Renewed caution

December 8, 2009 — Mitul Kotecha

Risk appetite is struggling to make any headway, with equities losing ground overnight. The positive impact on markets and adjustment to growth expectations following the US jobs report has given way to renewed concerns. Caution increased as Fed Chairman Bernanke introduced a dose of reality to markets talking about “formidable headwinds” to growth. As a result, bonds gained some lost ground and markets pared back expectations of interest rate hikes, leaving the USD vulnerable.

Eurozone risk factors continue to dampen market enthusiasm too, with ECB President Trichet warning of further bank writedowns and S&P downgrading the outlook for Greece and Portugal. The release of German factory orders data revealing a sharp 2.1% fall in October fed into concerns and played against strengthening recovery hopes in the region. EUR/USD failed to close below 1.4820 suggesting some alleviation of downside pressure. FX markets are likely eye stocks for further direction, with various EUR negative specific factors set to limit the upside.

The delayed release of additional stimulus measures in Japan will be the main focus of attention in Japanese markets assuming that an agreement is reached within the coalition. In the meantime markets will digest news that the current account surplus narrowed in October but was still up 51.4% from a year earlier. Additionally loan growth continued to slow, for the 11th straight month in November, adding further evidence that the injections of liquidity into banks are not finding their way into the economy.

GBP has come under growing pressure over recent days and bulls will be disappointed by the BRC retail sales data. The 1.8% YoY rise in like-for-like sales according will come as another disappointment for GBP. The gain was the slowest since August and below forecasts and as noted by the BRC looks even weaker when considering that the year ago figure was very weak. The sales data may fuel concerns about the recovery in consumer spending, especially going into the all important Christmas season. Attention will turn to the release of November Halifax house price data and October industrial production data later today and the pre-budget report tomorrow. GBP/USD looks likely to track EUR/USD for now and looks supported above 1.6390.

Although the USD has slipped as markets pare back expectations of rate hikes, the currency appears to be in a win-win situation and will likely see limited downside as risk aversion creeps back. Lingering concerns about Dubai as well as short covering towards year as well as other factors pushing risk aversion higher will likely see the USD retaining some support into the end of the week ahead of the US retail sales and Michigan confidence data

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Buffer for risk trades

November 25, 2009 — Mitul Kotecha

Firmer data, most recently in the form of the stronger than expected US consumer confidence and dovish Fed comments as reiterated in the Fed FOMC minutes will provide a buffer for risk trades, supporting the USDs role as the prime funding currency over coming weeks.  Nonetheless, any improvement in sentiment will have to push against the weight of position adjustment into year-end as investors book profits on risk trades.  The net effect could be an increase in volatility especially in thinning liquidity expected in the wake of holidays in Japan and the Thanksgiving holiday in the US.

This could make it difficult for many asset markets to sustain key psychological and technical levels.  Whether the S&P 500 can hold gains above 1100 could prove significant as could EUR/USD’s ability to hold onto gains above 1.50.  The expiry of last week’s EUR/USD 1.48/1.51 option may provoke a move out of its range but there seems to be little appetite for a sustained break above the 23rd October high around 1.5061.  Even so, an upside bias is more likely given the likely softer tone to the USD. EUR/USD looks well supported around 1.4865.

Position adjustment towards the end of the year has been particularly evident in FX markets.  For instance, the latest CFTC Commitment of Traders’ data revealed that speculative investors have sharply reduced net long EUR positions into last week whilst there was a significant degree of short covering of GBP positions.  It is worth noting however, that aggregate USD net short speculative positions actually increased, largely due to a sharp jump in net JPY positioning, suggesting that overall sentiment for the USD remains very negative.

It is difficult to see a strong reversal in USD sentiment into year-end and the Fed’s commitment to maintaining interest rates at a low-level for an “extended period” taken together with hints of extending asset purchase programmes suggests little support to the USD over the short-term unless there is a more significant increase in risk aversion and or profit taking/book closing into year-end.  It seems that the impact of improved risk appetite is winning for now, giving no respite to the USD.

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When things are just not right

November 20, 2009 — Mitul Kotecha

One knows when things aren’t quite right when a football team wins a game by using a hand to help score a goal rather than a foot.  In this case it was French striker Thierry Henry who helped France to qualify for the world cup at the expense of Ireland.  To English soccer fans this looks like decidedly similar situation to the “hand of god” goal scored by Diego Maradona during the 1986 World Cup. 

Similarly things don’t look quite right with markets at present and what began as a loss of momentum turned into a bit of a rout for US (Thursday) and Asian stocks (Friday).  In turn risk appetite has taken a turn for the worse whilst the USD is on a firmer footing.  Profit taking or simply repatriation at year end may explain some of the market moves but doubts about the pace and magnitude of economic recovery are playing a key role.

Ireland has called for a replay of the soccer game but markets may not get such an opportunity as sentiment sours into year end.  Markets chose to ignore some relatively positive news in the form a  stronger than forecast increase in the Philly Fed manufacturing survey and the improving trend in US jobless claims leaving little else to support confidence. 

The only event of note today was the Bank of Japan policy decision.   Interest rates were kept unchanged at 0.1%.  Given that official concerns about deflation are intensifying interest rates are unlikely to go up for a long while and we only look for the first rate hike to take place in Q2 2011.  The BoJ may however, be tempted to buy more government bonds in the future if deflation concerns increase further.   USD/JPY was unmoved on the decision, with the currency pair continuing to gyrate around the 89.00 level though higher risk aversion suggests a firmer JPY bias. 

In the short term increased risk aversion will play positively for the USD against most currencies, especially against high beta currencies such as the AUD, NZD and GBP.   Asian currencies will also be on the back foot due to profit taking on the multi-month gains in these currencies.

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FX position squaring

November 18, 2009 — Mitul Kotecha

It is becoming apparent that as the end of the year approaches market players are squaring FX positions rather than putting new risk on. The USD has failed to show any sign of sustaining a recovery over recent weeks but may be benefiting from short covering into year end, with the USD index pivoting around the 75.00 level. Supportive comments from US officials and international calls for the US to act to prevent the currency from being debased may also be helping on the margin.

Nonetheless, the USD’s outlook is still mired by a combination of both cyclical and structural concerns and it will fail to recover on a sustainable basis until it loses the mantle of preferred funding currency. This is unlikely to happen soon given the repeated commitment by the Fed to keep interest rates low for long as repeated this week by Fed Chairman Bernanke.

USD/JPY continues to gyrate around the 89-90 level and is showing little inclination to move either side though a run of positive economic surprises and the move in interest rate differentials (versus US) suggest that the JPY will trade on the firmer side of 90 over the short term; USD/JPY has been the most highly correlated currency pair with interest rate differentials over the past month. JPY speculative positioning is not particularly onerous at present, suggesting some room for an increase in JPY positioning.

The EUR continues to struggle to make any headway and is likely not being helped by European policy makers’ attempts to talk the USD higher. ECB President Trichet repeated his comments that a strong USD is in the world’s best interest though by now such comments are nothing new. It will need a clear break above 1.5061 in EUR/USD to renew the uptrend in the currency. For now, a reported 1.48-1.51 option expiring on Friday suggests range trading, with EUR/USD looking heavy on the top side.

GBP is set to remain firm despite the slightly dovish November MPC minutes. GBP looks resilient against the EUR against which it has benefited from a favourable move in interest rate differentials as a well as an adjustment in positioning where the market has decreased its GBP short positions and also decreased EUR long positions. EUR/GBP has been leading the way, and like USD/JPY this currency pair has become increasingly correlated with interest rate differentials, which has played positively for GBP. This has helped it to pivot around the 200 day moving average around 0.8871, a level that will prove important to determine further downside potential in EUR/GBP.

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Searching for inspiration

November 9, 2009 — Mitul Kotecha

After an eventful week which included several central bank meetings and the US Jobs report there is less for markets to get their teeth into this week.  Despite the weak US jobs report risk appetite looks relatively resilient suggesting that the USD will struggle to make much headway over coming days.  

Despite all of the events last week markets have been uninspired.  Even the G20 meeting delivered little to be excited about with no further developments on how to rebalance the global economy and the USD’s role in the process.  The lack of attention on the USD will leave it with little directional influence this week, with equity markets likely to the main driver once again.

One currency that may look a little better supported over coming days is the EUR.  GDP data later in the week is likely to reveal an expansion over Q3 after several quarters of contraction as indicated by various PMI data. Although it will likely be led by inventories and exports rather than domestic demand it will nonetheless come as good news, albeit backward looking.  Going forward growth in Europe is unlikely to match the pace of recovery in the US but for now the GDP data will be EUR supportive helping EUR/USD to gravitate around 1.50 and beyond. 

Meanwhile, central banks may also do their part in influencing currencies given their differing stances on monetary policy.  Although the Fed did not deliver any big surprises last week the FOMC statement will play for a softer USD as the currency looks to maintain its funding currency status for an “extended period”.   In contrast the RBA hiked rates as expected and despite hinting at more gradual rate increases in the months ahead the AUD continues to stand to benefit.   Going in the opposite direction the BoE increased its asset purchases but GBP avoided a significant negative fall out as the move is likely to be seen as the final step in the BoE’s asset purchase programme.

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