USD, EUR and JPY Outlook This Week

October 24, 2011 — Mitul Kotecha

The USD lost more ground last week extending its drop from the early October. Interestingly its latest drop has occurred despite an uptick in risk aversion suggesting other factors are at work. Mixed US data and earnings have not given the USD much direction with a downbeat Beige Book counterbalanced by a firmer Philly Fed manufacturing survey and housing starts.

The data have not been sufficiently weak to fuel expectations of more Fed quantitative easing but some Fed officials including Yellen, Tarullo, Evans and Rosengren in indicating that further QE could be considered. The USD has therefore been somewhat undermined but will take its cue from data releases and events in Europe this week.

This data slate will be mixed but on balance will not support more Fed QE. In particular, Q3 Real GDP is expected to come in sharply higher than in Q2, with a 2.5% annual rate expected to be revealed. Other indicators will be less positive, with October consumer confidence set to slip further and remain at a recessionary level, while September durable goods orders will decline by around 1%.

Despite an expected increase in new home sales in September the overall picture of the US housing market will remain very weak. Overall, the USD may find some respite from the GDP report but the data will be seen as backward looking, with the jury still out on the issue of more quantitative easing.

The EUR struggled to make any headway last week amid a barrage of rumors about the outcome of Sunday’s EU Summit. In the event the summit failed to deliver concrete details although there appeared to be some progress in key areas. Attention will now turn to Wednesday’s summit but once again the risk of disappointment is high. EUR/USD will only extend gains if markets are satisfied at the result but this is by no means guaranteed.

Data releases will not be supportive for the EUR this week, with a further deterioration in ‘flash’ eurozone purchasing managers indices (PMIs) and European Commission confidence surveys expected in October but hopes of a concrete resolution at Wednesday’s EU Summit will keep the EUR/USD supported early in the week although it will find strong resistance around 1.3915.

The sensitivity of the JPY to risk aversion has actually fallen over the last three months while the influence of bond yield differentials also appears to have slipped. The fact that USD/JPY continues to remain in a very tight range with little inclination to break in either direction despite gyrations in risk and yield differentials almost appears if the currency pair has been pegged.
Obviously this is not the case but a break out of the current range does not look imminent.

Speculative JPY positioning has dropped over recent weeks while equity and bond flows have overall been negative but this has not been reflected in JPY weakness resulting in increased frustration by Japanese officials. We continue to look for the JPY to weaken over coming months but much will depend on a widening in US / Japan yield differentials and easing risk appetite as both will regain their hold on the currency. In the meantime, the currency will continue to offer little to get excited about.

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High Hopes

October 11, 2011 — Mitul Kotecha

EUR/USD has rallied over recent days from a low around 1.3146 last week. Market hopes of a eurozone solution may fall flat but the pressure on officials has ratcheted higher, and the risks of failure are now too significant to jeopardize with half measures. Weekend promises of banking sector recapitalisation by Germany and France have helped but will not be enough should such promises prove empty. Markets will likely give the benefit of the doubt to eurozone officials ahead of the delayed October 23 EU Summit and the November 3 G20 meeting.

Consequently EUR will find some support over coming days and could extend gains as risk appetite improves; having broken above 1.3600 the next big resistance level for EUR/USD is 1.3800. The fact that EUR speculative positioning is very negative (biggest short position since June 2010 according to IMM data) highlights the potential for short covering.

Possible good news in Greece, with an announcement by the Troika (ECB, EU and IMF) on talks over the next tranche of the bailout will likely provide more EUR support. One stumbling block for the EUR could come from the Slovakian vote on EFSF bailout fund enhancement, which is by no means guaranteed to pass.

The JPY remains firm benefitting from higher risk aversion, registering one of the highest correlations with risk over recent months. However, the reason why the JPY is not even stronger is that bond yield differentials (especially 2-year) with the US have widened out in favour of the USD over recent days. If the recent improvement in risk appetite continues, combined with widening yield differentials it could push USD/JPY to finally move higher and sustain a break above 77.00.

GBP/USD has made an impressive bounce over recent days from a low around 1.5272 last week despite the Bank of England’s announcement of more quantitative easing last week and credit ratings downgrades of several UK banks. This resilience is impressive but it appears that GBP is caching onto the coat tails of a firmer EUR rather than benefitting from a domestically led improvement in sentiment. Nonetheless, there is scope for further gains in GBP given that speculative positioning in the currency moved close to its all time low early last week in anticipation of BoE QE.

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Fed does the Twist, markets do the Shake

September 22, 2011 — Mitul Kotecha

Although it was widely expected the Federal Reserve’s decision to implement a fresh version of Operation Twist together with a downbeat assessment of the economy came as a disappointment to equities and risk assets in general. The only surprise was the larger size of the operation at $400 billion.

Moody’s downgrade of three US banks added to the malaise as US equities dropped sharply, commodities slid, longer term Treasuries rallied whilst shorter term bonds dropped. The USD registered broad gains both on the back of the fact that no more quantitative easing was announced and due to a shift away from risk assets. At least there was no more negative news out of the eurozone as talks between the Troika (ECB, IMF, EC) and Greek officials continue on the next tranche of the bailout.

Markets will continue to digest the Fed’s outcome today and the negative tone will likely filter through markets today. There is little on the data front to result in a shift in this tone. In the US data includes weekly jobless claims while in Europe attention will be on manufacturing and service sector confidence measures.

While the potential for a positive outcome to talks in Greece may provide a short term boost to sentiment the overwhelming tone is likely to remain negative especially as Operation Twist is unlikely to change the dynamic of a weak growth trajectory for the US and developed economies over the coming months. Against this background, selling risk assets on rallies remains the preferred option.

The USD will continue to look firmest against high beta emerging market currencies in the current environment. Currencies in this group are those that have the highest correlations with risk (as m measured by my in house risk barometer) over the past 3 months including CAD, ZAR, TRY, INR, MXN, ARS & RUB. In contrast currencies that also have high correlations but actually strengthen as risk aversion increases are CNY and JPY.

Posted in Asia, Asian currencies, central banks, Commodities, Currencies, ECB, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Federal Reserve, Financial crisis, FX, Greece, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Italy downgrade adds to EUR woes

September 20, 2011 — Mitul Kotecha

The USD index remains firm but it remains unlikely that the USD is being bought on its own merits but rather on disappointments in the eurozone. Nonetheless, speculative USD sentiment has turned positive for the first time since June 2010 according to the CFTC IMM data, reflecting a major shift in appetite for the currency. Clearly there are risks to the USD including the potential for more QE3 being announced at this week’s FOMC meeting but this risk is likely to be small.

In contrast, the reversal in speculative sentiment for the EUR has been just as dramatic but in the opposite direction as the net short EUR position has increased over recent weeks, with positioning now at its lowest since June 2010. Sentiment is likely to have soured further overnight following news that Italy’s credit rating was cut by S&P to A from A+ despite the recent passage of an austerity package.

This outweighed any boost to sentiment from what was noted by the Greek Finance Minister as “productive” talks yesterday. Another conference call today is scheduled but the longer markets wait for approval of the next loan tranche the bigger the risk to the EUR. In addition Greek and Spanish T-bill auctions and European Central Bank (ECB) cash operations will be in focus. The EUR remains vulnerable to a test of support around 1.3500.

GBP has continued to slide over recent weeks, having fallen by around 5% since its high just above 1.66 a month ago. However, it has managed to hold its own against the EUR which looks in even more of a sorry state than the pound. The fact that GBP has been unable to capitalise on the EUR’s woes is largely attributable to growing expectations of further UK quantitative easing.

The minutes of the last Bank of England meeting on September 8 to be released on Wednesday will give more clues as to the support within the Monetary Policy Committee for further QE but its likely that the MPC will want to see the next Quarterly Inflation Report in November before committing itself to any further easing. In the meantime, GBP will find it difficult to sustain any recovery, with its drop against the USD likely to extend to around 1.5583 in the short term.

Japan returns from its Respect for the Aged holiday today but local market participants will have missed little action on the JPY, with the currency remaining confined to a very tight range. The inability of USD/JPY to move higher despite the general bounce in the USD index reflects 1) the fact that USD/JPY is very highly correlated with 2 year bond yield differentials and 2) the fact that US yields continue to be compressed relative to Japan. Additionally, risk aversion continues to favour the JPY and combined, these factors suggest little prospect of any drop in the JPY versus USD soon.

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