Talk but no action

January 19, 2011 — Mitul Kotecha

The eurozone periphery remains in the eye of the storm but markets may have to wait before any concrete action is taken. The possibility of increasing the size of the bailout fund (EFSF), preparation of new European bank stress tests and/or allowing the EFSF to purchase eurozone government debt are all on the table but so far agreement has been lacking. Ministers apparently rejected the idea of increasing the size of the fund from EUR 440 billion to EUR 750 billion whilst disagreement over stricter criteria may also be hampering any progress.

Nonetheless, the EUR has found renewed support, helped by the firm German IFO investor confidence survey and news that Russia is looking to buy EFSF bonds. EUR/USD upside may be face a hurdle around 1.3500 over the short term and gains above this level are likely to be difficult to sustain given the ongoing uncertainties about the EFSF none of which are likely to be resolved anytime soon. The bottom line is that talk but not action will not be sufficient to keep the EUR supported.

GBP is also doing well, partly on the coat tails of a firmer EUR but also in the wake of an acceleration in UK CPI inflation which came in at 3.7% YoY a two year high, surpassing the Bank of England’s (BoE) ceiling for the 10th straight month. Inflation is likely to remain elevated pushing closer to 4% due to the VAT hike to 20% which came into effect at the beginning of this year. The data puts the BoE in a difficult situation testing the Monetary Policy Committee (MPC) expectation that the jump in inflation will prove temporary. However, the market is increasing taking the stance that a rate hike is going to take placer sooner rather than later, with a growing probability of a rate hike.

Since the end of last year there has been a 25bps spread widening (between 2nd contract rate futures) as markets have become more hawkish on UK interest rate expectations. This has coincided with an increasing correlation with GBP/USD resulting in the currency pair cracking above the psychologically important 1.60 level. Much will depend on whether the BoE’s predictions come true. If inflation remains sticky on the upside the Bank may be forced into an earlier tightening. Whether this is good news for GBP will depend on the economy. The worst case scenario is premature monetary tightening just as austerity measures start to bite.

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The Week Ahead

September 20, 2010 — Mitul Kotecha

Equity markets and risk trades have generally performed well over the last couple of weeks, with for example the S&P 500 around 7.5% higher since its late August low, whilst equity and currency volatility have been generally low, the latter despite some hefty FX intervention by the Japanese authorities which did provoke a spike in USD/JPY volatility last week.

Risk appetite took a knock at the end of last week in the wake of worries that Ireland may seek EU / IMF assistance although this was denied by Irish officials. A similar worry inflicted Portugal, and as a result peripheral bond spreads were hit. Sovereign worries in Europe have not faded quickly and bond auctions in Greece, Spain and Portugal will garner plenty of attention this week. Renewed worries ahead of the auctions suggest that the market reception could be difficult.

Attention will swiftly turn to the outcome of the Fed FOMC meeting tomorrow and in particular at any shift in Fed stance towards additional quantitative easing following the decision at the August FOMC meeting to maintain the size of the Fed’s balance sheet. Given the recent improvement in US economic data the Fed is set to assess incoming data before deciding if further measures are needed.

Housing data in the US will also garner plenty of attention, with several releases scheduled this week. Increases in August housing starts, building permits, existing and new home sales are also expected. Whilst this may give the impression of housing market improvement, for the most part the gains will follow sharp declines previously, with overall housing market activity remaining weak following the expiry of the government tax credit.

Weakness in house prices taken together with a drop in equity markets over the quarter contributed to a $1.5 trillion drop in US household net wealth in Q2. Wealth had been recovering after its decline from Q2 2007 but renewed weakness over the last quarter will not bode well for consumer spending. Household wealth is around $12.4 trillion lower than its peak at the end of Q2 2007.

Aside from the impact of renewed sovereign concerns, European data will not give the EUR much assistance this week either, with Eurozone September flash PMIs and the German IFO survey of business confidence set to weaken as business and manufacturing confidence comes off the boil. If the Fed maintains its policy stance whilst risk aversion increases over coming days the USD may find itself in a firmer position to recoup some of its losses both against the EUR and other currencies.

This will leave EUR/USD vulnerable to drop back down to around support in 1.2955 in the very short-term. As indicated by the CTFC IMM data there has been further short EUR position covering last week whilst sentiment for the USD deteriorated, suggesting increased room for short-USD covering in the event of higher risk aversion.

The impact of Sweden’s election outcome over the weekend is unlikely to do much damage to the SEK despite the fact that the coalition government failed to gain an outright majority. EUR/SEK has edged higher over recent days from its low around 9.1528 but SEK selling pressure is unlikely to intensify following the election, with EUR/SEK 9.3070 providing tough technical resistance.

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Optimism dissipates

January 23, 2010 — Mitul Kotecha

Markets have been highly fickle so far this year. Optimism about strong recovery led by China – recall the fact that disappointment from the surprisingly weak US non-farm payrolls report in December was outweighed by strong Chinese trade data – has dissipated. Instead of rejoicing at China’s robust GDP report last week, which revealed a 10.7% rise in the fourth quarter of 2009, investors began to fret about whether China would have to move more aggressively to tighten monetary policy. Fuelling these fears was the release of Consumer price data which showed inflation rising above expectations to 1.9% YoY in China.

If such fears were not sufficient to hit risk appetite, US President Obama’s plan to limit the size and trading activities of financial institutions dealt another blow to financial stocks. The plan followed quickly after the Democrats lost the state of Massachusetts to the Republicans and managed to shake confidence in bank stocks whilst fuelling increased risk aversion. Meanwhile, rumblings about Greece continue to weigh on markets and Greek debt spreads continued to widen even as global bond markets rallied.

Following the US administration’s plans to restrict banks’ activities the fact that the rise in risk aversion was US led rather than broad based led to an eventual pull back in the dollar which helped EUR/USD to avoid a break below 1.40. Risk trades including the AUD came under pressure as risk appetite pulled back. A drop in commodity prices did not help. The AUD was also hit by news that Australia’s Henry Tax Review would look to tax miners in the country. As a result AUD/USD dropped below 0.90 though this level is likely to provide good buying levels for those wanted to take medium term AUD long positions. The one currency that did benefit was the JPY which managed to drop below sub 90 levels.

The aftermath of the “Volker Plan” will reverberate around markets this week keeping a lid on equity sentiment. Meanwhile Greece will be in the spotlight especially its bond syndication. A bad outcome could be the trigger for EUR/USD to sustain a move below 1.40 though it looks as though it may find a bottom around current levels, with strong support seen around 1.4029. The German IFO business survey for January will be important to provide some direction for EUR and could be a factor that weighs on the currency if as expected it reveals some loss of momentum in the economy.

Aside from the Fed the other G3 central bank to meet this week is the Bank of Japan but unless the Bank is seen to be serious about fighting deflation, USD/JPY may remain under downward pressure against the background of elevated risk aversion. Below 90.0 there does appear to be plenty of USD/JPY buyers however, suggesting that further upside for the JPY will be limited. USD/JPY will find strong support around 88.84.

Much will depend on the key events in the US this week including the Fed FOMC meeting and the President’s State of the Union speech. USD bulls will look for some indication that the US government is serious about cutting the burgeoning budget deficit. Also watch out for the confirmation vote on the renomination of Bernanke as Fed Chairman which could end up being close. There is a heavy slate of data to contend with including new and existing home sales, consumer confidence, durable goods orders, the first glance at Q4 GDP and Chicago PMI.

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