Ratings rampage hits Euro

December 20, 2010 — Mitul Kotecha

Both the data flow and market liquidity will be thin over the last couple of weeks of the year. After a bashing over much of H2 2010 it looks as though the USD will end the year in strong form having risen by over 6% since its early November low. In contrast the EUR is struggling having found no support from the meeting of European Union officials at the end of last week in which they agreed to a permanent sovereign debt resolution after 2013 but failed to agree on expanding the size of the bailout fund (EFSF). Similarly there was no traction towards a common euro bond. EUR/USD is now verging on its 200-day moving average around 1.3102, a break of which could see a drop to around 1.2960.

The failure to enlarge the size of the EFSF was disappointing given worries that it is perceived to be insufficient to cope with the bailout of larger eurozone countries if needed. It also highlight that the burden on the European Central Bank (ECB) to prop up eurozone bond markets until confidence improves. The increase in the size of ECB capital from EUR 5.8 billion to EUR 10.8 billion will help in this respect. Such support was clearly needed last week following the rampage across Europe by ratings agencies culminating in Moody’s five notch downgrade of Ireland’s credit ratings, surprising because of its severity rather than the downgrade itself. Ireland’s ratings are now just two notches above junk status and the negative outlook could mean more to come.

It was not just Ireland’s ratings that came under scrutiny. Ireland’s multi notch downgrade followed Moody’s decision to place Greece and Spain on review for a possible downgrade whilst S&P revised Belgium’s outlook to negative. Unsurprisingly peripheral debt markets came under renewed pressure as a result outweighing positive news in the form of strong flash eurozone PMI readings and firm German IFO business confidence survey. EUR did not escape and sentiment for the currency remains weak, with CFTC IMM speculative positioning data revealing a fourth straight week of net EUR short positioning in the week to 14th December.

In contrast, sentiment for the US economy continues to improve. Congress’ swift passage of President Obama’s fiscal plan will help to shore up confidence in US recovery. Data this week will be broadly positive too. On Wednesday, US Q3 GDP data is likely to be upwardly revised to a 2.8% QoQ annualized rate. Durable goods orders excluding transportation are set to increase by a healthy 2.0% (Thu) whilst both existing (Wed) and new (Thu) home sales will reveal rebounds in November following a drop in the previous month.

In the UK the main highlight is the Bank of England (BoE) MPC minutes. Another three way split is expected but this should not cause more than a ripple in FX markets. GBP/USD has slipped over recent days but there appears to be little other than general USD strength responsible for this. The currency pair looks vulnerable to a drop below 1.5500, with 1.5405 seen as the next support level. On balance, the USD will be in good form this week although the drop in US bond yields at the end of last week may take some of the wind out of its sails.

Posted in Bond markets, central banks, Currencies, ECB, Economics, Economy, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Interest rates, Ireland, Monetary Policy, UK, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

FX sensitivity to yield

December 9, 2010 — Mitul Kotecha

It’s all about yield. The back up in US bond yields in reaction to the US tax compromise from the Obama administration has been particularly sharp. US 10 year bond yields jumped around 35bps this week prior to a small correction in yields overnight whilst 2s were up 21bps. US bond yields are now back where they were in June, a fact that makes a mockery out of the Fed’s attempts to drive bond yields lower via quantitative easing (QE). Yields elsewhere increased too but by a smaller degree whilst equity market sentiment has been dampened by the rise in global yields although US stocks still ended higher overnight.

There is plenty of commentary discussing the impact on currencies of the move in bond yields so it’s worth looking in more detail how sensitive FX markets have been to yield. The most sensitive currencies i.e. those with the highest 3-month correlations with relative bond yield differentials (2 year) are the AUD/USD, EUR/USD, and of course USD/JPY. However, there is less sensitivity to gyrations in 10 year yields with no currency pair registering a statistically significant correlation with 10-year bond yield differentials over the past 3-months.

Assuming that US bond yields continue to push higher into 2011, with much lager increases in both nominal and yields expected, this means that AUD, EUR and JPY will face the most pressure relative to the USD. Moreover, the stimulus measures agreed by the US administration will likely lead to many analysts penciling in higher growth forecasts over 2011 whilst reducing the prospects of QE3 from taking place, all of which is USD positive. I still retain a degree of caution in Q1 2011, especially with regard to a potential bounce in EUR, especially if the ECB becomes more aggressive in its bond buying, but even so, any EUR rally is likely to prove termporary.

The impact of higher US yields on the AUD may be more limited however, despite the high correlation with relative bond yields, as Australian bond yields are also likely to rise somewhat given the resilience of its economy. This was clearly demonstrated by Australian November employment data released overnight revealing yet another consensus beating outcome of +54.6k, with all the gains coming from full time employment. Against the background of a generally firm USD, the best way to play AUD resilience is via the NZD, with the currency pair likely break through resistance around 1.3220 (21 October high).

Posted in Australia, Bond markets, central banks, Currencies, Economics, Economy, equity markets, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Germany, Interest rates, Monetary Policy, UK, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Irish bailout leaves EUR unimpressed

November 29, 2010 — Mitul Kotecha

As has been the case since the beginning of the global financial crisis policy makers have found themselves under pressure to deliver a solution to a potentially destabilising or even systemic risk before the markets open for a new week in order to prevent wider contagion. Last night was no different and following urgent discussions a EUR 85 billion bailout for Ireland to be drawn down over a period of 7 ½ years was agreed whilst moves towards a permanent crisis mechanism were brought forward. As was evident over a week ago a bailout was inevitable but the terms were the main imponderable.

Importantly the financing rate for the package is lower than feared (speculation centered on a rate of 6.7%) but still relatively high at 5.8%. Moreover, no haircuts are required for holders of senior debt of Irish banks and Germany’s call for bondholders to bear the brunt of losses in future crises was watered down. The package will be composed of EUR 45 bn from European governments, EUR 22.5 bn from the IMF and EUR 17.5 bn from Ireland’s cash reserve and national pension fund.

The impact on the EUR was stark, with the currency swinging in a 120 point range and failing to hold its initial rally following the announcement. A break below the 200-day moving average for EUR/USD around 1.3131 will trigger a drop to around 1.3020 technical support. Officials will hope that the bailout offers the currency some deeper support but this already seems to be wishful thinking. The EUR reaction following the Greek bailout in early May does not offer an encouraging comparison; after an initial rally the EUR lost close to 10% of its value over the following few weeks.

Although it should be noted that the bailout appears more generous than initially expected clearly the lack of follow through in terms of EUR upside will come as a blow. The aid package has bought Ireland some breathing space but this could be short lived if Ireland’s budget on December 7 is not passed. Moreover, the bailout will not quell expectations that Portugal and perhaps even Spain will require assistance. Indeed, Portugal is the next focus and the reaction to an auction of 12-month bills on 1 December will be of particular interest.

Taken together with continued tensions on the Korean peninsular, position closing towards year end ongoing Eurozone concerns will likely see a further withdrawal from risk trades over coming weeks. For Asian currencies this spells more weakness and similarly commodity currencies such as AUD and NZD also are likely to face more pressure. The USD remains a net beneficiary even as the Fed continues to print more USDs in the form of QE2.

Data and events this week have the potential to change the markets perspective, especially the US November jobs report at the end of the week. There is no doubt that payrolls are on an improving trend (145k consensus) in line with the declining trend in jobless claims but unfortunately the unemployment rate is set to remain stubbornly high at 9.6% and this will be the bigger focus for the Fed and markets as it implies not let up in QE. As usual further clues to the payrolls will be garnered from the ADP jobs report and ISM data on Wednesday.

Posted in Bond markets, central banks, Currencies, Economics, Economy, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Germany, Greece, IMF, Interest rates, Ireland, Spain, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Edging Towards A Bailout

November 18, 2010 — Mitul Kotecha

A confluence of factors have come together to sour market sentiment although there appeared to be some relief, with a soft US inflation reading (core CPI now at 0.6% YoY) and plunge in US October housing starts reinforcing the view that the Fed will remain committed to carry out its full QE2 program, if not more.

However any market relief looks tenuous. Commodity prices remain weak, with the CRB commodities index down 7.4% in just over a week whilst the Baltic Dry Index (a pretty good forward indicator of activity and sentiment) continues to drop, down around 21% since its recent high on 27 October. Moreover, oil prices are also sharply lower. Increasingly the drop in risk assets is taking on the form of a rout and many who were looking for the rally to be sustained into year end are getting their fingers burnt.

Worries about eurozone peripheral countries debt problems remains the main cause of market angst, with plenty of attention on whether Ireland accepts a bailout rumoured to be up EUR 100 billion. Unfortunately Ireland’s reluctance to accept assistance has turned into a wider problem across the eurozone with debt in Portugal, Greece and also Spain suffering. An Irish bailout increasingly has the sense of inevitability about it. When it happens it may offer some short term relief to eurozone markets but Ireland will hardly be inspired by the fact that Greece’s bailout has had little sustainable impact on its debt markets.

Ireland remains the primary focus with discussions being enlarged to include the IMF a well as ECB and EU. What appears to be becoming clearer is that any agreement is likely to involve some form of bank restructuring, with the IMF likely to go over bank’s books during its visit. Irish banks have increasingly relied on ECB funding and a bailout would help reduce this reliance. Notably the UK which didn’t contribute to Greece’s aid package has said that it will back support for Ireland, a likely reaction to potential spillover to UK banks should the Irish situation spiral out of control. Any bailout will likely arrive quite quickly once agreed.

Although accepting a bailout may give Ireland some breathing room its and other peripheral county problems will be far from over. Uncertainties about the cost of recapitalising Ireland’s bank will remain whilst there remains no guarantee that the country’s budget on December 7 (or earlier if speculation proves correct) will be passed. Should Ireland agree to a bailout if may provide the EUR will some temporary relief but FX markets are likely to battle between attention on Fed QE2 and renewed concerns about the eurozone periphery, suggesting some volatile price action in the days and weeks ahead.

Reports of food price controls of and other measures to limit hot money inflows into China as well as prospects for further Chinese monetary tightening, are attacking sentiment from another angle. China’s markets have been hit hard over against the background of such worries, with the Shanghai Composite down around 10% over the past week whilst the impact is also being felt in many China sensitive markets across Asia as well as Australia. For instance the Hang Seng index is down around 7% since its 8 November high.

Posted in Asia, bank rescue, Bond markets, central banks, China, Commodities, Currencies, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Greece, IMF, Ireland, Monetary Policy, Singapore, South Korea, Spain, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

Caught In The Headlights

November 15, 2010 — Mitul Kotecha

For a prolonged period of time market attention had firmly focused on the Fed and prospects for quantitative easing (QE2). Now that QE has been delivered with little surprise, as the Federal Reserve arguably did a good job of living up to market expectations, it is Europe that is back in the limelight. Until recently the major surprise about Europe was how well the economy and the EUR were doing and how quickly the European Central Bank (ECB) would diverge from the Fed in its policy path.

This all looks premature and as if to confirm the shift in outlook the slowing in eurozone growth in Q4 (0.4% QoQ) revealed last week is likely to mark the beginning of a sharp and diverging deceleration in growth over coming quarters. The EUR may still have some life left in it given the ongoing purchases via recycled intervention flows from Asian central banks but weaker growth and peripheral worries are undermining this vestige of support.

Unfortunately for Europe the region is now not being caste in a good light and the peripheral trio of Ireland, Greece and Portugal are all staring into the headlights with nowhere to run. A crash of sorts seems inevitable but will there be any casualties? Markets are being whipsawed as they determine what will happen next in this slow motion saga.

Irish officials have maintained they do not need any aid package following discussions held over the weekend. Any bailout would likely come from a EUR 60 billion fund from the European Commission meaning a quick distribution but Ireland’s refusal will likely see pressure resume on peripheral debt markets in Europe as well as the EUR.

Portugal is also in the spotlight following comments by its foreign minister that the country may be forced to abandon the EUR if there is a failure to adopt a broad coalition government to deal with the crisis. This sounds like scaremongering but nonetheless highlights the political tensions in the country.

In Greece the second round of regional elections reveals the ruling Pasok party candidates are in the lead, reducing the prospect of early general elections. Nonetheless, this will do little to alleviate pressure as the EU is set to revise higher Greece’s 2009 deficit and debt estimates implying even more difficulty in meeting this year’s targets.

An EU/IMF team will visit Greece to assess progress as well as decide on whether the country should receive its 3rd instalment of a EUR 110 billion loan. Suggestions from PM Papandreou that he does not rule out having to extend the repayment of the loan will not auger well for sentiment. Finally, the government is set to present its 2011 final budget on Thursday, suggesting plenty of event risk this week.

A meeting of EU finance ministers tomorrow and Wednesday will also garner attention. Germany’s stance that investors will only have to take the brunt of losses from debt rescheduling only from 2013 still remains a contentious issue amongst officials even though it is a slightly softer stance than previously stated. Agreement on this as well as pressure on Ireland to accept funding will be key points of discussion.

Event wise, an auction of T-bills in Greece tomorrow as well as a Spanish debt auction on Thursday will be watched to determine how far the contagion of Irish woes have spread. The news is unlikely to be good, with higher yields likely. Unfortunately tomorrow’s German November ZEW investor confidence survey will provide further signs of retreating investor sentiment in the wake of renewed peripheral debt concerns.

Posted in Currencies, Economics, Economy, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Germany, Greece, IMF, Interest rates, Ireland, Monetary Policy, Portugal, Spain, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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