G20 Leaves The US Dollar Under Pressure

October 25, 2010 — Mitul Kotecha

The G20 meeting of Finance Ministers and Central bankers failed to establish any agreement on clear targets or guidelines. Perhaps the problem of trying to achieve consensus amongst a variety of sometimes conflicting views always pointed to an outcome of watered down compromise but in the event the G20 summit appears to pass the buck to November’s summit of G20 leaders in Seoul where more concrete targets may be outlined.

Officials pledged to “move towards more market determined exchange rate systems” and to “refrain from competitive devaluation of currencies”. What does this actually mean? The answer is not a great deal in terms of practical implications. The first part of the statement is the usual mantra from such meetings and the addition of the latter part will do little to stop central banks, especially in Asia from continuing to intervene given that no central bank is actually devaluing their currency but rather preventing their currencies from strengthening too rapidly.

The communiqué highlighted the need for advanced economies being “vigilant against excess volatility and disorderly movements in exchange rates”, but once again this is the mantra found in the repertoire of central bankers over past years and is unlikely to have the desired effect of reducing the “excessive volatility in capital flows facing some emerging countries”. In other words many emerging countries will continue to have an open door to impose limited restrictions on “hot money” flows.

Although the language on currencies was stronger than in previous summits it arguably changes very little in terms of the behaviour of central banks and governments with respect to currencies. The communiqué is wide open to varying interpretations by countries and is unlikely to prevent the ongoing trend of USD depreciation and emerging market country FX appreciation and interventions from continuing over coming weeks.

The onus has clearly shifted to the November summit of G20 leaders but once again it seems unlikely that substantial agreements will be found. In the interim the November 3 Fed FOMC meeting will be the next major focus and if the Fed embarks on renewed asset purchases as widely expected FX tensions will remain in place for some time yet.

So whilst a “currency war” was always unlikely “skirmishes” will continue. In the meantime the USD is set to remain under pressure although it’s worth noting that speculative positioning has recorded a reduction in net aggregate USD short positions over the last couple of weeks, suggesting that some of the USD selling pressure may have abated. Whether this reflected caution ahead of the G20 meeting (as the data predates the G20 meeting) or indicated the USD having priced in a lot of quantitative easing (QE2) expectations already, is debatable.

The path of least resistance to USD weakness remains via major currencies including AUD, CAD and NZD. Officials in Europe are also showing little resistance to EUR strength despite the premature tightening in financial conditions and negative impact on growth that it entails. Scandinavian currencies such as SEK and NOK have also posted strong gains against the USD and will likely continue to show further outperformance.

The JPY has been the best performing major currency this year followed not far behind by the CHF despite the FX interventions of the authorities in Japan and Switzerland. Although USD/JPY is fast approaching the 80.00 line in the sand level expected to result in fresh FX intervention by the Japanese authorities, the path of the JPY remains upwards. Japan is unlikely to go away from the G20 meeting with any change in policy path as indicated by officials following the weekend deliberations.

Posted in Asia, Australia, central banks, China, Currencies, Economics, Economy, emerging markets, Europe, eurozone, Federal Reserve, FX, IMF, Interest rates, Japan, Monetary Policy, South Korea, Sweden, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

Two-way FX risk returns

August 18, 2010 — Mitul Kotecha

It appears that there is a bit of a sea change taking place in currency markets. Since early June the trend in currency markets would have looked like a one way bet to most casual observers. For instance, the USD index was declining fairly steadily and predictability as US growth worries intensified and markets anticipated a resumption of quantitative easing by the Fed. This changed quite dramatically over recent days, with a significant degree of two-way risk re-entering the market as the USD shook off worries about Fed quantitative easing and instead rallied in the wake of higher risk aversion.

The introduction of two-way risk into the market will cause a rethink of the increasingly fashionable view that the USD was about to embark on a renewed negative trend. This change in market perspective has coincided with renewed concerns about European sovereign risks, even as European growth has come in much stronger than expected over Q2. Other currencies have also lost ground against the USD more recently, with the notable exception of the JPY which remains close to the psychological level of 85.00.

Until recently the move in FX markets since early June contrasted with my view that Q3 would be a period of uncertainty and volatility. Improved risk appetite reflected a decline in uncertainty but whilst I now believe that Q3 will see less of an increase in risk aversion than previously anticipated, my core views remain unchanged. I see the USD resuming an appreciation trend against the EUR and funding currencies (JPY and CHF) whilst weakening against higher yielding risk currencies (AUD, NZD and CAD) over the medium term.

Although FX markets will likely gyrate between the influences of risk aversion on the one hand and growth/interest rates on the other, risk is likely to take the upper hand over the coming weeks. The influence of risk aversion has jumped sharply over the last few weeks for almost all currencies. As risk appetite was improving as it has done for much of the period since early June, it played negatively for the USD but the recent increase in risk aversion – brought about by renewed growth concerns, sovereign worries in the eurozone, with Ireland in particular coming under scrutiny – has managed to reverse this trend. The one-way bet for investors now appears to be over.

Only time will tell if the EUR’s recent bull run has come to an end but there is sufficient evidence to suggest that plenty of good news has now been priced in and that further upside will be much more difficult to achieve. Even the recently strong growth data in the eurozone has thrown up potential problems including growing divergence as well as the potential for a slowdown over coming quarters. Further strengthening of the EUR will be a particular problem for eurozone growth, especially for exporting countries such as Germany. In any case, even the recent drop in the EUR leaves the currency at an overvalued level and susceptible to further falls. Over the coming weeks a period of consolidation is likely, with the EUR set to take a weaker tone.

The JPY in contrast has shown little sign of weakening and continues to flirt with the key psychological level of 85.00 much to the detriment of the Japanese economy, leading to growing frustration from Japanese officials. Much weaker than expected Q2 GDP data has given even more reason to engineer a weaker JPY but as yet the only intervention has come verbally and even this has not been particularly strong. In the absence of FX intervention, the Japanese authorities may be forced to consider other options such as increasing outright JGB purchases.

Like the EUR and JPY, GBP will find it tough to extend gains against the USD especially given that the doves at the Bank of England will likely remain in the ascendancy as growth moderates. GBP is also less undervalued than it was just a few weeks back suggesting that the argument for GBP strength has weakened. Nonetheless, GBP is likely to outperform against a generally weaker EUR ending 2010 around 0.78.

Similarly, CHF will likely maintain its strength against the EUR in the short term but unlike GBP this will likely give way to weakness and a gradual move higher in EUR/CHF to around 1.37 by year end. An eventual improvement in risk appetite and some relative economic underperformance will undermine the case for holding CHF.

Scandinavian currencies are likely to struggle in the short term due to market nervousness about a US double dip in an environment of elevated risk aversion. Interest rates will also play an important role in driving NOK and SEK as will be the case for most currencies eventually. Divergence in rate views for Norway and Sweden suggests holding a short SEK long NOK position. Overall, with two-way risk now much more evident as many investors return from their summer break the FX market will look far less predictable than it did before they left.

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What To Watch This Week

May 24, 2010 — Mitul Kotecha

The end of last week proved to be a calmer affair than the preceding few days. There was some encouraging news on the Greek front, with Germany finally approving its share of the European Union (EU) aid package whilst Greece appeared to be on track with its budget deficit reduction as the country recorded a cash deficit of EUR 6.3billion in the first four months of the year, a 42% reduction compared to a year earlier. EU officials also agreed on tougher sanctions for countries breaching austerity rules.

There were plenty of negatives to offset the good news however, as European business surveys including the German IFO index and flash eurozone purchasing managers indices (PMIs) revealed some loss of momentum in growth as well as increased divergence. European banking sector concerns intensified as the Bank of Spain was forced to take control of CajaSur, a small savings bank holding 0.6% of total Spanish banking assets, which faced difficulties due to distressed real estate exposure. Its woes highlighted the problems faced by many Spanish savings banks due to property market exposure.

US data releases this week will confirm that economic recovery gathered steam in Q2. May consumer confidence data is likely to record a small gain, due in large part to improving job market conditions, whilst the Chicago PMI is set to retrace slightly in May, albeit from a healthy level. Both new and existing home sales are set to record gains in April, the former following a sizeable gain in March although the drop in house prices likely to be revealed by the Case-Shiller index will continue to fuel doubts about the veracity of the turnaround in the US housing market.

In Europe there is not much in terms of first tier releases and highlights include sentiment data such as German Gfk and French consumer confidence indices, and the May French business confidence indicator. The data are likely to be mixed, and as indicated by last week’s surveys will reflect a relatively healthy Q2 2010, but a worsening outlook for the second half of the year.

In the absence of UK data today there will be plenty of attention on the details of plans by Chancellor Osborne to cut GBP 6 billion from the budget deficit. The measures will be small change ahead of the emergency budget package on June 22nd when much bigger cuts are expected. Nonetheless, the first step today will be a crucial test of the new government’s ability to convince ratings agencies and markets that it is serious about reducing the burgeoning fiscal deficit.

Following the massive positioning adjustments of the last week markets will look somewhat calmer over coming days but risk aversion is likely to remain elevated, suggesting little respite for most currencies against the USD. The recent moves have left net aggregate USD positioning registering an all time high according to the CFTC Commitment of Traders data, in the latest week, but after the slight retracement lower in the USD index, it is set to make further gains over coming days.

It was notable that EUR and GBP looked more composed at the tail end of the week whilst attention turned to the liquidation of long positions in CHF, AUD, NOK and SEK. These risk currencies are set to remain under pressure but there will be little respite for EUR which is set to drift lower, albeit a less aggressive pace than over recent weeks and a re-test of EUR/USD technical support around 1.2296 is likely. GBP/USD has showed some resilience over recent days but remains vulnerable to further downside pressure, with 1.4310 immediate support.

Posted in Australia, bank rescue, central banks, Currencies, Economics, Economy, equity markets, Europe, eurozone, Financial crisis, Fiscal/Budget, FX, Germany, Greece, IMF, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

What To Watch This Week

February 7, 2010 — Mitul Kotecha

As usual the G7 meeting will leave markets with little to chew on. G7 officials maintained their commitment to stimulus measures and timely exit strategies but there was little of note for FX markets aside from the usual comments about wanting to avoid excess FX volatility. There was certainly know step up in pressure on China to strengthen though a report prepared for the meeting did push for countries with inflexible currencies to make adjustments. Meanwhile US officials mouthed the usual “strong dollar” mantra.

Where does this leave markets this week? Well I must admit my bullish view on risk currencies is clearly suffering after a positive start to the year. The pullback in high beta currencies (those with the highest sensitivity to risk aversion) has been dramatic. I have highlighted many of the factors weighing on sentiment in previous posts and whilst I still think the US dollar will find itself under renewed pressure over coming months the current environment remains conducive to more USD and JPY buying and selling of currencies such as the AUD, NZD, CAD, GBP, NOK, SEK, ZAR etc.

Ironically the US and Japan have arguably more severe deficit/debt concerns than some of the European countries under pressure but as most of Japan’s debt is held domestically there is little worry of a collapse in JGBs. Unlike Japan foreign investors hold over half of US debt but are not yet losing confidence with US Treasuries though this may not last unless there is some tangible sign that the burgeoning US budget deficit is being reduced. For now, attention remains firmly focussed on Greece, Spain, Portugal and to a lesser extent Italy.

Like the G7 meeting the US January jobs report released at the end of last week will give little direction for markets. Although the 20k drop in payrolls and revisions to past months were slightly disappointing the surprise drop in the unemployment rate was better news. This week’s data highlights include the January US retail sales report and December trade balance. The sales data is likely to help allay some concerns about faltering economic recovery, with retail sales forecast to rise over the month despite a likely pull back in autos spending.

How will this play out for currencies this week? Overall, the risk off tone is set to continue though the moves are looking increasingly stretched. The USD, JPY and CHF will remain on the front foot whilst risk currencies will remain under pressure. The EUR is set to continue to struggle against the background of eurozone deficit concerns and after its dive through 1.40 last week 1.35 now looms large. Meanwhile, the AUD may also struggle following the recent reassessment of interest rate expectations after the recent Reserve Bank of Australia (RBA) meeting in which interest rates were left unchanged.

UK markets will focus on the Quarterly Inflation Report from the Bank of England though the political situation may hold some interesting implications for GBP if polls continue to show that the gap between the governing Labour party and Conservative opposition continues to narrow. Prospects of a hung parliament will hardly hold any positive implications for GBP, a prospect which could limit any potential for GBP to recover ahead of May elections. The drop below 1.60 for Cable (GBP/USD) could extend further, especially as the BoE has kept the door open to further asset purchases if needed.

Posted in Australia, Bond markets, central banks, Currencies, Economics, Economy, Europe, Financial crisis, Fiscal/Budget, FX, Greece, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

High yield / commodity currencies take the lead

January 7, 2010 — Mitul Kotecha

Although equity markets continue to tread water the appetite for risk looks untarnished. So far into the new-year the winners are commodity / high yield plays as well as emerging market assets. The AUD, NOK, NZD and CAD have been the stars on the major currency front, with only GBP registering losses against the USD so far this year. The move in these currencies has been well supported by resurgent commodity prices; the CRB commodities index is up close to 10% since its low on 9 December.

There is little reason to go against this trend and the USD index is set to continue to lose ground as risk appetite improves further. I highlighted the upside potential in high yield / commodity currencies in a post titled “FX Prospects for 2010” and stick with the view that there is much further upside. I still prefer to play long positions in these currencies versus JPY which I believe will come under growing pressure as the year progresses.

Economic data has also been supportive, especially in Australia, supporting the AUD’s yield advantage. Although comments from the central bank towards the end of last year downplayed expectations of much further tightening, data releases support the case for another rate hike at the 2 February RBA meeting, with a fourth consecutive hike of 25bps to 4.00% likely at the meeting.

There will be some important clues from next week’s jobs data in Australia but judging by the solid gain in November retail sales, which rose 1.4% versus consensus expectations of 0.3%, and 5.9% jump in building approvals, the case for a rate hike has strengthened.  AUD/USD will now set its sights on technical resistance around 0.9326. 

AUD/USD has the highest sensitivity with relative interest rate differentials – correlation of 0.85 with Australia/US interest rate futures differentials over the past month – and so unsurprisingly the AUD rallied further as markets reacted to the strong retail sales data. I believe Australian interest rates will eventually get back up to 6% – pointing to more upside for AUD/USD as this is more than is priced in by the market.

It is fortunate for the USD that the correlation between the USD index and interest rate expectations remains low but nonetheless the December 15 FOMC minutes may have provided another excuse to sell the currency. The minutes were interpreted as slightly dovish by the market, with many latching on to the comments that some members of the FOMC debated the potential to expand the scale of asset purchases and continuing them beyond the first quarter.

Posted in Australia, central banks, Commodities, Currencies, Economics, emerging markets, equity markets, FX, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , . 2 Comments »
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