The extended Fed FOMC meeting will help to dictate USD sentiment as markets wait for further measures to stimulate the economy. The Federal Reserve has already committed to hold rates steady until at least mid 2013 and the extended two day meeting this week will likely discuss further options. However, more quantitative easing (QE3) appears unlikely at this stage while an ‘Operation Twist’ type approach is more probable. The USD will benefit from a lack of further quantitative easing but this is largely already priced in.

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