USD weaker, EUR resilient, JPY supported, CHF pressure

August 30, 2011 — Mitul Kotecha

Why has the USD come under pressure even after Fed Chairman Bernanke failed to signal more QE? The answer is that Bernanke offered hope of more stimulus and gave a shot in the arm to risk trades even if QE3 was not on the cards. Consequently the USD has looked vulnerable at the turn of this week but we suspect that a likely batch of soft US data releases over coming days including the August jobs report at the end of the week, ISM manufacturing survey on Thursday and consumer confidence today, will erase some of the market’s optimism and leave the USD in better position. The FOMC minutes today may also give some further guidance to the USD as more details emerge on the potential tools the Fed has up its sleeve.

The EUR’s ability to retain a firm tone despite the intensification of bad news in the eurozone has been impressive. Uncertainty on various fronts in Germany including but not limited to concerns about the outcome of the German Bundestag vote on the revamped EFSF on September 30, German commitment to Greece’s bailout plan and German opposition party proposals for changes to bailout terms including the possibility of exiting the eurozone, have so far gone unnoticed by EUR/USD as it easily broke above 1.4500. EUR was given some support from news of a merger between Greece’s second and third largest banks. Likely weak economic data today in the form of August eurozone sentiment surveys may bring a dose of reality back to FX markets, however.

The lack of reaction of the JPY to the news that Japan’s former Finance Minister Noda won the DPJ leadership and will become the country’s new Prime Minister came as no surprise. The JPY has become somewhat used to Japan’s many political gyrations over recent years and while Noda is seen as somewhat of a fiscal hawk his victory is unlikely to have any implications for JPY policy. Instead the JPY‘s direction against both the USD and EUR continues to be driven by relative yield and in this respect the JPY is likely to remain firmly supported. Both US and European 2-year differentials versus Japan are at historic lows, with the US yield advantage close to disappearing completely. Until this picture changes USD/JPY is set to languish around current levels below 77.00.

EUR/CHF has rebounded smartly over recent weeks, the latest bounce following speculation of a fee on CHF cash balances, with the currency pair reaching a high of 1.1972 overnight. The pressure to weaken the CHF has become all the more acute following the much bigger than anticipated drop in the August KOF Swiss leading indicator last week and its implications for weaker Swiss growth ahead. The ‘risk on’ tone to markets following Bernanke’s speech has provided a helping hand to the Swiss authorities as safe haven demand for CHF lessens but given the likely weak slate of economic releases this week his speech may be soon forgotten. Nonetheless, the momentum remains for more EUR/CHF upside in the short term, at least until risk aversion rears its head again.

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G7 Intervention Hits Japanese Yen

March 18, 2011 — Mitul Kotecha

One could imagine that it was not difficult for Japan to garner G7 support for joint intervention in currency markets given the terrible disaster that has hit the country. Given expectations of huge repatriation flows into Japan and a possible surge in the JPY Japanese and G7 officials want to ensure currency stability and lower volatility. Moreover, as noted in the G7 statement today officials wanted to show their solidarity with Japan, with intervention just one means of showing such support.

Although Japanese Finance Minister Noda stated that officials are not targeting specific levels, the psychologically important level of 80.00 will likely stick out as a key level to defend. Note that the last intervention took place on 15 September 2010 around 83.00 and USD/JPY was trading below this level even before the earthquake struck. The amount of intervention then was around JPY 2.1 trillion and at least this amount was utilised today. The last joint G7 intervention took place in September 2000.

Unlike the one off FX intervention in September 2010, further intervention is likely over coming days and weeks by Japan and the Federal Reserve, Bank of France, Bundesbank, Bank of England, Bank of Canada and other G7 nations. The timing of the move today clearly was aimed at avoiding a further dramatic drop in USD/JPY, with Thursday’s illiquid and stop loss driven drop to around 76.25 adding to the urgency for intervention. USD/JPY will find some resistance around the March high of 83.30, with a break above this level likely to help maintain the upside momentum.

The JPY has become increasingly overvalued over recent years as reflected in a variety of valuation measures. Prior to today’s intervention the JPY was over 40% overvalued against the USD according to the Purchasing Power Parity measure, a much bigger overvaluation than any other Asian and many major currencies. The trade weighted JPY exchange rate has appreciated by around 56% since June 2007. In other words there was plenty of justification for intervention even before the recent post earthquake surge in JPY

Although Japanese exporters had become comfortable with USD/JPY just above the 80 level over recent months, whilst many have significant overseas operations, the reality is that a sustained drop in USD/JPY inflicts significant pain on an economy and many Japanese exporters at a time when export momentum is slowing. Japan’s Cabinet office’s annual survey in March revealed that Japanese companies would remain profitable if USD/JPY is above 86.30. Even at current levels it implies many Japanese companies profits are suffering.

Upward pressure on the JPY will remain in place, suggesting a battle in prospect for the authorities to weaken the currency going forward. Round 1 has gone to the Japanese Ministry of Finance and G7, but there is still a long way to go, with prospects of huge repatriation flows likely to make the task of weakening the JPY a difficult one. The fact that there is joint intervention will ensure some success, however and expect more follow up by other G7 countries today to push the JPY even weaker over the short-term.

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US Dollar Tensions

September 6, 2010 — Mitul Kotecha

There was considerable relief, most acutely in the US administration, that the US August jobs report revealed a better than expected outcome. To recap, private sector payrolls increased by 67k vs. an upwardly revised 107k in July whilst total non farm payrolls dropped 54k. The data sets the market up for a positive start to the week in terms of risk appetite despite Friday’s drop in the August US non-manufacturing ISM index, deflating some of the market’s upbeat mood.

Once again I wonder how long positive sentiment can be sustained with so many doubts about recovery prospects and limited ammunition on the fiscal front as well as some reluctance on the monetary front, to provide further stimulus should a double dip become a reality.

Markets will be treated to several major central bank decisions including from the Bank of Japan, Bank of England, Bank of Canada and Reserve Bank of Australia this week. These meetings are set to prove uneventful, with unchanged decisions across the board expected although the Bank of Canada decision is a tough call.

The main US release this week is the Fed’s Beige Book on Wednesday, a report which will help the Fed to prepare for the FOMC meeting on September 21. The evidence contained within it is unlikely to be positive reading, with consumer spending set to be relatively soft and evidence of recovery likely to remain patchy.

On Thursday the US July trade deficit is set to reveal some narrowing and as usual the deficit with China will be of interest given the renewed tensions over FX policy. FX tension seems to be intensifying once again due to the relatively slow pace of CNY appreciation since the June de-pegging as well as political posturing ahead of November US mid-term elections. A deterioration in US trade data, a factor that largely contributed to the soft Q2 GDP outcome in contrast to a strengthening in China’s trade surplus will have added fuel to the fire.

The firmer risk backdrop has put the USD on the back foot, with the USD index dropping sharply overnight. Nonetheless, speculative USD positioning as reflected in the CFTC IMM data reveals further short covering up to the end of August, implying USD speculative sentiment is actually turning less negative.

Another country which has a different sort of tension regarding the USD is Japan. Improving risk appetite will likely prevent the JPY from visiting previous highs against the USD but will do little to reduce FX intervention speculation. Indeed, there was more jawboning over the weekend on the subject, with Japan’s finance minister Noda reiterating that Japan would take decisive action to stem the JPY’s appreciation but adding that coordinated FX intervention was a difficult option. Clearly Japan us unlikely to succeed with unilateral FX intervention.

Political events have added to the debate on FX policy as focus turns to the election for leader of the ruling DPJ party next week, with a battle looming between current Prime Minister Kan and challenger Ozawa. Although Ozawa is unpopular with the electorate he yields plenty of political power, and appea rs to be more inclined towards FX intervention. Having failed to sustain a move above 85.00 the pull back in USD/JPY suggests little appetite to extend gains, likely leaving USD/JPY in a relatively tight range, with strong support around 83.55 and resistance around 85.23.

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Split personality

August 25, 2010 — Mitul Kotecha

Markets are exhibiting a Strange Case of Dr Jekyll and Mr Hyde, with a clear case of split personality. Intensifying risk aversion initially provoked USD and JPY strength, with most crosses against these currencies under pressure. Both USD/JPY and EUR/JPY breezed through psychological and technical barriers, with the latter hitting a nine-year low. However, this reversed abruptly in the wake of extremely poor US existing home sales, which plunged 27.2% in July, alongside downward revisions to prior months, a much bigger drop than forecast.

Obviously double-dip fears have increased but how realistic are such fears? Whilst much of the drop in home sales can be attributed to the expiry of tax credits, investors can be forgiven for thinking that renewed housing market weakness may lead the way in fuelling a more generalized US economic downdraft. The slow pace of jobs market improvement highlights that the risks to the consumer are still significant, whilst tight credit and weaker equities, suggests that wealth and income effects remain unsupportive.

FX markets will need to determine whether to buy USDs on higher risk aversion or sell USDs on signs of weaker growth and potential quantitative easing. I suspect the former, with the USD likely to remain firm against most risk currencies. The only positive thing to note in relation to the rise in risk aversion is that it is taking place in an orderly manner, with markets not panicking (yet).

European data in the form of June industrial new orders delivered a pleasant surprise, up 2.5%, but sentiment for European markets was delivered a blow from the downgrade of Ireland’s credit rating to AA- from AA which took place after the close. The data suggests that the momentum of European growth in Q3 may not be as soft as initially feared following the robust Q2 GDP outcome.

Japan has rather more to worry about on the growth front, especially given the weaker starting point as revealed in recently soft Q2 GDP data. Japan revealed a wider than expected trade surplus in July but this was caused by a bigger drop in exports than imports, adding to signs of softening domestic activity. The strength of the JPY is clearly making the job of officials harder but so far there has been no sign of imminent official FX action.

Japan’s finance minister Noda highlighted that recent FX moves have been “one sided” and that “appropriate action will be taken when necessary”. The sharp move in JPY crosses resulted in a jump in JPY volatility, a factor that will result in a greater probability of actual FX intervention but the prospects of intervention are likely to remain limited unless the move in the JPY accelerates. USD/JPY hit a low of 83.60 overnight but has recovered some lost ground, with 83.50 seen as the next key support level. JPY crosses may see some support from market wariness on possible BoJ JPY action, but the overall bias remains downwards versus JPY.

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