Host Of Central Banks In Focus

Well, last week, tech stocks had their worst week since March, with stability far from returning.  While the jury is still out, most still view the pull back in tech stocks as a healthy correction following a prolonged period of gains, blaming increased options activity over recent months for the magnitude of the decline. The buy on dip mentality is likely to continue to prevail, though tech stocks have not yet show any sign of wanting to make a convincing pull back.   

Signs of nervousness are clear; equity volatility remains elevated, but many investors are still sitting on healthy gains over recent months.  Given the low cost of funding, low returns in government bonds, alongside continued strong demand for stay at home electronics and a vaccine that could still take months to arrive, it is hard to see the tech sector falling too far.   

The fall in the pound sterling has been quite dramatic over recent weeks, both against the US dollar and euro.  Fears over a collapse in trade talks with the European Union have intensified.  The sudden waking up of the market to these risks has been provoked by the prospects that the withdrawal agreement with the EU will be torn up, prompting threats of legal action by the EU.

Time is running out to get a deal on the table before the end of the Brexit transition period at the end of the year, but UK Prime Minister Johnson has said that the internal market bill is necessary to prevent “a foreign of international body from having the power to break up our country.” The new legislation is already facing a rebellion in parliament. Against this background its hard to see GBP rally, with the currency likely to be particularly volatile over the coming weeks.

Attention this week will turn to several central bank decisions, with monetary policy makers in Poland (Tue), US (Wed), Brazil (Wed), Japan (Thu), Indonesia (Thu), Taiwan (Thu), South Africa, (Thu), UK (Thu) and Russia (Fri) all scheduled to announce their decisions.  After months of policy easing globally, this week will look rather boring, with none of the above likely to ease further.   

The Fed FOMC meeting will likely capture most attention, but there is potential for disappointment if the Fed does not provide further details on its shift to average inflation targeting in its forward guidance, even as the accompanying statement and Chair Powell’s press conference are likely to sound dovish. The US dollar has continued to stabilize, aided by the drop in GBP, but a dovish Fed could limit further upside in the short term. 

Aside from central bank decisions attention will be on US election polls, which take on more importance as the election creeps closer.  US fiscal stimulus talks have hit a wall, with little chance of progress this week, while US pressure on China and Chinese companies is likely to continue to be unrelenting as elections approach.  On the political front the race to take over Japan’s prime minister following the resignation of Shinzo Abe will conclude this week (Wed).   

EUR/GBP upside overdone, CHF overly strong

Disappointing Eurozone service sector and manufacturing purchasing managers’ confidence indices as well as a contraction in Chinese manufacturing confidence sets the scene for a drop in risk assets. In addition in the US, existing home sales rose less than expected taking into account revisions to previous data.

Meanwhile scepticism over Greece’s ability to implement agreed upon reforms and reported resistance from Germany to increasing the firewall around peripheral Eurozone countries has delivered a further dose of negativity to markets. The market was probably looking for an excuse to sell after a strong rally and found plenty in yesterday’s news.

GBP has followed on the coat tails of the EUR over recent weeks, with the currency showing little independent direction. Reflecting this is the fact that EUR/GBP had until recently been trapped in a 0.83-0.84 range. As with the EUR I see downside risks to GBP over the short term against the USD.

Against the EUR, GBP will largely track the movement in yield differentials as it has done over recent months. Relatively dovish MPC minutes, with two members voting for bigger amounts of quantitative easing helped to put GBP under further pressure but the move higher in EUR/GBP look overdone.

My medium term view continues to show GBP appreciation versus EUR and current levels highlight a good opportunity to go short EUR/GBP. Markets are rewarding central banks that are proactive in their policy prescriptions. I exect this to result in some GBP resilience even if the BoE announces more QE.

EUR/CHF has continued to hug the 1.2000 line in the sand enforced by the Swiss National Bank. Ongoing Eurozone doubts even after the agreement of a second bailout for Greece mean that the CHF remains a favoured destination for European money. This is reflected by the fact that EUR/CHF has been highly correlated with Risk Aversion over the past 3-months.

It will take also take a relative rise in German yields versus Swiss yields for EUR/CHF to move higher. This is certainly viable given the deterioration in Swiss economic data over recent months. Indeed, as reflected in the KoF Swiss leading indicator and manufacturing PMI data, the economy is heading downwards. Assuming that there will be an eventual improvement in risk appetite, CHF will weaken given the strong correlation between EUR/CHF and risk aversion over the past 3-months.

Q1 Economic Review: Elections, Recovery and Underemployment

I was recently interview by Sital Ruparelia for his website dedicated to “Career & Talent Management Solutions“, on my views on Q1 Economic Review: Elections, Recovery and Underemployment.

Sital is a regular guest on BBC Radio offering career advice and job search tips to listeners. Being a regular contributor and specialist for several leading on line resources including eFinancial Careers and Career Hub (voted number 1 blog by ‘HR World’), Sital’s career advice has also been featured in BusinessWeek online.

As you’ll see from the transcript of the interview below, I’m still cautiously optimistic about the prospects for 2010 and predicts a slow drawn out recovery with plenty of hiccups along the way.

Sital: Mitul, when we spoke in December to look at your predictions for 2010, you were cautiously optimistic about economic recovery in 2010. What’s your take on things after the first quarter?

Click here to read the rest…

High yield / commodity currencies take the lead

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.

EUR/USD takes a crack at 1.50, where now?

It seemed inevitable and finally after flirting with the 1.50 level, EUR/USD managed to break through although there seems to be little momentum in the move, with the currency pair dipping back below 1.50 in the Asian trading session. Contrary to expectations the break above 1.50 did not lead to a sharp stop loss driven move higher. 

Even the break through 1.50 only provoked a limited reaction in the FX options market where implied EUR/USD volatility only moved slightly higher. In fact despite the warnings by ECB President Trichet about “excessive currency volatility” FX options volatility for most currency pairs has been on a downward trajectory over the past few months, implying that the move in EUR/USD and the USD itself has been quite orderly. 

Trichet’s warning is more likely a veiled threat on the level of EUR/USD rather than its volatility, unless of course the ECB chief is seeing something that the FX options market is not. Assuming that EUR/USD closes above 1.50 this week it technically has plenty of open ground on the run up to the record high of 1.6038 hit in July 2008 but there will also be plenty of official resistance to limit its appreciation. Such resistance is limited to rhetoric but it will not be long before markets begin discussing the prospects of actual FX intervention.  

Perhaps the reason that EUR/USD did not move sharply higher following the break of 1.50 was the late sell off in US stocks on Wednesday which helped to fuel some USD short covering.  The USD index is holding just above the 75.00 level but it’s not a big stretch from here to move down to the March 2008 low around 70.698, with the overall tone of broad USD weakness remaining intact and ongoing. 

GBP was helped by relief that the minutes of the BoE meeting showed no inclination to increase the level of quantitative easing despite the ongoing debate within the MPC.   The minutes even sounded slightly upbeat about economic prospects. GBP/USD hit a high of 1.6638 in the wake of these developments due in large part to more short covering whilst EUR/GBP briefly dipped below 0.90.  GBP/USD may find it tough going to make much headway above 1.66 as has been the case over recent months, with strong resistance seen around 1.6661.

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