A Better Start To The Week

November 30, 2009 — Mitul Kotecha

The start of this week looks somewhat better compared to the end of last week. Although nervousness will remain amidst thinning liquidity, news that the UAE central bank “stands behind” local and foreign banks and will lend, albeit at a rate of 0.5% above the 3-month benchmark rate, will reassure investors that banks have sufficient liquidity in the wake of any losses suffered due to the Dubai Holdings debacle. This will see some improvement in risk appetite.

The news will unlikely prevent stock markets in the UAE, which open today following Eid holidays, from sliding, however. Attention will turn to the suspended Sukuk bonds and also to the extent of support (and any strings attached) provided by Abu Dhabi to Dubai. The support from the central bank will help markets outside of the UAE regain a little composure and limit demand for safe haven assets but the rally may prove limited until there is greater transparency.

Nonetheless, even if there is some relief at the beginning of this week due to some containment of the problems in Dubai nerves are likely to fray going into the end of the year, with the multi-month trend of improving risk appetite faltering. There have been plenty of reasons for markets to worry lately including concerns about the shape of economic recovery in the months to come as well as renewed banking sector concerns and these will not be allayed quickly.

Data this week in the US is unlikely to help to dampen growth concerns. The main event is the US November jobs report and although the magnitude of job losses is set to decrease the unemployment rate is set to remain stubbornly high around 10.2%. In addition to an expected decline in the November ISM manufacturing index suggests that growth concerns will intensify rather than lessen. This in turn highlights that any improvement in risk appetite this week will prove limited.

The other key events this week include interest rate decisions in Europe and Australia. Although the ECB is widely expected to leave rates on hold on Thursday, there will be plenty of attention on any details of the Bank’s “gradual” exit strategy. Whether the ECB offers new loans to banks at a variable interest relative to the current fixed rate will be taken as an important sign on the path of liquidity withdrawal. We believe the Bank will stick with a fixed rate. The RBA will take a step further and announce a 25bps interest rate hike tomorrow.

FX markets are likely to be buffeted by the gyrations in risk appetite but at least at the beginning of the week the USD is set to give up its recent gains, with EUR/USD likely to try and hold above 1.5000 as markets digest the better news coming from the UAE. The JPY will be a particular focus given the growing attention of the authorities in Japan. Finance Minister Fujii is quoted in the Japanese press that they won’t intervene in the FX market, which appears to give the green light to further JPY strength though I suspect that if USD/JPY drops below 85.00 again there will plenty of FX intervention speculation and in any case these comments have since been denied.

Posted in central banks, Currencies, Economics, Economy, FX, Interest rates, Japan, Middle East, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , . 4 Comments »

CNY appreciation speculation hits EUR

November 12, 2009 — Mitul Kotecha

The USD index is trading close to a 15-month low and direction remains firmly downwards as risk appetite continues to improve and the USD’s status as a funding currency remains unaltered.   Whether it’s a weak USD driving stocks higher or vice-versa, US stocks are currently trading at 13-month highs, maintaining the negative correlation with the USD index. 

One currency that has failed to take advantage of the weak USD over recent days is EUR/USD and its failure to make a sustainable break above 1.50 highlights that momentum in the currency is fading.  EUR/USD looks vulnerable on the downside in the short term, with resistance seen around 1.5050.  Speculation that China will resume CNY appreciation has taken some of the steam out of the EUR given that it implies less recycling of intervention flows into the currency.  

The speculation that China will allow a stronger CNY follows a significant change by China’s central bank, the PBOC to its stated FX policy. The Bank removed the statement  that it will keep the CNY “basically stable” and noted instead that foreign exchange policy would take into account “capital flows and major currency movements”.   

Although this does not mean the CNY will immediately strengthen it will add to speculation that China will allow some appreciation next year following a long stretch in which the CNY has effectively been stuck in a very tight range against the USD.   The timing of the change in rhetoric should come as little surprise as it coincides with greater international calls for a stronger CNY to help rebalance the global economy as well as an improvement in economic data domestically.  

Any change in stance on the CNY could be a significant factor in determining the direction for the EUR given that it not only implies less flows into EUR from China but also from other central banks in Asia which may take China’s cue and allow greater strengthening of their currencies versus USD.  Given that central banks in Asia had been intervening to prevent local currency strength and then recycling this USD buying into other currencies, especially EURs, the change in stance could play negatively for the EUR. 

Currencies are also a focus of the APEC meeting of finance ministers, with the draft statement agreeing that flexible exchange rates and interest rates are critical in obtaining balanced and sustainable growth.  This has interesting implications given the FX intervention by Asian central banks to prevent their respective currencies from strengthening and attention will focus squarely on China’s CNY policy.

Posted in Asia, central banks, China, Currencies, emerging markets, FX, US. Tags: , , , , , , , , , , , , , , , . 1 Comment »

Who’s going to follow in Brazil’s footsteps?

October 25, 2009 — Mitul Kotecha

Last week saw a sell off in some emerging market currencies and whilst this may simply have been profit taking attributable to some large hedge funds it did coincide with the imposition of a tax on portfolio inflows in Brazil.  The tax dented sentiment as it quickly fuelled speculation that it would be followed elsewhere, especially in countries that had seen rapid FX appreciation.  

The BRL is one of the best performing currencies this year against the USD whilst the stock market has surged on strong capital inflows.  The huge increase in USD liquidity globally and substantial improvement in risk appetite has fuelled strong capital inflows into Brazil especially as the country has proven to be one of the most resilient during the crisis.

Although on the margin the tax will have a negative impact on speculative flows into Brazil it is unlikely to have a lasting impact.  Previous such measures have done little to prevent further appreciation.  The BRL is clearly overvalued by around 25-30 at present, but the tax in itself will not be sufficient to result in a move back to “fair value”. 

At best it may act a temporary break on currency appreciation and could limit the magnitude of further gains in the real but this could be at the cost of distorting resource allocation and market functioning.   The longer term solution is to enhance productivity but this will not help in the interim. The tax may make investors a little more reluctant to pile into Brazilian assets, which is what the authorities will desire but already the BRL is back on its appreciation path suggesting a short lived reaction. 

Other countries that could follow include South Africa, Turkey or South Korea but South Africa has already denied that it has any plans to move in this direction.  In South Korea’s case the central bank has chosen to intervene in currency markets to prevent the further strengthening in the won but that also has implications for sterilizing such flows limiting the extent that intervention can be carried out.    

The bottom line is that the broad based improvement in risk appetite is proving to be a strong driver of capital flows into emerging markets and the reality is that many emerging economies such as Brazil and many in Asia have been much more resilient than feared. 

Although there is clearly a limit on the extent that these countries want to allow their currencies to strengthen versus USD the upward pressure will continue, leading to more FX intervention and potential imposition of taxes or restrictions such as implemented in Brazil.   Despite this the outlook for most emerging currencies remains positive and the authorities will face an uphill struggle. 

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Talking about currencies

October 5, 2009 — Mitul Kotecha

It’s always the same story.  Ahead of the G7 (or G8 and now more important G20) meetings speculation of decisive action on currencies intensifies.  Traders and investors become cautious on the off chance that something significant will happen but the majority of times nothing of note emerges.

There was no difference this time around.  The G7 Finance Ministers meeting in Istanbul failed to deliver anything substantive on currencies, repeating the usual mantra about the adverse impact of “excess volatility and disorderly movements”.  Although the group pledged to monitor FX markets there was no indication of imminent action. 

The lack of action is perhaps surprising in one respect as there were plenty of central bankers and finance officials talking about currencies in the run up to the G7 meeting, most of which were attempting to talk the dollar higher against their respective currencies.  Given the increase in rhetoric ahead of the meeting, the relatively weak statement now leaves the door open to further dollar weakness.

The strongest indication of any FX action or intervention came from the country that was supposedly the least concerned about currency strength; Japanese Finance Minister Fujii warned that Japan “will take action” if “currencies show some excessive moves”.  The shift in stance from Japan since the new government took power has been stark (considering that the new government was supposedly in favour of a stronger yen).  Markets will likely continue to test the resolve of the Japanese authorities and buy yen anyway.

Although the G7 statement said little to support the dollar and the overall tone to the dollar likely remains negative over coming months, the softer tone to equity markets and run of weaker economic data in the US – the latest data to disappoint was the September US jobs report – may give some risk aversion related relief to the dollar this week. 

Weaker data and equities alongside the impact of official rhetoric is being reflected in CFTC Commitment of Traders’ data (a good gauge of speculative market positioning) which revealed a sharp drop in short dollar positions, by around a quarter, highlighting for a change, an improvement in dollar sentiment over the last week. 

The biggest losers in terms of speculative positioning were the British pound, where the net short position reached its most extreme since mid September 2008, and Canadian dollar where the net long position was cut by almost half.  Again this may reflect official views on currencies, with Canadian officials expressing concern about the strength of the Canadian dollar in contrast to the perception that UK officials favour a weaker pound.
Central bank meetings (BoE, ECB, RBA) will dominate the calendar this week and more comments on currencies are likely even if interest rates are left unchanged.  Meanwhile FX markets will continue to watch equities, and the start of the US Q3 earnings season will give important signals to determine the sustainability of the recent equity market rally.  Recent weak economic data has already cast doubt about a speedy recovery and if earnings disappoint risk aversion could once again be back on the table.

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

Asian currencies on the up

September 30, 2009 — Mitul Kotecha

The third quarter of 2009 has proven to be another negative one for the US dollar.  Over the period the dollar index fell by over 4%.  The only major currency to lose ground against the dollar over this period was the British pound.  Most other currencies, especially the so called “risk currencies” which had come under huge pressure at the height of the financial crisis, registered strong gains led by the New Zealand dollar, Swedish krona and Australian dollar.  Although the euro also strengthened against the dollar it lagged gains in other currencies over the quarter.

Asian currencies also registered gains against the dollar in Q3 but to a lesser extent than G10 currencies.  Asian currency appreciation was led by the Korean won, Indonesian rupiah and Singapore dollar, respectively.  The under performer over Q3 was the Indian rupee which actually depreciated against the US dollar slightly.  The reason for the smaller pace of appreciation for most Asian currencies was due mainly to intervention by Asian central banks to prevent their respective currencies from strengthening too rapidly, rather than due to any inherent weakness in sentiment.

In fact, Asian currencies would likely be much stronger if it wasn’t for such FX interventions.  A good indication of the upward pressure on Asian currencies can be found from looking at the strength of capital inflows into local stock markets over recent months.  South Korea has registered the most equity capital inflows so far this year, with close to $20 billion of flows into Korean equities year to date but in general most Asian stock markets have registered far stronger inflows compared with last year.   

For the most part, balance of payments positions are also strong.  For example, South Korea recorded a current account surplus of $28.15 billion so far this year, compared to a deficit of $12.58bn over the same period last year.  This is echoed across the region.  Although surpluses are expected to narrow over coming months due mainly to a deterioration in the terms of trade, the overall health of external positions across the region will remain strong and supportive of further currency appreciation.  

The outlook for the final quarter of 2009 is therefore likely to be positive for Asian currencies, with the US dollar set to weaken further against most currencies.  Some risk will come from a potential reversal in global equity market sentiment but overall, further improvements in risk appetite will support capital inflows into the region.  Capital will be attracted by the fact that growth in Asia will continue to out perform the rest of the world and yet again only interventions by central banks will prevent a more rapid appreciation of Asian currencies.

Posted in Asia, central banks, China, Currencies, Economics, Economy, equity markets, Financial crisis, India, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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