Selling Risk Trades On Rallies

February 4, 2010 — Mitul Kotecha

Disappointing earnings as well as a weaker than expected outcome for data on the health of the US service sector (the ISM non-manufacturing index failed to match expectations, coming in at 50.5 in January versus consensus of 51.0) has weighed on markets, undoing the boost received from the generally positive manufacturing purchasing managers (PMIs) indices earlier in the week. It was not all bad news however, as earnings from Cisco Systems beat expectations Meanwhile US ADP jobs data fell less than expected, dropping 22k whilst data for December was upwardly revised. These are consistent with a flat outcome for January non-farm payrolls.

Various concerns are still weighing on confidence. Sovereign ratings/fiscal concerns remain high amongst these and although much has been made of the narrowing in Greek debt spreads, attention now seems to be turning towards Portugal. Greece is also far from being out of the woods, and whilst the European Commission accepted Greece’s economic plans the country would be placed under much greater scrutiny by the EC.

The US has not escaped either, with Moody’s warning that the US AAA credit rating would come under pressure unless more stringent actions were taken to reduce the country’s burgeoning budget deficit. The move follows the US administration’s forecast of a $1.565 billion budget deficit for 2010, the highest as a proportion of GDP since the second world war, with the overall debt to GDP ratio also forecast to rise further.

The current environment remains negative for risk trades and the pullback in high beta currencies has been particularly sharp over recent weeks. Sentiment for the NZD was dealt a further blow from a surprisingly weak Q4 jobs report in New Zealand. Unemployment rose to a decade high of 7.3% over the quarter whilst employment growth contracted by 0.1%. The pull back in wage pressures will also be noted by interest rate markets, as it takes some of the pressure off the RBNZ to raise rates anytime soon.

Data in Australia will not help sentiment for the AUD too. Australian retail sales dropped by 0.7% in December, a worse than expected outcome. The data will only serve to reinforce market expectations that the RBA will no hike interest rates as quickly as previously expected. Nonetheless, I would caution reading too much into the data, with real retail sales volumes rising by a solid 1.1% over Q4 whilst other data showed a strong 2.2% jump in building approvals.

The overall strategy against this background is to sell risk trades on rallies. There are still too many concerns to point to a sustained improve in risk appetite. Moreover, the market is still long in many major risk currencies. Asian currencies have so far proven more resilient to the recent rise in risk aversion however, a reflection of the fact that a lot of concerns are emanating from the US and Europe. However, Asian currencies will continue to remain susceptible to events in China, especially to any further measures to tighten policy.

Further USD strength against this background is likely, which could see EUR/USD testing support around 1.3748, AUD/USD support around 0.8735, and NZD/USD support around 0.6916.

Posted in Asia, Australia, central banks, China, Currencies, Economics, Economy, emerging markets, equity markets, Europe, Financial crisis, Fiscal/Budget, FX, Interest rates, Monetary Policy, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

FX Prospects for 2010

December 23, 2009 — Mitul Kotecha

There can be no doubt that for the most part 2009 has been a year for risk trades, not withstanding the sell off into year end. The policy successes in preventing a systemic crisis and the massive flood of USD liquidity injected globally kept the USD under pressure for most of the year and the currency became a victim of this success. Risk appetite is likely to improve only gradually over coming months given the still significant obstacles to recovery in the months ahead.  This will coincide with the declining influence of risk on FX markets. 

2010 will not be as straightforward and whilst risk will dominate early in the year interest rate differentials will gain influence in driving currencies as the year progresses. The problem for the USD is that market expectations for the timing of the beginning of US interest rate hikes is likely to prove premature as the Fed is set to hold off until at least late 2010/early 2011 before raising interest rates. The liquidity tap will stay open for some time, and risk trades will still find further support at least in the early part of 2010, whilst the USD will come under renewed pressure.    

The ECB will be much quicker in closing its liquidity tap than the Fed and arguably an earlier reduction in credit easing and interest rate hikes compared to the Fed would favour a stronger EUR.  However, the EUR is already very overvalued and a relatively aggressive ECB policy is unwarranted. Consequently rather than benefiting from more favourable relative interest rate expectations, the EUR could be punished and the EUR is set to decline over much of 2010 following a brief rally in Q1 2010, with EUR/USD set to fall over the year. 

Japan is moving in the opposite direction to the ECB.  FX intervention is firmly on the table though the risk is limited unless USD/JPY drops back to around 85.00. Even at current levels the JPY is overvalued but for it to resume weakness it will need to regain the role of funding currency of choice, a title that the USD has assumed. Efforts by the BoJ to combat deflation will likely help result in fuelling some depreciation of the JPY and it is likely to be the worst performing major currency over 2010, with a move back up to around USD/JPY in prospect.

The issue of global rebalancing will need to involve currencies but the currency adjustments necessary will not be forthcoming in 2010.  USD weakness early in the year will be mostly exhibited against freely floating major currencies which will bear the brunt of USD weakness.  However, the bulk of adjustment is needed in Asian currencies and there is little sign that central banks in the region will allow a rapid appreciation.  China holds the key and a gradual appreciation in the CNY over 2010 suggests little incentive to allow other Asian currencies to appreciate strongly. 

So in many ways 2010 will be one of two halves for currency markets and this has the potential to reignite some volatility in FX markets.  High beta risk trades including the AUD, NZD, NOK and many emerging currencies will see further upside in H1 as the USD falls further.  Gains in risk currencies will look even more impressive when played against the JPY and/or CHF than vs. USD given that they will succumb to growing pressure in the months ahead as their usage as funding currencies increases.

Ongoing rate hikes in Australia and Norway and the likely beginning of the process to raise rates in New Zealand early next year will mean that these currencies will also have the additional support of yield to drive them higher unlike the JPY.  There is a limit to most things however, and eventually the USD will recover some of its lost ground against risk currencies, as it undergoes a cyclical recovery over H2 2010.

Posted in central banks, Currencies, Economics, Economy, Europe, FX, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , . 2 Comments »

Where will interest rates go up next?

October 7, 2009 — Mitul Kotecha

Following the decision by the Reserve Bank of Australia to raise interest rates attention has swiftly turned to which central bank will move next. Indeed, there has been a reassessment of global interest rate decisions following Australia’s move. The hike in Australia is unlikely, however, to be quickly followed by the US, Japan, Europe or UK where policy is set to remain highly accommodative for long while.

Attention will however, turn to the Bank of Korea as well as the RBNZ and Norges Bank. In particular, the Norges Bank may be the next to hike when it meets on October 28. Norway has already appears to be priming markets for a rate hike. The RBNZ is likely to be slower to hike given the still slow pace of recovery in New Zealand and comfortable inflation backdrop.

The impact on currencies is not straightforward as the bigger influence on currency markets throughout the crisis has been risk appetite rather than interest rates. However, the influence of risk on currencies is beginning to wane and although interest rates have not been a major driver of currencies over recent months the move by the RBA likely accelerates the process of yield re-emerging as a key currency driver.

This is a big problem for the US dollar given that the Fed is unlikely to be quick to raise interest rates even if quantitative easing is withdrawn sooner. This means that the dollar will suffer from a growing yield disadvantage as interest rate hikes are priced in elsewhere. Taken together with improving risk appetite as reflected in the resilience of global equity markets, the main casualty will be the dollar, hit both from a yield and risk appetite perspective.

Risk currencies and those currencies with the greater prospect of higher rates will do well meaning further upside for the Australian dollar and New Zealand dollar as well as the Norwegian krone. Asian currencies look to continue to strengthen with the Korean won remaining an outperformer despite intervention threats by the Korean central bank. The euro will benefit from dollar weakness but is unlikely to benefit from anything euro specific given the likely slower pace of recovery in the eurozone. Meanwhile sterling is likely to remain under pressure, not helped by yield or risk appetite, and sentiment hit afresh by weak data.

Posted in Asia, central banks, Currencies, Economics, Economy, equity markets, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . 5 Comments »
Newer posts »