Euro slippage, sterling under pressure

November 13, 2012 — Mitul Kotecha

A US holiday (bond market closed) and positive data in China over the weekend helped to result in an easing in risk aversion overnight although this was probably more due to relatively limited market action in thin trading conditions. Consequently the VIX ‘fear gauge’ fell sharply. Holidays in Asia today will similarly keep activity limited. The improvement in risk appetite did little to undermine the USD (index) which remained at its highest level since early September and shows little sign of reversing.

The Eurogroup meeting yesterday did not as result in an agreement to deliver Greece its next loan tranche but this came as no surprise. In the US there appeared to be some traction towards resolving the fiscal cliff, with a Senior Republican economist indicating that Congress should agree on higher taxes for the wealthy ahead of formal discussions on averting the fiscal beginning on Friday.

EUR/USD’s slide has continued unabated and looks set to test its 100 day moving average level around 1.2639. Its weakness can be attributed to the usual suspects, namely uncertainty surrounding Greece and Spain. The currency may gain a little respite today in the form of a small rise in the German ZEW investor confidence expectations index but it will be insufficient to turn the EUR around in the short term.

At a time when the US fiscal cliff is rapidly overtaking peripheral Eurozone issues as a cause for concern, the inability of the EUR to capitalize on this is a bit disconcerting. Some clues to the timing of the next Greek loan disbursement will undoubtedly help the currency assuming that it is not too far into the future. The EUR will also need today’s Greek treasury bill auction to go well to give it some support. Unfortunately for the currency the risks are still skewed to the downside.

UK data flow has been poor to say the least and includes a series of disappointments through November including manufacturing confidence, construction confidence, industrial production and retail sales (BRC). The Bank of England did not deliver on any further policy easing at its meeting last week and clues to further policy moves as well as GBP direction will emerge from a slate of data over coming days. Unfortunately the releases will not bode well for GBP.

October CPI Inflation today is set to reveal an increase while retail sales are likely to have fallen over the same month. The main event will be the quarterly inflation report (QIR) tomorrow and this will see upward revisions to short term inflation forecasts although we still see scope for more QE early in the new year. GBP will find little support from the data or the QIR leaving the currency exposed to further declines against a relatively firm USD and a resumption of weakness against the EUR. I look for a test of EUR/GBP 0.8081 in the short term.

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Negative yields hit the euro

November 6, 2012 — Mitul Kotecha

Market participants will be distracted by today’s US Presidential election and Thursday’s transfer of leadership in China. The USD seems to be enjoying strength despite a slight lead in the polls by President Obama. The consensus view is that a Romney win would be USD positive given that it may imply a more restrictive Fed in the form of less QE but the USD appears to be ignoring such polls.

The EUR is the worst performing currency so far this month after the CHF. Greek and Spanish concerns are placing a growing weight on the EUR the former due to tomorrow’s vote on austerity measures and the latter due to worsening economic data and a lack of traction towards requesting a bailout and thus activating the European Central Bank’s bond purchase program.

A massive weight on the EUR is the fact that Germany 2 year bond yields have turned negative, leading a widening US yield advantage and in turn a weaker EUR/USD. Indeed, the correlation between 2 year US – German yield differentials is very high, implying that the EUR will struggle below its 200 day moving average around 1.2828 until German yields push higher.

A generally firmer USD has also dealt a blow GBP, with the currency slipping below 1.6000. Notably GBP is holding up well against the EUR. Industrial and manufacturing production data today will give some direction to the currency but the news is unlikely to be positive, with a further sharp decline expected in September.

Thereafter attention will swiftly turn to the Bank of England policy decision on Thursday, where the decision will be a close call but we look for an additional GBP 25 billion in asset purchases to be announced. GBP could face some pressure in this event but given that the currency not been particularly impacted from QE in the past, we doubt that it will suffer a severe blow. However, the BoE action may help to stem the decline in EUR/GBP, with support seen around 0.7956.

AUD has lost some steam this week as speculative longs have been cut back ahead of the RBA policy decision. The pull back has largely to do with a generally firmer USD, some deterioration in risk appetite and lower commodity prices than any shift in policy expectations, however.

The market is pricing in around a 50% probability of a rate cut today Given that this is not fully priced in, the AUD is vulnerable in the wake of a rate cut. However, much will depend on the accompanying statement. Given that recent domestic and Chinese data have been a bit more encouraging we doubt that the statement will be particularly dovish, suggesting that downside risks to AUD will be limited to technical support around 1.0305 versus USD.

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Lower range for the JPY, GBP vulnerable

September 27, 2012 — Mitul Kotecha

The announcement of the Spanish 2013 budget, German jobs data, and the release of European confidence measures mean that attention will remain focussed on the Eurozone today and the news is unlikely to be good. The request for a Spanish bailout moves ever closer and could eventually provide some relief but prevarication continues to weigh on sentiment.

US data releases will not provide much solace for markets either, with weak durable goods orders and a revision lower to US Q2 GDP expected to be revealed. All in all, another tough session for markets is in store.

Meanwhile, currencies against the USD continue to look vulnerable, with EUR/USD, AUD/USD, USD/CHF in particular, close to breaching their 200 day moving average levels. USD/JPY has closed below the 78.00 level throughout this week suggesting that the currency pair may be moving into a new lower range. So far, there is little sign of potential FX intervention by the Japanese authorities.

Interestingly USD/JPY has dropped despite a general rebound in the USD, suggesting that it is very difficult for the Japanese authorities to blame the move on a weaker USD this time. Nor is the JPY particularly sensitive to risk aversion at present. For a change the move in the JPY cannot be blamed on a narrowing in US versus Japanese bond yield differentials too as the sensitivity of USD/JPY to yield differentials has dropped to an insignificant level while the US yield advantage has actually widened.

Net securities inflows into Japan have been strong recently however, suggesting either or both repatriation into Japanese fiscal half year end or renewed foreign interest in Japanese portfolio assets are helping the JPY. USD/JPY is expected to run into bids around the 77.10 level.

EUR/GBP has tracked the move lower in EUR/USD, while GBP/USD appears to be showing some resilience despite a generally firmer USD. Renewed Eurozone tensions are helping GBP as investors once again look for relative save havens although many would question whether GBP can really be considered as a safe haven.

With little on the data front in the UK today (only the third reading of Q2 GDP) GBP will be left to follow the travails of the EUR. Notably my models show that EUR/GBP divergence from its short term fair value estimate is growing, implying that the drop in the currency pair is unlikely to persist, with GBP resilience likely to give way over coming sessions. My estimate for short term EUR/GBP fair value is 0.8143. This is corroborated by my GBP/USD quantitative model, which also shows downside risks.

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JPY, SEK and GBP view

August 30, 2012 — Mitul Kotecha

USD/JPY remains stuck within a tight range having reversed its recent break higher towards the 80.00 level, once again settling back below 79.00. Once again the main determinant of the exchange rate appears to be yield differentials and notably the JPY has had a very low sensitivity to gyrations in risk over recent months.

For JPY bears it it’s worth noting that US 2-year bond yields have began to edge higher this week, suggesting some upward pressure on USD/JPY. The speculative market remains net long JPY suggesting scope for a drop in JPY speculative appetite too, but any upside is set to be gradual, with a technical hurdle at around 79.37 likely to be tough level to break above.

EUR/SEK has edged higher over recent days following its dramatic multi month drop. Why has the currency pair turned now? One of the key factors appears to be an increased sensitivity to risk which is playing negatively now that risk aversion is rising again. Indeed my risk barometer has been moving higher since around the middle of the month, in turn dragging SEK lower.

My quantitative model estimate based on interest rate differentials, relative equity performance and risk aversion, suggests that the SEK has further to weaken especially against the EUR. Based on the results of the model I suggest playing for such a move, targeting 8.7252, with a stop loss at 8.1616.

Another currency for which I am bearish on versus EUR is GBP. Although the move higher in EUR/GBP has been a slow grind, I continue to see value in this trade. Indeed, my models show that there is still much upside potential left for EUR/GBP based on the current levels of yield differentials and risk aversion.

As for cable (GBP/USD) it appears to be stuck to the coattails of EUR/USD but I expect it to lag any move higher in EUR/USD going forward. Moreover, if as I expect EUR/USD loses momentum into next week, this will leave GBP/USD rather exposed to downside risks.

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Fed passes the baton to the ECB. EUR and GBP downside risks

August 2, 2012 — Mitul Kotecha

Although the Fed’s inaction overnight was perhaps a little disappointing for markets the FOMC did note that it “will” provide further stimulus to the economy if needed. The USD rallied but risk currencies came under pressure. However, any sell off in risk assets will be limited as markets look to the FOMC meeting on September 13 for more action. This will also coincide with updates of the Fed’s economic forecasts. The below consensus reading for the ISM manufacturing index in July which came in at 49.8 added to the slight disappointment, with the data consistent with flat growth in manufacturing.

Attention now turns to the European Central Bank (ECB). Warnings by the Bundesbank President Weidmann for the ECB not to overstep its remit sets the scene for a stressful policy meeting today. Although markets have pared back their overly bullish expectations from the end of last week a lack of action by the ECB to reduce peripheral bond yields will disappoint and lead to a sell of in risk assets and EUR/USD but support around 1.2150 is likely to hold. Even a restart of Securities Market Purchases on its own would not be a game changer.

The Bank of England also decides on policy today but unlike the ECB there is little expectation of any action from the MPC. Inaction by the BoE today will highlight that after a GBP 375 billion in asset purchases there is limited room in the tool kit aside from lowering interest rates further. A weaker than expected reading for UK July manufacturing confidence weighed on GBP, with the data following a rash of disappointing data releases over recent weeks. I continue to see downside risks to GBP both against the EUR and USD, however. Indeed, my quantitative models reveal that GBP/USD should be trading around 1.5144 while EUR/GBP should be around 0.8242.

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