FX / Economic Preview

March 29, 2010 — Mitul Kotecha

The European Union (EU) aid package for Greece and extension of collateral requirements by the European Central Bank (ECB) helped return a semblance of confidence to markets. Although the probability of a Greek default now looks extremely small, further austerity measures, fiscal issues in other EU countries and the negative impact on growth that all of this implies, suggest that Europe will be plagued by various problems for some time yet.

As a result of more favourable market conditions Greece is set to launch a syndicated bond issues today or tomorrow of up EUR 5 billion according to press reports. Attention will also turn to Greek debt rollovers, beginning with EUR 8.2 billion on April 20.

Improving sentiment following the Greece deal has extended to the EUR, with the currency bouncing off its lows around 1.3267. EUR/USD will now look to break through resistance around 1.3446, which would set up a test of 1.3516. There is plenty of scope for short-covering to help the EUR as reflected in the latest IMM Commitment of Traders’ report (a gauge of speculative market positioning) which revealed net EUR positions reaching yet another record low in the week to 23rd March. Whilst sovereign/official buying interest may keep EUR/USD supported this week the currency pair is best played as a sell on rallies.

A similar assessment applies for GBP. Speculative sentiment for the currency also hit a record low in the latest week but unlike the Greek deal helping the EUR, last week’s UK budget has done little to boost GBP’s prospects. Moreover, a report in the Financial Times highlighting hedge funds bets against GBP, suggests that there are still plenty of headwinds against the currency.

Volumes are set to thin out this week ahead of upcoming holidays, whilst the US March jobs report at the end of the week will likely prevent moves out of current ranges ahead of its release. The consensus forecast is for a 190k increase in non-farm payrolls though much of this is likely to reflect hiring for the 2010 US consensus and a rebound from adverse weather effects in February.

In Europe March economic confidence surveys will be watched closely to determine how much damage Greece and general fiscal woes are having on sentiment. Some improvement, in line with the Eurozone Purchasing Managers Index (PMI) and the German IFO business confidence survey, is expected, which will help to give further, albeit limited relief to the EUR.

The Japanese data slate kicked off the week in good form, with the release of February retail sales data, revealing its biggest annual increase in 12-years. It is difficult to see the recovery in sales taking much greater hold given persistent deflation pressures however, and part of the gain probably reflects the government’s shopping incentive program.

Aside from industrial production and jobs data in Japan the key release will be the results of the Q1 Tankan survey on Wednesday. The survey of manufacturers’ confidence is set to show further improvement. USD/JPY is likely to remain supported around 91.67 but will need a further widening in US/Japan 10-year bond yield spreads to push higher.

Posted in Bond markets, central banks, Currencies, Economics, Economy, Europe, Fiscal/Budget, FX, Germany, Greece, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , . 3 Comments »

US Dollar Back On Top As Yields Rise

March 26, 2010 — Mitul Kotecha

Two issues are driving markets and both are playing negatively for sentiment; the rise in G7 bond yields and the outcome of the EU summit. At a time when G7 bond yields have been pushing higher the poor response to the US $32 billion 7-year note sale contributed to a further increase in yield. The sale resulted in a yield of 3.374%, which was higher than expected, and a bid/cover ratio of 2.61. A combination of large US Treasury supply, medium term funding issues and signs of improving growth suggest no let up for US Treasuries.

The most reactive currency to yield differentials is currently USD/JPY. The 1-month correlation between USD/JPY and US/Japan bond yield differentials is a high 0.85. The spike in US 10-year Treasury yields especially relative to JGB yields (by around 21 basis points this week) is the main contributor to the jump in USD/JPY over recent days. Given the bearish outlook for US bonds in the near term, it suggests more upside for USD/JPY but also increasingly for other currencies against the USD as the importance of yield increases. Immediate USD/JPY technical resistance is seen around 93.21, with support at 91.87.

The other event of note yesterday was developments surrounding Greece in the European Union summit though in truth it was probably the strong comments by ECB President Trichet that had the bigger impact on EUR sentiment. The final EU communiqué noted the readiness for bilateral loans to Greece and substantial International Monetary Fund (IMF) financing in a Greek aid mechanism. Importantly and a likely sop to Germany, any aid will not contain a subsidy for Greece. Aid by the EU and IMF will only be provided in the event of “very serious difficulties”.

The EU agreement means that no money will be forthcoming immediately, but at least there will be a back stop should Greece have financing difficulties over coming weeks, which will act as an important safety net ahead of substantial Greek debt rollovers. This news was supplemented by the fact that ECB will not raise its minimum collateral requirements at the end of the year, which means that Greek debt will not be excluded in the event of a ratings downgrade. This is good news for Greece.

The combination of the fact that Greece will have to borrow money only at market rates, ongoing worries about other EU countries fiscal problems and European Central Bank (ECB) President Trichet putting somewhat of a dampener on sentiment by criticizing IMF involvement in the deal, will keep the EUR under pressure. Although Trichet later reversed his comments, the damage was already done and any relief to EUR/USD will be short-lived. The currency pair is increasingly poised for a further downside move, with the next target at 1.3213 on the path towards an eventual test of 1.3000.

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Tarnishing The Euro

February 11, 2010 — Mitul Kotecha

I am just finishing up a client trip in Japan and waiting to take a flight back to Hong Kong. The time ahead of the flight has allowed some reflection on my meetings here. One thing that has been particularly evident is the strong interest in all events European. Some I have spoken to have wondered out loud whether this the beginning of the end of the European project.  At the least it is evident that fiscal/debt problems in Greece and elsewhere in Europe have tarnished the image of the EUR.

Markets continue to gyrate on any news about Greece and the potential for support from the Europe Union and/or IMF. The divergent views between European countries about how to deal with the problem has intensified, suggesting that reaching an agreement will not be easy. Some countries including the UK and Sweden have suggested enrolling the help of the IMF but this has been resisted by other European countries. Germany and France are trying to rally support ahead of today’s crucial meeting of European officials.

The EUR reacted positively to news that some form of support package is being considered but nothing concrete has appeared yet, leaving markets on edge. The EUR has been heavily sold over recent weeks; speculative market positioning reached a record low in the latest week’s CFTC Commitment of Traders’ IMM report. The fact that EUR positioning has become so negative suggests that the EUR could rebound sharply in the event that some support package for Greece is announced.

Any package will not come without strings attached, however, as European officials will want to avoid any moral hazard. A couple of options hinted at by German officials include fresh loans or some form of plan to purchase Greek debt. Either way, any solution to Greece’s problems will not be quick and will likely result in a sharp contraction in economic activity as the government cuts spending especially as Greece does not have the option of the old remedy of devaluing its currency. Meanwhile, strikes and social tensions in the country could escalate further. A solution for Greece will only constitutes around 2.5% of eurozone GDP will also not prevent focus from continuing to shift to Portugal, Spain and other countries with fiscal problems despite comments by Moody’s ratings agency to differentiate between the countries.

Even if the EUR rebounds on any positive news about support for Greece any relief is likely to prove temporary and will provide better levels to sell into to play for a medium term decline in the currency. Ongoing fiscal concerns, a likely slower pace of economic recovery, divergencies in views of European officials, and the fact that the EUR is still overvalued suggests that the currency will depreciate over much of 2010, with a move to around EUR/USD 1.30 or below in prospect over coming months.

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Modest growth in the G3 economies

January 14, 2010 — Mitul Kotecha

A few themes are already becoming evident into 2010. Firstly, the dominance of China and any news on the Chinese economy is becoming increasingly apparent as reflected in the market reaction to trade data and hike in reserve requirements this week. Despite the odd setback the second theme that is developing this year is the “risk on” environment for asset markets. Another theme is the problems and concerns about sovereign debt and ratings, which will likely intensify further.

I could add one more to the list; the underperformance of the Eurozone economy, a theme that is likely to become more apparent as the year progresses. As markets become increasingly bullish about the prospects for China’s economy the opposite is true for the eurozone. Growth over Q4 2009 appears to have lost momentum according to recent data. There is however, expected to be a rebound in November industrial production but this will follow a weak October reading, leaving overall output in Q4 looking lacklustre.

Economic conditions in Japan do not seem to be improving any more quickly, especially in the manufacturing sector as reflected in the surprisingly sharp 11.3% MoM drop in machinery orders in November. Orders have dropped by a whopping 20.5% annually sending a very negative signal for capital spending in the months ahead. Uncertainty over demand conditions has likely restrained capital spending plans whilst the strong JPY has not helped.

The US economy is showing more signs of life but even here the improvements are “modest” as reflected in the Fed’s Beige Book. Consumer spending showed some, limited improvement, whilst manufacturing performance was said to be mixed. In particular, the Beige Book noted that labour market conditions remained soft, with wage pressures subdued. Overall, the report highlighted the likely lack of urgency in a prospective Fed reversal of monetary policy.

In contrast to the modest growth improvements seen in the G3 economies, Australia seems to be powering ahead. Australian jobs data revealed a bigger than expected 35.2k increase in employment and surprise drop in the unemployment rate to 5.5% in December. The only slight negative about the jobs data was that many of the jobs (27.9k) were due to temporary hiring. Nonetheless, the report will give a boost to the AUD aiming for a test of resistance around 0.9326, and solidify expectations for a rate hike next month, when the RBA is set to hike by 25bps.

Posted in Asia, Australia, central banks, China, Currencies, Economics, Economy, emerging markets, FX, Interest rates, Japan, US. Tags: , , , , , , , , , , , , , , , , , , . Leave a Comment »

FX Prospects for 2010

December 23, 2009 — Mitul Kotecha

There can be no doubt that for the most part 2009 has been a year for risk trades, not withstanding the sell off into year end. The policy successes in preventing a systemic crisis and the massive flood of USD liquidity injected globally kept the USD under pressure for most of the year and the currency became a victim of this success. Risk appetite is likely to improve only gradually over coming months given the still significant obstacles to recovery in the months ahead.  This will coincide with the declining influence of risk on FX markets. 

2010 will not be as straightforward and whilst risk will dominate early in the year interest rate differentials will gain influence in driving currencies as the year progresses. The problem for the USD is that market expectations for the timing of the beginning of US interest rate hikes is likely to prove premature as the Fed is set to hold off until at least late 2010/early 2011 before raising interest rates. The liquidity tap will stay open for some time, and risk trades will still find further support at least in the early part of 2010, whilst the USD will come under renewed pressure.    

The ECB will be much quicker in closing its liquidity tap than the Fed and arguably an earlier reduction in credit easing and interest rate hikes compared to the Fed would favour a stronger EUR.  However, the EUR is already very overvalued and a relatively aggressive ECB policy is unwarranted. Consequently rather than benefiting from more favourable relative interest rate expectations, the EUR could be punished and the EUR is set to decline over much of 2010 following a brief rally in Q1 2010, with EUR/USD set to fall over the year. 

Japan is moving in the opposite direction to the ECB.  FX intervention is firmly on the table though the risk is limited unless USD/JPY drops back to around 85.00. Even at current levels the JPY is overvalued but for it to resume weakness it will need to regain the role of funding currency of choice, a title that the USD has assumed. Efforts by the BoJ to combat deflation will likely help result in fuelling some depreciation of the JPY and it is likely to be the worst performing major currency over 2010, with a move back up to around USD/JPY in prospect.

The issue of global rebalancing will need to involve currencies but the currency adjustments necessary will not be forthcoming in 2010.  USD weakness early in the year will be mostly exhibited against freely floating major currencies which will bear the brunt of USD weakness.  However, the bulk of adjustment is needed in Asian currencies and there is little sign that central banks in the region will allow a rapid appreciation.  China holds the key and a gradual appreciation in the CNY over 2010 suggests little incentive to allow other Asian currencies to appreciate strongly. 

So in many ways 2010 will be one of two halves for currency markets and this has the potential to reignite some volatility in FX markets.  High beta risk trades including the AUD, NZD, NOK and many emerging currencies will see further upside in H1 as the USD falls further.  Gains in risk currencies will look even more impressive when played against the JPY and/or CHF than vs. USD given that they will succumb to growing pressure in the months ahead as their usage as funding currencies increases.

Ongoing rate hikes in Australia and Norway and the likely beginning of the process to raise rates in New Zealand early next year will mean that these currencies will also have the additional support of yield to drive them higher unlike the JPY.  There is a limit to most things however, and eventually the USD will recover some of its lost ground against risk currencies, as it undergoes a cyclical recovery over H2 2010.

Posted in central banks, Currencies, Economics, Economy, Europe, FX, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , . 2 Comments »
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