News flow to remain volatile

July 25, 2009 — Mitul Kotecha

In past posts I wrote that it will take positive news as opposed to less negative news to drive the rally in equity and credit markets forward.   Although I remain doubtful about the durability of the rally over coming months, there has been good news on the earnings front up until now, and equities have rallied strongly as a result.

Of the S&P 500 companies reporting Q2 earnings 74% have beaten forecasts.  Although there are still many companies scheduled to release earnings, if this pattern continues it would be the highest on record.  Data releases have also given reason for optimism even in Europe where manufacturing gauges and the closely watched German IFO showed some improvement.

Unfortunately, the news was not all unidirectional as Amazon and Microsoft spoiled the party somewhat with their below forecast earnings.  US consumer confidence dropped for the first time in 5 months according to the Michigan survey as rising unemployment in particular weighed on sentiment.  Meanwhile, in the UK GDP data revealed the severe and broad based nature of the recession.

The news flow will continue to remain volatile in the weeks ahead.  The bottoming out process for many economies will be drawn out and rising unemployment and tight credit will act to restrain consumers.  Banks will face spiralling defaults on credit cards and increasing loan delinquencies as some recent earnings have revealed.

Unlike past recessions emerging markets are leading the recovery, especially in Asia as recent data has revealed.  Nonetheless, unless the developed country consumer engine kicks back into life the sustainability of Asian and emerging market recovery remains in doubt.

It is telling that currency markets are not reacting too sharply to the recent positive earnings news.  On balance the usual losers, dollar and yen, in an environment of improved risk appetite, have come under pressure.  In contrast, risk currencies such as the Australian, NZ and Canadian dollars have strengthened. Other high beta currencies are also stronger. Nonetheless, for the most part currencies remain in well worn ranges and as liquidity thins further over summer, there appears to be little scope for new trends in FX markets.

I still favour some dollar resilience over coming weeks as renewed market doubts creep but this view is becoming increasingly difficult to hold.  The reality is that currencies will track equities, which in turn will be dependent on earnings.   If the current earnings trend continues the dollar will face even more pressure but not to the extent that it breaks out of recent ranges.

Posted in China, Currencies, Economics, Economy, US. Tags: , , , , , , , , , , . 1 Comment »

Dollar, Euro and Sterling Volatility Within Ranges

June 25, 2009 — Mitul Kotecha

Two steps forward, one step back appears to describe the movement of the US dollar over recent weeks.  Although the dollar is still off its lows registered at the beginning of June it has failed to make much of a recovery.  After a solid start to the week the dollar came under renewed pressure ahead of the FOMC decision but managed to register small gains following the lack of action from the Fed on Wednesday. Overall, the Fed showed slightly less concern about disinflation and became slightly less negative on the economic outlook but there was not much in the Fed statement to impact the dollar strongly.

Some comments by ECB officials noting that European interest rates are unlikely to be cut further and that further expansion of stimulus measures are not needed, likely explained some of the recent bounce in the euro versus dollar, but the massive ECB allocation of EUR 442 billion in its 1-year tender on Wednesday helped to push the euro lower once again.  The demand for funds from banks was extremely strong and the ECB responded by providing a huge amount of emergency credit.  The allocation drove down overnight and long term rates as well as weakening the euro. 

I still believe any gain in the euro will be limited especially as the Eurozone data flow continues to suggest that any recovery will be tepid.  Eurozone June PMIs this week revealed a small rise in the manufacturing index but a surprise fall in the services index. There was also some improvement in the French INSEE business confidence indicator but at most the data pointed to a slower pace of contraction and continue to lag the improvement in similar surveys in the US and UK.   EUR/USD appears to be trapped in a 1.38-1.43 range with little momentum to break either side of this. 

FX markets are set to remain volatile but within ranges.  The failure of the dollar to extend gains amidst thin data flow highlights the lack of direction in markets.  I am still biased towards some dollar upside over coming days but once again currencies will take their cue from equity markets.  The dollar may find some support if US equities continue to struggle; the S&P 500 is finding it difficult to sustain gains above its 200 day (897.2) and 50 day (900.54) moving averages, suggesting some scope for a downside move in US stocks an in turn a firmer dollar if the S&P 500 fails to hold above this level.   

GBP/USD looks resilient despite coming under pressure following comments by BoE Chief economist Spencer Dale that a weak currency was a “key channel” to spur growth.  Although GBP has recovered sharply from its low of 1.3549 touched on 26 January it is still looks undervalued and such comments do not necessarily justify a further drop in GBP.   Although GBP/USD is set to appreciate further over the coming months it could struggle to sustain a break above its 3 June high of 1.6663 over the near term.  The downgrade to UK growth forecasts by the OECD this week and comments by BoE governor King that UK recovery will be a “long, hard, slog” highlight the difficulties ahead.

Posted in central banks, Currencies, Economics, Economy, equity markets, Financial crisis, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

A set back for the pound

June 18, 2009 — Mitul Kotecha

The multi week rally in the pound (GBP) has hit a snag as the currency has failed to extend gains above its recent highs around 1.66 against the dollar (USD).  The surprising fall in UK retail sales, with sales dropping by 0.6% from April compared to expectations of a 0.3% increase, dealt GBP another blow.   Sales were down 1.6% from a year earlier.  This is bad news for those that had believed that the UK consumer was enduring the economic downturn with some resilience. 

The reality is that the recovery in the economy will be a bumpy ride.  Whilst there have been some signs of improvement in the economy it is by no means a broad based pattern.  I would warn at getting too carried away with recovery expectations.  There have been clear signs of strengthening in both manufacturing and service sector survey data but they still only point to a gradual recovery in the months ahead. 

Moreover, some UK housing market indicators have pointed to early signs of recovery but a lot of this is due to a lack of supply and at best the housing market is entering a period of stabilisation.   Despite the signs of economic stabilisation the British Chamber of Commerce (BCC) cut its forecasts for the UK economy to -3.8% this year compared to a previous forecast of -2.8%.  

Meanwhile, UK banks continue to restrain credit and may even need more equity capital on top of the $158 billion in capital already raised according to Bank of England governor Mervyn King in his Mansion House speech.  He also warned about a “protracted” economic recovery. The good news is that the BoE is in no rush to take back its aggressive monetary easing and £125 billion asset purchase plan, but unless banks pass the benefits of this onto borrowers the fledgling recovery could stall quite quickly.   

The desire not to act quickly to reverse monetary policy was echoed in the minutes of the June BoE meeting, which revealed a unanimous 9-0 vote to maintain the status quo on policy.  The minutes also noted that the near term risks to the economy had lessened but monetary policy committee members remained cautious about the medium term prospects.  It is likely that the BoE will take several more months to gauge how successful policy has been. 

All of this highlights that GBP will be vulnerable to periodic bouts of profit taking and reversal.  Its ascent from its lows against the USD below 1.40 has been dramatic and rapid.  I believe that much of its gain has been justified especially as it had fallen to extreme levels of undervaluation.  Moreover, aggressive policy actions, both on fiscal and monetary policy, suggest that UK economic recovery will come quicker than Europe. This implies that GBP will at the least continue to recover against the euro (EUR) despite the weak retail sales induced set back.   

I also look for GBP to extend gains against the USD over coming months, with GBP/USD likely to end the year in the 1.70-1.80 region rather than low 1.60s where it is now. Market positioning leaves plenty of scope for GBP short covering over coming weeks adding further potential for recovery.  GBP appreciation will not continue in a straight line however, but set backs going forward should be looked upon as providing opportunities to rebuild long positions.

Posted in bank rescue, central banks, Currencies, Economics, Economy, Europe, Financial crisis, Monetary Policy, UK. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Are currency market dynamics shifting?

June 8, 2009 — Mitul Kotecha

There has been a major shift in market pricing for US interest rates following the US jobs report and comments from Fed officials including Atlanta Fed president Lockhart, suggesting that the Fed should not wait too long before tightening monetary policy.  As a result the implied yield on the December 09 3-month eurodollar futures contract has spiked by around 50bps since the middle of last week and markets have now moved to pricing in a US rate hike by year.  This looks wildly premature given the likely absence of inflation pressures for many months to come. 

The most interesting reaction to the shift in interest rate expectations was exhibited by the dollar which has managed to register solid gains over the last couple of days indicative of the past relationship between the dollar and interest rate expectations.  The odd thing about the strengthening in the dollar is that it has come at a time when risk appetite has continued to improve, suggesting that the strong risk appetite/dollar relationship that has been in place for much of the past year could be diminishing in strength.  For instance, the correlation between various dollar crosses and the VIX volatility index has been higher over the last few months than it has been in previous years.   

Admittedly its early days and the bounce in the dollar may just have reflected a market that was positioned very short dollars.  There was already signs of some short covering prior to the release of the US May jobs report as reflected in the CFTC IMM commitment of traders’ report which showed that net aggregate dollar speculative positioning (vs. EUR, JPY, GBP, AUD, NZD, CAD and CHF) improved for the first time in five weeks.  It is not inconceivable that investors have continued to cover short positions over the last few days.  

Nonetheless, it is difficult to ignore the possibility that currency market dynamics may be shifting back towards interest rate differentials as a key FX driver.  Over recent months the interest rate / FX relationship had all but broken down as reflected in very low and insignificant correlations between interest rate differentials and various currency pairs.  This could be changing and as interest rate markets begin to price in higher rates the relationship with currency markets may once again be strengthening.  

The risk for the dollar is that this tightening in US interest rate expectations looks premature.   It seems highly unlikely that the Fed will raise rates this year which points to the risk of a turnaround in rate expectations at some point over coming weeks and months.  In turn this suggests that the dollar could come under renewed pressure in the event of a dovish shift in US interest rate markets.  Even so, this is a factor to consider further out.  Over the next few days such a shift is unlikely and the dollar is likely to hold onto and even extend its gains as markets continue to ponder the probability that the Fed tightens policy sooner rather than later.

Posted in central banks, Currencies, Economics, Economy, Financial crisis, Interest rates, US. Tags: , , , , , , , , , , , , , , , . Leave a Comment »

US dollar beaten by the bears

May 22, 2009 — Mitul Kotecha

Since I wrote my last post on the US dollar a week ago, US dollar under pressure, the slide in the dollar has accelerated against most currencies. Rather than being driven by an improvement in risk appetite however, it appears that the dollar is being hit by a major shift in sentiment. Indeed currency market dynamics appear be changing rapidly.

In particular, there has been a major breakdown in the relationship between the dollar and equity markets, suggesting that the influence of risk on FX markets is waning. For example, rather than rallying on the back of weaker equity markets over recent days, dollar weakness has actually intensified.

More likely this is becoming a pure and clear slide in sentiment for the dollar. There was some indication of this from the latest CFTC IMM Commitment of traders’ report which is a good gauge to speculative market positioning, showing that net dollar positioning has become negative for the first time in several months.

More evidence of this is the fact that the dollar / yen exchange rate has fallen even as risk appetite has improved. This is at odds with the usual relationship between the Japanese yen and risk appetite. The yen benefited the most from higher risk aversion since the crisis began, strengthening sharply against many currencies. As risk appetite improves and equity markets rally the yen would be expected to weaken the most as risk appetite improves.

I had looked for dollar weakness to accelerate into the second half of 2009 but against some currencies the drop in the dollar has come earlier than anticipated. I also thought that the dollar may stand a chance at a bit of a recovery in the near term if equity markets slipped and risk aversion increased. I was wrong about this. Despite the drop in equities over recent days the USD has also lost ground. Nor has the USD benefited from higher bond yields in the US.

The evidence is clear; USD bearishness is becoming more entrenched and the likelihood of a risk related rebound is becoming more remote even as risk aversion picks up once again. There appears to be a general shift away from US assets in general particularly Treasuries and most likely by foreign official investors who appear to be accelerating their diversification away from the dollar over recent weeks.

The importance of foreign buying of US Treasuries should not be underestimated in terms of its influence on the USD. Foreign purchases of US Treasuries made up 77% of total foreign buying of US securities in 2008. If there is a growing chance of a downgrade to the US’s AAA credit rating in the wake of a budget deficit that will be around $1.85 trillion this year and a rising debt/GDP ratio, the drop in the dollar seen so far may prove to be small compared to downside risks in the months ahead.

Posted in Bond markets, central banks, Currencies, Economics, Economy, equity markets, Financial crisis, US. Tags: , , , , , , , , , , , , , , , , , , . 1 Comment »
« Older posts
Newer posts »