China Hikes Rates, More On the Cards

February 9, 2011 — Mitul Kotecha

In an otherwise unexciting day China livened things up by raising its 1 year deposit and lending rates by 25 basis points. The hike, the third in the last four months, should not have come as a surprise, given the growing emphasis by China’s central bank PBoC, to dampen inflation pressures. Indeed, more hikes are on the cards, with at least another two more in prospect over H1. The other tool to combat inflation is CNY appreciation further gains in the currency over coming months should be expected to around 6.3 by year-end versus USD.

Global markets largely shrugged of China’s move, with generally positive market sentiment continuing. Even in the eurozone, where there was some disappointment at the surprise drop in German December industrial production, market sentiment continued to improve as Egypt and local debt worries eased further. EUR was particularly resilient despite calls from a Belgian think tank that Greece needs to restructure its debt to avoid a long and painful path ahead. Commodity currencies also showed impressive resilience to China’s rate hike, with both the AUD and NZD holding up well.

The overall positive risk background is supportive for Asian currencies and other risk trades. Currencies in Asia remain highly correlated with portfolio capital inflows and so far this year the weakness in the INR and THB has matched the strong equity outflows from India and Thailand. However, this appears to be reversing, especially in the case of India registering positive equity flows this month, helping the INR to reverse some of its losses.

In the absence of key data releases markets will turn their attention to the testimony by Fed Chairman Bernanke to the House budget committee where he will give comments on the economy, jobs and the budget. Dallas Fed’s Fisher stated overnight that whilst he expects the Fed to complete QE2 he would not support another round of quantitative easing. Fisher’s comments on QE were similar to Atlanta Fed’s Lockhart who notes there is a “high bar” for more QE. Bernanke is unlikely to deviate from this tone in his speech today whilst also maintaining his view that there should be a long term commitment to fiscal retrenchment.

Against the background of improving risk appetite the USD is likely to stay under mild pressure although it is difficult to see a break of recent ranges for most currency pairs. EUR/USD ought to find strong support around its 100-day moving average 1.3535 whilst USD/JPY will be supported around 81.10. Equity sentiment is being supported by US data which remains encouraging. On cue the NFIB Small Business Optimism index duly rose in January to 94.1 as sentiment in this sector continued its improving trend.

Taken together with firmer equities, encouraging data is taking its toll on US bond markets, resulting in a back up in yields. Bond market sentiment wasn’t helped by a relatively poor 3-year auction. For example, US 2-year bond yields have backed up by over 30bps since 28 January. Bad news for bond is good news for the USD however, as higher relative US bond yields will likely help prevent a deeper USD sell-off, with EUR/USD in particular most reactive to relative eurozone / US bond yield differentials.

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Temporary Euro Relief

January 12, 2011 — Mitul Kotecha

Eurozone peripheral country travails continue to garner most market attention. There was at least a semblance of improvement on this front as peripheral bond spreads with German bunds narrowed on Tuesday but this was largely due to European Central Bank (ECB) bond buying than any improvement in sentiment. The fact that German bund yields also rose helped to narrow bund-peripheral spreads further.

A clearer test of sentiment will be today’s debt sales by Portugal followed by actions by Spain and Italy tomorrow. ECB buying of Portuguese bonds has given some relief to other debt, with Spanish and Italian debt spreads narrowing too. Even Greece managed to sell short term debt (EUR 1.95 bn of 26 week T-bills) but at a higher cost than the previous sale.

Perhaps a stronger boost to sentiment will come from the news that European Union (EU) governments are discussing an increase in the EUR 440 billion bailout fund in recognition of the fact that the fund may prove too small to cope if the crisis spreads to Spain. However, don’t expect a decision anytime soon, with next week’s meeting of EU finance ministers unlikely to agree to such a move. Support (or lack) of from Germany may prove to be a sticking point against the background of domestic political pressure.

Other options being considered include the possibility of the EFSF (European Financial Stability Facility) purchasing bonds in the secondary market and lowering interest rates on EFSF bailout loans. News that Japan will buy 20% of EFSF bonds this month as well as recent supportive comments from China suggest that an increase in the size of the EFSF may be easily funded by such investors. The EUR will gain some support against the background of such speculation but its upside may be restrained around its 200-day moving average at EUR/USD 1.3071.

In the US the economic news was not so positive for a change as the National Federation of Independent Business (NFIB) small business optimism survey came in weaker than expected in December, an outcome that will come as a blow given that it suggests some stuttering in the recovery process as well as hiring.

There is only secondary data scheduled today, with most attention on the Fed’s Beige Book later tonight. The survey of Federal Reserve districts will likely reveal a broad based but moderate improvement in economic conditions with the exception of housing activity. A speech by the Fed’s Fisher on Monetary policy will also be in focus. Like the Fed’s Plosser overnight he may highlight some caution about the impact of Fed quantitative easing (QE).

The AUD is increasingly feeling the impact of the flooding in Queensland Australia as the extent of economic damage is revealed. Reserve Bank of Australia (RBA) board member McKibbin estimated that it could knock off at least 1% from economic growth. This may prove too negative and although the flooding will result in a significantly negative impact on growth in Q1 rebuilding and reconstruction will mean that overall growth for 2011 will not be as significantly impacted. Nonetheless, a paring back in RBA policy tightening expectations will see the AUD come under further pressure, with a move down to around AUD/USD 0.9634 on the cards over the short-term.

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Risk on mood prevails

December 23, 2010 — Mitul Kotecha

The end of the year looks as though it will finish in a firmly risk on mood. Equity volatility in the form of the VIX index at its lowest since July 2007. FX volatility remains relatively low. A lack of market participants and thinning volumes may explain this but perhaps after a tumultuous year, there is a certain degree of lethargy into year end.

Whether 2011 kicks off in similar mood is debatable given the many and varied worries remaining unresolved, not the least of which is the peripheral sovereign debt concerns in the eurozone. It is no surprise that the one currency still under pressure is the EUR and even talk that China offered to buy Portuguese sovereign bonds has done little to arrest its decline.

Reports of officials bids may give some support to EUR/USD just below 1.31 but the various downgrades to ratings and outlooks from ratings agencies over the past week has soured sentiment for the currency. The latest move came from Fitch ratings agency which placed Greece’s major banks on negative ratings watch following the move to place the country’s ratings on review for a possible downgrade.

The USD proved resilient to weaker than forecast data including a smaller than forecast 5.6% gain in existing home sales in November. The FHFA house price index recorded a surprise gain of 0.7% in October, which mitigated some of the damage. The revised estimate of US Q3 GDP revealed a smaller than expected revision higher to 2.6% QoQ annualized from a previous reading of 2.5%. Moreover, the core PCE was very soft at 0.5% QoQ, supporting the view that the Fed has plenty of room to keep policy very accommodative.

Despite the soft core PCE reading Philadelphia Fed President Plosser who will vote on the FOMC next year indicated that if the economy continues to strengthen he will look for the Fed to cut back on completing the $600 billion quantitative easing (QE) program. Although the tax deal passed by Congress will likely reduce the need for QE3, persistently high unemployment and soft core inflation will likely see the full $600 billion program completed. Today marks the heaviest day for US data this week, with attention turning to November durable goods orders, personal income and spending, jobless claims, final reading of Michigan confidence and November new home sales.

Overall the busy US data slate will likely maintain an encouraging pattern, with healthy gains in income and spending, a rebound in new home sales and the final reading of Michigan confidence likely to hold its gains in December. Meanwhile jobless claims are forecast to match the 420k reading last week, which should see the 4-week average around the 425k mark. This will be around the lowest since August 2008, signifying ongoing improvement in payrolls. The data should maintain the upward pressure on US bond yields, which in turn will keep the USD supported.

Please note that this will be the last post on Econometer.org this year. Seasons greatings and best wishes for the new year to all Econometer readers.

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Ratings rampage hits Euro

December 20, 2010 — Mitul Kotecha

Both the data flow and market liquidity will be thin over the last couple of weeks of the year. After a bashing over much of H2 2010 it looks as though the USD will end the year in strong form having risen by over 6% since its early November low. In contrast the EUR is struggling having found no support from the meeting of European Union officials at the end of last week in which they agreed to a permanent sovereign debt resolution after 2013 but failed to agree on expanding the size of the bailout fund (EFSF). Similarly there was no traction towards a common euro bond. EUR/USD is now verging on its 200-day moving average around 1.3102, a break of which could see a drop to around 1.2960.

The failure to enlarge the size of the EFSF was disappointing given worries that it is perceived to be insufficient to cope with the bailout of larger eurozone countries if needed. It also highlight that the burden on the European Central Bank (ECB) to prop up eurozone bond markets until confidence improves. The increase in the size of ECB capital from EUR 5.8 billion to EUR 10.8 billion will help in this respect. Such support was clearly needed last week following the rampage across Europe by ratings agencies culminating in Moody’s five notch downgrade of Ireland’s credit ratings, surprising because of its severity rather than the downgrade itself. Ireland’s ratings are now just two notches above junk status and the negative outlook could mean more to come.

It was not just Ireland’s ratings that came under scrutiny. Ireland’s multi notch downgrade followed Moody’s decision to place Greece and Spain on review for a possible downgrade whilst S&P revised Belgium’s outlook to negative. Unsurprisingly peripheral debt markets came under renewed pressure as a result outweighing positive news in the form of strong flash eurozone PMI readings and firm German IFO business confidence survey. EUR did not escape and sentiment for the currency remains weak, with CFTC IMM speculative positioning data revealing a fourth straight week of net EUR short positioning in the week to 14th December.

In contrast, sentiment for the US economy continues to improve. Congress’ swift passage of President Obama’s fiscal plan will help to shore up confidence in US recovery. Data this week will be broadly positive too. On Wednesday, US Q3 GDP data is likely to be upwardly revised to a 2.8% QoQ annualized rate. Durable goods orders excluding transportation are set to increase by a healthy 2.0% (Thu) whilst both existing (Wed) and new (Thu) home sales will reveal rebounds in November following a drop in the previous month.

In the UK the main highlight is the Bank of England (BoE) MPC minutes. Another three way split is expected but this should not cause more than a ripple in FX markets. GBP/USD has slipped over recent days but there appears to be little other than general USD strength responsible for this. The currency pair looks vulnerable to a drop below 1.5500, with 1.5405 seen as the next support level. On balance, the USD will be in good form this week although the drop in US bond yields at the end of last week may take some of the wind out of its sails.

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Drastic Action Needed

December 1, 2010 — Mitul Kotecha

There has been no let up in pressure on eurozone markets and consequently risk aversion continues to increase. The failure of Ireland’s bailout package to stem the haemorrhaging in eurozone bond markets highlights the difficulties in finding in a lasting solution and worsening liquidity conditions in several eurozone bond markets highlights the urgency to act.

Indeed, if spreads continue to widen as they have since late October, by early to mid 2011, Portuguese, Spanish and Italian Euribor spreads would be higher than the EFSF loan spread. In the (admittedly extreme) case that sovereigns could not raise money in the market, peripherals would run out of money early in 2011. Policy makers will try to not let the situation get so out of hand but what can be done to stem the damage?

The European Central Bank (ECB) may be forced to delay its exit strategy by maintaining unlimited liquidity allotments to banks into next year and/or implement further liquidity support measures. The ECB meeting will be closely scrutinized for details, with ECB President Trichet having to adjust policy accordingly. A further option could be for the ECB to step up its bond buying programme which may provide some relief to peripheral eurozone bond markets and the EUR.

Whether this offers a lasting solution however, is debatable. The risk of action by the ECB tomorrow may fuel some caution in the market towards selling the EUR further in the short term and could even prompt some short EUR covering around the meeting which could see EUR/USD regain a sustainable hold above 1.3000 again but this may be temporary, offering better levels to sell.

Meanwhile, speculation of a break up of the eurozone into a core euro and a peripheral euro has intensified given the growing divergence in growth and competitiveness across the region. Such speculation looks far fetched. The eurozone project has been politically driven from the start and over the last 60 years or so internal economic strains have been papered over by politicians. The political will is likely to remain in place even if the divergence in fundamentals across Europe has continued to widen.

Bond market sentiment was not helped by the fact that S&P put Portugal’s ratings on creditwatch negative citing downward economic pressure and concerns over the government’s credit worthiness. Importantly S&P still expects Portugal to remain at investment grade if downgraded. Note that Portugal’s central bank highlighted that the country’s banking sector faced “intolerable” risk unless the government implements planned austerity measures.

In contrast the US story is looking increasingly positive, highlighting that the USD’s strength is not merely a reaction to EUR weakness but more likely inherent and broad improvement in USD sentiment. US consumer confidence, Chicago PMI and the Milwaukee PMI beat forecasts in November, continuing the trend of consensus beating data releases over recent weeks.
Although this does not change the outlook for quantitative easing (QE) as the Fed remains focused on core CPI and the unemployment rate, the data paints an encouraging picture of the economy.

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