The Dust Settles

May 12, 2010 — Mitul Kotecha

As the dust settles on the massive “shock and awe” package announced over the weekend it is become painfully apparent that markets are not at all convinced that underlying issues surrounding Europe’s woes are on the path to being resolved. Undoubtedly the EUR 750 billion provided by the European Union (EU) and International Monetary Fund (IMF) will go a long way towards fixing the symptoms of the crisis but it will take a lot more action to convince markets that the measures to cut budget deficits, improve productivity and enact structural reforms are being carried out.

As a result of ongoing skepticism EUR/USD dropped to its lowest level since March 2009. The currency pair shows little sign of turning around and over the short-term EUR/USD is likely to test its 2010 low around 1.2510. Market positioning remains heavily short EUR suggesting some scope for short covering but any rebound in EUR/USD is being met with plenty of sellers and the upside is likely to be restricted to around 1.2885.

The size of the EU/IMF package means that financing issues for eurozone peripheral countries will not be a major concern and spreads are likely to continue to narrow against core debt. However, attention has turned to the next step in the process, in particular the path of fiscal consolidation necessary in the months ahead and the negative impact on the economies in Europe that this will entail. As US Fed Chairman Bernanke noted, the package from the EU/IMF is “not a panacea”.

Overall, the measures may have cheapened the long term value of the EUR rather than boost it as it has highlighted the many problems in having a single currency to encompass a wide variety of countries. The stark reality in having differing fiscal policies across the euro region whilst maintaining a single monetary policy has proven to be highly problematic.

At least for now, the economic data in the eurozone is providing some support, though it is questionable how long this will continue. Eurozone GDP grew by 0.2% in the first quarter of 2010 compared to the previous quarter, which was stronger than expected and growth in the second quarter actually looks like it will have picked up from this pace based on the indications from recent monthly data.

Further out, the real damage will begin and in particular economic activity in southern European countries will slow sharply even as the German economy remains resilient due to relatively strong export performance. Deficit cutting measures in Portugal, Spain and Italy will begin to bite into growth later this year and into 2011. The weakness in growth in Europe relative to the US economy, which is likely to perform relaitvely better, will provide further rationale to sell EUR/USD, though at some point markets may just shift their attention back to the burgeoning US fiscal deficit.

Posted in central banks, Currencies, Economics, Economy, Europe, eurozone, Financial crisis, Fiscal/Budget, FX, Germany, Greece, IMF, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , . Leave a Comment »

What To Watch This Week

February 7, 2010 — Mitul Kotecha

As usual the G7 meeting will leave markets with little to chew on. G7 officials maintained their commitment to stimulus measures and timely exit strategies but there was little of note for FX markets aside from the usual comments about wanting to avoid excess FX volatility. There was certainly know step up in pressure on China to strengthen though a report prepared for the meeting did push for countries with inflexible currencies to make adjustments. Meanwhile US officials mouthed the usual “strong dollar” mantra.

Where does this leave markets this week? Well I must admit my bullish view on risk currencies is clearly suffering after a positive start to the year. The pullback in high beta currencies (those with the highest sensitivity to risk aversion) has been dramatic. I have highlighted many of the factors weighing on sentiment in previous posts and whilst I still think the US dollar will find itself under renewed pressure over coming months the current environment remains conducive to more USD and JPY buying and selling of currencies such as the AUD, NZD, CAD, GBP, NOK, SEK, ZAR etc.

Ironically the US and Japan have arguably more severe deficit/debt concerns than some of the European countries under pressure but as most of Japan’s debt is held domestically there is little worry of a collapse in JGBs. Unlike Japan foreign investors hold over half of US debt but are not yet losing confidence with US Treasuries though this may not last unless there is some tangible sign that the burgeoning US budget deficit is being reduced. For now, attention remains firmly focussed on Greece, Spain, Portugal and to a lesser extent Italy.

Like the G7 meeting the US January jobs report released at the end of last week will give little direction for markets. Although the 20k drop in payrolls and revisions to past months were slightly disappointing the surprise drop in the unemployment rate was better news. This week’s data highlights include the January US retail sales report and December trade balance. The sales data is likely to help allay some concerns about faltering economic recovery, with retail sales forecast to rise over the month despite a likely pull back in autos spending.

How will this play out for currencies this week? Overall, the risk off tone is set to continue though the moves are looking increasingly stretched. The USD, JPY and CHF will remain on the front foot whilst risk currencies will remain under pressure. The EUR is set to continue to struggle against the background of eurozone deficit concerns and after its dive through 1.40 last week 1.35 now looms large. Meanwhile, the AUD may also struggle following the recent reassessment of interest rate expectations after the recent Reserve Bank of Australia (RBA) meeting in which interest rates were left unchanged.

UK markets will focus on the Quarterly Inflation Report from the Bank of England though the political situation may hold some interesting implications for GBP if polls continue to show that the gap between the governing Labour party and Conservative opposition continues to narrow. Prospects of a hung parliament will hardly hold any positive implications for GBP, a prospect which could limit any potential for GBP to recover ahead of May elections. The drop below 1.60 for Cable (GBP/USD) could extend further, especially as the BoE has kept the door open to further asset purchases if needed.

Posted in Australia, Bond markets, central banks, Currencies, Economics, Economy, Europe, Financial crisis, Fiscal/Budget, FX, Greece, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

PIIGS fears fuelling risk aversion

January 29, 2010 — Mitul Kotecha

Risk aversion has come back with a vengeance over the last 10 days driven by a host of concerns that continue to damage market sentiment. As has been evident over the past year the USD and JPY remain the best currency plays against the background of rising risk aversion and both currencies look well supported.

Market concerns are not going away quickly but some of the fears plaguing markets have at least receded especially on the US political front, with Obama’s State of the Union address, Geithner’s testimony on AIG and Bernanke’s reappointment all passing without too much incident, at least from a market perspective. I still believe that market fears are overblown but it is clearly evident that the market is not in the mood to concur. More pain is likely in the weeks ahead.

Euro-sovereign spreads continue to suffer from the ongoing Greek saga whilst the other major fear remains further monetary tightening in China. Rumours that China is about to imminently revalue the CNY are also running rife. The bigger than expected hike in the reserve ratio in India reflects the fact that Asia is on a faster track to tighten policy than Western economies.

As regular readers probably noticed, my articles on econometer.org have been sporadic recently. This is due to the fact that I have been on the road for the last two weeks giving client seminars across several countries in Asia. Without giving too much away it is evident that pessimism is pervasive and most investors I polled are looking for a “W” or “double dip” profile for economic growth in the G7 economies over coming months. Hardly anyone looked for a “V”.

The other casualty emanating from Greece’s woes, as well as worries that other European PIIGS (Portugal, Italy, Ireland, Greece, Spain) face ratings downgrades, is the EUR. EUR/USD slipped below the psychologically important level of 1.40 this week and is showing no sign of turning around. Warnings by S&P ratings that Portugal faces challenges on the fiscal front show that these sovereign concerns will be with us for a long while yet.

After letting investors believe that the European Commission would offer no support for Greece, there appears to be a growing realization that Greece is not simply a local problem but a Euro wide problem, as noted by European Commission President Barroso. Whilst this may be good for Greek debt the path to recovery is still likely to be a massively painful one, and the EUR may gain little support from this news.

The UK has not escaped the clutches of ratings agencies and warnings by S&P that UK banks are no longer among the “most stable and low-risk” in the world highlights the headwinds faced by GBP at present. The weaker than expected out-turn for Q4 GDP (0.1%) highlights the fact that UK economic recovery is fragile, which in turn plays negatively for the banking sector. This news has put a break on GBP but there appears to be plenty of demand for GBP above 1.600 vs USD.

Posted in Asia, Bond markets, central banks, China, Currencies, Economics, Economy, emerging markets, Europe, Financial crisis, Fiscal/Budget, FX, Greece, India, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Not quite a Greek tragedy, but close

January 15, 2010 — Mitul Kotecha

Not quite a Greek tragedy but getting there. Greece’s announcement of a three-year plan to reduce its burgeoning fiscal deficit has not convinced markets. Greece’s 5-year CDS widened out to around 333bps whilst 10-year sovereign spreads widened further. There has been some contagion in other European countries notably Spain, Portugal, Ireland, Italy, Poland etc.

The plan which aims to cut the budget deficit from 12.7% to 2.8% of GDP by the end of 2012 appears to be very optimistic if not unrealistic. One of the main problems is not related to the magnitude of deficit reduction but to the starting point of 12.7% of GDP which is more realistically around 14-15% of GDP.

The deficit is planned to be cut by 4% this year alone which seems tough given the likelihood that the economy will contract this year and thereby increase the cyclical portion of the deficit. However, the major concern is the ability of the Greek authorities to cut nominal wages and pensions and in areas where inefficiency and corruption are widespread, such hospital and defense spending.

Greece needs to convince the European Commission and if the negative reaction by markets is anything to go by it may need further revisions including more drastic spending cuts as well as concrete plans for structural reforms. Greece will also find it difficult to ignore the skeptical market reaction given that the country aims to raise around EUR 54 billion to fund its public debt.

Greek concerns and similar countries elsewhere in Europe will likely act as a major weight on the EUR in the days ahead. Interestingly GBP seems to be a beneficiary. The situation does not appear to have a happy ending in sight and more pain looks likely. Rumours/talk of a Eurozone break-up are likely to intensify, however unrealistic such an event may be. ECB President Trichet dampened speculation in his speech following the ECB meeting that Greece could exit the euro but also confirmed that there would be no special treatment for Greece.

Posted in Bond markets, central banks, Currencies, Economics, Europe, Financial crisis, Fiscal/Budget, FX, Greece. Tags: , , , , , , , , , , . 2 Comments »

“Risk On”- Which Currencies Will Benefit?

January 5, 2010 — Mitul Kotecha

It was a “risk on” beginning of the week as equity markets rallied, commodities prices rose, and G10 bonds and USD came under pressure. Stronger manufacturing PMIs helped to boost confidence in the global economic recovery, with solid PMIs revealed in China, and across the rest of Asia, UK, and the US. The US ISM manufacturing which rose to its highest since April 2006 also revealed a rise in the unemployment component, consistent with view of an unchanged reading for December payrolls.

In the Eurozone the PMI matched the flash release and remained in expansion territory though there was some slippage in Germany, Spain, and Italy, underscoring the likely underperformance of the Eurozone economy relative to expectations of faster recovery in the US. Nonetheless, the PMIs continued to show a picture of expansion, with the Eurozone PMI at its highest in 21-months.

The USD lost ground against the background of improved risk appetite and looks set to fall further abruptly ending its short covering rally. The USD appears to be finding little support from interest rate expectations, with the correlation between most currencies and relative interest rate differentials remaining relatively low for the most part (just -0.04 over the past 3-months between the USD index and US rate futures).  The correlation between the USD and US 10-year bond yields looks somewhat stronger however, and could offer some relief to the USD if yields continue to push higher.

Speculative (CFTC Commitment of Traders) data reveals just how massive the shift in USD positioning has been over recent weeks, with net aggregate USD positioning (vs EUR, JPY, GBP, AUD, NZD, CAD, CHF) registering its first net long USD position since May 2008. The swing in positioning has been dramatic, from -167k contracts on 15 September 2009 to +8.7k in the week ending 29th December 2009. The data also reveals the sharp deterioration in sentiment for the EUR to its lowest since September 2008. Likewise net JPY positions have shifted to their biggest net short since August 2008.

What does this imply? The market is very short EUR and JPY but the JPY has much further to go on the downside as it increasingly retakes the mantle of funding currency.  In any case compared to historical positioning JPY shorts are not so big suggesting more room to increase short positions.   

The EUR has moved into a short term uptrend, with the MACD (12,26,9) having crossed its signal line and positioning supports further upside. EUR/USD will need to take out strong resistance at 1.4459 (December 29) before it can embark on a more significant move higher. Asian currencies also look set to take more advantage of a resumption of USD weakness, especially in the wake of strong risk seeking capital flows into the region. KRW, TWD, IDR and PHP look bullish technically.

Posted in Asia, Commodities, Currencies, Economics, Economy, equity markets, FX, Interest rates, US. Tags: , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »
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