AUD oversold, GBP running into resistance

January 21, 2014 — Mitul Kotecha

AUD/USD has faced a significant bout of pressure since testing a high of around 0.9087. A dismal jobs report in December piled on more pressure on the currency and since then it has failed to recover. Consequently short speculative positioning has increased as sentiment has deteriorated. Yesterday’s slate of Chinese data failed to dent the AUD however, with the currency encouragingly showing some resilience.

Attention will now turn to tomorrow’s CPI inflation data. The release of the TD Securities inflation gauge which printed higher than consensus, highlights upside risks to the release of Q4 CPI and in this respect I believe market expectations of any RBA policy rate cuts look overdone. My quantitative model estimate for AUD/USD suggests that the currency is oversold, with short term fair value seen at around 0.9226.

GBP/USD is edging back up to its year highs around 1.6526 recorded at the turn of the year, a level that is likely to prove to be a tough resistance level. In spite of softer data including manufacturing and service sector confidence readings as well as industrial production the currency was buoyed by a strong December retail sales report at the end of last week.

Jobs data and the Bank of England MPC minutes will be on tap on Wednesday providing more direction for the currency. The minutes are likely to reveal few surprises but there is no doubt that the Bank is moving towards some sort of change in language on its forward guidance. GBP will find little further support over coming days, with consolidation likely. However, market positioning does not appear to be particularly stretched, suggesting limited downside risks.

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Shaky start to the year for equities

January 14, 2014 — Mitul Kotecha

Equity markets and risk assets in general are having a decidedly shaky start to the year. Following a 30% increase in the US S&P 500 last year markets are finally looking at whether earnings expectations and economic growth will justify further gains in equities.

Worries ahead of Q4 earnings releases and perhaps concerns about the economy in the wake of the disappointing US December jobs report weighed on US equities overnight. These concerns also fuelled a further drop in US Treasury yields and undermined the USD. In contrast gold prices were buoyed.

The sharp drop in Treasury yields over recent days highlights both the previous extent of bearishness in bonds but also some hope / expectation that the Fed may slow the pace of tapering in the wake of the jobs data. This seems unlikely however, and as indicated by the Fed’s Lockhart overnight the data is highly unlikely to alter Fed policy.

Q4 earnings releases from JP Morgan and Wells Fargo as well as speeches by Dallas Fed President Fisher and Philly Fed President Plosser will be in focus today to provide further direction to markets. On the data front US December retail sales is the main release of note for which a drop in headline sales will be more than compensated by a gain in sales ex autos.

Overall a cautious tone is likely to continue until further clarity on the earnings outlook is revealed but economic data at least should look more encouraging over coming days. Clearly lower US Treasury yields are weighing on the USD but this is likely to prove to be a correction rather than a sustained USD decline.

It is interesting that the EUR has not managed to capitalize on the weakness in the USD. Lingering expectations that the European Central Bank may need to become more aggressive in terms of policy in the wake of soft inflation could be restraining the EUR. A solid reading for November Eurozone industrial production expected to be revealed today is unlikely to help the currency.

GBP was a major loser overnight although there does not seem to be much of a fundamental reason to sell the currency aside from soft November industrial production data released at the end of last week. Perhaps some profit taking on long GBP positioning may be attributable for the drop in the currency but the CFTC IMM data shows that speculative positioning was not overly long. Inflation data today will provide further direction, with GBP likely to remain under short term pressure.

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Running into resistance

December 18, 2013 — Mitul Kotecha

Currency markets will remain range bound today although many currencies appear to be running into resistance in the wake of recent sharp moves. For instance, GBP/USD has run into a wall and lost momentum following the release of softer than forecast UK November CPI data yesterday. Unless the UK jobs report and MPC minutes today are particularly strong, GBP/USD will remain capped around 1.6300.

Similarly EUR/USD will find it difficult to make much further headway although a gain in the German IFO survey will keep the currency pair supported around 1.3730. USD/JPY’s upside is being undermined by lower US yields but firmer Japanese equities are helping to keep the currency pair supported.

AUD faced yet more jawboning by RBA Governor Stevens attempting to talk the currency lower. Given that such comments are nothing new markets are beginning to discount them, with AUD/USD likely to consolidate above 0.8900.

Asian currency direction will be limited ahead of the Fed outcome too although lower US yields will give some relief. Overall, it remains a case of South East Asian FX underperformance versus North East Asia outperformance.

The exception is the INR which has outperformed so far this month but will face an obstacle in terms of today’s RBI policy decision. 25 bps hikes in the repo and reverse repo rates are widely expected in the wake of higher inflation readings but the INR will also have one eye on the Fed FOMC given that it is the most sensitive Asian currency to US yield movements as outflows from India’s bonds continue. INR will continue to remain capped against this background.

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JPY, EUR and GBP view

December 17, 2013 — Mitul Kotecha

It is highly unlikely that the Bank of Japan adjusts policy at its meeting later this week but further action next year remains likely. More importantly for USD/JPY will be the actions of the Fed this week and the subsequent move in US yields. US 10 year yields have struggled to sustain a move above 2.9% recently, reducing the yield advantage over JGBs and in turn pulling USD/JPY back from its highs.

It is only a matter of time before US yields resume their uptrend and in this respect the outlook remains for more USD/JPY upside. Nonetheless, I am cognisant of the large short (CFTC IMM) JPY position in the speculative market, which into year end suggests plenty of scope for position squaring and short USD covering.

The EUR is set to end the year on firm note but further upside looks limited and the risk / reward favours selling the currency from current levels. Although economic data reveals continued improvement as reflected in the flash Eurozone composite purchasing managers’ index yesterday, much in terms of recovery expectations is in the price.

While a strong basic balance (current account + FDI + portfolio flows) continues to underpin the EUR I do not expect this to persist. Nonetheless as many bears have found out the EUR is a difficult currency to sell and while EUR/USD is likely to increasingly struggle on its approach to 1.3800, any sell off will not be rapid unless the ECB belatedly adopts a more aggressive monetary policy stance.

Like the EUR, GBP is struggling to push higher, as profit takers emerge and a dose of reality sets in given the magnitude of its rally versus USD over recent months (around 10% since July). The rationale for GBP’s gains are clear; surprisingly good economic data and a reassessment of monetary policy implications. However, GBP bullishness has resulted in net long speculative positions reaching their highest since 15 January 2013.

Further GBP gains will require yet more positive economic surprises but this is unlikely to be delivered in the jobs data, inflation data and Bank of England MPC minutes over coming days. Consequently GBP/USD is unlikely to extend gains above 1.6300 in the near term.

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A lot to get through before year end

December 16, 2013 — Mitul Kotecha

As the end of the year nears markets will still need to get through a heavy week in terms of events and data releases before winding down. The main event is the Federal Reserve FOMC meeting on Tuesday and Wednesday and trading direction is likely to be limited ahead of this. There remains a considerable degree of uncertainty about the timing of Fed tapering, with most market participants split between this week and January 30th. We see a one in three chance of Fed tapering beginning this week, with our bet on a January move.

There are also plenty of US data releases on tap including the December Empire manufacturing and Philly Fed surveys, industrial production, CPI inflation, Q3 current account balance, housing starts, existing home sales and Q3 GDP this week. The data will be mixed with manufacturing surveys showing little improvement, home sales declining while in contrast GDP will be revised higher and industrial production will reveal a decent gain.

In Europe there is also plenty to digest amid thinning market liquidity. The final EU summit of the year on 19-20 December will focus on the steps towards banking union while Eurozone flash manufacturing and confidence purchasing managers confidence indices to be released today will show some, albeit limited improvement. Further gains in the German ZEW investor confidence and IFO business confidence surveys are likely to be recorded in December although the surveys are unlikely to match the pace of recent gains.

The UK will also reveal further economic clues in the form of the CPI inflation, jobs data and Bank of England Monetary Policy Committee (MPC) minutes. In particular, the minutes are unlikely to reveal any urgency to change policy despite the faster than anticipated drop in the unemployment rate. In terms of central banks the Bank of Japan is set to leave policy unchanged given recent the progress on inflation while the Reserve Bank of Australia (RBA) minutes will reveal further focus on the strength of the AUD.

The intense focus on the Fed means that there will very limited market movements until after the outcome of the meeting. It is unclear whether the recent slippage in US equities has been due to renewed nervousness about Fed tapering or simply year end profit taking. Either way, a delay in Fed tapering may provide some, albeit limited relief to risk assets.

The USD will benefit if tapering is announced this week, but much will depend on what US bond yields do. Recent moves in currency markets are looking increasingly stretched, with EUR and GBP failing to build on their recent gains, while USD/JPY is also struggling to move higher. This may continue over coming days as FX market activity thins further.

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