Limbo ahead of Fed FOMC meeting

March 13, 2012 — Mitul Kotecha

A mixed session overnight leaves markets with little direction ahead of the Bank of Japan and Federal Reserve FOMC meetings today. There was no stimulus for markets from the meeting of European officials yesterday while Greece’s debt swap has failed to boost confidence.

Overall there is a real hesitancy for investors to take positions, with both volumes and volatility remaining very low. For instance the VIX volatility gauge has dropped to its lowest level since May 2011 while my measure of composite FX volatility continues to languish at relatively low levels compared to last year.

The USD has little to fear from the Fed FOMC meeting tonight. If anything it may even benefit from a less downbeat statement from Fed Chairman Bernanke following the meeting. Growing speculation that the Fed will embark on some form of sterilised quantitative easing, i.e. not printing any more money, bodes well for the USD too.

Ahead of the FOMC decision a firm February retail sales report will help add to the plethora of evidence revealing stronger signs of US recovery. A key indicator to watch in this respect is the (National Federation of Independent Business (NFIB) report of small business confidence which should also strengthen. Importantly for the USD the data should also help to maintain pressure on US bonds, keeping yields elevated and in turn the USD supported.

The BoJ meeting today will not deliver any surprises, an outcome that will likely leave the JPY largely unmoved. Speculative sentiment for the JPY has shifted negatively as reflected in the latest CFTC IMM report which reveals the biggest short position in the currency since April last year.

Crucial in pushing the JPY weaker has been the widening in bond yield differentials with the US, thanks largely to a rise in US bond yields. The 2-year yield gap is now around 20 basis points, the highest gap since August 2011. This will help to keep USD/JPY supported but my quantitative models suggest that the upmove may be overdone in the short term, with a correction lower in prospect to technical support around 81.44.

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Fed weighs on the dollar

January 26, 2012 — Mitul Kotecha

The USD was already losing ground over the last couple of weeks against the background of firming risk appetite but the currency was dealt another blow from the Fed when it announced in the FOMC statement new guidance for monetary policy, stating that interest rates would remain “exceptionally low until at least late 2014” while keeping the door open to further quantitative easing. The statement helped to counter the pressure on the EUR from rising Portuguese bond yields, with EUR/USD breaking above 1.3100.

The prospect of prolonged low US interest rates means that the USD could remain a funding a currency for longer than anticipated. My forecasts of only a gradual appreciation of the USD over coming months take this into account to a large extent. I remain positive on the prospects for the USD against the EUR, JPY and CHF but predict further weakness against high beta commodity currencies and emerging market currencies over coming months. However, should US bond yields continue to remain suppressed even expectations of USD gains against the EUR, JPY and CHF may be dashed.

Although the Fed downgraded its growth expectations over coming quarters US data releases are looking more encouraging and in this respect the US is beginning to outperform other major economies. In contrast Europe’s growth outlook looks even gloomier while there is a long way to go before the problems in the region are resolved. Portugal has moved increasingly into the spotlight as markets increasingly anticipate some form of debt restructuring while in Greece debt talks have so far failed to reach any agreement on the extent of debt writedowns.

As the end of the week approaches risk is definitely on the front foot and the EUR has confounded many expectations by strengthening against all odds. I have highlighted the fact that the market was extremely short EUR over recent weeks as well as the EUR’s increasing resilience to bad news. I also noted that the Eurozone external position is still very healthy providing underling support for the currency. While I still look for the EUR to weaken over coming months expectations of a one way will not be fulfilled. EUR/USD will face strong resistance around 1.3201 (the 21 December high and 61.8% retracement from its 1.3553 high).

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Ratings agencies spoil the party

December 13, 2011 — Mitul Kotecha

Just as I thought that attention may finally switch to the US along comes the ratings agencies to spoil the party once again. Moody’s and Fitch Ratings criticised last week’s European Union Summit outcome for falling short of a comprehensive solution to Eurozone ills. Consequently the risk of further sovereign credit downgrades across Europe remains high over coming weeks especially as economic growth weakens. Moody’s also put 8 Spanish banks and two bank holding companies on review for a possible downgrade.

The EUR and Eurozone bonds came under pressure as a result, with EUR/USD verging on its strong support level around 1.3146. Further pressure is likely into year end although the fact that the speculative market is still very short EUR may limit its downside potential in the short term. Disappointment that the ECB has not stepped up to the plate to support the Eurozone bond market more aggressively is also having a damaging effect on confidence. A test of sentiment will come from today’s EFSF and Spanish bill auctions while on the data front we look for a below consensus outcome for the German December ZEW survey, which will deteriorate further.

The comments from the ratings agencies resulted in risk assets coming under pressure once again, leaving the market open to further selling today given the lack of positives. US data and events will at least garner some attention, with the Federal Reserve FOMC meeting and November retail sales on tap. We do not look for any big surprise from either of these, but at least the Fed may sound a little more positive in light of firmer data over recent weeks. Even so, speculation of more Fed QE early next year will remain in place. In the current environment demand for US Treasuries remains strong with a Treasury auction yesterday receiving the highest bid/cover ratio since 1993.

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The Devil is in the details

December 12, 2011 — Mitul Kotecha

The “partial solution” delivered by European Union (EU) leaders last week has failed to match the high hopes ahead of the EU Summit. Nonetheless, the deliverance of a “fiscal compact”, acceleration of the European Stability Mechanism (ESM) to July 2012 , no forced private sector participation in debt restructuring (outside Greece), and possible boost to the International Monetary Fund (IMF) of up to EUR 200 billion, are steps in the right direction. The fact that UK Prime Minister Cameron threw a spanner in the works to veto a joint proposal to revise the EU Treaty should not detract from the progress made.

Nonetheless, the measures may not be sufficient to allay market concerns, with disappointment at the lack of European Central Bank (ECB) action in terms of stepping up to the plate as lender of the last resort still weighing on sentiment. Data will add to the disappointment this week as “flash” Eurozone purchasing managers indices (PMI) drop further in December.

This week events in the US will garner more attention, including the Federal Reserve FOMC meeting, November inflation and retail sales data plus manufacturing confidence gauges as well as November industrial production on tap. The Fed will not shift its policy stance at this meeting but may sound a little more upbeat on the economy following recent firmer data. Inflation will likely remain subdued while the other data will continue to show gradual recovery.

Overall, the market is likely to thin further as the week progresses and holidays approach, with ranges likely to dominate against the background of little directional impetus. Our call to sell risk assets on rallies remains in place, however. The EUR will likely struggle to make much headway in the current environment, especially given that many details of the EU agreement still need to be ironed out and once again the risk to market confidence lies in implementation or lack of it. A range of EUR/USD 1.3260-1.3550 is likely to hold over the short term.

Posted in ECB, Economics, Economy, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , . Leave a Comment »

Super Failure By Supercommittee

November 22, 2011 — Mitul Kotecha

The USD remains a clear beneficiary in the ‘risk off’ environment enveloping markets at present. Indeed as reflected in the latest jump in USD (IMM) speculative positioning the market is turning increasingly to the USD at a time of intense stress. Moreover, the run of better economic data over recent weeks including October existing home sales yesterday points to less need for further Fed quantitative easing, which comes as further relief to the USD.

Further information on this front will be revealed in the Federal Reserve FOMC minutes on Wednesday, with the Fed set to keep the option open. Even the lack of agreement by the US Congressional Supercommittee on a deal to cut the US budget deficit by $1.2 trillion has failed to dent the USD’s progress as the failure of deficit talks was largely expected. Further USD gains are likely but the pace of its upside move will slow.

Although sentiment towards the Eurozone has deteriorated further EUR/USD is just about clinging onto the 1.3500 level despite several forays lower. More active European Central Bank (ECB) bond buying likely helped dampen some bearishness on the currency although reports suggest that the central bank has imposed a limit of EUR 20 billion on such purchases.

The EUR is not being helped however, by ongoing rumblings of a EUR break up despite Greek Prime Minister Papademos attempting to downplay talk of a Greek EUR exit. A meeting today between Italian Prime Minister Monti and EU officials will be in focus, with markets looking to see further signs of commitment to reforms. We expect no let up in pressure on the EUR, though further declines are likely to be slower, with last week’s low around 1.3420 providing short term support.

GPB has been an underperformer, with the currency on the path for a re-test of the 6 October low around 1.5272. News this week will not be helpful for the currency, with potentially dovish Bank of England monetary policy committee (MPC) minutes likely to inflict further damage, with support from the MPC for more QE set to be revealed.

Ahead of the minutes, UK public finances data today will not make for attractive reading just over a week away from UK Chancellor Osborne’s Autumn statement, which will likely reveal a downward revision to growth forecasts and an upward revision to deficit forecasts. GBP has even lost ground against the beleaguered EUR although we continue to believe that the overall trend will continue to be lower for EUR/GBP over coming weeks.

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