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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A set back for the pound

June 18, 2009 — Mitul Kotecha

The multi week rally in the pound (GBP) has hit a snag as the currency has failed to extend gains above its recent highs around 1.66 against the dollar (USD).  The surprising fall in UK retail sales, with sales dropping by 0.6% from April compared to expectations of a 0.3% increase, dealt GBP another blow.   Sales were down 1.6% from a year earlier.  This is bad news for those that had believed that the UK consumer was enduring the economic downturn with some resilience. 

The reality is that the recovery in the economy will be a bumpy ride.  Whilst there have been some signs of improvement in the economy it is by no means a broad based pattern.  I would warn at getting too carried away with recovery expectations.  There have been clear signs of strengthening in both manufacturing and service sector survey data but they still only point to a gradual recovery in the months ahead. 

Moreover, some UK housing market indicators have pointed to early signs of recovery but a lot of this is due to a lack of supply and at best the housing market is entering a period of stabilisation.   Despite the signs of economic stabilisation the British Chamber of Commerce (BCC) cut its forecasts for the UK economy to -3.8% this year compared to a previous forecast of -2.8%.  

Meanwhile, UK banks continue to restrain credit and may even need more equity capital on top of the $158 billion in capital already raised according to Bank of England governor Mervyn King in his Mansion House speech.  He also warned about a “protracted” economic recovery. The good news is that the BoE is in no rush to take back its aggressive monetary easing and £125 billion asset purchase plan, but unless banks pass the benefits of this onto borrowers the fledgling recovery could stall quite quickly.   

The desire not to act quickly to reverse monetary policy was echoed in the minutes of the June BoE meeting, which revealed a unanimous 9-0 vote to maintain the status quo on policy.  The minutes also noted that the near term risks to the economy had lessened but monetary policy committee members remained cautious about the medium term prospects.  It is likely that the BoE will take several more months to gauge how successful policy has been. 

All of this highlights that GBP will be vulnerable to periodic bouts of profit taking and reversal.  Its ascent from its lows against the USD below 1.40 has been dramatic and rapid.  I believe that much of its gain has been justified especially as it had fallen to extreme levels of undervaluation.  Moreover, aggressive policy actions, both on fiscal and monetary policy, suggest that UK economic recovery will come quicker than Europe. This implies that GBP will at the least continue to recover against the euro (EUR) despite the weak retail sales induced set back.   

I also look for GBP to extend gains against the USD over coming months, with GBP/USD likely to end the year in the 1.70-1.80 region rather than low 1.60s where it is now. Market positioning leaves plenty of scope for GBP short covering over coming weeks adding further potential for recovery.  GBP appreciation will not continue in a straight line however, but set backs going forward should be looked upon as providing opportunities to rebuild long positions.

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US dollar under pressure

May 15, 2009 — Mitul Kotecha

The US dollar has come under major pressure, with the US dollar index (a composite of the dollar against various currencies) falling to 4-month lows.   The weakness of the US dollar has been broad based and even the Japanese yen which normally weakens as risk appetite improves, has strengthened against the USD.  The euro has also taken advantage of dollar weakness despite ongoing concerns about the European economy. The main source of pressure on the dollar is the improvement in market appetite for risk.  

As I noted in a previous post, “What drives currencies?” risk appetite has been one of the biggest drivers of currencies in the past year.   This has pushed other drivers such as interest rate differentials into the background.   In the post I also stated that we would all have to watch equity markets to determine where currencies will move, with stronger equities implying a weaker dollar.

The dollar looks particularly sickly at present and it is difficult to go against the trend.  It will need a major reversal in equity markets or risk appetite to see a renewed strengthening in the dollar.   Although I still think it will require some positive news as opposed to less negative news to keep the momentum in equity markets going (see previous post) the prospects for a stronger dollar remain limited.   

Over the coming months the dollar is set to weaken further and those currencies that have suffered most at the hands of a strong dollar will benefit the most as risk appetite improves.  It is no coincidence that the UK pound has strengthened sharply over recent days, and this is likely to continue given its past undervaluation.  Other currencies which were badly beaten such as the Australian dollar and Canadian dollar will also continue to make up ground, helped too by a rebound in commodity prices.   

Aside from improving risk appetite the dollar may also come under growing pressure from the Fed’s quantitative easing policy, especially if inflation expectations in the US rise relative to other countries as a consequence of this policy.  It will be crucial that the Fed removes QE in a timely manner and many dollar investors will be watching the Fed’s exit strategy closely.  

Although the US trade deficit is showing improvement another concern for dollar investors is the burgeoning fiscal deficit.   The US administration revised up its estimate for the FY 2009 deficit to $1.84 trillion or about 12.9% of GDP, highlighting the dramatic deterioration in the US fiscal position.  Concerns about this were highlighted in an FT article warning about the risk to US credit ratings.

The deterioration in dollar sentiment has also been reflected in speculative market positioning, which has seen speculative appetite for the dollar drop to its lowest level in several months. The bottom line is that any recovery in the dollar over the coming weeks is likely to be limited offering investors to take fresh short positions as investors continue to move away from holding the dollar.

Posted in central banks, Commodities, Currencies, Economics, equity markets, Europe, Financial crisis, US, US administration. Tags: , , , , , , , , , , , , , , , , . 6 Comments »
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