USD pressured by drop in yield

March 26, 2012 — Mitul Kotecha

Risk sentiment starts the week in positive mode. Weekend reports that Germany will not stand in the way of allowing the (European Financial Stability Facility) EFSF and its successor the European Stability Mechanism (ESM) bailout funds to be combined to boost the ‘firewall’ against contagion in the Eurozone has helped to boost sentiment.

Market direction may be obscured by month end and quarter end window dressing this week and despite the likely positive start to the week there are still plenty of factors to dent risk appetite over coming days, not least of which is the gyrations in oil prices.

The USD has slipped over recent days in line with a pull back in US Treasury bond yields. Notably there has also been a pull back in speculative USD sentiment as recorded in the CFTC IMM data. The ‘risk on’ tone to market that appears to be developing today will likely result in renewed downside risks to the currency.

US economic data continues to outshine economic releases elsewhere although US housing data last week was notably mixed. It will be the turn of March consumer confidence and February durable goods orders to capture the market’s attention over coming days.

A slight decline in the former and a healthy increase in the latter are expected. However, it seems unlikely that either release will be particularly supportive for yields and in turn the USD, so it will require a further increase in risk aversion to push the USD higher over coming days.

EUR/USD appears to be settling into the middle of a 1.30-1.35 range. Direction has increasingly been led by economic factors rather than debt issues recently but the news on the former has not been particularly good.

The March German IFO today and EU Finance Ministers meeting will be the key events of the week while there will also be interest on Spain’s budget as well as Spanish and Italian debt auctions. The IFO will likely prove to be more positive for the EUR than the manufacturing surveys last week, with an uptrend in the data continuing.

Moreover, hopes that Finance Ministers will bolster the ‘firewall’ to prevent other peripheral countries from repeating Greece’s debacle, will also likely keep the EUR supported. Overall, this implies EUR/USD will likely continue to creep higher over the week, with a test of technical resistance around 1.3356 eyed.

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FX outlook this week

February 19, 2012 — Mitul Kotecha

Direction in FX markets will largely hinge on developments at the beginning of the week in Europe but a US holiday (Presidents’ Day) will mean a subdued start. US data has continued to beat expectations as revealed by the recent gains in core retail sales, manufacturing surveys, jobless claims and industrial production. US recovery is taking shape and the USD is finally showing some signs of perking up on the news.

Rising US bond yields have provided the USD with some support although the impact has been muted by higher bond yields elsewhere. Nonetheless, despite ongoing speculation of more Fed quantitative easing the USD looks set to be on a slightly firmer footing over coming days. In a relatively light week of data releases housing data will be the major focus of attention.

Assuming approval for a second Greek bailout goes ahead (after much procrastination) the week will at least begin on a positive note for the EUR. Whether the EUR will extend gains will partly be determined by the release of flash February purchasing managers’ indices (PMI) and the German IFO business confidence survey. Our forecasts of weak service sector readings but firm manufacturing indices will be a mixed blessing for the EUR but overall data will remain consistent with mild recession.

Failure of EUR/USD to sustain a move below the psychologically important 1.30 level suggests a bit more resilience over coming days. Nonetheless, speculation of a Greek euro exit will not fade quickly and markets will likely gyrate between ‘risk on’ and ‘risk off’ depending on the latest comments from Greek or European officials. All in all, the EUR will continue to struggle to move higher.

For a change one of the bigger movers in currency markets over recent days has been the JPY. Its decline following more aggressive monetary policy action by the Bank of Japan has extended further. The move by the BoJ helped to suppress Japanese government bond yields (JGBs) allowing USD/JPY to move higher in line with relatively higher US yields. This week’s release of January trade data will support the case for more JPY weakness given the deteriorating trend.

The data will also strengthen the resolve of the Japanese authorities to intervene in FX markets should the JPY strengthen anew. Immediate focus will be whether USD/JPY can break through the psychologically important 80 level where JPY weakness will be met by plenty of exporters offloading USDs. I suspect the upside momentum in USD/JPY will fade over coming days unless US bond yields continue their ascent.

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Risk Aversion to remain elevated

July 18, 2011 — Mitul Kotecha

It remains a tumultuous time for markets, gripped by a cacophony of concerns ranging from the lack of resolution to the Eurozone debt crisis to the failure to reach agreement on raising the US debt ceiling and associated deficit reduction plans. Mingled among these is the growing evidence that economic growth is turning out weaker than expected. Meanwhile Europe’s crisis appears to be shifting from bad to worse, as reflected in a shift in attention towards the hitherto untouched Italy although Italian concerns have eased lately.

The release of the EU bank stress test results at the end of last week have not helped, with plenty of criticism about their severity and rigour following the failure of only 8 banks out of the 90 tested. Expectations centred on several more banks failing, with much more capital required than the EUR 2.5 billion shortfall revealed in the tests. Answering to this criticism officials note that there has already been a significant amount of capital raised over recent months by banks, but this will be insufficient to stem the growing disbelief over the results.

Attention is still very much focussed on Greece and reaching agreement on a second bailout for the country, with further discussions at the special EU summit on July 21. The contentious issue remains the extent of private sector participation in any debt restructuring. The decision to enhance the flexibility of the EFSF bailout fund to embark on debt buybacks has not helped. Consequently contagion risks to other countries in the Eurozone periphery are at a heightened state. Despite all of this the EUR has shown a degree of resilience, having failed to sustain its recent drop below 1.40 versus USD.

One explanation for the EUR’s ability to avoid a steeper decline is that the situation on the other side of the pond does not look much better. Hints of QE3 in the US and the impasse between Republicans and Democrats on budget deficit cutting measures tied to any increase in the debt ceiling are limiting the USD’s ability to benefit from Europe’s woes. Moreover, more weak data including a drop in the Empire manufacturing survey and a drop in the Michigan consumer sentiment index to a two-year low, have added to the worries about US recovery prospects.

Against this background risk aversion will remain elevated, supporting the likes of the CHF and JPY while the EUR and USD will continue to fight it out for the winner of the ugliest currency contest. Assuming that a deal will eventually be cobbled together to raise the US debt ceiling (albeit with less ambitious deficit cutting measures than initially hoped for) and that the Fed does not embark on QE3, the EUR will emerge as the most ugly currency, but there will be plenty of volatility in the meantime.

Data and events this week include more US Q2 earnings, June housing starts and existing home sales. While housing data are set to increase, the overall shape of the housing market remains very weak. In Europe, July business and investor surveys will be in focus, with a sharp fall in the German ZEW investor confidence survey likely and a further softening in July purchasing managers indices across the eurozone. The German IFO business confidence survey is also likely to decline in July but will still point to healthy growth in the country. In the UK Bank of England MPC minutes will confirm no bias for policy rate changes with a 7-2 vote likely, while June retail sales are likely to bounce back.

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Euro resilient but for how long?

March 25, 2011 — Mitul Kotecha

The resilience of the EUR to bad news has been impressive but is unlikely to persist. The recent negatives include 1) the rejection of the Portuguese government’s austerity plan and the increased likelihood of a bailout, 2) a likely delay in the decision on increasing the size and scope of the EFSF EU bailout fund, 3) a drop in Eurozone purchasing managers indices in March, 4) downgrades to Portugal’ sovereign credit ratings by Fitch last night and S&P and 5) Moodys downgrades of 30 Spanish banks. Despite all of this, and after hitting a low of around EUR/USD 1.4054, EUR has bounced back close to the 1.4200 level.

Further direction will come from the outcome of the EU leaders’ summit today and the March German IFO business confidence survey. For the former there is unlikely to be a decisive result, with the optimism following the informal March 11 leaders’ summit likely to give way to delay due to wrangling over details. For the latter, a slight moderation in the IFO is expected following February’s upside surprise. However, there is a bigger risk of a downside surprise following the softer than forecast March German manufacturing PMI released. Against this background, EUR/USD is likely to struggle to break resistance around 1.249.

In general FX markets look somewhat more stable and even the pressure on the USD appears to have abated slightly despite a much weaker than expected outcome for US February durable goods orders yesterday, which revealed a drop in both headline and ex-transportation orders. My composite FX volatility measure has dropped sharply over recent days, led by short term implied JPY volatility which has dropped close to pre-crisis levels. Lower volatility has also likely reduced the prospects of further FX intervention although USD/JPY 80 will continue to be well defended.

Lower volatility as also reflected in the sharp drop in the VIX index has corresponded with a general easing in risk aversion as both Middle East and Japan tensions have eased slightly. US data today are unlikely to offer much direction, with a slight upward revision to US Q4 GDP and an unchanged outcome for the final reading of Michigan consumer confidence expected.

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The Week Ahead

February 20, 2011 — Mitul Kotecha

Housing and durable goods orders data will form the highlights of the US calendar this week. Speeches from several Fed speakers will also give some further guidance to the appetite for completing the Fed’s $600 billion in asset purchases. Overall it will be a slow start for FX markets with liquidity thinned by the Presidents Day holiday and as a result currencies are likely to remain in relatively tight ranges. The heavy tone of the USD seen last week is likely to persist over coming days given the absence of driving factors. Even the unrest in the Middle East has been unable to derail the improving trend in risk appetite, another factor dampening USD sentiment.

The EUR held up well last week recouping its early week losses to end on a firm note. The ability of the EUR to shake off various bits of bad news was impressive but whether it can continue to do so is debatable. Data releases are unlikely to provide much of a boost. Whilst eurozone business surveys set to remain at high levels, consistent with a rebound in Q1 GDP growth, further improvements are unlikely. The week kicks off with the February German IFO business confidence survey but at best this will reveal stable reading. The EUR may find some support from signs of higher and in Germany and an above consensus reading for M3 money supply growth though this is not usually a market mover. The data will likely feed nervousness about European Central Bank (ECB) tightening. Ireland could rock the boat however, with general elections likely to keep markets nervous about potential renegotiations of Ireland’s bailout terms.

Although deflationary pressures are easing in Japan there is a long way before the spectre of inflation will emerge. Nonetheless, the Bank of Japan (BoJ) revised up its growth outlook last week, suggesting that the likelihood of more aggressive measures to combat deflation is narrowing. A reminder of ongoing deflation will come with the release of January CPI data this week whilst trade data will be watched to determine what impact the strength of the JPY is having on exports. Both EUR/JPY and USD/JPY are close to the top of their recent ranges and the data are unlikely to provoke a break higher. USD/JPY will likely remain capped around 84.51 whilst EUR/JPY will find tough resistance around 114.02.

GBP performed even better than the EUR last week helped by an even more hawkish sounding than usual BoE Monetary Policy Committee (MPC) member Sentance and a letter from the BoE governor hinting at rate hikes. Even a relatively more slightly dovish Quarterly Inflation Report failed to halt GBP’s ascent. Further direction will come from the February MPC minutes in which we expect to see two dissenters, namely Sentence and Weale who likely voted for a rate hike. However, there is a risk that they may have been joined by at least one other, with speculation that MPC member Bean may have joined the dissenters. Such speculation alongside the jump in January UK retail sales at the end of last week will likely add to more upside potential for GBP, setting it up for another gain this week. Its upward momentum may however, be hampered by the large net long GBP positioning overhang.

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