US Dollar Upside, Euro tensions

February 14, 2011 — Mitul Kotecha

Following the famine that was last week this week will see a feast of data releases, which hopefully will give some clearer direction to currency markets. The key eurozone data focus for FX markets will be the German February ZEW survey and it should highlight that investor confidence is bouncing back smartly. This will be accompanied by data showing a slight acceleration in GDP in the eurozone in Q4 2010. Good news, but the reality is that the EUR is being driven more by peripheral bond tensions and relative yields.

Although the EUR may get a brief lift from the news of the resignation of Egypt’s President Mubarak this will likely prove temporary. Given that tensions are beginning to creep higher EUR/USD may struggle to make any headway this week and will more likely slip below 1.3500 for a test of 1.3440 as sentiment sours. Even the usual sovereign interest may look a little more reluctant to provide support this week. The net long positioning overhang as reflected in the CFTC IMM data suggests some scope for a squaring in long positions, likely accelerating any downside pressure.

As usual data releases are failing to have a major impact on the JPY whilst interest rate / yield differentials suggest the JPY should be much weaker. One explanation for the stubbornly strong JPY is the strength of recent portfolio inflows to Japan, especially into its bond markets. This could reverse quickly and IMM positioning suggests that the potential for a shakeout of long positioning looms large, something that many Japanese margin traders are well positioned for according to TFX data. USD/JPY 84.51 will provide firm resistance to a move higher in the short-term.

GBP will be guided by the Bank of England Quarterly Inflation Report on Wednesday as well as the January CPI and retail sales data. The Report will reveal that inflation moderates over the medium term, even if short-term projections are shifted higher. Consequently, interest rate markets may even pare back overly hawkish expectations for UK rates, leaving GBP vulnerable. Nonetheless, markets maybe somewhat more sceptical or at least nervous in light of a likely increase in UK CPI, albeit mostly due to the increase in value added tax (VAT) at the turn of the year. Moreover, GBP may find some solace from a rebound in retail sales in January.

Overall, GBP/USD will take its cue from EUR/USD and the currency is vulnerable to a sustained drop below 1.6000 this week. The fact that GBP/USD IMM positioning is at its highest since September 2008 suggests a lot of scope for a sell-off. EUR/GBP looks like its consolidating in an even narrower range between 0.8400-0.8500.

Another positive slate of US data releases and likely more pressure on US bond markets this week suggest that the USD will find further support, with the USD index likely to take a shot at the 79.00 level. Indeed a further improvement in both the Philly Fed and Empire manufacturing surveys is expected, providing more evidence of strengthening manufacturing momentum, will be borne out in the hard data, with a healthy gain in industrial output expected. Similarly a healthy reading for US retail sales will support the evidence that the US consumer is in full recovery mode.

The positive impact on the USD may be dampened however, by benign inflation readings this week, supporting the view that US policy rates will not be raised for a long time yet. This is likely to be echoed in the Fed FOMC minutes this week. Nonetheless, speculative positioning suggests plenty of scope for short USD covering, with the latest CFTC IMM report revealing the biggest net short position since October 2010.

Econometer.org has been nominated in FXstreet.com’s Forex Best Awards 2011 in the “Best Fundamental Analysis” category. The survey is available at http://www.surveymonkey.com/s/fx_awards_2011

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China Hikes Rates, More On the Cards

February 9, 2011 — Mitul Kotecha

In an otherwise unexciting day China livened things up by raising its 1 year deposit and lending rates by 25 basis points. The hike, the third in the last four months, should not have come as a surprise, given the growing emphasis by China’s central bank PBoC, to dampen inflation pressures. Indeed, more hikes are on the cards, with at least another two more in prospect over H1. The other tool to combat inflation is CNY appreciation further gains in the currency over coming months should be expected to around 6.3 by year-end versus USD.

Global markets largely shrugged of China’s move, with generally positive market sentiment continuing. Even in the eurozone, where there was some disappointment at the surprise drop in German December industrial production, market sentiment continued to improve as Egypt and local debt worries eased further. EUR was particularly resilient despite calls from a Belgian think tank that Greece needs to restructure its debt to avoid a long and painful path ahead. Commodity currencies also showed impressive resilience to China’s rate hike, with both the AUD and NZD holding up well.

The overall positive risk background is supportive for Asian currencies and other risk trades. Currencies in Asia remain highly correlated with portfolio capital inflows and so far this year the weakness in the INR and THB has matched the strong equity outflows from India and Thailand. However, this appears to be reversing, especially in the case of India registering positive equity flows this month, helping the INR to reverse some of its losses.

In the absence of key data releases markets will turn their attention to the testimony by Fed Chairman Bernanke to the House budget committee where he will give comments on the economy, jobs and the budget. Dallas Fed’s Fisher stated overnight that whilst he expects the Fed to complete QE2 he would not support another round of quantitative easing. Fisher’s comments on QE were similar to Atlanta Fed’s Lockhart who notes there is a “high bar” for more QE. Bernanke is unlikely to deviate from this tone in his speech today whilst also maintaining his view that there should be a long term commitment to fiscal retrenchment.

Against the background of improving risk appetite the USD is likely to stay under mild pressure although it is difficult to see a break of recent ranges for most currency pairs. EUR/USD ought to find strong support around its 100-day moving average 1.3535 whilst USD/JPY will be supported around 81.10. Equity sentiment is being supported by US data which remains encouraging. On cue the NFIB Small Business Optimism index duly rose in January to 94.1 as sentiment in this sector continued its improving trend.

Taken together with firmer equities, encouraging data is taking its toll on US bond markets, resulting in a back up in yields. Bond market sentiment wasn’t helped by a relatively poor 3-year auction. For example, US 2-year bond yields have backed up by over 30bps since 28 January. Bad news for bond is good news for the USD however, as higher relative US bond yields will likely help prevent a deeper USD sell-off, with EUR/USD in particular most reactive to relative eurozone / US bond yield differentials.

Econometer.org has been nominated in FXstreet.com’s Forex Best Awards 2011 in the “Best Fundamental Analysis” category. The survey is available at http://www.surveymonkey.com/s/fx_awards_2011

Posted in Asia, Australia, central banks, China, Commodities, Currencies, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Greece, India, Interest rates, Japan, Monetary Policy, South Korea, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Egypt Unrest Hits Risk Trades

January 29, 2011 — Mitul Kotecha

Recent weeks have seen a real contrast in policy and growth across various economies. A case in point was the surprise drop in UK GDP in Q4 contrasting sharply with the solid (albeit less than forecast) rise in US Q4 2010 GDP. The resilience of the US consumer was particularly evident in the data. The European Central Bank’s (ECB) hawkish slant as reflected in comments from President Trichet compared to the dovish pitch of the Fed FOMC is another clear contrast for markets to ponder.

The ECB’s hawkish tone gave the EUR a lift but expectations of an early Eurozone rate hike looks premature. Although Eurozone inflation data (Monday) will reveal a further rise in CPI above the ECB’s target, to around 2.4% in January, this will not equate to a policy rate hike anytime soon. This message is likely to be echoed at this week’s ECB meeting where policy will be characterised as “appropriate”.

Whilst monetary tightening expectations look overdone in the Eurozone the same can be said for hopes of an expansion in the EU bailout fund (EFSF). Indeed, the fact that EU Commissioner Rehn appeared to pour cold water over an expansion in the size of the fund could hit the EUR and the currency may find itself struggling to extend gains over coming weeks especially if interest rate expectations return to reality too, with a move to EUR/USD 1.4000 looking far harder to achieve than it did only a few days ago.

It’s worth noting that a renewed widening in peripheral debt spreads will also send an ominous signal for the EUR. Against this background the EU Council meeting on February 4 will be in focus but any expectation of a unified policy resolution will be disappointed.

However, markets perhaps should not solely focus on peripheral Europe as the downgrading of Japan’s credit ratings last week highlights. Warnings about US credit ratings also demonstrate that the US authorities will need to get their act together to find a solution to reversing the unsustainable path of the US fiscal deficit, something that was not particularly apparent in last week’s State of the Union Address.

Last week ended with a risk off tone filtering through markets as unrest in Egypt provoked a sell-off in risk assets whilst worries about oil supplies saw oil prices spike. Gold surged on safe haven demand too. This week, markets will focus on events in the Middle East but there will be thinner trading conditions as Chinese New Year holidays result in a shortened trading week in various countries in Asia.

The main release of the week is the US January jobs report at the end of the week. Regional job market indicators and the trend in jobless claims point to a 160k gain in January although the unemployment rate will likely edge higher. Final clues to the payrolls outcome will be deemed from the ISM manufacturing confidence survey and ADP private sector jobs report this week. Whilst the January jobs report is unlikely to alter expectations for Fed policy (given the elevated unemployment rate) the USD may continue to benefit from rising risk aversion.

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Interest rate and FX gyrations

January 27, 2011 — Mitul Kotecha

Following a brief rally at the start of the year the USD has found itself under growing pressure in the wake of widening interest rate differentials versus many other currencies. In particular, the contrasting stance between the hawkish rhetoric (bias for tighter monetary conditions) from European Central Bank (ECB) President Trichet and the relatively dovish US Federal Reserve stance as highlighted in the 26th January FOMC statement has provided more fuel to the widening in interest rate expectations between the US and eurozone. Since the end of last year interest rate differentials have widened by around 31 basis points in favour of the EUR (second general interest rate futures contract).

The Fed remains committed to carrying out its full $600 billion of asset purchases by end Q2 2011 whilst the ECB appears to be priming the market for a scaling back of its liquidity operations. Whilst there may be more juice in EUR over the short term based on the move in interest rate differentials as well as improved sentiment towards the eurozone periphery the upside potential for EUR/USD is looking increasingly limited. Even European officials are beginning to inject a dose of caution, with the ECB’s Nowotny stating that markets are too euphoric over a potential enlargement of the European Financial Stability Facility (EFSF) bailout fund. Indeed, it is highly likely that the euphoria fades quickly once it becomes apparent that enlarging the bailout fund is by no means a panacea to the region’s ailments.

GBP is another currency that has undergone sharp gyrations over recent days in the wake of a shift in interest rate expectations. A surprise 0.5% quarterly drop in UK Q4 GDP (which could not all be blamed on poor weather) set the cat amongst the pigeons and gave a GBP a thrashing but much of this was reversed following the release of Bank of England Monetary Policy Committee (MPC) minutes which revealed a hawkish shift within the MPC, with two dissenters voting for a rate hike and most members agreeing that the risks to inflation has probably shifted higher.

Does this imply an imminent rate hike? No, a policy rate hike closer to the end of the year appears more likely. BoE Governor King provided support to this view, in a speech that was interpreted as dovish, with the governor once again highlighting the temporary nature of the current rise in inflation pressure. Consequently UK interest rate expectations have shifted back and forth over recent days, but still remain wider relative to the US since the start of the year. GBP/USD has of course benefitted, but given worries about growth and the dovish message from King, it is unlikely that rate differentials will widen much further. Consequently GBP/USD is unlikely to make much if any headway above 1.6000.

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Euro Sentiment Jumps, USD Sentiment Dives

January 24, 2011 — Mitul Kotecha

The bounce in the EUR against a broad range of currencies as well as a shift in speculative positioning highlights a sharp improvement in eurozone sentiment. Indeed, the CFTC IMM data reveals that net speculative positioning has turned positive for the first time since mid-November. A rise in the German IFO business confidence survey last week, reasonable success in peripheral bond auctions (albeit at unsustainable yields), hawkish ECB comments and talk of more German support for eurozone peripheral countries, have helped.

A big driver for EUR at present appears to be interest rate differentials. In the wake of recent commentary from Eurozone Central Bank (ECB) President Trichet following the last ECB meeting there has been a sharp move in interest rate differentials between the US and eurozone. This week’s European data releases are unlikely to reverse this move, with firm readings from the flash eurozone country purchasing managers indices (PMI) today and January eurozone economic sentiment gauges expected.

Two big events will dictate US market activity alongside more Q4 earnings reports. President Obama’s State of The Union address is likely to pay particular attention on the US budget outlook. Although the recent fiscal agreement to extend the Bush era tax cuts is positive for the path of the economy this year the lack of a medium to long term solution to an expanding budget deficit could come back to haunt the USD and US bonds.

The Fed FOMC meeting on Wednesday will likely keep markets treading water over the early part of the week. The Fed will maintain its commitment to its $600 billion asset purchase program. Although there is plenty of debate about the effectiveness of QE2 the program is set to be fully implemented by the end of Q2 2011. The FOMC statement will likely note some improvement in the economy whilst retaining a cautious tone. Markets will also be able to gauge the effects of the rotation of FOMC members, with new member Plosser possibly another dissenter.

These events will likely overshadow US data releases including Q4 real GDP, Jan consumer confidence, new home sales, and durable goods orders. GDP is likely to have accelerated in Q4, confidence is set to have improved, but at a low level, housing market activity will remain burdened by high inventories and durable goods orders will be boosted by transport orders. Overall, the encouraging tone of US data will likely continue but markets will also keep one eye on earnings. Unfortunately for the USD, firm US data are being overshadowed by rising inflation concerns elsewhere.

Against the background of intensifying inflation tensions several rate decisions this week will be of interest including the RBNZ in New Zealand, Norges Bank in Norway and the Bank of Japan. All three are likely to keep policy rates on hold. There will also be plenty of attention on the Bank of England (BoE) MPC minutes to determine their reaction to rising inflation pressures, with a slightly more hawkish voting pattern likely as MPC member Posen could have dropped his call for more quantitative easing (QE). There will also be more clues to RBA policy, with the release of Q4 inflation data tomorrow.

Both the EUR and GBP have benefitted from a widening in interest rate futures differentials. In contrast USD sentiment has clearly deteriorated over recent weeks as highlighted in the shift in IMM positioning, with net short positions increasing sharply. It is difficult to see this trend reversing over the short-term, especially as the Fed will likely maintain its dovish stance at its FOMC meeting this week. This suggests that the USD will remain on the back foot.

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