Euro looking rich at current levels

October 21, 2011 — Mitul Kotecha

Markets continue to be rumour driven with little concrete news to provide direction. The news that a comprehensive deal by European officials at this Sunday’s EU Summit is now very unlikely has come as a further blow to hopes of a swift resolution to the crisis.

So it seems that Sunday’s meeting will provide a forum to thrash out ideas before a second summit next Wednesday. As a reminder the issues at hand are leveraging the EFSF, banking sector recapitalisation and the extent of private sector participation in Greek debt write downs.

The main disagreement appears to be between Germany and France on method of additional funding the EFSF bailout fund (which has EUR 280billion of firepower left), with Germany and the European Central Bank (ECB) opposed to French demands to utilise the ECB to help back the EFSF with France wanting the facility being turned in a bank. In terms of write downs for Greek bond holders there is a push for at least a 50% reduction compared to the 21% agreed in July.

Separately speculation of the amount of new capital needed for banking sector recapitalisation now revolves around a figure of EUR 80 billion. One spanner in the works is that Chancellor Merkel will have to gain approval from the German parliament before agreeing on further changes to the EFSF, which may delay the process further.

Clearly as this week has gone on the air has continued to seep out of the balloon as the market braces for disappointment. Surprisingly the EUR has held up well and while it has failed to extend gains, hitting a high earlier in the week around 1.3915 but still pricing in some scope for success, at current levels.

Helping the EUR was the fact that the market was very short, and while it could still move higher next week if European officials agree on a plan it still looks like a sell on rallies, with the scope for further gains limited from current rich levels. Good news from Europe next week could see a test of EUR/USD 1.40 but this will prove to be a good selling area further out.

At least there was some good news from Greece for a change as the Prime Minister won a vote to pass further austerity measures to help secure the next tranche (delayed from September) of the bailout despite ongoing protests in the country. The near term focus will be on a meeting of Finance Ministers today ahead of Sunday’s summit.

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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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Euro vulnerable to event risk

September 26, 2011 — Mitul Kotecha

The USD is benefitting in the current environment of elevated risk aversion reflected in a jump in USD speculative positioning over recent weeks, with current IMM positioning currently at its highest since June 2010.

Admittedly there is still plenty of scope for risk aversion to intensify but what does this mean for the USD? The USD index is currently trading just over 78 but during the height of the financial crisis it rose to around 89, a further gain from current levels of around of around 14%.

The main obstacle to further USD strength in the event of the current crisis intensifying is if the Fed implements QE3 but as the Fed has indicated this is unlikely to happen anytime soon, as “Operation Twist” gets underway.

Now that the Fed FOMC meeting is out of the way markets will also be less wary of buying USDs as the prospect of more QE has diminished for now. Data this week will likely be USD supportive too, with increases in consumer confidence, durable goods orders, an upward revision to Q2 GDP expected.

The EUR remains highly vulnerable to event risk this week. Various votes in eurozone countries to approve changes to the EFSF bailout fund will garner most attention in FX markets, with the German vote of particular interest although this should pass at the cost of opposition from within Chancellor Merkel’s own party.

The EUR may garner some support if there is some traction on reports of a three pronged approach to help solve the crisis which includes ‘leveraging’ the EFSF fund, large scale European bank recapitalisation and a managed default in Greece, but there has been no confirmation of such measures.

Meanwhile, the potential for negotiations between the Troika (EC, IMF, ECB) and the Greek government to deliver an agreement on the next loan tranche for the country has increased, which could also offer the EUR a boost this week, albeit a short lived one.

Speculation of a potential European Central Bank (ECB) rate cut has increased a factor that could undermine the EUR depending on whether markets see it as growth positive and thus EUR positive or as a factor that reduced the EUR’s yield attraction. There is also more speculation that the ECB will offer more liquidity in the form of a 1-year operation but once again there has been no confirmation.

A likely sharp drop in the German IFO survey today and weakness in business and economic confidence surveys on Thursday will support the case for a rate cut, while helping to maintain the downward pressure on the EUR.

Given the potential for rumours and events to result in sharp shifts in sentiment look for EUR/USD to remain volatile, with support seen around 1.3384 and resistance around 1.3605.

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Another Day, Another Drop In The US Dollar.

April 15, 2011 — Mitul Kotecha

The USD index is now close to breaching its November 2009 low around 74.17, with little sign of any turnaround in prospect. A surprise jump in weekly jobless claims to 412k (380k expected) did little to help the USD’s cause whilst higher commodity prices, and in particular energy prices played negatively.

Indeed, many USD crosses have experienced an increase in sensitivity to oil price movements over recent weeks, with the USD on the losing side when oil prices move higher. Commodity currencies including CAD and NOK are the key beneficiaries but EUR/USD is also highly correlated with the price of oil.

Various Fed comments overnight including supportive comments on the USD’s role as a reserve currency have done little to boost USD sentiment despite the generally hawkish slant to comments. A host of US data releases will keep markets busy.

The data are unlikely to deliver any strong surprises but given the growing FX attention on Fed policy, CPI data may take on more importance than usual. Our expectation of a trend like 0.2% increase in core CPI, which is unlikely to cause any consternation within the Fed, suggests that the USD will garner little support.

The ability of the EUR to withstand a torrent of bad news regarding the eurozone periphery is impressive. In particular, peripheral bond yields continue to rise especially Greek yields as expectations of debt restructuring grow. Comments from Germany’s finance minister have added to such expectations. News that the Bank of Spain approved the recapitalisation of 13 bank and that Spanish banks borrowed only EUR 44 billion last month, the lowest since Jan 2008, may have provided some relief.

However, given that markets are already relative hawkish about eurozone interest rates and given growing peripheral worries as well as overly long EUR market positioning, the upside for EUR/USD is looking increasingly restrained, with a break above technical support around 1.4580 likely to be difficult to achieve over the short-term.

AUD and NZD have registered stellar performances over recent weeks as yield attraction has come back to the fore and risk appetite has strengthened. The gains since their post Japan earthquake lows have been in the region of 7.3% and 10.5%, respectively for AUD and NZD.

The additional element of support, especially for AUD has come from central bank diversification, an increasingly important factor for both currencies. The gains in both currencies have been impressive and neither is showing signs of reversing but there are clear risks on the horizon.

One indication of such risks is the fact that market positioning is stretched especially in terms of AUD positioning, with CFTC IMM contracts registering an all time high. The move in AUD especially has been well in excess of what interest rate / yield differentials imply. Whilst I would not suggest entering into short AUD and NZD positions yet, the risks to the downside are clearly intensifying.

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