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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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.

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Economic reality check supports dollar

October 2, 2009 — Mitul Kotecha

The US dollar appears to be making a tentative recovery of sorts at least when taking a look at the performance of the US dollar index.  Much of this can be attributable to a softer tone to equities. The S&P 500 registered its biggest back to back quarterly rally since 1975 over Q3 and either through profit taking or renewed economic doubts, stocks may be in for shakier ground into Q4. 

This increase in equity pressure/risk aversion is being triggered by weaker data. Since the Fed FOMC on 24th September the run of US data has generally disappointed expectations; in addition to the ISM survey, existing and new home sales, durable goods orders, consumer confidence and ADP jobs data all failed to match forecasts.   This list was joined by the September jobs data which revealed a bigger than expected 263k drop in payrolls.  Consequently doubts about the pace of recovery have intensified as markets face up to a reality check.

The dollar’s firmer tone is not just being helped by weaker stocks but also by plenty of official speakers discussing currency moves. Although this is potentially a dangerous game considering the recent turnaround in Japanese official comments on the Japanese yen the net effect is to support the dollar.  In particular, Treasury Secretary Geithner stressed the importance of a strong dollar, whilst European officials including Trichet, Almunia and Junker appear to have become more concerned with the strength of the euro. 

In the current environment such comments will contribute to putting further pressure on the euro which in any case has lagged the strengthening in other currencies against the dollar over recent months.   Although ECB President Trichet highlighted “excess volatility” in his comments about currencies overnight implied FX volatility is actually relatively low having dropped significantly over recent months.  The real reason for European official FX concerns is quite simply the fact that the eurozone remains highly export dependent and that recovery will be slower the stronger the euro becomes.  

It’s not just G10 officials that are becoming concerned about currency strength against the dollar as Asian central banks have not only been jawboning but also intervening to prevent their currencies from strengthening against the dollar.   A firmer dollar tone is likely to put Asian currencies on the back foot helping to alleviate some of the upward pressure over the short term but the overall direction for Asian FX is still upwards.

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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.

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Dollar, Euro and Sterling Volatility Within Ranges

June 25, 2009 — Mitul Kotecha

Two steps forward, one step back appears to describe the movement of the US dollar over recent weeks.  Although the dollar is still off its lows registered at the beginning of June it has failed to make much of a recovery.  After a solid start to the week the dollar came under renewed pressure ahead of the FOMC decision but managed to register small gains following the lack of action from the Fed on Wednesday. Overall, the Fed showed slightly less concern about disinflation and became slightly less negative on the economic outlook but there was not much in the Fed statement to impact the dollar strongly.

Some comments by ECB officials noting that European interest rates are unlikely to be cut further and that further expansion of stimulus measures are not needed, likely explained some of the recent bounce in the euro versus dollar, but the massive ECB allocation of EUR 442 billion in its 1-year tender on Wednesday helped to push the euro lower once again.  The demand for funds from banks was extremely strong and the ECB responded by providing a huge amount of emergency credit.  The allocation drove down overnight and long term rates as well as weakening the euro. 

I still believe any gain in the euro will be limited especially as the Eurozone data flow continues to suggest that any recovery will be tepid.  Eurozone June PMIs this week revealed a small rise in the manufacturing index but a surprise fall in the services index. There was also some improvement in the French INSEE business confidence indicator but at most the data pointed to a slower pace of contraction and continue to lag the improvement in similar surveys in the US and UK.   EUR/USD appears to be trapped in a 1.38-1.43 range with little momentum to break either side of this. 

FX markets are set to remain volatile but within ranges.  The failure of the dollar to extend gains amidst thin data flow highlights the lack of direction in markets.  I am still biased towards some dollar upside over coming days but once again currencies will take their cue from equity markets.  The dollar may find some support if US equities continue to struggle; the S&P 500 is finding it difficult to sustain gains above its 200 day (897.2) and 50 day (900.54) moving averages, suggesting some scope for a downside move in US stocks an in turn a firmer dollar if the S&P 500 fails to hold above this level.   

GBP/USD looks resilient despite coming under pressure following comments by BoE Chief economist Spencer Dale that a weak currency was a “key channel” to spur growth.  Although GBP has recovered sharply from its low of 1.3549 touched on 26 January it is still looks undervalued and such comments do not necessarily justify a further drop in GBP.   Although GBP/USD is set to appreciate further over the coming months it could struggle to sustain a break above its 3 June high of 1.6663 over the near term.  The downgrade to UK growth forecasts by the OECD this week and comments by BoE governor King that UK recovery will be a “long, hard, slog” highlight the difficulties ahead.

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