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 »

Central banks in the spotlight

February 1, 2010 — Mitul Kotecha

The market mood continues to be weighed down by a combination of worries including monetary tightening in China and Greece’s debt woes. Consequently, risk aversion has taken a turn for the worse over the last couple of weeks. Measures of currency and equity market volatility have also spiked. Meanwhile, risk currencies have remained under pressure, especially those that are most sensitive to risk aversion including AUD, NZD, CAD, and a long list of emerging market currencies.

Greece’s problems remain a major drag on the EUR, with speculative sentiment for the currency dropping close to the all time low recorded in September 2008, according to the CFTC IMM data. Further developments including news that the European Commission will officially recommend that Greece should implement more severe cuts on public sector spending are unlikely to help to reverse negative sentiment for the currency. A lack of confidence and scepticism over Greece’s ability to cut its budget deficit suggest little respite for the EUR in the weeks ahead.

Markets will have plenty of other things to focus on this week, with various manufacturing and service sector PMIs, four major central bank decisions, and the January US non-farm payrolls report, due for release. The PMIs are likely to confirm that output in both manufacturing and service industries remains expansionary but only consistent with limited growth rather than the rapid rebound in activity seen following past recessions.

The most interesting central bank decision this week is likely to be that of the Reserve Bank of Australia. Recent data has if anything given more reason for the central bank to raise interest rates, including the latest release which was the TD Securities inflation gauge, which jumped 0.8% in January, the biggest increase in 6-months. Although a hike is now largely discounted, some hawkish rhetoric from the RBA could be sufficient to give the AUD some support.

Although the UK Bank of England is unlikely to shift policy at its meeting on Thursday the statement will be scrutinized for clues as to whether quantitative easing is over. Any indication that there will be no further QE measures will play positively for GBP given that it has been restrained by speculation that the BoE will increase asset purchases. No change is also expected by the ECB but once again Greece will likely dominate the press conference. Meanwhile Norway’s Norges Bank is likely to pause in its policy of gradual tightening.

Clearly the funding currency of choice, the USD, has been one of the main beneficiaries of higher risk aversion and this has been reflected in the latest CFTC Commitment of Traders report, which shows that net short aggregate USD speculative positions have dropped sharply, with USD positioning close to flat again. Similarly, the other beneficiary, namely the JPY, has also seen a significant shift in positioning as shorts have been covered. Expect more to come.

Appetite for carry trades was not be helped by the news that the UK’s Lord Turner has signalled a regulatory crackdown on FX carry trades. The report in the UK press fuelled a sell of in JPY crosses but is unlikely to have more than a short term market impact given the practical difficulties in regulating carry trades. Nonetheless, the fact that speculative positioning is still quite long in the AUD, NZD and CAD suggest scope for more downside in such currencies in the current risk averse environment.

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

“Risk On”- Which Currencies Will Benefit?

January 5, 2010 — Mitul Kotecha

It was a “risk on” beginning of the week as equity markets rallied, commodities prices rose, and G10 bonds and USD came under pressure. Stronger manufacturing PMIs helped to boost confidence in the global economic recovery, with solid PMIs revealed in China, and across the rest of Asia, UK, and the US. The US ISM manufacturing which rose to its highest since April 2006 also revealed a rise in the unemployment component, consistent with view of an unchanged reading for December payrolls.

In the Eurozone the PMI matched the flash release and remained in expansion territory though there was some slippage in Germany, Spain, and Italy, underscoring the likely underperformance of the Eurozone economy relative to expectations of faster recovery in the US. Nonetheless, the PMIs continued to show a picture of expansion, with the Eurozone PMI at its highest in 21-months.

The USD lost ground against the background of improved risk appetite and looks set to fall further abruptly ending its short covering rally. The USD appears to be finding little support from interest rate expectations, with the correlation between most currencies and relative interest rate differentials remaining relatively low for the most part (just -0.04 over the past 3-months between the USD index and US rate futures).  The correlation between the USD and US 10-year bond yields looks somewhat stronger however, and could offer some relief to the USD if yields continue to push higher.

Speculative (CFTC Commitment of Traders) data reveals just how massive the shift in USD positioning has been over recent weeks, with net aggregate USD positioning (vs EUR, JPY, GBP, AUD, NZD, CAD, CHF) registering its first net long USD position since May 2008. The swing in positioning has been dramatic, from -167k contracts on 15 September 2009 to +8.7k in the week ending 29th December 2009. The data also reveals the sharp deterioration in sentiment for the EUR to its lowest since September 2008. Likewise net JPY positions have shifted to their biggest net short since August 2008.

What does this imply? The market is very short EUR and JPY but the JPY has much further to go on the downside as it increasingly retakes the mantle of funding currency.  In any case compared to historical positioning JPY shorts are not so big suggesting more room to increase short positions.   

The EUR has moved into a short term uptrend, with the MACD (12,26,9) having crossed its signal line and positioning supports further upside. EUR/USD will need to take out strong resistance at 1.4459 (December 29) before it can embark on a more significant move higher. Asian currencies also look set to take more advantage of a resumption of USD weakness, especially in the wake of strong risk seeking capital flows into the region. KRW, TWD, IDR and PHP look bullish technically.

Posted in Asia, Commodities, Currencies, Economics, Economy, equity markets, FX, Interest rates, US. Tags: , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

All eyes on US payrolls

January 4, 2010 — Mitul Kotecha

Happy New Year.  Markets are likely to struggle for direction ahead of the key US December non-farm payrolls data though the end of the year ended on a softer note for equity markets in the US, whilst Asian stocks were somewhat firmer.  The USD has taken a firmer tone at the start of this week but is likely to face renewed pressure into the new-year.  The fact that USD/Asian FX has failed to build any momentum on the upside also highlights risks to the USD from current levels. 

Ahead of payrolls look for EUR/USD technical support around 1.4177, with strong resistance around 1.4459 whilst USD/JPY will find support at 91.00 and resistance around 94.08.   I favour a firmer bias for the USD at the beginning of the week but this may not last too long and would look to take profits on long USD / short risk currency positions into next week. 

2010 is set to be a year of two halves for currency markets and whilst the USD is to eventually recover, the rally seen at the end of last year is likely to prove unsustainable, especially now that a lot of short USD positions have been covered.   If anything the pull back in various risk currencies provide better levels to take long positions, especially in the AUD and NZD as well as many Asian currencies where renewed appreciation in the months ahead is likely.  I particularly like the IDR and KRW, two of last year’s winners. 

The US jobs report will provide some evidence of a normalisation in economic conditions, with December likely to have marked the best month in two years for payrolls (Bloomberg consensus forecasts a 1k drop in payrolls). Although hiring is unlikely to pick up quickly and wage pressures are set to remain subdued, the data will mark an encouraging shift in job market conditions following the loss of 7.2 million jobs since the US recession began.  The unemployment rate is likely to remain stubbornly high, however.

Ahead of the jobs data markets will be able to garner some clues to the data from the jobs component in today’s release of the December ISM data.  The ISM is likely to remain in expansion territory though is unlikely to register much of a gain from last month’s 53.6 reading.   The eurozone and UK also release their manufacturing PMIs today and although both will remain above the 50 boom/bust mark, neither are set to register much improvement from November’s reading. 

There will also be some attention on central bank thinking this week, with the release of the December 16 meeting FOMC minutes as well as the BoE rate decision to digest.  The minutes will likely acknowledge some signs of improvement in the economy but there will be no indication that the Fed is shifting its “extended period” thinking even if the Fed wants to reassure markets that it has an exit strategy in place.   The BoE meeting will be a non-event for markets, with more interest on the outcome of the February meeting.

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

What’s driving FX – Interest rates or risk?

December 13, 2009 — Mitul Kotecha

The November US retail sales report has really set the cat amongst the pigeons. For so long we have become accustomed to judging the move in the USD based on daily gyrations in risk aversion. Well, that may all be about to change. There was an inkling that all did not look right following the release of the November jobs report which unsurprisingly helped to boost risk appetite but surprisingly boosted the USD too.

It was easy to dismiss the USD reaction to year end position adjustment, markets getting caught short USDs etc. What’s more the shift in interest rate expectations following the jobs report in which markets began to price in an earlier rate hike in the US was quickly reversed in the wake of Fed Chairman Bernanke’s speech highlighting risks to the economy and reiterating the Fed’s “extended period” stance.

However, it all has happened again following the release of the November retail sales data, which if you missed it, came in stronger than expected alongside a similarly better than forecast reading for December Michigan confidence. The USD reaction was to register a broad based rally as markets once again moved to believe that the “extended period” may not be so extended after all.

Interest rates will become increasingly important in driving currencies over the course of the next few months but if anyone thinks that the Fed will shift its stance at this week’s FOMC meeting, they are likely to be off the mark. No doubt the Fed will note the recent improvement in economic data but this is highly unlikely to result in a change in the overall stance towards policy.

Further improvements in US data this week including industrial production, housing starts, Philly Fed and Empire manufacturing may lead markets to doubt this but the Fed calls the shots and a potentially dovish statement may act to restrain the USD this week. Also, it’s probably not a good idea to rule out the influence of risk appetite on currencies just yet and with a generally positive slate of data expected, firmer risk appetite will similarly act as a cap on the USD this week.

Other than the US events there is plenty of other potentially market moving data to digest this week. More central banks meet this week including the Riksbank, Norges Bank and Bank of Japan. No change is expected from all three but whilst the Riksbank is set to maintain a dovish stance the Norges Bank meeting is a closer call. So soon after the emergency BoJ meeting, a shift in policy appears unlikely but the pressure to increase Rinban (outright JGB buying) operations could throw up some surprises for markets.

Europe also has its fair share of releases this week including the two biggest data for markets out of the eurozone, namely, the German ZEW and IFO surveys as well as the flash December PMI readings. The biggest risk is for the ZEW survey which could suffer proportionately more in the wake of recent sovereign concerns in the Eurozone. Sovereign names may still lurk to protect the downside on EUR/USD and if the USD finds it tougher going as noted above, the EUR may be able to claw back some of its recent losses.

Posted in central banks, Currencies, Economics, Economy, Europe, FX, Germany, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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