Lots of event risk in the days ahead

November 3, 2009 — Mitul Kotecha

Fears about yet another market crash in October proved unfounded but there were severe bouts of nervousness during parts of the month.  This was hard to tie in with the strength of earnings and continued good news on the economic front but perhaps markets had already priced in a lot of good news.   This was evident in the fact that economic surprises were becoming increasingly negative.

Nervousness is good for the dollar and has at least given the currency a semblance of support.   However, not all the economic news is coming in below forecast as demonstrated by the stronger than consensus reading for the US ISM index for October whilst even the eurozone PMI moved back into expansion territory following 17 months of contraction.

The tone over the rest of the week will depend on the outcome of several central bank meetings the main ones being the Fed, ECB and BoE as well as the US non-farm payrolls report.  None of the central banks are likely to hike rates but in an FX market that is becoming increasingly reactive to interest rate differentials whichever bank sounds relatively more hawkish will see their respective currency strengthen the most.

Unless the Fed sounds particularly dovish the dollar is likely to consolidate further over the short term and given the still significant size of dollar short positioning there is still some scope for some further relief for the dollar.   However, don’t expect much movement out of current ranges until after the payrolls report and even then markets may be hesitant ahead of this weekend’s G20 meeting.

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US dollar and equity gyrations

October 21, 2009 — Mitul Kotecha

Although there appears to be some consolidation at present the USD remains on a steady downward path and is likely to continue to face a combination of both cyclical and structural negative forces.  Cyclical pressure will come from the extremely easy monetary policy stance of the Fed as well as the ongoing improvement in risk appetite. The structural pressure on the USD continues to come from the diversification of new FX reserve flows (mainly from Asian central banks) as well as concerns about the reserve value of the USD in the wake of massive US fiscal and monetary stimulus.

Although risk aversion is no longer as correlated with the USD as it was a few months ago there is no doubt that the USD is still highly sensitive to equity market movements. Correlations between the USD index and the S&P 500 are consistently high (and negative) over 1M, 3M and 6M time periods. The relationship reveals just how closely the fortunes of the USD are tied to the gyrations in equity markets.  

Much will therefore depend on the shape of US Q3 earnings. The fact that the majority of earnings released so far have beaten expectations has provided equities with more fuel whilst the USD has come under greater pressure. Should as is likely the trend in earnings continue to beat forecasts the USD is likely to weaken further, pushing through key resistance levels.   In particular, a sustained break above EUR/USD 1.50 could see a swift move substantially higher, with little in the way of technical resistance on the way up to 1.60

The real test will come when the lofty expectations for economic recovery match the reality of only sub-par growth in the months ahead. In the meantime, the firmer tone to global equity markets may encourage capital outflows from the US into foreign markets by investors who had repatriated huge amounts of capital during the crisis.

As risk appetite improves, the hunt for yield will intensify. The USD has easily taken over the mantle from the JPY as funding currency of choice for investors, pointing to further pressure on the USD. The timing of monetary policy reversal in the US will be crucial for the USD but it is highly unlikely that the Fed will hike rates next year.

As would be expected in this hunt for yield interest rate differentials are beginning to show a growing influence in driving currencies as the influence of risk appetite begins to wane.  The prospect of US interest rates remaining at a low level for a long time does not bode well for the USD, at least until markets begin to price in higher US rates which is at least a few months away.

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Earnings in focus

October 19, 2009 — Mitul Kotecha

The majority of US Q3 earnings have beaten market expectations resulting in a boost to risk appetite and further pressure on the US dollar. At the time of writing, 61 companies have reported earnings in the S&P 500 and an impressive 79% have beaten forecasts according to Thomson Reuters. This week there are plenty of earnings on tap and although a lot of positive news appears to be priced in the overall tone to risk appetite remains positive. This implies a weaker US dollar bias given the strong negative correlation between US equities and the USD index.

Aside from the plethora of earnings there are plenty of data releases on tap this week including housing data in the US in the form of building permits and starts as well as existing home sales. The data will likely maintain the message of housing market stabilisation and recovery in the US. There will also be plenty of Fed speakers this week and markets will once again scrutinize the speeches to determine the Fed’s exit strategy.

Highlights this week also include interest rate decisions in Canada and Sweden. Both the BoC and Riksbank to leave policy unchanged and expect a further improvement in the German IFO in October though at a more gradual pace than in recent months. There will be plenty of interest in the UK MPC minutes given conflicting comments from officials about extending quantitative easing. RBA minutes will be looked at for the opposite reason, to determine how quickly the Bank will raise interest rates again.

The USD index managed a slight rebound at the end of last week but is likely to remain under pressure unless earnings disappoint over coming days. US dollar Speculative sentiment became more bearish last week according to the CFTC IMM data, with dollar bloc currencies including the AUD, NZD and CAD benefiting the most in terms of an increase in speculative appetite. GBP short positions increased to a new record but the rally towards the end of last week may have seen some of these short positions being covered. Overall any recovery in the USD this week may just provide better levels to go short.

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Risk On / Risk Off

October 16, 2009 — Mitul Kotecha

Risk was firmly back on over the past few days as the majority of earnings came in stronger than expected; around 80% of S&P 500 companies have beaten expectations so far. Data releases in the US have also continued to beat forecasts, the latest of which was the September industrial production report. The dollar stood little chance of a recovering against this background and continues to languish around 14-month lows.

Sterling has been the star performer, perhaps a reflection of the fact that the market was extremely short (CTFC IMM data revealed record net short sterling positions last week) and some hints that the Bank of England may not extend quantitative easing was sufficient to provoke a short covering rally. Still the pound’s gains may prove short-lived until there are clearer signs of economic recovery and of a turn in the interest rate cycle.

There will be some key events and data over the coming week that will give further direction to sterling including a speech by BoE Governor King, MPC minutes, retail sales and preliminary Q3 GDP data. Overall, the data are unlikely to deliver much of a boost to the pound even though both retail sales and GDP are likely to deliver positive readings. Sentiment for the pound continues to swing in a wide range and though a lot of negativity was in the price a sustained recovery is far off. The risks remain that GBP/USD will push back towards support around 1.5902.

I still believe that there is little positive to be said for the euro too. The currency benefits from a weaker dollar but is hardly supported by fundamentals especially as a stronger euro damages one of the main engines of eurozone growth, namely exports. EUR/USD will struggle to make headway through 1.50 though once through here it could easily be carried higher. The most positive factor supporting the euro is the continued recycling of central bank intervention flows here in Asia and this may be sufficient to propel EUR/USD through 1.50 before hitting a wall of resistance around 1.5084.

The dollar itself may be given a lifeline from what looks like a softer tone to markets at the end of the week but overall sentiment remains very bearish despite attempts by various US officials to talk the dollar higher this week. The Fed’s Fisher hit the nail on the head when he said that the dollar’s long term value depends on policymakers “getting it right”. In the short term however, it’s all about risk and increasingly it will be about interest rate differentials, both of which will play negatively for the dollar.

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What to watch this week

October 12, 2009 — Mitul Kotecha

Over recent days trading has been characterised by dollar weakness, stronger equities, rising commodity prices and most recently an increase in US bond yields, the latter driven by some slightly hawkish Fed comments. Whether the tone of stronger attraction to risk trades continues will largely depend on US Q3 earnings however, with many earnings reports scheduled this week.

Given the plethora of Fed officials on the wires over recent days and the mixed comments from these officials there may more attention on US CPI on Thursday than usual but the data is unlikely to fuel any concern about inflation risks. Instead there will be more interest on the Fed FOMC minutes on Wednesday which will once again be scrutinised for the timing of an exit strategy.

Over the week there is plenty for markets to digest aside from earnings reports. US consumer and manufacturing reports will garner most attention. The key release is US September retail sales (Wed) where some payback for the “cash for clunkers” related surge in sales over the last month is likely to result in a drop in headline retail sales, though underlying sales will likely post a modest rise.

Fed speeches will also be monitored and speakers include Kohn, Dudley, Tarullo and Bullard this week. Recent comments have hinted that some Fed members are becoming increasingly concerned about the timing of policy reversal and further signs of this in this week’s speeches may give the dollar some comfort but this will prove limited given that the Fed is still a long way off from reversing policy.

Even if the market believes the Fed is starting to contemplate the timing of reversing its current policy setting it is unclear that the dollar will benefit much in the current environment. Sentiment remains bearish; speculative dollar sentiment deteriorated sharply over the past week according to the CFTC Commitment of Traders (IMM) data, to levels close to the lowest for the year.

Moreover, the correlation between interest rate differentials and currencies is still insignificant in most cases suggesting that even a jump in yields such as the move prompted by last week’s comments by Fed Chairman Bernanke should not automatically be expected to boost the dollar. Once markets become more aggressive in pricing in higher US interest rates this may change but there is little sign of this yet

In contrast the euro continues to benefit from recycling of central bank reserves and recorded a jump in speculative appetite close to its highest level this year according to the IMM data. Reserve flows from central banks may contribute to EUR/USD taking aim at its year high around 1.4844 (last tested on 24 September 09) over coming days.

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