Plenty of event risk

October 17, 2011 — Mitul Kotecha

This week is heavy with event risk, with a lot expected from EU leaders. So far the risk on tone to markets has held up, with for example the VIX fear gauge resting below the key 30.0. The G20 meeting over the weekend set the deadline for action for concrete solutions to the eurozone debt crisis for the October 23 EU Summit.

However, there will be little detail on issues such as banking sector recapitalisation, private sector involvement in any debt restructuring or ‘leveraging’ the EFSF bailout fund until the report on Wednesday night by the Troika on Greece. The reward to EU leaders would be the potential for more aid from the IMF but even now it seems that a German government official has poured cold water of a plan being announced at the EU Summit which will disappoint markets.

There are also plenty of data releases for markets to digest over coming days including inflation releases, manufacturing surveys and industrial production data in the US while in Europe the German IFO and ZEW surveys are scheduled for release. The data will follow on from the better than expected September US retail sales releases at the end of last week continuing to dampen expectations that the global economy is falling in recession though there will be a marked deceleration in European data.

Meanwhile the US Q3 earnings season rolls. The risk on tone will likely continue to weigh on the USD and weigh on bonds but unlike a few weeks ago when a lot of bad news was priced in, the scope for disappointment is becoming increasingly high.

Many currencies remain highly correlated with gyrations in risk and in this respect the improvement in risk appetite is good news for high beta / commodity. AUD, NZD, CAD and JPY are amongst the most sensitive currencies and therefore prone to a bigger reaction as risk improves, with the former three strengthening and the JPY weakening. Asian currencies poised to benefit from firmer risk appetite include INR and KRW, both with relatively high correlations with risk.

EUR/USD has made a solid recovery over recent days from its lows around 1.3146 spurred by hopes of action by European officials. Such hopes may yet be dashed but the EUR looks supported over coming days ahead of the EU summit Speculative positioning also reflects a slight improvement in EUR sentiment as IMM short positions have declined in the last week but its worth noting that this week’s European data are unlikely to be supportive for the EUR.

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Euro crisis intensifies

July 12, 2011 — Mitul Kotecha

The blowout in eurozone non-core debt has intensified and unlike in past months the EUR has been a clear casualty. The lack of a concrete agreement over a solution given divergent views of EU officials, the European Central Bank (ECB) and private sector participants threatens a further ratcheting higher of pressure on markets over coming weeks.

The only real progress overnight as revealed in the Eurogroup statement appeared to be in the renewing the option of buying back Greek debt via the eurozone bailout fund, extending maturities and lowering interest rates on loans. This will be insufficient to stem the pressure on the EUR, with the currency verging on a sharp drop below 1.40.

The USD continues to take advantage of the EUR’s woes and has actually staged a break above its 100-day moving average yesterday after several attempts previously. This sends a bullish signal and the USD is set to remain supported given that there is little in sight of a resolution to the problems festering in the eurozone.

Today’s release of the June 22 Fed FOMC minutes will give some clues to Fed Chairman Bernanke’s testimony to the House of Representatives tomorrow, but as long as the minutes do not indicate a greater willingness to embark on more asset purchases, the USD is set to remain resilient.

GBP has also benefitted from the EUR’s weakness, and unlike the EUR has only drifted rather than dived versus the USD. However, the UK economy is not without its own problems as revealed in a further drop in retail sales overnight, albeit less negative than feared, with the British Retail Consortium (BRC) like for like sales falling 0.6% in June.

A likely increase in June CPI inflation in data today to a 4.8% annual rate will once again highlight the dichotomy between weak growth and high inflation. In turn, such data will only provoke further divisions within the Bank of England MPC. While further gains against the beleaguered EUR are likely, with a test of EUR/GBP 0.8721 on the cards in the short term, GBP will struggle to sustain any gain above 1.6000 versus USD.

Both AUD and NZD are vulnerable against the background of rising risk aversion and a firmer USD in general. However, both currencies are not particularly sensitive to risk aversion. Interestingly the major currency most sensitive to higher risk aversion in the past 3-months is the CAD and in this respect it may be worth considering playing relative CAD underperformance versus other currencies.

As for the AUD it is more sensitive to general USD strength, suggesting that it will be restrained over coming sessions too and given that market positioning is still very long AUD, there is scope for further downside pressure to around 1.0520 versus USD.

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EUR Supported, AUD dives, NZD jumps

June 9, 2011 — Mitul Kotecha

Today is probably not the best day to sell EUR given that the ECB policy decision looms on the horizon. Whilst there is a risk of a ‘buy on rumour, sell on fact’ impact on the EUR following the European Central Bank (ECB) decision later today the relatively high probability that the ECB flags a rate hike in July will likely give further support to the EUR especially as it is not fully priced in by the market.

Of course should ECB President Trichet fail to mention “strong vigilance” in his press conference the EUR could suffer but this is likely to be a lower probability event. Some justification for higher rates will come from an upward revision in the ECB’s inflation forecasts. Consequently EUR/USD looks well supported around 1.4450.

The Bank of England is unlikely to deliver any surprises today, with an unchanged policy rate outcome and asset purchases target likely. The outcome will keep GBP restrained versus USD but given the likely contrast with the ECB, EUR/GBP could head higher as the currency pair continues to set its sights on the 0.90 level.

Even against the USD, GBP is unlikely to extend its gains, with 1.6474 likely providing a near term technical cap. The dichotomy of weaker activity and higher inflation is clearly causing a problem for policy makers but we still believe a rate hike is likely later in the year. In the meantime GBP remains vulnerable to further data disappointments over coming weeks.

There was more bad news for the AUD today in the form of a weak than forecast May employment report. The data will reinforce expectations that the RBA will not hike interest rates over coming months, with July and August effectively ruled out, though a hike in September remains probable.

The data had major impact on AUD which dropped sharply below the 1.0600 handle versus USD. Clearly the combination of the RBA statement and weak jobs data has resulted in a major headwind against further near term AUD appreciation. AUD will remain under downward pressure in the short-term, with technical support seen at 1.0440.

Unlike the RBA the Reserve Bank of New Zealand (RBNZ) opened the door for higher interest rates following its unchanged policy decision today, with the Bank stating that “a gradual increase in the overnight cash rate over the next two years will be required”. Despite noting some caution about the strength of the NZD and its impact on the economy the Kiwi strengthened versus the USD

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US Economic Data Disappointments

June 2, 2011 — Mitul Kotecha

Risk gyrations continue, with a sharp shift back into risk off mood for markets driven in large part by yet more disappointing US economic data as the May ADP jobs report came in far weaker than expected at 38k whilst the ISM manufacturing index dropped to 53.5 in May, its lowest reading since September 2009. This was echoed globally as manufacturing purchasing managers indices (PMI) softened, raising concerns that the global ‘soft patch’ will extend deeper and longer than predicted.

The market mood was further darkened by news that Moodys downgraded Greece’s sovereign credit ratings to Caa1 from B1, putting the country on par with Cuba and effectively predicting a 50% probability of default.

The resultant jump in risk aversion was pretty extensive, with US Treasury yields dipping further, commodity prices dropping led by soft commodities, and equity volatility spiking although notably implied currency volatility has remained relatively well behaved.

Global growth worries led by the US have now surpassed Greek and eurozone peripheral country concerns as the main driver of risk aversion, especially as it increasingly looks as though agreement on a further bailout package for Greece is moving closer to being achieved. Moreover, it seems as though a ‘Vienna initiative’ type of plan is moving towards fruition involving a voluntary rollover of debt.

The lack of first tier economic data releases today suggests that it will be a case of further digestion or perhaps indigestion of the weak run of US data releases over recent weeks and the implications for policy. For instance, it is no coincidence that QE3 is now being talked about again following the end of QE2 although it still seems very unlikely.

Bonds may see some respite from the recent rally given the lack of data today although this may prove short-lived as expectations for the May US jobs report tomorrow are likely to have been revised sharply lower in the wake of the weak ADP jobs data and ISM survey yesterday, with an outcome sub 100k now likely for May US non-farm payrolls.

Meanwhile, FX markets are caught between the conflicting forces of higher risk aversion and weaker US data, leaving ranges to dominate. On balance, risk currencies will likely remain under pressure today and the USD may get a semblance of support in the current environment.

This may be sufficient to prevent EUR/USD from retesting its 1 June high around 1.4459 as markets wait for further developments on the Greek front. Once again the likes of the CHF and to a lesser extent JPY will do well in a risk off environment whilst the likes of the AUD and NZD will suffer.

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