Buffer for risk trades

November 25, 2009 — Mitul Kotecha

Firmer data, most recently in the form of the stronger than expected US consumer confidence and dovish Fed comments as reiterated in the Fed FOMC minutes will provide a buffer for risk trades, supporting the USDs role as the prime funding currency over coming weeks.  Nonetheless, any improvement in sentiment will have to push against the weight of position adjustment into year-end as investors book profits on risk trades.  The net effect could be an increase in volatility especially in thinning liquidity expected in the wake of holidays in Japan and the Thanksgiving holiday in the US.

This could make it difficult for many asset markets to sustain key psychological and technical levels.  Whether the S&P 500 can hold gains above 1100 could prove significant as could EUR/USD’s ability to hold onto gains above 1.50.  The expiry of last week’s EUR/USD 1.48/1.51 option may provoke a move out of its range but there seems to be little appetite for a sustained break above the 23rd October high around 1.5061.  Even so, an upside bias is more likely given the likely softer tone to the USD. EUR/USD looks well supported around 1.4865.

Position adjustment towards the end of the year has been particularly evident in FX markets.  For instance, the latest CFTC Commitment of Traders’ data revealed that speculative investors have sharply reduced net long EUR positions into last week whilst there was a significant degree of short covering of GBP positions.  It is worth noting however, that aggregate USD net short speculative positions actually increased, largely due to a sharp jump in net JPY positioning, suggesting that overall sentiment for the USD remains very negative.

It is difficult to see a strong reversal in USD sentiment into year-end and the Fed’s commitment to maintaining interest rates at a low-level for an “extended period” taken together with hints of extending asset purchase programmes suggests little support to the USD over the short-term unless there is a more significant increase in risk aversion and or profit taking/book closing into year-end.  It seems that the impact of improved risk appetite is winning for now, giving no respite to the USD.

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US rates “low for long”

November 19, 2009 — Mitul Kotecha

Risk appetite is failing to show much improvement this week and sharply weaker than forecast US housing data dampened sentiment further following other soft data over recent days including the Empire manufacturing survey, industrial production and retail sales less autos. The data will add to concerns about the pace and magnitude of growth in the months ahead.

A sub-par recovery and benign inflation outlook are the two main reasons why the Fed will not hike rates for a long while yet. This was echoed by St. Louis Fed President Bullard – a voting member of the FOMC – who gave a little more colour on the Fed’s “extended period” statement. He highlighted the probability that US interest rates will not be raised until the first half of 2012.

Bullard noted that following the past two recessions the Fed did not raise rates until two and half to three years after recession ended. This is accurate given that in 2001 the Fed did not begin to hike rates until around 2 ½ years after the end of the recession whilst in 1990-91 rates did not go up until close to 3 years after recession ended. This recession just passed was arguably worse than both of the past two, so why should rates rise any earlier?

One factor that could trigger an earlier rate hike is the risks from the massive global liquidity fuelled carry trade fuelled by Fed policy. Bullard highlighted that the risks of creating an asset bubble from keeping rates “too low for too long” may prompt an earlier tightening. What will be important is that the Fed gets the exit strategy right and the risk that delaying any reduction in the Fed’s balance sheet and asset purchases could turn out to be inflationary which in turn would be negative for the USD and hit confidence in US assets.

The Fed is very likely to adjust the level of quantitative easing well before contemplating raising interest rates. The market is pricing in around 50bps of rate hikes in the next 12 months but even this looks to aggressive and as has been the case of recent months the market is likely to push back the timing of expected rate hikes. The consequences for the USD are negative at least until the market becomes more aggressive in pricing in US interest rate hikes or believes the Fed is serious about its exit strategy.

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FX position squaring

November 18, 2009 — Mitul Kotecha

It is becoming apparent that as the end of the year approaches market players are squaring FX positions rather than putting new risk on. The USD has failed to show any sign of sustaining a recovery over recent weeks but may be benefiting from short covering into year end, with the USD index pivoting around the 75.00 level. Supportive comments from US officials and international calls for the US to act to prevent the currency from being debased may also be helping on the margin.

Nonetheless, the USD’s outlook is still mired by a combination of both cyclical and structural concerns and it will fail to recover on a sustainable basis until it loses the mantle of preferred funding currency. This is unlikely to happen soon given the repeated commitment by the Fed to keep interest rates low for long as repeated this week by Fed Chairman Bernanke.

USD/JPY continues to gyrate around the 89-90 level and is showing little inclination to move either side though a run of positive economic surprises and the move in interest rate differentials (versus US) suggest that the JPY will trade on the firmer side of 90 over the short term; USD/JPY has been the most highly correlated currency pair with interest rate differentials over the past month. JPY speculative positioning is not particularly onerous at present, suggesting some room for an increase in JPY positioning.

The EUR continues to struggle to make any headway and is likely not being helped by European policy makers’ attempts to talk the USD higher. ECB President Trichet repeated his comments that a strong USD is in the world’s best interest though by now such comments are nothing new. It will need a clear break above 1.5061 in EUR/USD to renew the uptrend in the currency. For now, a reported 1.48-1.51 option expiring on Friday suggests range trading, with EUR/USD looking heavy on the top side.

GBP is set to remain firm despite the slightly dovish November MPC minutes. GBP looks resilient against the EUR against which it has benefited from a favourable move in interest rate differentials as a well as an adjustment in positioning where the market has decreased its GBP short positions and also decreased EUR long positions. EUR/GBP has been leading the way, and like USD/JPY this currency pair has become increasingly correlated with interest rate differentials, which has played positively for GBP. This has helped it to pivot around the 200 day moving average around 0.8871, a level that will prove important to determine further downside potential in EUR/GBP.

Posted in central banks, Currencies, Economics, Economy, FX, Interest rates, Japan, US. Tags: , , , , , , , , , , , , , , , , . 3 Comments »

Fed keeps the risk trade party going

November 17, 2009 — Mitul Kotecha

Risk is back on and the liquidity taps are flowing. Fed Chairman Bernanke noted that it is “not obvious” that US asset prices are out of line with underlying values, comments that were echoed by Fed Vice Chairman Kohn, effectively giving the green light to a further run up in risk trades. The last thing the Fed wants to do is ruin a good party and the comments indicate that the surge in equities over recent months will not be hit by a reversal in monetary policy any time soon.  

Aside from comments by Fed officials risk appetite was also boosted by a stronger than forecast rise in US October retail sales, with US markets choosing to ignore the sharp downward revision to the previous month’s sales, the weaker than forecast ex-autos reading and a surprisingly large drop in the Empire manufacturing survey in November.

Fed comments were not just focussed on the economy and equity markets as Bernanke also tried to boost confidence in the beleaguered USD, highlighting that the Fed is “attentive” to developments in the currency.  He added that the Fed will help ensure that the USD is “strong and a source of global financial stability”.  The comments had a brief impact on the USD and may have given it some support but this is likely to prove short lived. 

The reality is that the Fed is probably quite comfortable with a weak USD given the positive impact on the economy and lack of associated inflation pressures and markets are unlikely to take the Fed’s USD comments too seriously unless there is a real threat of the US authorities doing something to arrest the decline in the USD, a threat which has an extremely low probability.

It is perhaps no coincidence that the Fed is attempting to talk up the USD at the same time that US President Obama meets with Chinese officials.  The comments pre-empt a likely push by China for the US not to implement policies that will undermine the value of the USD but comments by Obama appear to be fairly benign, with the President noting that the US welcomes China’s move to a “more market based currency over time”. The relatively soft tone of these comments will further dampen expectations of an imminent revaluation of the CNY.

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Searching for inspiration

November 9, 2009 — Mitul Kotecha

After an eventful week which included several central bank meetings and the US Jobs report there is less for markets to get their teeth into this week.  Despite the weak US jobs report risk appetite looks relatively resilient suggesting that the USD will struggle to make much headway over coming days.  

Despite all of the events last week markets have been uninspired.  Even the G20 meeting delivered little to be excited about with no further developments on how to rebalance the global economy and the USD’s role in the process.  The lack of attention on the USD will leave it with little directional influence this week, with equity markets likely to the main driver once again.

One currency that may look a little better supported over coming days is the EUR.  GDP data later in the week is likely to reveal an expansion over Q3 after several quarters of contraction as indicated by various PMI data. Although it will likely be led by inventories and exports rather than domestic demand it will nonetheless come as good news, albeit backward looking.  Going forward growth in Europe is unlikely to match the pace of recovery in the US but for now the GDP data will be EUR supportive helping EUR/USD to gravitate around 1.50 and beyond. 

Meanwhile, central banks may also do their part in influencing currencies given their differing stances on monetary policy.  Although the Fed did not deliver any big surprises last week the FOMC statement will play for a softer USD as the currency looks to maintain its funding currency status for an “extended period”.   In contrast the RBA hiked rates as expected and despite hinting at more gradual rate increases in the months ahead the AUD continues to stand to benefit.   Going in the opposite direction the BoE increased its asset purchases but GBP avoided a significant negative fall out as the move is likely to be seen as the final step in the BoE’s asset purchase programme.

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