US dollar tracking Treasury yields

May 2, 2012 — Mitul Kotecha

Despite the firmer tone to risk appetite the USD index moved higher tracking the move in US Treasury yields. Indeed, the USD’s reaction was actually opposite to what would be expected given the rally in risk assets but its move clearly reflects the growing influence of yields.

The surprisingly robust April ISM manufacturing survey following the disappointing Chicago PMI for the same month highlights that recovery is not straightforward, suggesting that USD gains will also not be straightforward.

March factory orders are on tap today but the bigger focus will be on the April ADP jobs report, which will give important clues to Friday’s payrolls data. Expectations centre on a 170k outcome for the ADP report, a smaller increase than the 209k registered in March. In the meantime I expect the USD to hold its gains.

As noted at the start of the week EUR/USD was poised to edge higher despite the bad economic news emerging from the region. EUR/USD has continued to strengthen over recent weeks despite the release of data showing Eurozone economic underperformance relative to the US. A case in point is the April Eurozone purchasing manager’s data to be released today, which will reveal further weakness, especially in peripheral countries.

Some easing in peripheral bond yields has helped to support sentiment for the EUR leading to further short covering in the currency but further gains are expected to be limited. EUR/USD now sits around the middle of its 1.30-1.35 range but further upside will be restricted ahead of the key US jobs data on Friday. EUR/USD resistance is seen around the 1.3385 level.

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Dollar still in a stupor

April 23, 2012 — Mitul Kotecha

The increase in the International Monetary Fund’s (IMF) funding by $430 adds another layer of firepower to provide help to the Eurozone periphery should it be required. Nonetheless, many other worries continue to afflict markets suggesting that any positive boost will be short lived. There are plenty of data and events this week including central banks in the US, Japan and New Zealand. Additionally US corporate earnings will remain in focus while bond auctions in the Eurozone will also provide direction. I continue to see risk aversion creeping higher against this background.

It is unlikely that the FOMC meeting tomorrow and Wednesday will provoke any change in the currently low FX volatility environment given that policy settings will remain unchanged, with the majority of FOMC members likely to look for the first tightening at the earliest in 2014. The Fed is therefore unlikely to wake the USD out of its stupor and if anything a softening in durable goods orders, little change in new home sales and a pull back in consumer confidence will play in favour of USD bears over coming days. Even a relatively firm reading for Q1 GDP will be seen as backward looking given the slowing expected in Q2.

The EUR will have to contend with political events as it digests the aftermath of the first round of the French presidential elections. The fact that the political process will continue to a second round on 6 May could act as a constraint on the EUR. Various ‘flash’ purchasing managers indices (PMI) readings and economic sentiment gauges will offer some fundamental direction for the EUR but largely stable to softer readings suggest little excitement. Consequently EUR/USD will largely remain within its recent range although developments in Spain and Italy and their debt markets will have the potential to invoke larger moves in EUR.

The JPY is usually quite insensitive to Japanese data releases and this is unlikely to change this week. Key releases include March jobs data, CPI inflation, industrial production and retail trade. Although inflation has moved into barely positive territory the BoJ is still set to increase the size of its asset purchase programme. This will act as a negative factor for the JPY but unless US Treasury yield differentials renew their widening trend against Japanese JGB yields and drop in the JPY will be limited.

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Euro and Yen capitalise on weaker Dollar

April 13, 2012 — Mitul Kotecha

Equities continued their bounce back overnight helped by a reiteration from Fed officials that US monetary policy will remain highly accommodative through late 2014. Risk assets overcame a weaker than expected report on US jobless claims, with a smaller than expected trade deficit in February ($46 billion) helping sentiment. The launch of a North Korean missile which apparently failed did little to dent sentiment. Nonetheless, Spanish concerns continue to weigh on its markets, bucking the trend of improvement elsewhere.

Today’s data slate has little in terms of first tier data on tap, with inflation releases in Europe and the US in focus. The bigger influence will be a slate of Chinese data including Q1 GDP. The market has already priced in a good number (around 9% YOY) and therefore there is a risk of disappointment, which could hit risk assets. Also watch out for earnings from US financials including JP Morgan and Wells Fargo. So far US earnings have been positive, although admittedly its early days yet.

Downward pressure on EUR/USD has lessened for the time being and any further decline will be limited in the short term. While it is evident that the boost to markets provided by the European Central Bank’s Long Term Refinancing Operation (LTRO) has faded, EUR bears have been dealt a blow from renewed prospects of securities market purchases.

Italy’s debt auction yesterday provided little help to the EUR but at least it was not cause of further selling pressure. Concerns about Spain continue but any further downside pressure on EUR/USD will be restricted to technical support around the 1.3004 level (March 15 low), with EUR/USD set to remain in a 1.30-1.32 range.

JPY has pulled back sharply against the USD over the past month as I repeatedly warned. But before I blow my own trumpet any further I would note that further downside risks to USD/JPY remain in place although the room is now more limited than in previous weeks. According to my quantitative model a drop to around 79.00 is likely to mark a low in USD/JPY.

Warnings by the Bank of Japan of more “powerful” monetary easing have helped to prevent further JPY strengthening over recent sessions. However, a renewed narrowing in the US 2-year bond yield advantage over Japan will likely limit any upside for USD/JPY as reflected in the extremely strong correlation between USD/JPY and yield differentials over the past 3-months.

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FX volatility declining, AUD still vulnerable

March 29, 2012 — Mitul Kotecha

FX options appear to be increasingly comfortable with the current lack of movement in currencies. For example, 3-month EUR/USD implied volatility has dropped to multi-year lows while my measure of G3 implied volatility has been at very low levels over recent months.

This has corresponded with the drop in risk aversion as market fears over US growth and Eurozone debt issues recede. Over the short term there appears to be little to jolt markets out of their stupor and if anything EUR/USD is likely to continue to drift higher according to our short term quantitative models.

Indeed, firmer risk appetite, despite the odd hiccup, plays positively for the EUR while the pull back in US bond yields has restrained the USD. The Ecofin meeting beginning tomorrow will likely give further support to the EUR, if as expected, ministers bolster the Eurozone ‘firewall’.

It has been a one step forwards, two steps back motion for AUD/USD over recent weeks as it continues to edge lower. Although US bond yields have pulled back Australian yields have pulled back relatively more, reducing Australia’s yield advantage and weighing on the AUD in the process.

Over recent weeks speculative AUD positioning has also fallen, reflecting deteriorating sentiment for the currency, but the fact that the market is still long suggests scope for further short term downside.

Aside from yield differentials most of the usual correlations with AUD have broken down suggesting that the AUD is getting a dose of independent weakness. However, China news remains a key focal point for AUD and the decline in the Shanghai composite stock index has become an interesting lead indicator for AUD performance. Over the near term AUD will likely continue to weaken in jagged steps.

Dear readers please note that there will be very limited updates of econometer.org over the next couple of weeks due to my Easter vacation.

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USD pressured by drop in yield

March 26, 2012 — Mitul Kotecha

Risk sentiment starts the week in positive mode. Weekend reports that Germany will not stand in the way of allowing the (European Financial Stability Facility) EFSF and its successor the European Stability Mechanism (ESM) bailout funds to be combined to boost the ‘firewall’ against contagion in the Eurozone has helped to boost sentiment.

Market direction may be obscured by month end and quarter end window dressing this week and despite the likely positive start to the week there are still plenty of factors to dent risk appetite over coming days, not least of which is the gyrations in oil prices.

The USD has slipped over recent days in line with a pull back in US Treasury bond yields. Notably there has also been a pull back in speculative USD sentiment as recorded in the CFTC IMM data. The ‘risk on’ tone to market that appears to be developing today will likely result in renewed downside risks to the currency.

US economic data continues to outshine economic releases elsewhere although US housing data last week was notably mixed. It will be the turn of March consumer confidence and February durable goods orders to capture the market’s attention over coming days.

A slight decline in the former and a healthy increase in the latter are expected. However, it seems unlikely that either release will be particularly supportive for yields and in turn the USD, so it will require a further increase in risk aversion to push the USD higher over coming days.

EUR/USD appears to be settling into the middle of a 1.30-1.35 range. Direction has increasingly been led by economic factors rather than debt issues recently but the news on the former has not been particularly good.

The March German IFO today and EU Finance Ministers meeting will be the key events of the week while there will also be interest on Spain’s budget as well as Spanish and Italian debt auctions. The IFO will likely prove to be more positive for the EUR than the manufacturing surveys last week, with an uptrend in the data continuing.

Moreover, hopes that Finance Ministers will bolster the ‘firewall’ to prevent other peripheral countries from repeating Greece’s debacle, will also likely keep the EUR supported. Overall, this implies EUR/USD will likely continue to creep higher over the week, with a test of technical resistance around 1.3356 eyed.

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