Rising risk aversion

December 5, 2013 — Mitul Kotecha

The US ADP November jobs report and October new home sales both beat expectations yesterday piling on the pressure on US Treasuries and adding further weight to support those looking for the Fed to taper at the December 17-18 FOMC meeting. Consequently non farm payrolls expectation will likely be revised higher from the current consensus of around 180k. In contrast the ISM non manufacturing index came in below consensus, with the jobs component slipping. US equities ended marginally lower while the USD held its ground. However, risk measures such as the VIX “fear gauge” moved higher. Rising risk aversion may reflect expectations of imminent tapering and some angst ahead of US budget talks.

US November payrolls data to be released tomorrow will be crucial to provide more decisive clues to the timing of Fed tapering. Attention ahead of the jobs report will turn to the European Central Bank policy decision where no action is expected although some downward revisions to staff forecasts are likely. We continue to expect a more aggressive ECB stance into 2014. The Bank of England and Norges Bank will also decide on policy rates but no change is expected in both cases. In the US an upward revision to Q3 US GDP is expected to around 3.1% QoQ annualised while jobless claims will also be in focus. Market nervousness is likely to continue today although activity is likely to be limited ahead of the US payrolls data tomorrow.

The USD should be supported due to higher US Treasury yields although USD/JPY has lost some ground in the wake of higher risk aversion. The large short JPY market position may also be limiting the JPY’s downside for now. EUR/USD is trading shy of its recent highs above 1.36 and could be vulnerable to a dovish ECB statement today as well as to growth forecast downgrades by the ECB. AUD continues to remain under pressure having traded just below 0.90 overnight in the wake of disappointing GDP data yesterday and is likely to remain vulnerable to further slippage. CAD was further undermined by a relatively dovish Bank of Canada statement following the decision overnight to leave policy rates unchanged.

Given that US Treasury yields have risen by around 33bps since the end of October it is worth looking at which currencies are most sensitive to rising yields. In Asia the most correlated currencies with 10 year US Treasury yields over the last 3 months and therefore most vulnerable currencies are the SGD, THB, and MYR. The least sensitive have been CNY, IDR and KRW. Playing long KRW / short SGD appears to be a good way of playing an environment of rising US yields, especially given that yields are set to continue to rise over the coming months.

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Awaiting the Fed

October 30, 2013 — Mitul Kotecha

Another positive day for US equities overnight reflected the ongoing gradual but steady improvement in risk sentiment. The USD also managed to shake off some of its malaise, rising against most major currencies although US Treasuries continued to flat line. Data in the US did little to change expectations for the Fed FOMC policy decision tonight; headline retail sales dropped (-0.1%) in September but core orders looked healthier (0.4%), while US consumer confidence slipped by more than expected in October (71.2) and US house prices rose (0.93%) in August.

Direction will be limited ahead of the Fed outcome where markets hope to garner some clues on the timing of the beginning of tapering. However, given that the consensus has clearly shifted to a March 2014 beginning of tapering it is difficult to see how the Fed could build on already dovish market expectations. Ahead of the Fed decision we will be able to assess further evidence on the state of the private sector jobs market, with October ADP jobs scheduled for release.

Given the risk / reward around today’s Fed meeting we remain constructive on the USD, with further albeit gradual recovery ahead. Indeed, it is encouraging that the EUR failed to hold onto gains even after ECB member Nowotny effectively gave the green light for further EUR strength when he noted that policy makers `have to live with` a strong EUR. EUR will continue to look a sell on rallies above 1.3800.

Nototny’s sanguine tone is not shared elsewhere as reflected in attempts by RBA Governor Stevens to talk down the AUD this week or by NZ’s central bank, noting that the strength of the NZD could give scope to delay interest rate hikes. GBP also seems to be failing to shake off the after effects of relative dovish comments by Bank of England MPC members over recent days. The overall winner appears to the USD especially as a lot of dovishness is already priced into the currency.

The USD is also set to take a firmer tone against Asian currencies over the short term. Asian currencies most sensitive to USD strength are SGD, MYR and PHP and these currencies will be most exposed in the short term to further downside risks. IDR also looks vulnerable given the continued outflows of equity portfolio capital from Indonesia over recent weeks (month to date outflows USD 175 million). KRW looks more stable although disappointing September industrial production data released this morning will put a firm cap on the currency.

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USD edges higher, AUD supported, KRW in focus

October 10, 2013 — Mitul Kotecha

US equities and risk assets in general edged higher overnight as US politicians edged towards a budget deal. The nomination of Janet Yellen as next Fed Chairman was met with a positive reaction from risk assets as it was perceived that she would be more likely to maintain the easy policy of her predecessor, with markets in any case delaying expectations of tapering into next year.

The Fed FOMC minutes released overnight gave little clarity on the timing of Fed tapering however, but it did highlight the split within the FOMC between those wanting to begin tapering in September and those preferring to wait. More consolidation is likely today as markets await political developments in the US.

Contrary to our expectations the USD has actually edged higher over recent days shaking off some the pressure associated with the budget impasse in the US. News that President Obama will meet around 20 senior Republicans from the House following a similar meeting with Democrats highlights progress of sorts, with hints of compromise in the air.

A slight uptick in US bond yields has managed to provide the USD with a semblance of support and further consolidation is likely in the short term as market fears over a US default gradually recede. Indeed, it appears that the USD is in a bottoming out process at present, with short term pain likely to give way to medium term gain.

GBP has lost ground over recent days undermined yesterday by disappointing August manufacturing/industrial production data and a worse than expected trade deficit. The data is unlikely to affect the outcome of today’s Bank of England MPC meeting however, with an unchanged outcome both on policy rates and asset purchases on the cards.

Despite yesterday’s data disappointments UK data has been improving and point to a reasonably good growth outcome in Q3 and a reduced likelihood of further asset purchases by the BoE. Nonetheless, GBP’s gains look overdone, with scope for short covering having diminished. Further pressure is expected against both EUR and GBP in the short term.

Australian jobs data revealed an increase of 9.1k in employment evenly split between full time and part time jobs and a surprise drop in the unemployment rate to 5.6%. The headline increase in employment was below consensus. Moreover, there was a marginal drop in the participation rate which helped to push the unemployment rate lower. On balance, the data will leave the AUD unperturbed, with the AUD/USD likely to remain supported over the short term. AUD/USD looks primed to test resistance around the 0.9530.

Asian currencies are on the back foot in the face of a slightly firmer USD. KRW will be in focus, with the Bank of Korea delivering an unchanged policy outcome but revising lower its growth and inflation forecasts. Against this background KRW appreciation looks overdone and appears to face strong resistance on any breach down to USD/KRW 1070. Nonetheless, downside risks will be limited. Encouragingly Korea has been a major beneficiary of the prospects of a delayed Fed tapering, with the country recording a strong return of equity portfolio flows over recent weeks

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Bernanke hits Treasuries, boosts dollar

May 23, 2013 — Mitul Kotecha

Fed Chairman Bernanke’s prepared testimony expressed no hurry to scale back policy accommodation given the risks to economy recovery. However, in the Q&A session following the testimony he noted that the Fed is prepared to adjust the current flow rate of asset purchases in response to incoming data. Importantly in terms of timing Bernanke hinted that the Fed could “take a step down in the pace of purchases” in the next few FOMC meetings dependent on the data. While it is likely that many FOMC members want to see more evidence of recovery especially in the jobs market a reduction in asset purchases in Q4 is likely assuming this evidence if forthcoming. The FOMC minutes echoed this sentiment.

Bernanke’s comments and the minutes fuelled plenty of market volatility, with equities selling off after an initial rally and Treasury yields rising, with the 10 year US Treasury yield flying through the 2% level. Commodities dropped and the USD strengthened, with USD/JPY breaking through 103.00. This pattern is likely to be echoed in Asian trading today but much of the market reaction to the Fed has already occurred and it will need more evidence of either stronger US data or more hawkish Fed comments to extend yesterday’s moves. US jobless claims today will take on more prominence in this respect in the absence of other major data releases with the exception of a likely gain in April new home sales.

The USD is set to consolidate its gains over the short term firmly underpinned by higher US bond yields. Funding currencies (JPY and CHF), yielding and commodity currencies (AUD, NZD and CAD ) look most vulnerable to a firm USD although almost all currencies have felt some of the pressure. The net result is that the USD index has reached its highest level in close to 3 years. Given that the rise in US yields may only mark the beginning of a deeper reversal the upside for the USD over coming months could be significant.

Fortunately for Asian currencies they have not been particularly sensitive to USD strength over recent months as domestic factors have taken on more prominence although the KRW and SGD have been particularly sensitive to JPY weakness. Nonetheless, Asian currencies are set to remain under pressure over the short term as concerns of a slowing in capital flows to the region may grow. Singapore’s better than expected Q1 GDP reading (1.8% QoQ) released this morning will do little to stem the pressure. Meanwhile comments by Korean officials on the impact on the country’s exports from a stronger JPY will keep the KRW pressured.

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Not so straightforward

May 20, 2013 — Mitul Kotecha

To casual observers the global market picture look very good, reflective of an improving growth and earnings story; risk assets continue to rally as central banks keep the liquidity taps open. In reality the picture is not as black and white as the US economy appears to be doing better than most other major economies despite the impact of the sequester and tax hikes while other economies are in differing states of health.

Japan’s turbo charged stimulus measures have helped contribute to a solid GDP growth outcome in the first quarter and to the rally in risk assets but much needs to be done in terms of reforms. Indeed, the jury is still out whether growth recovery can be sustained (just look back at the growth spurts and subsequent declines following past stimulus).

Europe remains in the doldrums as the impact of austerity weighs heavily, with even the core economies facing growing economic pressures. It’s no wonder that the anti austerity backlash continues to grow. While Eurozone data this week may look a little perkier than usual, with gains in the May purchasing managers’ confidence indices and the German IFO business climate confidence survey (both good forward looking indicators) likely, the overall picture will remain one of contraction. All of this will be unhelpful for the EUR which looks set to test its year low around 1.2745 versus USD.

US outperformance is fuelling a rise in US bond yields and consequently a stronger USD as expectations that the Fed will want to taper off asset purchases sooner rather than later grows. Fed Chairman Bernanke’s testimony this week will therefore be closely regarded as clues are sought However, he is unlikely to suggest that the Fed is verging on any reduction in asset purchases. Although US data was mixed last week the recovery theme will continue this week, with housing data and durable goods orders set to record gains.

In Japan the highlight of the week is the Bank of Japan policy meeting. Given the aggressiveness of recent measures expect a pause from the central bank at this meeting although the JPY will remain under pressure as the US / Japan yield differential continues to widen in favour of the USD. Nonetheless, comments by Japan’s Economy Minister Amari emphasising the negative impact of a weaker JPY may help to slow the pace of JPY decline.

The general strength in the USD has contributed to growing pressure on many Asian currencies. Only the THB, CNY and MYR have recorded gains this year. Other currencies including the KRW, TWD, and SGD have been particularly vulnerable to a weaker JPY. A slower pace of JPY decline will help these currencies although the prospects of further monetary easing and regional tensions will dampen any upside in the short term.

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