Talking about currencies

October 5, 2009 — Mitul Kotecha

It’s always the same story.  Ahead of the G7 (or G8 and now more important G20) meetings speculation of decisive action on currencies intensifies.  Traders and investors become cautious on the off chance that something significant will happen but the majority of times nothing of note emerges.

There was no difference this time around.  The G7 Finance Ministers meeting in Istanbul failed to deliver anything substantive on currencies, repeating the usual mantra about the adverse impact of “excess volatility and disorderly movements”.  Although the group pledged to monitor FX markets there was no indication of imminent action. 

The lack of action is perhaps surprising in one respect as there were plenty of central bankers and finance officials talking about currencies in the run up to the G7 meeting, most of which were attempting to talk the dollar higher against their respective currencies.  Given the increase in rhetoric ahead of the meeting, the relatively weak statement now leaves the door open to further dollar weakness.

The strongest indication of any FX action or intervention came from the country that was supposedly the least concerned about currency strength; Japanese Finance Minister Fujii warned that Japan “will take action” if “currencies show some excessive moves”.  The shift in stance from Japan since the new government took power has been stark (considering that the new government was supposedly in favour of a stronger yen).  Markets will likely continue to test the resolve of the Japanese authorities and buy yen anyway.

Although the G7 statement said little to support the dollar and the overall tone to the dollar likely remains negative over coming months, the softer tone to equity markets and run of weaker economic data in the US – the latest data to disappoint was the September US jobs report – may give some risk aversion related relief to the dollar this week. 

Weaker data and equities alongside the impact of official rhetoric is being reflected in CFTC Commitment of Traders’ data (a good gauge of speculative market positioning) which revealed a sharp drop in short dollar positions, by around a quarter, highlighting for a change, an improvement in dollar sentiment over the last week. 

The biggest losers in terms of speculative positioning were the British pound, where the net short position reached its most extreme since mid September 2008, and Canadian dollar where the net long position was cut by almost half.  Again this may reflect official views on currencies, with Canadian officials expressing concern about the strength of the Canadian dollar in contrast to the perception that UK officials favour a weaker pound.
Central bank meetings (BoE, ECB, RBA) will dominate the calendar this week and more comments on currencies are likely even if interest rates are left unchanged.  Meanwhile FX markets will continue to watch equities, and the start of the US Q3 earnings season will give important signals to determine the sustainability of the recent equity market rally.  Recent weak economic data has already cast doubt about a speedy recovery and if earnings disappoint risk aversion could once again be back on the table.

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Economic reality check supports dollar

October 2, 2009 — Mitul Kotecha

The US dollar appears to be making a tentative recovery of sorts at least when taking a look at the performance of the US dollar index.  Much of this can be attributable to a softer tone to equities. The S&P 500 registered its biggest back to back quarterly rally since 1975 over Q3 and either through profit taking or renewed economic doubts, stocks may be in for shakier ground into Q4. 

This increase in equity pressure/risk aversion is being triggered by weaker data. Since the Fed FOMC on 24th September the run of US data has generally disappointed expectations; in addition to the ISM survey, existing and new home sales, durable goods orders, consumer confidence and ADP jobs data all failed to match forecasts.   This list was joined by the September jobs data which revealed a bigger than expected 263k drop in payrolls.  Consequently doubts about the pace of recovery have intensified as markets face up to a reality check.

The dollar’s firmer tone is not just being helped by weaker stocks but also by plenty of official speakers discussing currency moves. Although this is potentially a dangerous game considering the recent turnaround in Japanese official comments on the Japanese yen the net effect is to support the dollar.  In particular, Treasury Secretary Geithner stressed the importance of a strong dollar, whilst European officials including Trichet, Almunia and Junker appear to have become more concerned with the strength of the euro. 

In the current environment such comments will contribute to putting further pressure on the euro which in any case has lagged the strengthening in other currencies against the dollar over recent months.   Although ECB President Trichet highlighted “excess volatility” in his comments about currencies overnight implied FX volatility is actually relatively low having dropped significantly over recent months.  The real reason for European official FX concerns is quite simply the fact that the eurozone remains highly export dependent and that recovery will be slower the stronger the euro becomes.  

It’s not just G10 officials that are becoming concerned about currency strength against the dollar as Asian central banks have not only been jawboning but also intervening to prevent their currencies from strengthening against the dollar.   A firmer dollar tone is likely to put Asian currencies on the back foot helping to alleviate some of the upward pressure over the short term but the overall direction for Asian FX is still upwards.

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Contrasting fortunes for GBP and JPY

September 28, 2009 — Mitul Kotecha

The main FX movers over recent days have been JPY and GBP. Japan’s non interventionist FX stance and the approach of fiscal half year end on September 30 have given markets plenty of appetite to push the JPY higher.  In particular a change in Japanese tax rules which waives taxes on repatriated profits suggests there will be more repatriation flows than usual ahead of fiscal half year end.  Such repatriation flows have played a role in the appreciation of the JPY.    

Even if such flows do not actually materialise the mere speculation that they exist will be sufficient to keep the JPY supported.  Helping the JPY on its way is the view that Japanese officials are not particularly concerned about a strengthening JPY although it is worth noting that Japan’s new finance minister Fujii did note that he was carefully watching the JPY’s rise.  Nonetheless, it appears that the new government’s policy in Japan is in sharp contrast to the previous government’s FX policy which favoured a weaker JPY.  

The positive shift in JPY sentiment over recent weeks has been particularly evident in speculative positioning data which reveals that net JPY speculative positions have hit their highest since 3 February 2009, a sharp turnaround from negative net positioning just three months ago.  Further JPY gains are likely over the short term as speculative appetite for the currency continues to improve. 

In contrast to Japan, UK officials appear to be more comfortable with a weaker currency. Recent comments by Bank of England (BoE) Governor King that a weaker GBP would help exporters has weighed on GBP.  Consequently, speculative sentiment for GBP deteriorated particularly sharply last week, with CFTC IMM data revealing the biggest short GBP positioning since early April 2009.  Even though the latest UK Monetary Policy Committee minutes revealed no sign that the BoE is contemplating expanding quantitative easing, GBP continues to be a much unloved currency.  

Some likely improvements in economic data this week may provide relief to GBP but it will prove limited against the weight of negative GBP sentiment.  The Hometrack housing survey revealed a further increase in UK house prices in September and data this week will likely reveal an upside revision to Q2 GDP, and an improvement in manufacturing confidence.  Overall, despite the encouraging data GBP/USD looks vulnerable to a further downside push.

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Key events for FX markets this week

September 21, 2009 — Mitul Kotecha

Key events this week include the Fed FOMC and G20 meetings .  The G20 meeting is likely to be a non-event as far as markets are concerned.  There will be plenty of discussion about co-ordinating exit strategies but officials are set to repeat the commitment to maintain stimulus policies until recovery proves sustainable.  

There is likely to be little emphasis on currencies despite the fact that the dollar is trading around its lowest level in a year, except perhaps at the fringes of the meeting, with focus in particular on Japan’s new government’s pro yen policy.  

Regulation will also figure high amongst the topics debated but this will have little impact on markets over the short term.  Another topic that could be debated is protectionism, especially in light of the US decision to impose tariffs on Chinese tyres.

Ahead of the G20 meeting the Fed FOMC meeting is unlikely to result in any change in interest rates but the statement is likely to be cautiously upbeat in line with Fed Chairman Bernanke’s recent comments that the recession is “very likely over”.  The statement will be scrutinised for clues to the timing of policy reversal, especially given recent speculation that a couple of FOMC members were advocating an early exit.  Given that the dollar has suffered due to its funding currency appeal, any hint that some Fed officials are turning more hawkish could give the currency some much needed relief but we doubt this will last long. 

In contrast to speculation of a hawkish shift in thinking by some Fed members the Bank of England appears to be moving in the opposite direction.  The MPC minutes on Wednesday will be viewed to determine just how close the BoE was to extending quantitative easing and reducing interest rates on bank reserves at its last meeting. 

Sterling (GBP) has been a clear underperformer over recent weeks and a dovish tint to the minutes will act as another factor weighing on the currency as speculation over further action intensifies ahead of the next meeting.  

Sterling is also struggling against the euro having hit a five month low.  A combination of factors have hit the currency including concerns about quantitative easing expansion, the health of the banking system, and the latest blow coming from a the Bank of England in its Quarterly Bulletin where it states that GBP’s long run sustainable exchange rate may have fallen due to the financial crisis.   

Against this background it is not surprising that sterling was the only major currency against in which speculative positioning actually deteriorated versus the dollar last week (according to the latest CFTC Commitment of Traders report).   It is difficult to see any sterling recovery over the short term against this background, with a re-test of the 9 July low just under GBP/USD 1.60 in focus.

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The best funding currency

September 13, 2009 — Mitul Kotecha

The dollar was beaten up over the past week, finally breaking through some key levels against many major currencies; the dollar index touched 76.457, the lowest since September 25, 2008.  The usual explanation for dollar weakness over recent months has been an improvement in risk appetite.  However, this explanation fails to adequately explain the drop in the currency over recent days.   

Although we have seen a multi month trend of improving risk appetite it is not clear that there was any further improvement last week.  On the one hand the ongoing rise in equity markets points to a continued improvement in risk appetite; the S&P 500 recorded its biggest weekly gain since July.  Equity volatility has also declined, reflected by the decline in the VIX index.   

On the other hand, other indicators reveal a different picture.  The ultimate safe haven and inflation hedge, namely gold, registered further gains above $1000 per troy ounce. That other safe haven, US Treasuries underwent the strongest demand in almost 2 years (bid-cover ratio 2.92) for the $12 billion 30-year note auction, whilst the earlier 10 year note auction also saw solid demand (bid-cover ratio 2.77) as well as strong interest from foreign investors.  

The massive increase in bond issuance to fund the burgeoning fiscal deficit continues to be well absorbed by the market for now, whilst the drop in the dollar does not appear to be putting foreign investors off US assets.  The strong demand for Treasuries could reflect a lack of inflation concerns but may also reflect worries about recovery, quite a contrast to the move in equities.

The fact that the Japanese yen and Swiss franc strengthened against the dollar also contrasts with the view that risk appetite is improving.  The yen was the biggest beneficiary currency during the economic and financial crisis but has continued to strengthen even as risk appetite improves.  USD/JPY dropped close to the psychologically important level of 90 last week which actually indicates a drop in risk appetite.  Perhaps the move is more of an indication of general dollar pressure rather than yen strength.  

A likely explanation for the drop in the dollar is that it is increasingly becoming a favoured funding currency, taking over the mantle from the Japanese yen; investors borrow dollars and then use it to take short positions against higher yielding currencies.  US dollar 3-month libor rates fell below those of the yen and Swiss franc for the first time since November, effectively making the dollar the cheapest funding currency and fuelling broad based weakness in the currency.

Although the historically strong relationship between currencies and interest rates has yet to establish itself to a significant degree, ultra low interest rates suggests that the dollar will remain under pressure for a while yet, especially as the Fed continues to highlight that US interest rates are not going to go up in a hurry.

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