EUR to struggle to extend gains

July 5, 2011 — Mitul Kotecha

Once again the USD index failed to break above its 100-day moving average, its third failure to do so over recent weeks. The USD is now trading below its 20- and 50- day moving averages and looks vulnerable to further weakness. However, much will depend on the travails of the EUR and how quickly the boost to this currency fades following last week’s Greek austerity plan approval.

The USD was helped last week by the relative move higher in US bond yields, which saw 2-year yield differentials between the Eurozone and US drop below 100bps for the first time since the beginning of April. Given that the six-month correlation between 2-year bond yield differentials and EUR/USD is at a very high level, it is reasonable to assume that this will remain an important factor driving the currency pair going forward.

The yield differential narrowing seen last week has reversed as German yields have moved sharply higher this week, however. This is in large part attributed to more positive developments in Greece but nonetheless, it has helped to push the EUR higher.

Ratings agencies may yet spoil the party for the EUR, with S&P’s warning that Greece’s debt rollover plans may put the country’s ratings into select default, fuelling some caution. Should ratings agencies downgrade Greek debt to junk it will not only be international investors that will re-think their exposure to the country but the European Central Bank (ECB) could also stop holding Greek debt as collateral for loans although an official from the Bank noted that this would happen only if all the major ratings agencies downgrade Greek debt to default.

Attention is now turning to the implementation risks of austerity measures and asset sales. While Greece’s contribution to eurozone GDP is small, the pain of implanting more budget cuts will push the economy deeper into recession and reveal the stark divergences in growth in the eurozone at a time when the ECB is hiking interest rates.

In reaction to such concerns there is likely to be a series of measures announced over coming days and weeks to boost growth according to Greece’s finance minister. As the S&P comments and implementation/growth concerns suggest, the EUR may struggle to extend gains, especially as the currency is looking increasingly stretched at current levels, with this week’s ECB rate hike largely in the price. Top side resistance for EUR/USD is seen around 1.4598.

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Asia Helps The Euro Again

May 26, 2011 — Mitul Kotecha

Following the pressure on markets over recent days there is some relief filtering through markets today although sentiment remains fickle. Weaker than expected US April durable goods orders data failed to dent confidence with equity markets ending in positive territory overnight even though the data added to a plethora of global data disappointments over recent weeks.

Once again the EUR has been saved by Asian demand, this time not directly for the EUR itself but by reports that China and other Asian investors will purchases EFSF bailout bonds, with China apparently reported to be “clearly interested” in the mid June sales of Portuguese bailout bonds, with Asian investors representing a “strong proportion” of the buyers.

Despite the reassuring news about Asian official interest in eurozone debt, problems in the periphery remain a major drag on the EUR. Developments at the two day G8 heads of governments meeting in Deauville and various speeches by officials from the European Financial Stability Facility (EFSF), European Union (EU) and European Central Bank (ECB) regarding Greece’s travails will be particularly important for EUR direction.

The various speakers are likely to maintain the pressure on peripheral countries to continue their austerity programmes in order to gain external support. Nonetheless, there still appears to be conflicting comments about what Greece will do with regard to its debt burden. Whilst some EU officials have espoused the benefits of extending Greek debt maturities on a voluntary basis, the ECB has steadfastly stood against any form of restructuring.

Other than the events above, in the US the second reading of Q1 GDP will be released. The consensus looks for an upward revision to a 2.1% annual rate from an initial estimate of 1.8% due mainly to an upward revision to inventories. US weekly jobless claims will also be of interest especially as the recent increase in the 4-week average for jobless claims has provoked renewed fears about the jobs market recovery.

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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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Central bank decisions and US payrolls in focus

May 1, 2011 — Mitul Kotecha

The USD’s troubles are far from over. Data and events this week will do little to stop the rot. As US Federal Reserve Chairman Bernanke made clear last week the Fed is committed to completing its asset purchase programme by the end of June though there is plenty of debate about what comes after. Reduced growth forecasts and the Fed’s view that price pressures are “transitory” have been sufficient to keep the USD on its knees.

The weaker than expected reading for Q1 US GDP growth at 1.8% QoQ clearly did nothing to alleviate pressure on the USD even though it is widely believed that the soft growth outcome will prove fleeting, with recovery set to pick up pace over the coming months. In truth much will depend on the trajectory for oil prices, especially as petrol prices in the US verge on the psychologically important $4 per gallon mark. Even higher energy prices could dent growth further but lower or stable prices will keep the recovery on track.

The highlight in this holiday shortened week for many countries this week is the US April jobs report at the tail end of the week. Estimates centre on around a 200k gain in payrolls but forecasts will be refined with the release of the ADP private sector jobs report and ISM manufacturing survey earlier in the week. The unemployment rate may prove sticky and will likely remain at 8.8%, a disappointment to those looking for a quicker recovery. The elevated unemployment rate will only reinforce expectations that the Fed will not be quick to reverse policy, with the USD continuing to suffer as a result.

Central bank meetings will be plentiful this week, with the European Central Bank (ECB) and Bank of England (BoE) likely to garner most attention. Recent data in the Eurozone has provided further evidence of growth divergence between North and South, but the EUR has remained resilient to this as well as to increased concerns about the periphery. This make the ECB’s job even tougher than usual when it meets this week and it is unlikely that the Bank will hike rates again so soon, especially given the strength of the EUR. Nonetheless, Trichet will continue to sound hawkish, limiting any damage to the EUR (if any) of no move in policy rates.

Similarly the Bank of England will also remain on the sidelines though this should come as little surprise in the wake of disappointing data recently and a surprise drop in inflation, albeit to still well above the BoE’s target. GBP has made up ground against a generally weak USD but judged against other currencies it has been an underperformer as expectations of monetary tightening have been pared back. Finally, the Reserve Bank of Australia (RBA) is set to remain on hold, but a hike over coming months remains likely even with the AUD at such a high level. Quite frankly although the USD is looking increasingly oversold there is nothing this week that would suggest it will recover quickly.

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