What’s driving FX – Interest rates or risk?

December 13, 2009 — Mitul Kotecha

The November US retail sales report has really set the cat amongst the pigeons. For so long we have become accustomed to judging the move in the USD based on daily gyrations in risk aversion. Well, that may all be about to change. There was an inkling that all did not look right following the release of the November jobs report which unsurprisingly helped to boost risk appetite but surprisingly boosted the USD too.

It was easy to dismiss the USD reaction to year end position adjustment, markets getting caught short USDs etc. What’s more the shift in interest rate expectations following the jobs report in which markets began to price in an earlier rate hike in the US was quickly reversed in the wake of Fed Chairman Bernanke’s speech highlighting risks to the economy and reiterating the Fed’s “extended period” stance.

However, it all has happened again following the release of the November retail sales data, which if you missed it, came in stronger than expected alongside a similarly better than forecast reading for December Michigan confidence. The USD reaction was to register a broad based rally as markets once again moved to believe that the “extended period” may not be so extended after all.

Interest rates will become increasingly important in driving currencies over the course of the next few months but if anyone thinks that the Fed will shift its stance at this week’s FOMC meeting, they are likely to be off the mark. No doubt the Fed will note the recent improvement in economic data but this is highly unlikely to result in a change in the overall stance towards policy.

Further improvements in US data this week including industrial production, housing starts, Philly Fed and Empire manufacturing may lead markets to doubt this but the Fed calls the shots and a potentially dovish statement may act to restrain the USD this week. Also, it’s probably not a good idea to rule out the influence of risk appetite on currencies just yet and with a generally positive slate of data expected, firmer risk appetite will similarly act as a cap on the USD this week.

Other than the US events there is plenty of other potentially market moving data to digest this week. More central banks meet this week including the Riksbank, Norges Bank and Bank of Japan. No change is expected from all three but whilst the Riksbank is set to maintain a dovish stance the Norges Bank meeting is a closer call. So soon after the emergency BoJ meeting, a shift in policy appears unlikely but the pressure to increase Rinban (outright JGB buying) operations could throw up some surprises for markets.

Europe also has its fair share of releases this week including the two biggest data for markets out of the eurozone, namely, the German ZEW and IFO surveys as well as the flash December PMI readings. The biggest risk is for the ZEW survey which could suffer proportionately more in the wake of recent sovereign concerns in the Eurozone. Sovereign names may still lurk to protect the downside on EUR/USD and if the USD finds it tougher going as noted above, the EUR may be able to claw back some of its recent losses.

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Risk appetite firms

December 11, 2009 — Mitul Kotecha

Risk appetite is slightly firmer at the end of the week.  US data failed to deliver much guidance on Thursday following a better than forecast trade deficit but disappointment on jobless claims. US retail sales came in better than expected on Friday, rising 1.3% and 1.2% ex-autos, likely helping the firmer tone to risk appetite.  This followed the release of a set of positive data releases in China on Friday revealing that the recovery in the country remains strong.

Fiscal concerns, especially in Europe continue to linger like a bad smell maintaining a degree of caution for markets and capping the EUR, with strong technical resistance seen around the November 20 low of 1.4794.   On this note GBP could struggle given the growing criticism of the pre-budget report on Wednesday.   However, worries about a ratings  downgrade have eased somewhat following comments from Moody’s that there was no threat to UK or US ratings for now, which has given GBP some likely short-lived breathing room.

I still favour AUD and NZD and out of the two NZD looks the better, especially given further likely unwinding of long AUD/NZD positions into year-end.  Markets will continue to ignore jawboning by RBNZ governor attempting to talk down the kiwi and focus on the shift in rhetoric following the RBNZ meeting pointing to an earlier rate hike than previously indicated.    However, the sharp drop in AUD/NZD over recent days has brought the currency cross back in line with my regression model estimates, which suggests that much of the pull back has already taken place.  The JPY is the main casualty of the improving trend in risk appetite edging back towards the 90.0 level.

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Renewed caution

December 8, 2009 — Mitul Kotecha

Risk appetite is struggling to make any headway, with equities losing ground overnight. The positive impact on markets and adjustment to growth expectations following the US jobs report has given way to renewed concerns. Caution increased as Fed Chairman Bernanke introduced a dose of reality to markets talking about “formidable headwinds” to growth. As a result, bonds gained some lost ground and markets pared back expectations of interest rate hikes, leaving the USD vulnerable.

Eurozone risk factors continue to dampen market enthusiasm too, with ECB President Trichet warning of further bank writedowns and S&P downgrading the outlook for Greece and Portugal. The release of German factory orders data revealing a sharp 2.1% fall in October fed into concerns and played against strengthening recovery hopes in the region. EUR/USD failed to close below 1.4820 suggesting some alleviation of downside pressure. FX markets are likely eye stocks for further direction, with various EUR negative specific factors set to limit the upside.

The delayed release of additional stimulus measures in Japan will be the main focus of attention in Japanese markets assuming that an agreement is reached within the coalition. In the meantime markets will digest news that the current account surplus narrowed in October but was still up 51.4% from a year earlier. Additionally loan growth continued to slow, for the 11th straight month in November, adding further evidence that the injections of liquidity into banks are not finding their way into the economy.

GBP has come under growing pressure over recent days and bulls will be disappointed by the BRC retail sales data. The 1.8% YoY rise in like-for-like sales according will come as another disappointment for GBP. The gain was the slowest since August and below forecasts and as noted by the BRC looks even weaker when considering that the year ago figure was very weak. The sales data may fuel concerns about the recovery in consumer spending, especially going into the all important Christmas season. Attention will turn to the release of November Halifax house price data and October industrial production data later today and the pre-budget report tomorrow. GBP/USD looks likely to track EUR/USD for now and looks supported above 1.6390.

Although the USD has slipped as markets pare back expectations of rate hikes, the currency appears to be in a win-win situation and will likely see limited downside as risk aversion creeps back. Lingering concerns about Dubai as well as short covering towards year as well as other factors pushing risk aversion higher will likely see the USD retaining some support into the end of the week ahead of the US retail sales and Michigan confidence data

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Risk appetite dented

August 17, 2009 — Mitul Kotecha

The surprise decline in the Michigan reading of US consumer confidence which dropped to 63.2 in August put a dampener on risk appetite at the end of last week helping to fuel a sea of red for most US and European equity markets at the close of play on Friday.   Nonetheless, FX markets remained range-bound, albeit with the dollar taking a firmer bias at the end of the week.

The impact of the drop in confidence is likely to prove short lived as risk appetite continues to improve this week although don’t look for big market moves as summer trading conditions continue to dominate.  For the most part the data releases should not throw any spanners in the works over coming days as a positive tone to data is set to be retained.  

The highlights this week include more GDP data from Japan and Norway following surprise increases in growth from Germany and France in Q2 last week.  Japan’s release showed a marginally softer than expected 0.9% QoQ increase in GDP with growth led by external demand and government stimulus measures.  In contrast, capital spending continued to remain weak.  

US numbers are set to show further improvement as likely reflected in manufacturing surveys including the August Empire survey and the Philly Fed.  Similarly housing data including housing starts and existing homes sales will point to more stabilisation whilst Fed Chairman Bernanke is set to deliver a similar tone to the recent FOMC statement. 

The highlight of the European calendar is the German ZEW survey and flash August PMIs.  Firmer equities point to a higher ZEW whilst manufacturing indices are likely to reveal a slower pace of contraction.  In the UK the minutes of the BoE MPC meeting are likely to reveal a unanimous vote for extending QE policy. 

On balance, the beginning of the week is likely to see a bit of a risk aversion led sell off in risk currencies including commodity currencies such as the Australian and NZ dollars as well as weaker Asian currencies led by the likes of the Korean won but the pressure is unlikely to last for long.  Nonetheless, Commodity currencies will face another layer of pressure from the sharp drop in commodity prices at the end of last week as reflected in the drop in the CRB index.

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