JPY retracement, AUD restrained

January 8, 2013 — Mitul Kotecha

Equity markets looked more restrained overnight as the sharp rally so far this year stalled ahead of the US Q4 earnings season which kicks off with Alcoa earnings after the close today. The looming budget battle in the US has also prompted some hesitancy to buy risk assets.

Direction will remain limited given the notable absence of first tier data releases today, with only Eurozone economic sentiment gauges, German factory orders, US small business confidence and consumer credit on tap. The bulk of releases are due in the later part of the week including rate decisions from the ECB and BoE.

For a currency that spent most of last year trapped in a relatively tight the JPY has lost an incredible amount of ground (12.7%) versus USD since the beginning of October 2012. The historically strong relationship between bond yield differentials and USD/JPY has broken down (albeit temporarily in my view), and cannot be used to explain the jump in USD/JPY.

Expectations of more aggressive monetary policy action have pushed USD/JPY higher especially as Prime Minister Abe continues to highlight his desire for a 2% inflation target. Nonetheless, as wires report today there may be no deadline for achieving this target a factor which may help USD/JPY to push lower in the short term. USD/JPY is likely to find some support around 86.54 (Jan 2 low). Speculative positioning in JPY has become increasingly short but notably is a long way from the all time low, suggesting scope remains for an eventual increase in JPY shorts.

AUD/USD has made an impressive recovery from its lows around 1.0344 at the end of last year. Risk appetite and the USD index both register a limited and insignificant correlation with AUD/USD suggesting that the currency will not be influenced by either over coming weeks. Yield differentials however, remain important and the widening of Australia 2 year yield differentials with Treasuries has provided important support for AUD.

Further upside in the currency will require Australian yields to move higher and this may in turn depend on the outcome of November retail sales data tomorrow but 2 year yields have hit trend line resistance suggesting that the AUD will struggle to move higher from current levels. AUD/USD 1.0585 will offer strong resistance, while my quantitative model suggests AUD/USD short term fair value around 1.0557.

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USD firm but running into resistance

January 7, 2013 — Mitul Kotecha

Happy New Year!

The consensus view for 2013 favours equities over bonds helped by expectations of a sustained improvement in risk appetite as tail risk diminishes further. Additionally relative valuations support the consensus. So far equities are on track although it may be a mistake to make a strong judgement based on the first week’s trading.

The US December jobs report provided more evidence that the US economy will trundle along this year at a modest pace of growth. Meanwhile, the US fiscal cliff agreement may have played into a tone of firmer risk appetite but the fact that in less than two months there may be even greater tensions on the debt ceiling and spending cuts suggest that a one way bet of improving risk appetite can by no means be guaranteed.

The USD has begun the year in firm shape appearing to break free from the constraint of improving risk appetite at the turn of the year. In part its strength especially against the JPY can be attributed to higher US bond yields which in turn was pushed higher by less dovish than expected Fed December 11-12 FOMC minutes last week. Given that yields are running into technical resistance the USD may find less support from this source over coming days.

A light data week will give little directional impetus to the USD, with highlights including trade data, consumer credit and small business confidence. Instead the USD will take its cue from various Fed speakers who will likely provide more elaboration on their views on an eventual exit from QE. The USD is likely to remain firm in the short term although we would be wary of extrapolating trends based on early year moves.

In contrast to the limited US data schedule there are plenty of data releases and events in Europe to digest this week including the European Central Bank Council meeting. The ECB is unlikely to ease policy at this meeting, with those in the Council against a cut unlikely to have shifted their stance although a rate cut, possibly in March remains on the cards. Data releases will continue to show weakness although importantly sentiment surveys will stabilise rather than drop further.

Sovereign debt issuance may take more importance for the EUR this week, with Austria, Belgium, Italy, Germany, Italy and Spain all scheduled to issue debt. Given the better risk environment a generally favourable reception to the debt issues will give the EUR some solace, likely preventing the currency from sliding further. Strong EUR/USD technical support is set to come just below 1.3000 at 1.2996.

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Euro falls, yen rises as risk aversion picks up

December 20, 2012 — Mitul Kotecha

The USD index is quickly slipping back to its mid September lows, although downside momentum has been restrained by an overnight jump in risk aversion. The USD had been undermined by a continued improvement in risk appetite as markets expect (hope) that a deal to avert the fiscal cliff can be averted although recent developments have not been encouraging on this front. Additionally, given the relative strong performance of US equities this year there may be an element of profits repatriation out of the US weighing on the USD. A likely upward revision to US Q3 GDP, rise in the Philly Fed survey manufacturing, and existing home sales, will if anything imply firmer risk appetite and consequent USD weakness.

EUR/USD is trading close to multi month highs but dropped from a high of 1.3309 overnight despite a firmer than expected reading for the December German IFO survey on renewed caution over a deal to avert the fiscal cliff. News flow has provided some impetus to the EUR over recent weeks following recent agreements by European leaders on issues such as banking supervision and a positive Greek debt buyback. Such progress has set the background for a firm end to the year for the currency. Nonetheless, as reflected in its drop overnight any increase in risk aversion will limit the ability of the EUR to move higher. Additionally the EUR will be restrained by caution expressed by the Greek finance minister in the FT over the country’s future highlighting that Greece is not out of the woods yet.

The JPY’s slide has continued unabated ahead of today’s BoJ policy decision. Markets have already priced in further easing in the form of an increase in asset purchases and any outcome that reveals anything less than JPY 10 trilion in asset purchases will provoke JPY buying in a market that is heavily short. However, the LDP’s strong showing in elections implies that markets will need to take seriously threats of more aggressive policy action over coming months, especially with regard to JPY strength. Indeed, weak export data revealed yesterday, while not solely attributable to JPY strength, will nonetheless, fuel more pressure for a weaker currency. Therefore, any pull back in USD/JPY will prove short lived as investors once again eye the JPY as the favoured short leg of carry trades.

Please note this will be my last blog post for 2012. Thank you for reading econometer.

Seasons Greetings and best wishes for the new year to all econometer.org readers.

ps. if you haven’t checked it out please click on the link below to order my new book, Chronology of a Crisis.

http://www.searchingfinance.com/products/books-econ-politics-finance/chronology-of-a-crisis.html

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USD and JPY on the back foot

December 17, 2012 — Mitul Kotecha

Running into the end of the year it is clear that the USD is turning into the biggest loser. In part this reflects year end flows but also the dovish Fed stance and uncertainty about a resolution of the fiscal cliff. Indeed, with the Fed FOMC meeting out of the way the lack of progress on averting the fiscal cliff is quite disconcerting. Market confidence of an agreement appears to be slipping judging by the weakness in risk assets at the end of the week.

The USD is unlikely to make up much ground in the days ahead despite some likely positive data releases including yet more data showing housing market recovery, gradually improving manufacturing confidence gauges as well as a revision higher to Q3 GDP.

The EUR is on the verge of ending the year in strong form (too strong for Eurozone economies) as news of agreements on Greece’s loan tranche and banking supervision have given the currency even more support. Much of the rally in the EUR is likely to come from position adjustment into year end and could reverse quickly into new year, however.

Nonetheless, there is no doubt that receding tail risk due in large part due to continued support from expected eventual ECB asset purchases (OMT) activation will limit any downside in the EUR. In the near term the EUR may still take some direction from the German IFO survey on Wednesday but assuming that this survey continues its stabilisation, EUR/USD will likely maintain gains above technical support around 1.2880.

Japan faces a new reality following elections following Shinzo Abe’s Liberal Demoractic Part (LDP) victory in lower house elections. In particular, pressure for more aggressive policy will be sustained given the two thirds majority obtained. Nonetheless, it is not obvious that coalition parties will be as welcoming while some of the rhetoric from LDP leader Abe has already softened.

As the deterioration in the Tankan survey revealed the economic picture is clearly worryingly weak. Trade data over the coming week will be scrutinised to determine the lingering impact of frictions with China as well as the strength of the JPY. On this note, a further increase in asset purchases by the BoJ this week will mean that the JPY is unlikely to retrace its losses very quickly. Nonetheless, USD/JPY will face strong resistance around 84.60.

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USD underperforms

December 13, 2012 — Mitul Kotecha

The Fed expanded its asset purchases by buying $45 billion in longer dated Treasuries following the end of Operation Twist, with total purchases at USD 85 billion per month. The Fed went a step further by changing the guidance, now anticipating that policy will be maintained at an “exceptionally low range for the Fed Funds rate” as long as the unemployment rate remains above 6 ½ % and inflation no more than ½ % above the Fed 2% goal.

Equity market reaction was limited, with any positive boost dampened by the recognition that the Fed will not be able to offset the blow to the economy from the fiscal cliff. On this front, progress has been limited as the likelihood of a deal by the end of the year is diminishing by the day.

In Europe sentiment is somewhat better as hopes that the EU Council meeting today will yield an agreement on banking union and supervision. Final approval for the delayed Greek loan tranche is likely to be delivered following the completion of Greece’s debt buyback. The better news in Europe will be reflected in a decent reception to the Spanish and Italian bond offerings today.

The USD did not take too kindly to the latest efforts by the Fed to boost the economy although there are clearly diminishing returns as far as FX markets are concerned with regard to Fed QE. Nonetheless, the USD is coming under growing pressure into year end.

Next year assuming that the fiscal cliff in the US is resolved, with a limited fiscal drag on the economy, a relatively positive growth trajectory for the US alongside an expected increase in US bond yields will mean that the USD will still enjoy gains against currencies with weaker growth paths namely the EUR and JPY.

My forecasts for the USD index based on forecasts for its constituents show a gradual strengthening over the course of the next couple of years (82.4 and 85.7 by end-2013 and -2014, respectively) largely due to the USD’s expected appreciation versus EUR and JPY. In reality, this is misleading as improving risk appetite and continued capital inflows to EM and commodity currencies will mean that the USD will underperform.

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