PIIGS fears fuelling risk aversion

January 29, 2010 — Mitul Kotecha

Risk aversion has come back with a vengeance over the last 10 days driven by a host of concerns that continue to damage market sentiment. As has been evident over the past year the USD and JPY remain the best currency plays against the background of rising risk aversion and both currencies look well supported.

Market concerns are not going away quickly but some of the fears plaguing markets have at least receded especially on the US political front, with Obama’s State of the Union address, Geithner’s testimony on AIG and Bernanke’s reappointment all passing without too much incident, at least from a market perspective. I still believe that market fears are overblown but it is clearly evident that the market is not in the mood to concur. More pain is likely in the weeks ahead.

Euro-sovereign spreads continue to suffer from the ongoing Greek saga whilst the other major fear remains further monetary tightening in China. Rumours that China is about to imminently revalue the CNY are also running rife. The bigger than expected hike in the reserve ratio in India reflects the fact that Asia is on a faster track to tighten policy than Western economies.

As regular readers probably noticed, my articles on econometer.org have been sporadic recently. This is due to the fact that I have been on the road for the last two weeks giving client seminars across several countries in Asia. Without giving too much away it is evident that pessimism is pervasive and most investors I polled are looking for a “W” or “double dip” profile for economic growth in the G7 economies over coming months. Hardly anyone looked for a “V”.

The other casualty emanating from Greece’s woes, as well as worries that other European PIIGS (Portugal, Italy, Ireland, Greece, Spain) face ratings downgrades, is the EUR. EUR/USD slipped below the psychologically important level of 1.40 this week and is showing no sign of turning around. Warnings by S&P ratings that Portugal faces challenges on the fiscal front show that these sovereign concerns will be with us for a long while yet.

After letting investors believe that the European Commission would offer no support for Greece, there appears to be a growing realization that Greece is not simply a local problem but a Euro wide problem, as noted by European Commission President Barroso. Whilst this may be good for Greek debt the path to recovery is still likely to be a massively painful one, and the EUR may gain little support from this news.

The UK has not escaped the clutches of ratings agencies and warnings by S&P that UK banks are no longer among the “most stable and low-risk” in the world highlights the headwinds faced by GBP at present. The weaker than expected out-turn for Q4 GDP (0.1%) highlights the fact that UK economic recovery is fragile, which in turn plays negatively for the banking sector. This news has put a break on GBP but there appears to be plenty of demand for GBP above 1.600 vs USD.

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

Not quite a Greek tragedy, but close

January 15, 2010 — Mitul Kotecha

Not quite a Greek tragedy but getting there. Greece’s announcement of a three-year plan to reduce its burgeoning fiscal deficit has not convinced markets. Greece’s 5-year CDS widened out to around 333bps whilst 10-year sovereign spreads widened further. There has been some contagion in other European countries notably Spain, Portugal, Ireland, Italy, Poland etc.

The plan which aims to cut the budget deficit from 12.7% to 2.8% of GDP by the end of 2012 appears to be very optimistic if not unrealistic. One of the main problems is not related to the magnitude of deficit reduction but to the starting point of 12.7% of GDP which is more realistically around 14-15% of GDP.

The deficit is planned to be cut by 4% this year alone which seems tough given the likelihood that the economy will contract this year and thereby increase the cyclical portion of the deficit. However, the major concern is the ability of the Greek authorities to cut nominal wages and pensions and in areas where inefficiency and corruption are widespread, such hospital and defense spending.

Greece needs to convince the European Commission and if the negative reaction by markets is anything to go by it may need further revisions including more drastic spending cuts as well as concrete plans for structural reforms. Greece will also find it difficult to ignore the skeptical market reaction given that the country aims to raise around EUR 54 billion to fund its public debt.

Greek concerns and similar countries elsewhere in Europe will likely act as a major weight on the EUR in the days ahead. Interestingly GBP seems to be a beneficiary. The situation does not appear to have a happy ending in sight and more pain looks likely. Rumours/talk of a Eurozone break-up are likely to intensify, however unrealistic such an event may be. ECB President Trichet dampened speculation in his speech following the ECB meeting that Greece could exit the euro but also confirmed that there would be no special treatment for Greece.

Posted in Bond markets, central banks, Currencies, Economics, Europe, Financial crisis, Fiscal/Budget, FX, Greece. Tags: , , , , , , , , , , . 2 Comments »

What to watch this week

January 11, 2010 — Mitul Kotecha

The 85k drop in US non-farm payrolls in December was obviously disappointing given hopes/expectations/rumours of a positive reading over the month.  There was a small silver lining however, as November payrolls were revised to show a positive reading of +4k, the first monthly gain in jobs since December 2007.  Overall, the US labour market is still gradually improving as the trend in jobless claims and other indicators show. 

The fact that the market took the drop in US payrolls in its stride highlights the fact that recovery is becoming more entrenched despite the occasional set back.  More significantly weaker US jobs disappointment has been countered by strong Chinese trade data, which showed both strong imports and exports growth in December.  Whilst the data, especially the strength in exports, will support calls for a stronger CNY, it also highlights China’s growing influence on world trade and the important role that the country is providing for global economic recovery.

Market resilience in the wake of the drop in US payrolls and positive reaction to Chinese trade data will maintain a “risk on” tone to markets this week.  In particular, the USD is set to start the week on the back foot and despite data last week showing that Eurozone unemployment reached an 11-year high of 10% and growing evidence that the Eurozone economy is falling behind the pace of recovery seen elsewhere, EUR/USD held above technical support (200 day moving average) around 1.4257, and is setting its sights on the 16 December 2009 high of 1.4591 helped by renewed Asian sovereign interest.  

The main event in the Eurozone is the ECB meeting on Thursday no surprises are expected, with the Bank set to keep policy unchanged whilst maintaining current liquidity settings.  The bigger concern for European markets is ongoing fiscal woes in the region, with press reports warning of a ratings downgrade for Portugal and still plenty of attention on Greece and its attempts at deficit reduction.  Fiscal concerns are not going to go away quickly and will clearly act as a restraint on market sentiment for European assets. 

In a holiday shortened week in the US as markets close early on Friday ahead of the 3-day MLK holiday, there are a number of data this week that will shed further light on the shape of US recovery. The main event is the December advance retail sales report on Thursday, which is expected to record a reasonable gain, helped by firm autos sales. 

Preceding this, tomorrow there is expected to be a renewed widening in the US trade deficit in November whilst on Wednesday the Fed’s Beige Book as well as various Fed speakers this week including Bullard, Lockhart, Fisher, Plosser, Evans and Lacker, will give important clues ahead of the January 27 Fed FOMC meeting.  Bullard sounded dovish in his comments in Shanghai, as he highlighted that US interest rates will remain low for some time. 

At the end of the week there will be a heavy slate of releases including December CPI, industrial production, capacity utilization, January Empire manufacturing and Michigan confidence. The outlook for these data is generally positive, with gains expected in both manufacturing and consumer confidence, whilst hard data in the form of industrial production is likely to record a healthy increase and CPI is set to reveal another benign reading.

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AUD and NZD outperformance

December 10, 2009 — Mitul Kotecha

Just as the euro looked as though it was showing some signs of rebounding following the battering it received in the wake of the downgrade of Greece’s credit ratings, S&P placed Spain on credit watch negative from neutral, which helped drag EUR/USD all the way down again. Expect more to come as sovereign risk concerns / fiscal deficit remain in focus. EUR/USD was helped by the usual sovereign demand, preventing a test of technical support around 1.4625 but another push lower is likely over the short term.

Despite a tough budget from Ireland yesterday, it alongside the likes of Latvia, Ireland, Hungary and Portugal will remain on the ratings agencies’ hit lists. Eurozone periphery bond spreads have widened sharply against bunds but even larger countries in Europe such as Italy have seen an increase in funding costs. Added to these concerns are the lingering uncertainties about Dubai as reflected in the continued rise in CDS.

In contrast, growth worries are receding quickly in Australia where another robust jobs report was released. Employment rose 31.2k in November, with an upward revision to the previous month, to 27.2k from 24.5k initially. The details looked good too, with much of the jobs increase coming from full time hires (30.8k). The jobless rate fell to 5.7% compared to 5.8% in October. Taken together with the hawkish slant to the RBNZ statement, the data will help keep the AUD and NZD resilient to any sell off in risk trades.

The decision by the RBNZ to leave interest rates unchanged at 2.5% came as no surprise. However, Governor Bollard did shift away from the earlier pledge not to hike interest rates until H2 10 and stated that a hike could come around the middle of 2010. The RBNZ also upgraded its growth forecasts. A rate hike could come even earlier in my view, a factor likely to keep the NZD well supported.

Markets will digest more interest rate decisions today, in the UK and Switzerland. No change is likely from both the BoE and SNB but the issue of QE will remain at the forefront, especially given the split decision by the BoE MPC at the last meeting. As for the SNB the usual concerns about CHF strength are likely to be expressed but the tone of the SNB’s comments are likely to remain dovish, expressing little urgency to begin implementing an exit strategy.

The US data slate is light but does include weekly jobless claims and October trade data. There will be more interest than usual on the claims data given the surprise in last week’s payrolls report. Claims have been on an improving trend declining at a more rapid pace than previous recessions and markets will eye the numbers to determine whether they point to further improvement in payrolls or whether they suggest the November data was merely an aberration.

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Renewed caution

December 8, 2009 — Mitul Kotecha

Risk appetite is struggling to make any headway, with equities losing ground overnight. The positive impact on markets and adjustment to growth expectations following the US jobs report has given way to renewed concerns. Caution increased as Fed Chairman Bernanke introduced a dose of reality to markets talking about “formidable headwinds” to growth. As a result, bonds gained some lost ground and markets pared back expectations of interest rate hikes, leaving the USD vulnerable.

Eurozone risk factors continue to dampen market enthusiasm too, with ECB President Trichet warning of further bank writedowns and S&P downgrading the outlook for Greece and Portugal. The release of German factory orders data revealing a sharp 2.1% fall in October fed into concerns and played against strengthening recovery hopes in the region. EUR/USD failed to close below 1.4820 suggesting some alleviation of downside pressure. FX markets are likely eye stocks for further direction, with various EUR negative specific factors set to limit the upside.

The delayed release of additional stimulus measures in Japan will be the main focus of attention in Japanese markets assuming that an agreement is reached within the coalition. In the meantime markets will digest news that the current account surplus narrowed in October but was still up 51.4% from a year earlier. Additionally loan growth continued to slow, for the 11th straight month in November, adding further evidence that the injections of liquidity into banks are not finding their way into the economy.

GBP has come under growing pressure over recent days and bulls will be disappointed by the BRC retail sales data. The 1.8% YoY rise in like-for-like sales according will come as another disappointment for GBP. The gain was the slowest since August and below forecasts and as noted by the BRC looks even weaker when considering that the year ago figure was very weak. The sales data may fuel concerns about the recovery in consumer spending, especially going into the all important Christmas season. Attention will turn to the release of November Halifax house price data and October industrial production data later today and the pre-budget report tomorrow. GBP/USD looks likely to track EUR/USD for now and looks supported above 1.6390.

Although the USD has slipped as markets pare back expectations of rate hikes, the currency appears to be in a win-win situation and will likely see limited downside as risk aversion creeps back. Lingering concerns about Dubai as well as short covering towards year as well as other factors pushing risk aversion higher will likely see the USD retaining some support into the end of the week ahead of the US retail sales and Michigan confidence data

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