Italy downgrade adds to EUR woes

September 20, 2011 — Mitul Kotecha

The USD index remains firm but it remains unlikely that the USD is being bought on its own merits but rather on disappointments in the eurozone. Nonetheless, speculative USD sentiment has turned positive for the first time since June 2010 according to the CFTC IMM data, reflecting a major shift in appetite for the currency. Clearly there are risks to the USD including the potential for more QE3 being announced at this week’s FOMC meeting but this risk is likely to be small.

In contrast, the reversal in speculative sentiment for the EUR has been just as dramatic but in the opposite direction as the net short EUR position has increased over recent weeks, with positioning now at its lowest since June 2010. Sentiment is likely to have soured further overnight following news that Italy’s credit rating was cut by S&P to A from A+ despite the recent passage of an austerity package.

This outweighed any boost to sentiment from what was noted by the Greek Finance Minister as “productive” talks yesterday. Another conference call today is scheduled but the longer markets wait for approval of the next loan tranche the bigger the risk to the EUR. In addition Greek and Spanish T-bill auctions and European Central Bank (ECB) cash operations will be in focus. The EUR remains vulnerable to a test of support around 1.3500.

GBP has continued to slide over recent weeks, having fallen by around 5% since its high just above 1.66 a month ago. However, it has managed to hold its own against the EUR which looks in even more of a sorry state than the pound. The fact that GBP has been unable to capitalise on the EUR’s woes is largely attributable to growing expectations of further UK quantitative easing.

The minutes of the last Bank of England meeting on September 8 to be released on Wednesday will give more clues as to the support within the Monetary Policy Committee for further QE but its likely that the MPC will want to see the next Quarterly Inflation Report in November before committing itself to any further easing. In the meantime, GBP will find it difficult to sustain any recovery, with its drop against the USD likely to extend to around 1.5583 in the short term.

Japan returns from its Respect for the Aged holiday today but local market participants will have missed little action on the JPY, with the currency remaining confined to a very tight range. The inability of USD/JPY to move higher despite the general bounce in the USD index reflects 1) the fact that USD/JPY is very highly correlated with 2 year bond yield differentials and 2) the fact that US yields continue to be compressed relative to Japan. Additionally, risk aversion continues to favour the JPY and combined, these factors suggest little prospect of any drop in the JPY versus USD soon.

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Payrolls sour mood, Eurozone concerns intensify

September 5, 2011 — Mitul Kotecha

The market mood has soured further and risk aversion has increased following disappointing August US jobs report in which the change in payrolls was zero and downward revisions to previous months has reinforced the negative mood on the US and global economy while raising expectations of more Federal Reserve action. Moreover, the report has put additional pressure on US President Obama to deliver fresh jobs measures in his speech on Thursday though Republican opposition may leave Obama with little actual leeway for further stimulus.

There is plenty of event risk over coming days, with a heavy slate central bank meetings including in Europe, UK, Japan, Australia, Canada and Sweden. The European Central Bank will offer no support to a EUR that is coming under growing pressure, with the Bank set to take a more neutral tone to policy compared its previously hawkish stance. In the UK, GBP could also trade cautiously given recent comments by Bank of England Monetary Policy Committee members about potential for more UK quantitative easing.

The EUR has been unable to capitalise on the bad economic news in the US as news there has been even worse. The negative news includes the weekend defeat of German Chancellor Merkel’s centre-right bloc in regional elections, which comes ahead of a vote in Germany’s constitutional court on changes to the EFSF bailout fund.

The withdrawal of the Troika (ECB, IMF and EU) from Greece has also put renewed emphasis on the country at a time when protests are escalating. If all of this is not enough there is growing concern about Italy’s apparent backtracking on austerity measures, with the Italian parliament set to discuss measures this week. Separately Germany, Holland and Finland will hold a meeting tomorrow on the Greek collateral issue. On top of all of this is the growing evidence of deteriorating growth in the euro area.

Data releases are unlikely to garner a great deal of attention amidst the events noted above, with mainly service sector purchasing managers indices on tap and at least threw will look somewhat better than their manufacturing counterparts. In the US the Beige Book and trade data will be in focus but all eyes will be on Obama’s speech later in the week. The USD has maintained a firm tone despite the jobs report but its resilience may be better explained by eurozone negativity rather than US positivity. Even so, the USD is looking less uglier than the EUR in the current environment.

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Edging Towards A European Deal For Greece

July 21, 2011 — Mitul Kotecha

The momentum towards some form of agreement at the Special EU Summit today is growing, with French and German leaders reaching a “joint position on Greece’s debt situation”. Details of this position are still unknown, however. EUR has found support as expectations of a positive outcome intensify.

However, given that positive news is increasingly being priced in, and the market is becoming increasingly long, upside EUR potential will be limited even in the wake of a comprehensive agreement. A break above EUR/USD resistance around 1.4282 would bring in sight the next key resistance level around 1.4375 but this where the rally in EUR/USD is set to be capped.

Prospects of a major US debt default or at the least a government shutdown appear to be receding as the US administration has indicated some willingness to opt for a short term increase in the US borrowing limit to give more time for a bigger deficit reduction deal to be passed by Congress. Meanwhile, there will be further news on the deficit reduction plans put forward by the “gang of six” US senators, with a press conference scheduled for later today.

Debt ceiling negotiations are likely to be the main focus of market attention, with the Philly Fed manufacturing survey and weekly jobless claims relegated to the background. A speech by Fed Chairman Bernanke is unlikely to deliver anything new today. The USD is likely to be on the back foot given expectations of a deal in Europe and improved risk appetite but we expect losses to be limited.

The JPY continues to defy my bearish expectations. Over recent days the US yield advantage over Japan in terms of 2Y bonds dropped to multi-year lows below 20bps. Given the high correlation between USD/JPY and yield differentials, this has corresponded with the fall below 80.00.

Expectations of JPY weakness versus USD is highly dependent on the US – Japan yield gap widening over coming months. For this to happen it will need concerns about the US economy and expectations of more Fed asset purchases to dissipate, something that may not happen quickly given the rash of disappointing US data releases lately.

GBP found itself on the front foot following the release of the Bank of England Monetary Policy Committee minutes, which were less dovish than anticipated. They also revealed that the BoE expects inflation to peak higher and sooner than previously expected. However, the fact that the overall tone was similar to the last set of minutes meant there was little follow through in terms of GBP.

Further direction will come from June retail sales data today and forecasts of a bounce in sales will likely help allay concerns about a downturn in consumer spending. Nonetheless, GBP is still likely to struggle to break through resistance around 1.6230 versus USD.

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Euro unimpressed by Greek confidence vote

June 22, 2011 — Mitul Kotecha

News that the Greek government won a confidence vote has left the EUR unimpressed and gains will be limited ahead of the June 28 vote on the country’s 5-year austerity plan. The EUR was in any case rallying ahead of the vote, which the government won by 155-143 votes, and has actually lost a little ground following the vote.

EUR sentiment is likely to remain somewhat fragile given the ongoing uncertainties, but now that the first hurdle has been passed markets there is at least a better prospect of Greece receiving the next EUR 12 billion aid tranche before the July 15 “do or default” deadline. Over the near term EUR/USD upside is likely to remain capped around the 1.4451 resistance level (15 June high).

The next key event for markets is the Fed FOMC meeting outcome and press conference. This is unlikely to bode particularly well for the USD given that the Fed is set to downgrade its growth forecasts, with the comments on the economy likely to sound a little more downbeat given the loss of momentum recently as reflected in a string of disappointing data releases.

Nonetheless, monetary settings are unlikely to be changed, with the Fed committed to ending QE2 by the end of June. I remain positive on the USD’s prospects but its recovery is fragile due to the fact that US bond yields remain at ultra low levels.

Whilst only AUD/USD and USD/JPY have maintained significant correlations with bond yield differentials over the past three months, it will eventually require US bond yields to move higher in relative terms for the USD to find its legs again on a more sustainable basis.

In the meantime the approach of the end of QE2 by the end of June will on balance play positively for the USD as at least the Fed’s balance sheet will no longer be expanding even if the reinvestment of principle from its holdings of US Treasuries suggest that there will not be a quick or immediate reduction in the size of the balance sheet anytime soon.

There is little appetite to intervene to weaken the JPY at present, with the Japanese authorities blaming the strengthening in the JPY versus USD on the latter’s weakness rather than the former’s strength. Until yield differentials widen, USD/JPY will continue to languish at current levels or even lower.

GBP will garner direction from the release of the Bank of England Monetary Policy Committee meeting minutes. Whilst GBP has edged higher against the USD it has remained vulnerable against EUR. A likely dovish set of minutes reflecting some weak activity data, easing core inflation and soft wage growth, suggests little support for GBP over the short term.

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Interest Rate Decisions Galore

March 10, 2011 — Mitul Kotecha

The Reserve Bank of New Zealand (RBNZ) decision to cut policy rates by a bigger than expected 50bps does not necessarily mark the onset of a new wave of NZD selling. Indeed, whilst the NZD was hit by the rate cut it recovered quickly.

The NZD was aided by comments from the RBNZ Governor Bollard that short term inflation may spike due to the earthquake but this tempered by another RBNZ official who stated that the central bank may hold rates at 2.5% at least until January 2012. The post meeting statement indicated that the RBNZ will not embark on a series of rate cuts, a fact that will provide some relief to the Kiwi. Moreover, the currency looks increasingly oversold especially relative to the AUD as indicated by relative positioning.

Weaker than expected employment data in Australia will also help to stem AUD strength versus NZD. After many months of positive surprises the labour market is showing signs of cracking. Admittedly full time employment rose but this was outweighed by an even bigger drop in part time employment, resulting in a 10.1k fall in overall employment.

Although the AUD is unlikely to face too much downside markets the data will likely dampen expectations of possible rate hikes in the months ahead. My preferred way of playing possible AUD underperformance is via the NZD. AUD/NZD is likely to face plenty of resistance around the 1.3800 level and eventually as indicated by our quantitative models the currency pair is likely to move lower over coming weeks.

In sharp contrast to the RBNZ, the Bank of Korea hiked interest rates by 25bps in a further move to normalize policy. The decision was not much of a surprise and the statement indicated that more rate hikes should be expected. The KRW remains rangebound but the currency remains on path for further appreciation over coming months. The surprise trade deficit in China has weighed on Asian currencies in general but weakness is likely to be limited.

The Bank of England is the next central bank on tap today but is unlikely to hike rates despite the hawkish shift within the Monetary Policy Committee. A rate hike is moving closer but the Bank will likely wait until at least May before moving. Further details about today’s decision will as usual wait for the minutes in two weeks time. GBP looks vulnerable and whilst a rate move today is not expected the currency may lose ground over coming days against the background of a firmer USD.

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