Plenty of data and events before winding down

December 2, 2013 — Mitul Kotecha

Although markets already appear to be in wind down mode ahead of the year end holidays there is plenty of data and events over coming days that could change the complexity of market activity. To begin the week news that that China’s official November purchasing managers’ index remained at an 18 month high will bode well for markets, especially in Asia.

Elsewhere it is still too early to gauge how well the four day spending over the US Thanksgiving holiday fared for US retailers although initial indications suggest that spending will be down on last year. Over coming days there will be plenty of evidence to finalise opinions about what the Federal Reserve will do at its December 17-18 FOMC meeting. US data releases this week include the November ISM manufacturing survey, home sales, Fed’s Beige, US Q3 GDP revision and the November jobs report.

Ahead of the Fed meeting other central banks will be in focus this week including the European Central Bank, the Bank of England and the Reserve Bank of Australia. No change in policy is expected from any of them leaving all the attention on the US jobs report. This ought to ensure that the asset allocation shift from bonds to equities will leave equities around record highs while core bond yields continue to edge higher.

The USD has failed to benefit versus EUR despite higher US yields but has made gains against the JPY and many commodity and EM currencies. I look for the USD to move higher over coming weeks. Overall risk appetite is likely to remain supported into year end although much will depend on the plethora of data releases and central bank meetings this week.

EUR is looking increasing stretched around current levels, especially given the likelihood that the ECB will sound relatively dovish this week, with staff growth forecasts likely to be revised lower and inflation forecasts remaining below target. The strength of the EUR is clearly acting as a counterweight to efforts to ease policy but efforts to sell the currency continue to face renewed buying interest. Technical resistance around EUR/USD 1.3627 ought to provide a short term cap.

GBP has made somewhat better progress against the EUR and there appears to be little to stop its upward progress at present. Meanwhile USD/JPY remains under upward pressure, with last week’s inflation data highlighting that there has been some progress on ending deflation although the likelihood of more Bank of Japan easing in the months ahead suggests that further JPY downside is in store.

Aside from the JPY last month’s biggest underperformers in Asia were the IDR and THB. There is little sign of this pattern changing. Indeed, in terms of Asian FX relative value in terms of North versus South East Asia continues to pay dividends. Both Indonesia and Thailand registered outflows of equity capital last month compounding the pressure on the currencies.

THB has taken another leg lower in the wake of escalating protests over the weekend and looks set to test its 6 September USD/THB high at 32.480. As noted by the BoT governor the protests are affecting the economic outlook. In Indonesia questions about the external balance remain a weight on the currency An expected widening in the October deficit and higher November inflation will not help the IDR today.

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JPY, AUD and Asian FX

November 12, 2013 — Mitul Kotecha

Risk appetite remains relatively well supported, with US and Asian equities edging higher and the VIX ‘fear gauge’ moving lower. There is a lack of first tier data releases today, with only German and UK CPI inflation data on tap as well as the US NFIB small business optimism index. Attention will instead centre on various Fed and ECB speakers for further policy clues.

Indeed, markets will look for any hints of reinforced forward guidance by ECB speakers and further insight into the timing of tapering from Fed officials. ECB speakers include Angeloni, Weidmann, Nowotny and Asmussen while Kocherlakota and Lockhart are scheduled to speak from the Fed. There will also be plenty of interest in speeches by the Fed’s Yellen and Bernanke on Thursday.

The JPY appears to be finally succumbing to the pressure of a generally firmer USD and higher US yields although the currency has yet to break out of its recent ranges and correlations suggest that the JPY has not been as sensitive as other currencies to either factor. I remain bearish on the JPY.

While the JPY has not been as sensitive as other currencies to yield lately it has still faced some pressure and will continue to do so if we are correct in our view that US yields will push even higher against Japanese JGBs. Firmer US data has helped to shift expectations of Fed tapering to around December or January. In contrast the BoJ is showing no sign of pulling back from its balance sheet expansion and in our view could even extend asset purchases next year in order to sustain its inflation around its 2% inflation target. This remains a recipe for more USD/JPY upside.

Having rallied by around 9% since its end August low AUD has been unable to hold onto gains. Fortunately for AUD the recent rise in Australian bond yields has acted to mitigate against some of the potential pressure from rising US bond yields; since the USD began its recent rally around 28 October Australia’s yield advantage has narrowed by only 3 basis points. However, the strengthening in the USD has wreaked havoc on many currencies and the AUD has not escaped.

While AUD may face headwinds from a firmer USD, Australia’s relative yield attraction will give it some scope for recovery into year end. Indeed, if yield appetite continues to strengthen in an environment of improving risk appetite and low volatility AUD should prove to be a key beneficiary. In the near term AUD/USD will find some technical support around 0.9280.

Asian currencies have gained a little respite from general USD strength but remain vulnerable to a stronger USD over the coming weeks. Deficit currencies have renewed their position as the biggest underperformers over recent weeks, with the IDR and INR under most pressure followed by MYR. The least vulnerable to USD strength and higher US yields are North East Asian currencies especially TWD and KRW.

Reflecting renewed tapering fears most Asian countries have experienced renewed equity portfolio outflows month to date. The RMB continues to buck the trend although its relative strength may reflect the timing of China’s 3rd plenum which ends today.

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Asian currencies benefit from weaker US jobs data

October 23, 2013 — Mitul Kotecha

Weaker than forecast US September jobs data, delayed in the wake of the government shutdown, spurred risk appetite overnight pushing equities higher helped further by encouraging US Q3 earnings. The employment report revealed that jobs growth slowed to 148,000 while the unemployment rate declined slightly to 7.2%.

In contrast to the reaction in risk assets, 10 year US Treasury yields dropped to around 2.5% and the USD took another hit as the data was perceived to provide more concrete evidence that the Fed will only begin to slow its asset purchases next year, with many now looking for tapering to only begin in March 2014.

Unfortunately for the USD this effectively means its attraction as a funding currency may continue for longer than previously expected. Consequently gold prices rallied benefiting from both the drop in yields and weaker USD.

Data today (Bank of England MPC minutes, Bank of Canada rate decision, terms of the European Central Bank’s Asset Quality Review) will not be as important for markets but it is clear that fundamentals are taking a bigger grip on market direction after a period of being relegated to the sidelines in the wake of US political mayhem.

Asian currencies have benefitted from the drop in the USD overnight and the potential further delay in tapering to Mach next year. The main gainers of recent weeks are those that stand most to gain from delayed tapering (ie those with external funding requirements and that are most sensitive to US Treasury yields). In this respect the IDR, MYR and INR have been the best performing Asian currencies so far this month and look best placed to benefit in the short term from the consequences of the weaker US jobs report.

Against the backdrop of delayed tapering equity capital inflows to Asia have continued their steep recovery since the beginning of September, providing another layer of support to Asian FX. India, Korea and Taiwan have been major winners in this respect, with a surge in equity flows registered to these countries. However, the INR’s ability to benefit is partly negated by continued outflows from India’s bond markets.

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Fed keeps the party going

September 19, 2013 — Mitul Kotecha

The party goes on! The Fed decided to play on the side of caution by not acquiescing to market expectations. The FOMC maintained its current USD 85 billion of asset purchases wanting to see more evidence of economic recovery before pulling the trigger. Market expectations centred on a USD 10-15 billion paring back of asset purchases. Clearly worried about a rise in market interest rates Fed Chairman Bernanke strengthened the Fed’s forward guidance by highlighting that the first rate increase may not come until the unemployment rate is “considerably below” 6.5%. A downgrade in the Fed’s economic forecasts will also have helped to justify the inaction by the FOMC.

Clearly risk assets loved what they saw, with equities and commodities rallying and US Treasury yields dropping. Gold prices in particular jumped on the news while the VIX ‘fear gauge’ dropped. The USD was a major casualty losing ground to most currencies, with notably EUR/USD spiking above 1.35 and GBP/USD to above 1.60. High beta emerging market currencies were big winners, given the positive impact of lower US yields and prospects of ongoing capital inflows. While the Fed has merely delayed tapering this will not stop markets from following through on the positive dynamic today. The positive tone will be reinforced across Asian and European markets.

The sharp drop in US Treasury yields hit the USD hard and it is likely to remain under pressure over the short term against a variety of currencies. Although the drop in US yields is likely to prove temporary it is difficult to go against the move in the near term. In order to identify which currencies will benefit the most versus USD I have looked at their sensitivity to US 10 year Treasury yields. The biggest beneficiaries will be Asian currencies given that they register the strongest correlations. The IDR, THB, MYR and INR are at the top of the list in this respect. In any case Asia was already experiencing a resumption of capital inflow as tapering expectations were being priced in and the Fed inaction will reinforce this trend.

GBP bounced following the unanimous vote for no policy shift revealed in the Sep 3-4 Bank of England MPC meeting minutes. Its gains were reinforced by Fed inaction overnight, with GBP/USD breaking through key levels above 1.60. Although the MPC’s 9-0 vote for no change was in line with expectations there was a minority looking for one of two MPC members to have voted for increased asset purchases. Citing upside risks to the growth outlook the BoE appears more confident about the UK’s economy. However, this all but makes a mockery of “forward guidance” and attempts to cap market interest rates. A further test for GBP will come from today’s August retail sales release. There are downside risks to consensus but even this may prove to a temporary stumbling block to a resurgent GBP.

The Swiss National Bank is widely expected to keep policy unchanged today and will make no changes to the CHF ceiling. The desire to keep the ceiling in place remains strong even though the economy is showing signs of recovery, deflationary pressures are receding and capital inflows from the Eurozone have diminished and in fact showing signs of reversing, albeit slowly. Reflecting this SNB reserves growth has slowed while Swiss banks’ foreign liabilities have decreased. The fact that the currency remains overvalued however, means that there is only an extremely slim chance that the ceiling will be removed over coming months. Although the SNB will likely revise upwards its growth forecasts, expect a cautious tone to emerge from the meeting. Accordingly EUR/CHF is set to remains capped around 1.2400 over the near term.

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USD losing steam, AUD, firm, INR bounces back

September 12, 2013 — Mitul Kotecha

Risk appetite has sustained an improving trend since the end of August. A combination of an easing in tensions surrounding Syria and firmer data globally have helped to shore up sentiment. Notably the Baltic Dry Index has surged over recent days too, pointing to an improvement in global growth prospects in the months ahead.

US Treasury yields have lost some upside momentum as tapering worries have eased, providing relief to risk assets including emerging market currencies. Consequently the USD continues to lose ground and looks vulnerable to further slippage in the days ahead. Australian employment data and Eurozone industrial production will be the main data releases of note today.,

In Asia, central banks in Korea, Philippines and Indonesia will follow the RBNZ overnight with policy decisions. No change in policy is expected from any of the central banks. Indeed, the recent firming in the rupiah suggests that there will be less urgency for Indonesia’s central bank to hike rates to protect the currency. The Indian rupee has been the best performing currency since the start of the month as portfolio capital has returned. In the near however, the INR looks may struggle to breach the 63.00 level versus USD.

Despite all the doomsayers’ bearish predictions AUD has managed to sustain a solid recovery, helped by the election victory by Tony Abbot and his coalition, and positive data both locally and in China. Additionally a firmer tone to risk appetite has helped the currency provoking some short covering.

Australian jobs data this morning will provide the next test for the AUD but we don’t expect it to get in the way of further short term strength. However, AUD/USD will face some technical resistance around the 0.9440 level. Separately, AUD/NZD lost some ground following a relatively hawkish statement from the RBNZ in which they pointed to the prospects of higher policy rates next year but this is likely to prove to be a temporary set back for the currency pair.

Swiss officials continue to defend the CHF ceiling and show no sign of eliminating it any time soon. We concur as the CHF remains overvalued but the reality is that Swiss economic data has shown some improvement while foreign demand for CHF assets has eased in the wake of improving sentiment towards peripheral Europe as reflected in reduced Swiss banks’ foreign liabilities.

The SNB is also not intervening to hold back CHF gains, with reserves growth flattening out over recent months. Although any reversal of flows from Switzerland will prove sticky the bias for EUR/CHF will be higher. In the near term the currency pair may run into resistance around the top of its recent range around 1.2438.

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