Resilient Markets

January 19, 2012 — Mitul Kotecha

Risk assets have registered a good start to the year despite ongoing tensions in the Eurozone. US stocks rose overnight, with the S&P 500 extending its rally to 4% year to date. Evidence that markets are becoming increasingly resilient to bad news emerged from the muted reaction to sharp downgrades in growth forecasts by the World Bank, with the world economy expected to grow by 2.5% this year compared to a June forecast of 3.6%.

US markets also reacted positively to news that the US NAHB Homebuilders index rose to its highest level in more than 4 years and while industrial output expanded, albeit less than expected. Markets will continue to keep one eye on earnings to ascertain whether the equity rally can be sustained, with at least 48 S&P 500 companies reporting earnings this week including Morgan Stanley Bank of America, Intel and Google today. So far, relatively more companies have fallen short of expectations than have beaten expectations.

Even in the Eurozone the news has been slightly more encouraging than of late, with reports that a deal between Greece and private creditors on the extent of debt writedowns could be reached by the end of this week. Moreover, the International Monetary Fund (IMF) is reported to be raising $500 billion in new funds for bail out funds, another factor that has helped to shore up market sentiment. The net result has been to see peripheral bond yields ease further and the EUR to strengthen, helped by the fact that the market is extremely short.

There is still plenty of event risk on the horizon, however, including debt auctions in Spain and France today although these ought to pass relatively smoothly. US data are likely to be mixed today, with benign inflation keeping the door open to more Fed quantitative easing (QE) while a gain in the Philly Fed manufacturing survey will continue to reveal signs of economic recovery. In the short term risk assets look supported but given the risks ahead any bounce still looks to be short-lived.

Posted in equity markets, eurozone, Greece, Spain. Tags: , , , , . Leave a Comment »

Beware of EUR short covering

January 11, 2012 — Mitul Kotecha

Europe has plenty of events to focus on over the next couple of days including the European Central Bank (ECB) Council meeting, and debt auctions in Spain and Italy. While I am by no means a EUR bull the risk is skewed towards some short term recovery or at least stabilization around EUR/USD 1.28. The speculative market is extremely short EUR while policy makers, specifically German Chancellor Merkel and French President Sarkozy are making the right noises. it appears to have finally dawned on Eurozone officials that its not just about austerity but also about growth and reform.

News that Fitch ratings is unlikely to downgrade France’s ratings this year has provided a boost to Eurozone confidence. Greece could yet spoil the party given the ongoing discussion with the Troika (Euuropean Commission, International Monetary Fund and ECB) to finalise the second bailout package for the country. Opposition resistance within Greece suggests that more austerity may not be easy to implement. Meanwhile there are ongoing questions about the extent of writedowns that Greek debt will undergo. Despite these issues it appears that markets are becoming somewhat more immune to events in the Eurozone. While still high bond yields for Italy and other debt still point to ongoing trouble, risk appetite has firmed.

One factor that is helping to boost sentiment is the encouraging news out of the US. Although the Q4 earnings season has not began particularly well data releases look somewhat more positive. Not only has positive impact of last week’s US December jobs report continued to filter through the market but so has other news such as a pick up in small business confidence and a rise in consumer credit. These lesser watched data highlight the gradual recovery process underway in the US and the growing divergence with the Eurozone economy and support the view of medium term USD outperformance versus EUR.

Posted in Currencies, eurozone, France, FX. Tags: , , , , , . Leave a Comment »

The Devil is in the details

December 12, 2011 — Mitul Kotecha

The “partial solution” delivered by European Union (EU) leaders last week has failed to match the high hopes ahead of the EU Summit. Nonetheless, the deliverance of a “fiscal compact”, acceleration of the European Stability Mechanism (ESM) to July 2012 , no forced private sector participation in debt restructuring (outside Greece), and possible boost to the International Monetary Fund (IMF) of up to EUR 200 billion, are steps in the right direction. The fact that UK Prime Minister Cameron threw a spanner in the works to veto a joint proposal to revise the EU Treaty should not detract from the progress made.

Nonetheless, the measures may not be sufficient to allay market concerns, with disappointment at the lack of European Central Bank (ECB) action in terms of stepping up to the plate as lender of the last resort still weighing on sentiment. Data will add to the disappointment this week as “flash” Eurozone purchasing managers indices (PMI) drop further in December.

This week events in the US will garner more attention, including the Federal Reserve FOMC meeting, November inflation and retail sales data plus manufacturing confidence gauges as well as November industrial production on tap. The Fed will not shift its policy stance at this meeting but may sound a little more upbeat on the economy following recent firmer data. Inflation will likely remain subdued while the other data will continue to show gradual recovery.

Overall, the market is likely to thin further as the week progresses and holidays approach, with ranges likely to dominate against the background of little directional impetus. Our call to sell risk assets on rallies remains in place, however. The EUR will likely struggle to make much headway in the current environment, especially given that many details of the EU agreement still need to be ironed out and once again the risk to market confidence lies in implementation or lack of it. A range of EUR/USD 1.3260-1.3550 is likely to hold over the short term.

Posted in ECB, Economics, Economy, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , . Leave a Comment »

IMF Hopes For Italy

November 28, 2011 — Mitul Kotecha

Following a week in which risk aversion increased further and equity markets fell sharply the start of this week looks a little steadier. Reports in the Italian press that the International Monetary Fund (IMF) is readying a EUR 600 billion loan for Italy in the event of a worsening in the debt crisis may help to support markets as the week kicks off.

Moreover a report in the German press that German Chancellor Merkel and French President Sarkozy are preparing a fast track “Stability Pact” for euro countries similar to the Schengen agreement, that may be announced this week, will also help to steady market nerves. However, neither report has been confirmed suggesting that as usual the scope for disappointment is high. The sell on risk on rallies environment is likely to persist for a while longer despite such reports.

Liquidity is likely to thin further this week and scope for volatility is high given that there are plenty of events and data on tap. Included among these are debt auctions in Belgium and Italy today and France and Spain later in the week against the background where Germany’s failed bond auction last week has fuelled even more nervousness in bond markets. A European Finance Ministers meeting beginning tomorrow will also come under scrutiny, especially given the lack of progress so far on many issues including the issue of Eurobonds.

The key data of the week will arrive from the US, with the November jobs report, ISM manufacturing survey, Beige Book and consumer confidence reports scheduled for release. Following what appears to be strong Thanksgiving holiday weekend spending the US data will continue to show improvement although this may not be enough to stem speculation that the Fed is verging on buying of mortgage backed securities in a third round of quantitative easing.

Risk currencies have commenced the week in strong firm, with the EUR and AUD rallying. Any gain in the EUR will prove limited and unsustainable unless the weekend press reports are confirmed. EUR/USD will find upside resistance around the 1.3412 level, while the risk of a downside test of support around its October 4 low at 1.3146 remains high over coming days.

Posted in Bond markets, Currencies, Europe, Italy, US. Tags: , , , . Leave a Comment »

Plenty of event risk

October 17, 2011 — Mitul Kotecha

This week is heavy with event risk, with a lot expected from EU leaders. So far the risk on tone to markets has held up, with for example the VIX fear gauge resting below the key 30.0. The G20 meeting over the weekend set the deadline for action for concrete solutions to the eurozone debt crisis for the October 23 EU Summit.

However, there will be little detail on issues such as banking sector recapitalisation, private sector involvement in any debt restructuring or ‘leveraging’ the EFSF bailout fund until the report on Wednesday night by the Troika on Greece. The reward to EU leaders would be the potential for more aid from the IMF but even now it seems that a German government official has poured cold water of a plan being announced at the EU Summit which will disappoint markets.

There are also plenty of data releases for markets to digest over coming days including inflation releases, manufacturing surveys and industrial production data in the US while in Europe the German IFO and ZEW surveys are scheduled for release. The data will follow on from the better than expected September US retail sales releases at the end of last week continuing to dampen expectations that the global economy is falling in recession though there will be a marked deceleration in European data.

Meanwhile the US Q3 earnings season rolls. The risk on tone will likely continue to weigh on the USD and weigh on bonds but unlike a few weeks ago when a lot of bad news was priced in, the scope for disappointment is becoming increasingly high.

Many currencies remain highly correlated with gyrations in risk and in this respect the improvement in risk appetite is good news for high beta / commodity. AUD, NZD, CAD and JPY are amongst the most sensitive currencies and therefore prone to a bigger reaction as risk improves, with the former three strengthening and the JPY weakening. Asian currencies poised to benefit from firmer risk appetite include INR and KRW, both with relatively high correlations with risk.

EUR/USD has made a solid recovery over recent days from its lows around 1.3146 spurred by hopes of action by European officials. Such hopes may yet be dashed but the EUR looks supported over coming days ahead of the EU summit Speculative positioning also reflects a slight improvement in EUR sentiment as IMM short positions have declined in the last week but its worth noting that this week’s European data are unlikely to be supportive for the EUR.

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