US dollar remains funding currency of choice

November 5, 2009 — Mitul Kotecha

Rate hikes in some countries including Australia and Norway and a general improvement in economic data had led to some expectations that the Fed would shift its rhetoric on monetary policy but in the event this was not to be the case.  The key comment in the FOMC statement following the interest rate decision was that rates would be kept low for an “extended period”. The Fed added that its policy stance was contingent on “low rates of resource utilization, subdued inflation trends and stable inflation expectations.”  

The fact that the Fed maintained its relatively dovish stance contrary to some expectations ahead of the FOMC meeting resulted in interest rate markets paring back expectations for future rate hikes though I still believe that a rate hike anytime in 2010 will prove premature.  The Fed’s new conditions mean however, that the Fed will be more restricted when it does come to timing rate hikes and markets will watch closely, the unemployment rate and inflation expectations to determine this timing. 

Given that the unemployment rate is still rising and is expected to decline only slowly over coming months whilst core inflation is set to decline further, and excess slack in the economy is only likely to be reduced gradually, markets are still too aggressive in looking for increases in interest rates next year.  The Fed did not remove the reference to an “extended period” of low rates despite speculation ahead of the meeting and whilst many in the market continue to debate how long this will be, the Fed will not feel any need to rush to reverse policy. 

The USD weakened following the FOMC meeting but did not suffer a particularly hard blow.  Going forward the USD will not recover until there is clearer evidence that the Fed is ready to reverse policy and in the near term this means that the USD will remain under pressure, especially if markets push back expectations of rate hikes.  This will mean that the USD will continue to be the funding currency of choice for several months yet.  Cyclical USD recovery is still some way off but eventually the Fed’s actions will pay off and the USD will recover by around mid 2010 as the market becomes more aggressive in pricing in rate hikes in the US.

Posted in central banks, Currencies, Economics, Economy, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , . Leave a Comment »

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.

Posted in central banks, Currencies, Economics, Economy, equity markets, Europe, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , . 1 Comment »

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.

Posted in central banks, Currencies, Economy, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Is the Fed trying to support the dollar?

October 9, 2009 — Mitul Kotecha

Did Fed Chairman Bernanke really provide any real support to the dollar when he said at the Board of Governors conference on Thursday that the Fed will be prepared to tighten monetary policy when the outlook for the economy “has improved sufficiently”. Various newswires report that these comments have given the dollar some relief but the reality is that Bernanke only stated the obvious. Of course the Fed has to raise interest rates at some point and most likely this will be when the economic recovery looks sustainable. There is indication when this point in time will be, however.

In fact there was unsurprisingly no sign from Bernanke that the Fed was preparing to raise rates any time soon. As was noted in the September 23 Fed FOMC statement Bernanke reiterated that the Fed “believe that accommodative policies will likely be warranted for an extended period”. An extended period could mean at the least some months but even years and this is no exaggeration.

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. Arguably this recession was worse in terms of depth and breadth suggesting that it will take a long time before the Fed even contemplates reversing policy. In any case the first step is to reduce the size of the Fed’s balance sheet.

Admittedly there has been some suggestions from other Fed members that when interest rates are raised it may be done “with greater force” as stated by Fed Governor Warsh recently but others such as NY Fed President Dudley have said that the pace of recovery “is not likely to be robust”, suggesting a more cautious tone and also highlighting that there is some debate within the Fed about the timing of exit strategies and raising interest rates.

There is no doubt that some Fed members are becoming more nervous about holding policy at such an accommodative level but it could still be several months before policy is reversed given the massive excess capacity in the product and labour markets and benign outlook for inflation. Judging by past history markets have little to be nervous about in terms of an early rate hike.

For the dollar this is bad news and as noted in my previous post the dollar will suffer from a growing yield disadvantage as other countries raise interest rates ahead of the Fed. The dollar may have benefited from some short covering at the end of the week and this could have been provoked by Bernanke’s comments but if so, the dollar’s gains are likely to be short-lived as investors take the opportunity of better levels to take short positions in the currency.

Posted in central banks, Currencies, Economics, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , . 3 Comments »

Key events for FX markets this week

September 21, 2009 — Mitul Kotecha

Key events this week include the Fed FOMC and G20 meetings .  The G20 meeting is likely to be a non-event as far as markets are concerned.  There will be plenty of discussion about co-ordinating exit strategies but officials are set to repeat the commitment to maintain stimulus policies until recovery proves sustainable.  

There is likely to be little emphasis on currencies despite the fact that the dollar is trading around its lowest level in a year, except perhaps at the fringes of the meeting, with focus in particular on Japan’s new government’s pro yen policy.  

Regulation will also figure high amongst the topics debated but this will have little impact on markets over the short term.  Another topic that could be debated is protectionism, especially in light of the US decision to impose tariffs on Chinese tyres.

Ahead of the G20 meeting the Fed FOMC meeting is unlikely to result in any change in interest rates but the statement is likely to be cautiously upbeat in line with Fed Chairman Bernanke’s recent comments that the recession is “very likely over”.  The statement will be scrutinised for clues to the timing of policy reversal, especially given recent speculation that a couple of FOMC members were advocating an early exit.  Given that the dollar has suffered due to its funding currency appeal, any hint that some Fed officials are turning more hawkish could give the currency some much needed relief but we doubt this will last long. 

In contrast to speculation of a hawkish shift in thinking by some Fed members the Bank of England appears to be moving in the opposite direction.  The MPC minutes on Wednesday will be viewed to determine just how close the BoE was to extending quantitative easing and reducing interest rates on bank reserves at its last meeting. 

Sterling (GBP) has been a clear underperformer over recent weeks and a dovish tint to the minutes will act as another factor weighing on the currency as speculation over further action intensifies ahead of the next meeting.  

Sterling is also struggling against the euro having hit a five month low.  A combination of factors have hit the currency including concerns about quantitative easing expansion, the health of the banking system, and the latest blow coming from a the Bank of England in its Quarterly Bulletin where it states that GBP’s long run sustainable exchange rate may have fallen due to the financial crisis.   

Against this background it is not surprising that sterling was the only major currency against in which speculative positioning actually deteriorated versus the dollar last week (according to the latest CFTC Commitment of Traders report).   It is difficult to see any sterling recovery over the short term against this background, with a re-test of the 9 July low just under GBP/USD 1.60 in focus.

Posted in central banks, Currencies, Economics, Economy, Financial crisis, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
« Older posts
Newer posts »