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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Posted in Asia, Australia, central banks, China, Commodities, Currencies, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Greece, India, Interest rates, Japan, Monetary Policy, South Korea, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Beyond Expectations

February 7, 2011 — Mitul Kotecha

Egypt worries continue to reverberate across markets, yet there appears to be growing resilience or at least some perspective being placed on problems there. Encouraging economic data, particularly in the US has helped to shield markets to some extent, with equity market rallying and US bond yields rising last week. The main impact of Egypt and worries about Middle East contagion continues to be felt on oil prices.

Even the mixed US January jobs report has failed to dent market sentiment; the smaller than expected 36k increase in payrolls was largely attributed to severe weather. A further surprising drop in the unemployment rate to 9.0% due mainly to a significant drop in the labor force was also well received by the market.

There will be less market moving releases on tap this week and the data are unlikely to dent recovery hopes. Michigan confidence is set to record an improvement in February whilst the December trade deficit is set to widen to around $41.0 billion. There are also plenty of Federal Reserve speakers this week including a testimony by Chairman Bernanke.

One central bank that has softened its hawkish rhetoric is the European Central Bank (ECB), with President Trichet dampening speculation of an early rate hike last week and alleviating some of the pressure on eurozone interest rate markets. Consequently the EUR fell as the interest rate differential with the USD became somewhat less attractive. The EUR was also undermined by the opposition from some member states to French and German ideas for greater fiscal policy coordination, an aim apparently not shared across euro members.

Data in Europe will be largely second tier. The EUR will look increasingly vulnerable to a further drop this week especially given the increase in net positioning over the past week to (1st February) according to the CFTC IMM data. The potential for position squaring looms large as positioning is now well above the three-month average. Stops are seen just below EUR/USD 1.3540.

In the UK the Bank of England policy meeting will take centre stage but there is unlikely to be any change in policy settings. Clues to policy thinking will be available in the monetary policy committee meeting minutes in two weeks times but it seems unlikely that any more members have joined the two voting for a hike at the last meeting.

Recent data have been a little more encouraging helping to wash off the disappointment of the surprise drop in Q4 GDP. The UK industrial production report is likely to be similarly firm on Thursday, with the annual pace accelerating. GBP/USD may however, struggle to make much headway against the background of a firmer USD and the weigh of long positioning, with GBP/USD 1.6279 seen as strong resistance.

There are plenty of releases in Australia this week to focus including the January employment data, consumer confidence, and a testimony by RBA governor Stevens in front of the House of Representatives on Friday. The data slate started off somewhat poorly this week, with December retail sales coming in softer than expected, up 0.2% MoM. AUD/USD is likely to be another currency that may struggle to sustain gains this week but much will depend on data over coming days. Resistance is seen around 1.0255.

On a final note, the weekend’s sporting events highlight how it’s not just economic data or moves in currencies that don’t always go as expected. After a solid run in the Ashes cricket England slumped to a 6-1 series loss to Australia in the one-day series, putting the Ashes win into distant memory. A similarly solid performance by Man United was dented with their unbeaten record broken by bottom of the table Wolves.

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Euro Problems Intensify

January 10, 2011 — Mitul Kotecha

Following the bullish build up and increasingly lofty expectations for the US December jobs report the actual outcome was disappointing, at least on the headline reading. Non farm payrolls rose 103k which in reality was not that much less than initial forecasts but the real consensus was somewhat higher following the robust ADP private sector jobs report earlier in the week. There was some mitigation in the 70k upward revisions to October and November and surprisingly large decline in the unemployment rate to 9.4%. Consequently the market impact was less severe than it could have been and even the USD ended higher on the day.

Nonetheless, the data provided a dose of reality to markets’ optimistic expectations and this was reinforced by Fed Chairman Bernanke in testimony on Friday. He highlighted that it will take “considerable time” before the unemployment rate drops to a normal level, which could threaten recovery. Even the drop in the unemployment rate revealed in the December is report is vulnerable to a reversal given it was in part due to a drop in the labour force. This reality provided support to bond markets which may undermine the USD given the drop in bond yields. However, the USD’s anti-EUR credentials suggest that it will remain resilient.

Eurozone’s woes continued to heat up last week as the holiday season relief proved temporary. Stress in peripheral debt markets increased despite buying from the ECB last week and faced with debt sales in Italy, Portugal and Spain this week the pressure is likely to continue over coming days. Whether its worries about a resolution to funding issues and investor haircuts and/or the growing divergence in growth across the eurozone, the EUR continues to look vulnerable in the absence of any resolution to these issues. Having easily slipped below its 200-day moving average EUR/USD will eye support around 1.2767.

US data this week will look upbeat and provide more support for the USD, with December retail sales likely to record a healthy increase both on the headline and ex-autos readings as indicated by strong holiday sales. Similarly industrial production will reveal a solid gain whilst the Beige Book will highlight that economic conditions across the Federal Reserve districts, have continued to improve. The weak spot will remain housing but despite this consumer spending and sentiment are likely to be reported as resilient. The Beige Book is unlikely to reveal much of an inflation threat despite higher commodity prices. This will be echoed in the core CPI reading this week.

Although headline inflation in the eurozone breached the 2.0% threshold in December the ECB is unlikely to use it as an excuse to move towards tighter monetary conditions any time soon. The ECB meeting this week will nonetheless likely note the increase in various inflation gauges in President Trichet’s press statement. Most attention will be focused on any comments that Trichet makes regarding peripheral bond strains. In reality there is little that he can say that will alter market sentiment. Whilst an ongoing commitment to buy debt will help on the margin it will do little to stem the growing tide of negative sentiment towards eurozone assets.

Posted in Bond markets, central banks, Currencies, ECB, Economics, Economy, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Greece, Interest rates, Ireland, Monetary Policy, Portugal, Spain, US. Tags: , , , , , , , , , , , , , , , , , , , . 1 Comment »

Euro support unwinding

December 16, 2010 — Mitul Kotecha

The USD is set to end the year in firm form aided by rising US bond yields. Yesterday’s data supported this trend. The Empire manufacturing survey beat expectations rebounding nearly 22 points in December and industrial production rose 0.4% in November although there was a downward revision to the previous month. This was against the background of soft inflation, with headline and core CPI rising 0.1%, indicating that the Fed will remain committed to its $600 billion program of asset purchases.

EUR/USD dropped below support around 1.3280, weighed down by various pieces of negative news. Moodys downgrade of Spain’s credit ratings outlook dented sentiment but the bigger sell off in EUR followed the move in US bond yields. The prospect of EUR recovery over the short term looks limited. The issue of finding agreement on a permanent debt resolution fund continues to fuel uncertainty and will likely come to a head at the EU summit starting today.

Added to this Ireland’s main opposition party which will likely play a part in forming a new government early next year wants some of the debt burden shared with senior bank debt holders. The good news in Europe was few and far between but at least Ireland’s parliament backed the EU/IMF bailout for the country. Of course the backing could be derailed following elections in January. Perhaps the most surprising aspect of the move in EUR is that it’s not weaker. The next support level for EUR/USD is around 1.3160.

The divergence between the US and Europe on policy is stark, with loose fiscal and monetary policy in the US providing a significant prop to the US economy, whilst the much tighter fiscal stance and less loose monetary policy threatens to result in more pressure on eurozone growth especially against the background of an overvalued EUR. This divergence will manifest itself next year in the form of US growth outperformance and stronger USD vs. EUR.

The resilience of the UK consumer continues to surprise, with the CBI distributive trades survey coming in strong and rising further to +56 in December. The only problem with the survey data is that is has not tracked official data. November retail sales data today will give further clues to the strength of spending heading into Christmas. More worryingly from the Bank of England’s perspective is the fact that inflation continues to rise despite assurances that the increase in inflation is temporary. At the least the likelihood of more quantitative easing QE from the BoE has evaporated though it is still a long way off before interest rates are hiked. In the meantime GBP continues to underperform both EUR and USD though GBP/USD will find strong support around 1.5512.

Upward pressure on US yields and the USD us unlikely be derailed US data releases today. Housing starts are set to bounce back in November, with a 6% gain expected, whilst the trend in jobless claims will likely continue to move lower. The Philly Fed manufacturing survey is set to lose a little momentum reversing some of November’s sharp gain but will still remain at a healthy level.

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The Week Ahead

December 13, 2010 — Mitul Kotecha

As markets make the last strides towards year end it appears that currencies at least are becoming increasingly resigned to trading in ranges. Even the beleaguered EUR has not traded far from the 1.3200 level despite significant bond market gyrations. Even news that inflation in China came in well above expectations in November (5.1% YoY) and increased prospects of a rate hike is likely to prompt a limited reaction from a lethargic market.

At the tail end of last week US data provided further support to the growing pool of evidence indicating strengthening US economic conditions, with the trade deficit surprisingly narrowing in October, a fact that will add to Q4 GDP growth, whilst the Michigan measure of consumer confidence registered a bigger than expected increase in November to its highest level since June.

The jump in consumer confidence bodes well for retail spending and highlights the prospects that US November retail sales tomorrow are set to reveal solid gains both headline and ex-autos sales driven by sales and promotions over the holiday season. Other data too, will paint an encouraging picture, with November industrial production (Wed) set to reveal a healthy gain helped by a bounce in utility output. Manufacturing surveys will be mixed with a rebound in the Empire manufacturing survey in December likely but in contrast a drop in the Philly Fed expected.

The main event this week is the FOMC decision tomorrow the Fed is expected to deliver few surprises. The Fed funds rate is expected to remain “exceptionally low for an extended period”. Despite some recent encouraging data recovery remains slow and the fact that core inflation continues to decelerate (CPI inflation data on Wednesday is set to reveal a benign outcome with core CPI at 0.6%) whilst the unemployment rate has moved higher means that the Fed is no rush to alter policy including its commitment to buy $600 billion in Treasuries including $105 billion between now and January 11.

In Europe there are also some key releases that will garner plenty of attention including the December German ZEW and IFO investor and manufacturing confidence surveys and flash purchasing managers indices (PMI) readings. The data are set to remain reasonably healthy and may keep market attention from straying to ongoing problems in the eurozone periphery but this will prove temporary at least until the markets are convinced that European Union leaders are shifting away from “piecemeal” solutions to ending the crisis. The EU leaders’ summit at the end of the week will be important in this respect. A Spanish debt auction on Thursday will also be in focus.

Assuming the forecasts for US data prove correct it is likely that US bond markets will remain under pressure unless the Fed says something that fuels a further decline in yield such as highlighting prospects for more quantitative easing (QE). However, following the tax compromise agreement last week this seems unlikely. Higher relative US bond yields will keep the USD supported, and as I have previously noted, the most sensitive currencies will be the AUD, EUR and JPY, all of which are likely to remain under varying degrees of downward pressure in the short term. The AUD will also be particularly sensitive to prospects of further Chinese monetary tightening.

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