USD/JPY bracing for a rebound

February 10, 2014 — Mitul Kotecha

In the post below I look at the arguments for JPY weakness in the weeks and months ahead.

A combination of elevated risk aversion and a narrowing US / Japan yield differential have been the major contributors to the strengthening in the JPY over January resulting in safe haven JPY demand and repatriation flows. The sensitivity of the JPY to both factors has been especially strong and it will require a reversal of one if not both of these to spur another wave of JPY selling.

Improving risk appetite required
If there is not a metamorphosis of the current bout of pressure into a full blown crisis as seems likely, risk appetite will improve and the upward pressure on the JPY will abate. Any improvement in risk appetite will however, be gradual and prone to volatility, especially in an environment of Fed tapering. It may therefore require more than simply improving risk appetite to weaken the JPY anew.

Japanese equity performance will be eyed
Of course associated with any improvement in risk appetite has to be a reversal of the recent negative performance of Japanese equities. Although Japanese equities will continue to be hostage to the fortunes of global risk sentiment, assuming that “Abenomics” continues to deliver results and growth in Japan continues to pick up (our forecast this year is 2% YoY GDP growth) further fallout in the Japanese equity market may be limited.

Flows will need to reverse
Over the past several weeks Japan has registered net inflows of capital in large part due to repatriation by Japanese investors. JPY has faced upward pressure from such inflows over recent weeks. Looking ahead assuming that risk appetite improves and US yields increase net capital outflows are expected to resume, which will put further downward pressure on the JPY.

Yield differentials will be particularly important
The extra dose of JPY pressure and important determinant of renewed weakness will be a re-widening of the US / Japan real yield differential. Eventually US bond yields will resume their ascent, driving the yield differential with Japan wider, and putting upward pressure on USD/JPY. The same argument will apply for EUR/JPY, albeit to a lesser degree.

Speculation positioning more balanced
The recent short covering rally has likely resulted in a market more evenly balanced in terms of positioning, providing a solid footing for the next leg lower in JPY. Indeed, compared to the three month average, JPY positioning has bounced back and is susceptible to a rebuilding of JPY shorts over coming weeks, driving the JPY lower.

Model points to renewed JPY weakness
Combining the factors above (except positioning) and adding in forecasts for US bond yields, risk aversion and conservative estimates for a recovery in Japanese equity markets over coming months, my quantitative model for USD/JPY highlights the prospects of a major rebound in the currency pair.

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A further blow to risk appetite

February 4, 2014 — Mitul Kotecha

Amid a market that is already very nervous the much weaker than expected US ISM manufacturing confidence index (51.3 versus 56.0 consensus) taken together with the weaker Chinese non manufacturing purchasing managers index (53.4 versus 54.6 prior) dealt another blow to risk appetite.

Consequently the VIX fear gauge has spiked to its highest level since the end of 2012 and our risk barometer has moved swiftly into risk hating territory. US Treasury yields have continued to drop, with the 10 year yield having slid by around 45 basis points so far this year.

Suffice to say investors should steer clear of risk assets over the short term as the turmoil does not look like it will be over anytime soon. A combination of tapering, a confluence of country specific emerging market country concerns and weaker growth in China provide the backdrop for a volatile few weeks if not longer, ahead.

The main event today is the Reserve Bank of Australia meeting where we look for no change in policy. However, the key events of the week are yet to come, with the European Central Bank and Bank of England policy decisions and US January jobs report all on tap over coming days. In brief, no change in policy is expected from either central bank and payrolls are expected to come in around 200k.

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Risk appetite still supported

November 5, 2013 — Mitul Kotecha

Relatively subdued trading yesterday ended with stocks higher and US bond yields lower. Our risk barometer is currently around its lowest since February 2011, signifying still strong appetite for risky assets, as also reflected by the drop in the VIX “fear gauge”. After a sharp 30+% drop since early October the Baltic Dry Index has also turned higher while gold prices are holding in a relatively tight range around its 100 day moving average at USD 1320.

There are a few releases and events to give direction to markets, with the RBA policy meeting, European Commission autumn economic forecasts, and service sector confidence surveys from the UK and US, all on tap today. Overall, there will be little to dent the positive risk bias but caution will intensify ahead of the ECB Council meeting and US employment report towards the end of the week.

Following last week’s USD rally the currency is likely to consolidate its gains over the short term ahead of Friday’s US October employment report. A dip in US yields helped by a softer US factory orders report took some of the steam out of the USD as caution crept in. A series of Fed speakers overnight did little to clarify the picture regarding the timing of tapering and thus provided little direction for the USD.

Nonetheless, despite some near term consolidation the USD looks set to gain further over the coming weeks helped by the fact that the market had already squared a lot of long positions over past weeks. A renewed increase in US yields accompanied by better economic data will help the USD’s cause but much will depend on when there is greater clarity regarding the timing of tapering. Expectations of a March 2014 may yet prove off the mark, leaving the USD plenty of scope for further recovery.

AUD benefitted from the robust September retail sales report yesterday but faces another hurdle today in the form of the RBA policy meeting. Although AUD remain a loser year to date, the currency has registered impressive gains from the beginning of September, much to the chagrin of the RBA.

Although a policy rate cut is highly unlikely today (I believe the RBA is at the bottom of its easing cycle), Governor Stevens is set to warn that the strength of the currency could warrant further policy easing in the months ahead. However, such warnings may sound hollow given worries about house price inflation and recently firmer data. Given some likely restraint in the USD ahead of the US employment report, AUD/USD will find some any losses limited to support around 0.9430.

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Risk assets rallying on trust and hope

May 16, 2013 — Mitul Kotecha

The rally in risk assets continues unabated, with equity markets continuing to post record highs. The fact that this is occurring in spite of weaker data from both the US and in particular Europe, highlights the trust and hope that is being placed on central banks to continue to deliver monetary stimulus in the months ahead. While many will question the dichotomy between equity markets, bond yields and economic data, there is little sign of this changing any time soon.

Spurred by a rise in US Treasury bond yields which in turn has been fuelled by better than expected US economic data the USD index has been driven higher. Disappointing data overnight in the form of the May Empire manufacturing survey, US Treasury TIC capital flows, and April industrial production led to a pull back in US bond yields.

Going forward much in terms of USD direction will depend on upcoming data and Federal Reserve speeches, with a relatively full calendar today including April CPI, housing starts and the May Philly Fed manufacturing confidence survey. Additionally there are no less than five Fed speakers on tap today, with any clues on a tapering off of asset purchases sought. The USD index is set to test its 2012 high of 84.10 but is likely to consolidate in the near term given the pull back in yields.

EUR continues to remain under pressure as it edges towards its 2013 lows around 1.2745, with a test of this level expected soon. Weaker than expected Q1 GDP readings from France, Germany, Italy and the over Eurozone dampened any ability of the currency to reverse losses.

The Eurozone has registered six straight quarters of contraction and any recovery is likely to be limited in the months ahead. Pressure on the European Central Bank to provide more monetary policy accommodation will only be reinforced by today’s release of the April CPI data (likely to be confirmed at 1.2%) leaving the EUR under further pressure. Near term technical support for EUR/USD is seen around 1.2772.

The JPY is facing a perfect storm of negative factors including a widening in US Treasury / Japanese JGB yield differentials, improving risk appetite and portfolio capital outflows from Japan. I expect capital outflows from Japan to intensify. Japanese life insurers have accounted for more than 20% of the net foreign securities purchases since 2011, and recent indications show that they are planning to increase their foreign bond buying.

Additionally the Japanese Government Pension Investment Fund has already begun to increase its proportion of foreign asset holdings. Portfolio data released this morning revealed that Japanese investors continued to channel money overseas. Near term resistance for USD/JPY is seen around 103.50.

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US dollar surges through key levels

May 13, 2013 — Mitul Kotecha

Demand for risky assets continues to strengthen as reflected in various indicators including my Risk Aversion Barometer which has moved deeper into risk loving territory while equities remain on an upward trajectory. Central banks are providing the main source of support for investor risk appetite, with a combination of lower policy rates and quantitative easing providing a major fillip.

Additionally various central banks appear to be talking down their currencies and/or intervening (note RBNZ and Riksbank) adding to the downward pressure versus USD. In Japan’s case the G7 appeared to give its blessing to Japanese policy over the weekend, aiding in the decline in the JPY.

Usually the USD would not benefit in times of improving risk appetite but it is finding plenty of support from the fact that Fed policy is set to diverge with other central banks, with the currency breaking key levels against major currencies including EUR (below 1.30), JPY (above 100) and AUD (below 1.00). The surge in US Treasury yields is underpinning the USD helped by firmer US economic data in particular on the jobs front.

According to a Wall Street Journal article over the weekend the Fed is already formulating an exit strategy from QE although the timing is still being debated, another factor supporting the USD at the beginning of this week. Various Fed speeches over coming days will likely provide more clues on any timing or plans for an exit policy. Meanwhile, higher US yields and a firmer USD continue to pile on the pressure on gold prices.

There may be a little caution in pushing the USD higher this week as US data releases are likely to look softer, with retail sales, industrial production and housing starts set to record declines. Nonetheless, any pull back in the USD or yields may simply provide better levels for investors to go long the USD and short Treasuries especially as data elsewhere will not look much better. Indeed, while in Europe there will be a likely bounce in the German ZEW investor confidence index in May, Q1 Eurozone GDP will record a contraction for the sixth consecutive quarter.

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