Euro Resilience To Fade

May 31, 2011 — Mitul Kotecha

There will at least be a little more liquidity in FX markets today following yesterday’s public holidays in the US and UK. Whether this means that there will be a break out of recent ranges is another matter. Clearly global growth worries as well as eurozone peripheral debt concerns are having an important impact on market dynamics but are also providing conflicting signals.

On the one hand the USD ought to garner support from Europe’s problems but on the other, safe haven demand and growth concerns is bolstering demand for US Treasuries keeping US bond yields at very low levels despite the lack of progress on increasing the US debt ceiling and agreeing on medium to long term deficit reduction.

In the wake of a run of US data disappointments including April durable goods orders, Q1 GDP and weekly jobless claims last week, fears of a loss of momentum in the US economy have intensified. Manufacturing and consumer confidence surveys in the form of the May Chicago PMI and Conference Board consumer confidence survey today will be closely scrutinised to determine whether the ‘soft patch’ in the US economy will persist.

This will have important implications for the USD as worries about growth may feed into expectations that the Fed’s ultra loose monetary policy will be sustained for longer. As it is US 2-year bond yields have dropped to their lowest level this year.

Fortunately for the USD only USD/JPY and USD/CHF have maintained a statistically strong correlation with bond yield differentials although we expect the break in relationship for other currencies to prove temporary. In the case of USD/JPY, yield differentials have narrowed between the US and Japan, a factor playing for JPY appreciation.

Perhaps the fact that unlike the US Japanese data has on balance been beating expectations notwithstanding disappointing April household spending and industrial output data has helped to narrow the yield gap with the US. One explanation is that that worst fears of post earthquake weakness have not been borne out, suggesting that economic expectations have been overly pessimistic. In any case, USD/JPY 80 is still a major line in the sand for the currency pair.

The EUR continues to show impressive resistance, with EUR/USD breaking technical resistance around 1.4345, which opens up a test of 1.4423. Reports that Greece had failed to meet any of its fiscal targets and of harsh conditions set by European officials for further aid have failed to dent the EUR. Whether the market is simply becoming fatigued or complacent will be important to determine if the EUR can gain further.

A report in the WSJ that Germany is considering dropping its push for early rescheduling of Greek debt has given some support to the EUR too. Ongoing discussions this week are unlikely to prove conclusive however, with attention turning to meetings of European officials on 20th and 24th June. I still believe EUR gains will limited, with the break above 1.4345 likely to prove shortlived.

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Risk on, risk off

May 27, 2011 — Mitul Kotecha

The USD has lost some upward momentum as risk appetite improved but FX markets remain skittish as sentiment gyrates between ‘risk on’ and ‘risk off’. The fact that US Q1 GDP was left unrevised whilst jobless claims surprisingly increased together with ongoing Greece concerns suggests that a risk off mood may filter into markets despite positive US earnings. Although the USD has not particularly benefitted from any rise in risk aversion lately, worries about the next IMF tranche being withheld from Greece will likely play more positively for the USD.

Nonetheless, lurking in the background and helping to keep the USD restrained is the Fed’s ongoing asset purchases as QE2 remains in place until the end of June. Moreover US data disappointments points to risks that the Fed will only slowly embark on its exit strategy. Additionally any agreement towards extending the US debt ceiling appears to be far off, and threatens to go down to the wire all the way to August 2. US debt markets and the USD appear to be downplaying this issue at present but it remains a clear threat to US markets.

Continuing to limit any upside in the EUR is the fact that officials and markets continue to gyrate on whether Greece will or will not restructure its debt. Apparent divisions between the view of some officials and the ECB are adding to the confusion whilst fresh worries about the IMF withholding funding for Greece will likely keep EUR/USD capped.

Peripheral worries as well as growth concerns are clearly weighing on confidence and a broad based decline in economic and business confidence in various eurozone May measures is expected to be revealed in data today . Weaker data taken together with ongoing concerns about the eurozone periphery will likely see the EUR struggle, with the currency set to settle into a range versus USD over the short-term, with technical support around 1.3968 and resistance at 1.4210.

The loss of USD momentum has also been exhibited in USD/JPY which has turned lower following its recent upward move hitting a low around 81.09. The big news was the fact that April nationwide core CPI recorded its first YoY increase since December 2008. At the margin may reduce the pressure on the Bank of Japan (BoJ) to enact more aggressive policy measures, which in turn is positive for the JPY. A big factor contributing to keeping the JPY supported over recent weeks is the ongoing inflow of foreign capital into Japan’s bond and equity markets, with Japan recording six straight weeks of net inflows.

USD/JPY is one currency pair where the correlation with US – Japan 2-year bond yield differentials is holding up well over the past 3-months. The fact that the yield differential has dropped to its lowest level since November 2010 at around 30bps reveals the declining US yield advantage, and plays for a lower USD/JPY. Against this background the JPY is likely to remain supported in the short-term, but will find it tough to break through technical support around USD/JPY 80.15.

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Risk off mood

May 23, 2011 — Mitul Kotecha

A ‘risk off’ tone is quickly permeating its way through the market psyche as tensions surrounding the eurozone periphery reach fever pitch. This is reflected in the sharp jump in equity volatility as indicated by the VIX ‘fear’ gauge. Equity markets and risk trades in general look set to remain under pressure in the current climate.

Moreover, the EUR which is finally succumbing to bad news about the periphery will continue to face pressure over the short-term. Against this background economic data will likely be relegated to the background this week but it worth noting that what data there is on tap, is likely to send a weaker message, with data such as durable goods orders in the US as well as various purchasing managers indices (PMI) data in the eurozone today likely to show some slippage.

The Greek saga remains at the forefront of market attention, with restructuring speculation remaining high despite various denials over the weekend by Greek and European Central Bank (ECB) officials. News that Norway has frozen payments to Greece, whilst Fitch ratings agency’s downgrades of Greece’s ratings by 3 notches and S&P’s downgrade of Italy’s ratings outlook to negative, have all contributed to the malaise afflicting the periphery.

This weekend’s local election in Spain in which Prime Minister Zapatero and his Socialist Party suffered its worst defeat in more than 30 years leading to a transfer of power in the Spanish regions, will lead to concerns about the ability of the government to carry out much needed legislative changes.

It is difficult to see any improvement in sentiment towards the peripheral Europe and consequently the EUR over the short-term. In Greece, Prime Minister Papandreou will attempt to push through further unpopular austerity measures through parliament this week in advance of a 5th bailout tranche of EUR 12 billion scheduled for next month. This comes at a time when opinion polls show the government losing more support and 80% of those surveyed saying they would not accept more austerity measures.

The deterioration in sentiment for the EUR has been rapid as reflected in the CFTC IMM data, with net long speculative positions now at their lowest since 15 February and heading further downhill. Conversely, USD short covering has been significant though there is still a hefty USD short overhang, which points to more USD short covering as EUR sentiment sours.

Nonetheless, the USD still has plenty of risks hanging over it including the fact that it still suffers from an adverse yield differential (note that 2-year Treasury yields have fallen to the lowest since 6 December 2010). Safe haven currencies in particular CHF are the key beneficiaries and notably EUR/CHF touched a record low around 1.2354 and is showing little sign of any rebound.

Posted in Bond markets, central banks, Currencies, ECB, Economics, Economy, equity markets, Europe, eurozone, Financial crisis, Fiscal/Budget, FX, Greece, Monetary Policy, Spain, Switzerland, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

US Dollar On The Rise

May 16, 2011 — Mitul Kotecha

There are plenty of US releases on tap this week but perhaps the most important for the USD will be the minutes of the April 26-27 Fed FOMC meeting. Taken together with speeches by Fed officials including Bernanke, FX markets will attempt to gauge clues to Fed policy post the end of QE2. The Fed’s stance at this point will be the major determinant of whether the USD can sustain its rally over the medium term. The lack of back up in US bond yields suggests that USD momentum could slow, with markets likely to move into wide ranges over coming weeks.

It is worth considering which currencies will suffer more in the event that the USD extends its gains. The correlation between the USD index and EUR/USD is extremely strong (even accounting for the fact that the EUR is a large part of the USD index) suggesting that the USDs gains are largely a result of the EUR’s woes. Aside from the EUR, GBP, AUD and CAD are the most sensitive major currencies to USD strength whilst many emerging market currencies including ZAR, TRY, SGD, KRW, THB, IDR, BRL and MXN, are all highly susceptible to the impact of a stronger USD.

Robust Q1 GDP growth readings in both Germany and France helped to spur gains in the EUR but this proved short-lived. Sentiment for the currency has soured and as reflected in the CFTC IMM data long positions are being scaled back. Nonetheless, there is still plenty of scope for more EUR selling given ongoing worries about the eurozone periphery, which are finally taking their toll on the EUR. A break below EUR/USD 1.4021 would open the door for a test of 1.3980.

The eurogroup and ecofin meetings will be of interest to markets this week but any additional support for Greece is unlikely to be announced at this time. However, likely approval of Portugal’s bailout may alleviate some pressure on the EUR but any positive impetus will be limited. Even on the data front, markets will not be impressed with the German ZEW index of investor confidence likely to register a further decline in May.

Japanese officials have been shying away from further FX intervention by blaming the drop in USD/JPY over recent weeks on general USD weakness despite the move towards 80. However, this view is not really backed up by correlation analysis which shows that there is only a very low sensitivity of USD/JPY to general USD moves over recent months. One explanation for the strength of the JPY is strong flows of portfolio capital into Japan, with both bond and equity markets registering net inflows over the past four straight weeks.

This is not the only explanation, however. One of the main JPY drivers has been a narrowing in yield differentials. This is unlikely to persist with yield differentials set to widen sharply over coming months resulting in a sharply higher USD/JPY. As usual data releases are unlikely to have a big impact on the JPY this week but if anything, a further decline in consumer confidence, and a negative reading for Q1 GDP, will maintain the pressure for a weaker JPY and more aggressive Bank of Japan (BoJ) action although the BoJ is unlikely to shift policy this week.

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Position Unwinding Boosts USD

May 9, 2011 — Mitul Kotecha

The USD’s multi-month fall has come to an abrupt halt, with the currency registering gains in reaction to what appears to be a major position unwinding across asset markets, led by a drop in commodity prices.

Will it continue? Whilst I am amongst the more bullish forecasters on the USD over the medium term, the current rally could prove to be short-lived in the absence of a shift in Federal Reserve rhetoric or end to quantitative easing (QE2). Nonetheless, the market had got itself very short USDs (as reflected in the CFTC IMM data as of early last week which showed an increase in net short positions) and the rally in the USD last week was likely spurred by major short-covering which could extend further into this week.

The move in the USD gained momentum as European Central Bank (ECB) President Trichet proved to be less hawkish than many expected in the press conference following last Thursday’s ECB meeting. Moreover, renewed worries about Greece at the end of last week, with a report in the German Der Spiegel, later denied by Greek officials, that the country was planning to leave the Eurozone dented the EUR,

Taken together with the improving trend in US April non-farm payrolls (April registered +244k increase, with private payrolls 268k), these factors colluded to provide further positive stimulus to the USD and negative fallout on the EUR. The room for EUR downside is evident in the net long EUR speculative position, which rose to its highest since December 2007 as of 3rd May.

This week’s batch of US releases including March trade data, April retail sales and CPI, are unlikely to result in a reversal in last week’s trend though a trend like reading for core CPI, with the annual rate below the Fed’s comfort zone will reinforce expectations of dovish Fed policy being maintained, which could inject a dose of caution into the USD’s rally.

Against the background of a likely widening in the US trade deficit in March there will plenty of attention on the annual strategic and economic dialogue beginning today, with markets interested in discussions on Chinese worries about the gaping US fiscal deficit and US concerns about China’s exchange rate policy.

Greece’s denial of plans to leave the eurozone and discussions over a further adjustment to Greece’s bail out package, may help limit any drop in the EUR this week though it will by no means mark the end of such speculation about the periphery especially with this weeks’ Q1 GDP data releases across the eurozone likely to further highlight the divergence between the core and the periphery even if the headline eurozone reading rebounds strongly as we expect.

In the UK the Bank of England Quarterly Inflation Report will be the main influence on GBP. Downward growth revisions will play into the view that inflation will eventually moderate, capping expectation of higher interest rates over the coming months. However, the likely upward revision to near term inflation forecasts will help limit any damage to GBP.

GBP has lost ground to the USD but it should be noted that it has outperformed the EUR over recent days, reversing some of the recent run up in EUR/GBP. Given that EUR sentiment is likely to remain fragile this week, GBP may continue to capitalise, with a test of EUR/GBP 0.8672 on the cards.

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