The Pain Of A Stronger Swiss Franc

June 9, 2010 — Mitul Kotecha

Volatility and increasingly large market swings are characterizing current market conditions. A warning by Fitch on the UK’s “formidable” fiscal challenge, concerns about Bulgaria’s public finance statistics and a massive public sector strike in Spain, combined to fuel another bout of risk aversion.

Hungary’s government attempted to diffuse worries about its finances, with the country’s Prime Minister listing measures including cutting public pay and prohibiting mortgages denominated in foreign currencies, in order to hit the 3.8% of GDP budget deficit target. There was also some good news in the US, with small business confidence (NFIB) rising to its highest level since September 2008 whilst ABC consumer confidence edged higher.

The US Beige Book and Fed Chairman Bernanke’s testimony on the US economy to Congress, mark the highlights today. The Beige Book is set to reveal further signs of economic recovery but with limited inflation pressures. Bernanke is likely to maintain a similar tone to comments he made yesterday, highlighting a “moderate” economic recovery, with unemployment likely to stay “high for a while”. His testimony will be scrutinized for the timing of rate hikes, and any elaboration on his comments about rates rising before the economy is at full employment.

Against the background of the many and varied uncertainties still afflicting markets maintain a sell on rallies view on risk trades is still the best option. EUR/USD will struggle to breach resistance around 1.2010 and remains susceptible to test support around 1.1826. GBP/USD could target fresh lows in a “negative reversal”, with potential to head back down to 1.3996.

Confidence has plummeted to extreme lows and it will be several months before appetite for risk trades returns. The AUD and NZD as well as many Asian currencies will struggle over the interim period before their appreciation trend finally resumes.

In contrast to the weakening of risk currencies, CHF strength is showing little sign of letting up. Switzerland recorded a massive 50% jump in FX reserves in May to CHF 232 billion from CHF 153 billion in April. This is not usually market moving data but the scale of the jump in reserves is huge and it is not just due to valuation changes. The Swiss National Bank (SNB’s) effective abandonment of defending a particular level in EUR/CHF turned into more a smoothing operation but this did not stop the bank from massive FX interventions. Despite the interventions EUR/CHF dropped by 0.8% over the month.

Aside from alleviating upward pressure on the CHF the interventions had an indirect effect of reducing the pain of holders of CHF mortgages. E.g. around 30% of Hungary’s bank loans and 60% of mortgages are denominated in CHF but countries across Europe have plenty of CHF denominated loans, especially Austria. Although Hungary announced steps to meet its deficit targets its woes are far from over.

The CHF has appreciated by around 3% since the beginning of May versus HUF, exacerbating the pain for CHF borrowers in the country. The fact that CHF strength shows no sign of letting up on the back of strong data and safe haven flows, the pain for these borrowers will only add to the problems for banks and borrowers alike in Europe.

Posted in Australia, bank rescue, central banks, Currencies, Economics, Economy, equity markets, Europe, eurozone, Fiscal/Budget, FX, Hungary, Monetary Policy, UK. Tags: , , , , , , , , , , , , , , , , , , . 2 Comments »

Shock and Awe

May 10, 2010 — Mitul Kotecha

The Greek crisis spread further last week, not only to Portugal and Spain, but in addition to battering global equity markets, contagion spread to bank credit spreads, OIS-libor and emerging market debt. In response, European Union finance ministers have rushed to “shock and awe” the markets by formulating a “crisis mechanism” package with the International Monetary Fund (IMF). The package includes loan guarantees and credits worth as much as EUR 750 billion. The support package can be added to the EUR 110 billion loan package announced last week.

In addition, the US Federal Reserve (Fed) announced the authorisation of temporary currency swaps through January 2011 between the Fed, European Central Bank (ECB), Bank of Canada (BoC), Bank of England (BoE) and Swiss National Bank (SNB) in order to combat in the “the re-emergence of strains” in European markets. Separately, the ECB will conduct sterilised interventions in public and private debt markets, a measure that was hoped would be announced at the ECB meeting last week, but better late than never. The ECB did not however, announce direct measures to support the EUR.

The significance of these measures should not be underestimated and they will go a long way to reducing money market tensions and helping the EUR over the short-term. Indeed, recent history shows us that the swap mechanisms work well. The size of the package also reduced default and restructuring risks for European sovereigns. However, the risk is that it amounts to a “get out of jail free card” for European governments. A pertinent question is whether the “crisis mechanism” will keep the pressure on governments to undertake deficit cutting measures.

The Greek crisis has gone to the heart of the euro project and on its own the package will be insufficient to turn confidence around over the medium term. In order to have a lasting impact on confidence there needs to be proof of budget consolidation and increasing structural reforms. Positive signs that the former is being carried out will help but as seen by rising public opposition in Greece, it will not be without difficulties whilst structural reforms will take much longer to implement. Confidence in the eurozone project has been shattered over recent months and picking up the pieces will not be an easy process.

Some calm to markets early in the week will likely see the USD lose ground. There was a huge build up of net USD long positioning over the last week as reflected in the CFTC IMM data, suggesting plenty of scope for profit taking and/or offloading of USD long positions. In contrast, EUR positioning fell substantially to yet another record low. Some short EUR covering is likely in the wake of the new EU package, but EUR/USD 1.2996 will offer tough technical resistance followed by 1.3114.

The EU/IMF aid package will help to provide a strong backstop for EUR/USD but unless the underlying issues that led to the crisis are resolved, EUR/USD is destined to drop further. Perhaps there will be some disappointment for the EUR due to the fact that the package of support measures involves no FX intervention. This could even limit EUR upside given that there was speculation that “defending the EUR” meant physically defending the currency. In the event the move in implied FX volatility over the last week did not warrant this.

Posted in central banks, Currencies, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Germany, Greece, IMF, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

Greek Saga Rumbles On – Does Anybody Care?

March 24, 2010 — Mitul Kotecha

The debate over Greece continues to rumble on. France and Spain requested a separate summit meeting of the 16 heads of eurozone countries immediately before the full 27-member EU summit starting tomorrow but this was met with resistance. Meanwhile, Germany has called for “a substantial contribution” from the IMF towards a Greek aid package, whilst maintaining that no EU deal will be reached for Greece at the summit.

Frankly, the whole Greek saga has become extremely boring, with the lack of agreement about how to fix it doing little to inspire confidence. In particular the fractured opinion amongst EU leaders highlights the difficulties in reaching an agreement in a union made up of so many conflicting interests. At most the summit may agree on the conditions for a rescue package for Greece rather than a package itself. This will leave markets unimpressed,

US new home sales data today is likely to paint a slightly better picture with a small gain expected, albeit following the 11.2% plunge in the previous month. Sales will be helped by the extension of the home buyer tax credit. The US February durable goods orders report is also released today, with a small increase expected. A smaller gain in transport orders suggests that the 2.6% jump last month will not be repeated.

In Europe, the key release is the March German IFO business climate survey and a rebound is likely following February’s decline, helped by warmer weather and a weaker EUR. Flash readings of Eurozone March purchasing managers indices (PMIs) are also released but these are unlikely to extend gains from the previous month. Despite expectations of firmer data the EUR/USD is vulnerable to a further decline, with support around 1.3432 in sight for an imminent test.

Attention in the UK will turn to the pre-election Budget and particularly the government’s plans to cut spending and reduce the fiscal deficit. Failure to provide a credible blue print to restore fiscal credibility will damage confidence, heightening the risks of an eventual sovereign ratings downgrade and more pressure on GBP which appears destined for another drop below 1.50 versus USD.

Most currencies have remained within ranges and the most interesting currency pair is EUR/CHF having failed to react to verbal warnings from the Swiss National Bank (SNB) about excessive CHF strength. EUR/CHF looks vulnerable to a further decline unless the SNB follows up rhetoric with action. Even if there is FX intervention by the SNB it may prove to be a temporary barrier to a market with an eye on the psychologically important 1.4000 level.

Despite the pressure on the Japanese government and Bank of Japan (BoJ) to engineer a weaker JPY, export performance has proven resilient, with exports jumping 45.3% on the year in February, helped by the strength of demand from Asia. Unfortunately this is doing little to end Japan’s deflation problem and even if there is less urgency for a weaker JPY to boost exports, JPY weakness will certainly help to reduce deflationary pressures in the economy. USD/JPY is stubbornly clinging to the 90.00 level, with little inclination to move in either direction.

Posted in Bond markets, central banks, Currencies, Economics, Economy, equity markets, Europe, Financial crisis, Fiscal/Budget, FX, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

What To Watch This Week

March 13, 2010 — Mitul Kotecha

A “crisis over” mode is being adopted across markets as worries about Greece wane and economic data provides support to recovery hopes, whilst importantly allaying fears of a “double-dip”. Equities, bonds and currencies are reacting accordingly; equities are close to year highs, bond yields have risen and spreads have narrowed, whilst the USD and JPY are weaker, and conversely risk currencies are stronger. Even EUR/USD pushed higher on its way to 1.3800 as a number of stops were cleared and shorts were squeezed.

The coming weeks will be important to determine whether there is any staying power in the upward move in risk assets. A lot of the February data in the US will likely be obscured by bad weather however, including industrial production figures this week, leaving markets with little to go on. In Europe, the key release is the March German ZEW investor confidence survey, and better news in Greece, will likely prevent a sharper decline in confidence.

After both the Swish National Bank (SNB) and Reserve Bank of New Zealand (RBNZ) unsurprisingly left policy unchanged last week this week sees the turn of the US Federal Reserve and Bank of Japan (BoJ). Neither central bank is likely to shift policy but the Fed statement will be looked upon for guidance on the timing of rate hikes. The comment in the FOMC statement that the Fed Funds rate is expected to remain low for an “extended period” is set to be retained, even if some FOMC members are itching to remove it soon.

The BoJ meeting will be particularly interesting. I have just returned from a week long trip in Japan and on the ground there is plenty of speculation that the BoJ will take extra action to combat deflation and weaken the JPY. Additionally comments by Japan’s Prime Minister and Deputy PM have highlighted the potential for action to weaken the JPY although the usual market hesitation to sell JPY into fiscal year end and repatriation talk may mean a weaker JPY path is not straightforward.

Greece will not move too far from the spotlight, with EU officials likely to give the official stamp of approval on Greece’s deficit cutting measures and plenty of discussion at the Eurogroup Finance Minister’s meeting and Ecofin meeting early in the week. Moreover, weekend press reports suggest that a bailout up to EUR 25 billion is close to being agreed. Other topics of conversation will include the possible formation of a European Monetary Fund, though this looks like it will be a non-starter given the many objections to it.

Overall, risk appetite is set to continue its upward trajectory, likely keeping the USD on the back foot. Some deterioration in USD sentiment was reflected in the fact that net long aggregate USD speculation positioning has turned negative again according to the latest CFTC Commitment of Traders (IMM) report. Much in terms of FX direction will depend on what the FOMC says rather than does tomorrow.

EUR/USD may take a crack at resistance around 1.3840 on improving Greek news but it is difficult to see much upside from current levels. The one to watch will be the JPY, especially if the BoJ embarks on aggressive actions at this week’s meeting, leaving USD/JPY plenty of scope to test resistance around 92.16.

Posted in Bond markets, central banks, Currencies, Economics, Economy, equity markets, Europe, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Germany, Greece, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

What to watch

March 7, 2010 — Mitul Kotecha

US February non-farm payrolls released at the end of last week put the finishing touches to a week that saw risk appetite continue to improve each day. There were no big surprises from the various central bank decisions including the RBA, BoE and ECB last week though Malaysia’s central bank did surprise by hiking 25bps. The RBA’s 25bps hike was a close call but in the event the Bank delivered a 25bps hike too.

Sentiment towards Greece has improved in the wake of the announcement of fresh austerity measures by the Greek government, which provoked a short covering EUR/USD rally from around 1.3435 lows though the EUR never really showed signs of embarking on the sort of rebound the massive short EUR speculative position had suggested.

US jobs report revealed that non-farm payrolls dropped by 36k and was all the more remarkable given the potentially very negative impact of severe weather distortions to the data. The data provides the setting for a firm start to the week in terms of risk appetite which will likely put the USD under a bit of pressure into the week.

This week’s events include central bank decisions in New Zealand and Switzerland. The RBNZ has already indicated that it sees no reason to raise interest rates in H1 and an unchanged decision will come as no surprise to the market. The NZD offers better potential for appreciation than the AUD in the short term and I suspect that a “risk on” tone at least early in the week will keep the Kiwi supported.

The SNB in Switzerland is also unlikely to offer any surprises in its rate decision with an unchanged outcome likely. It appears that the Bank has take a somewhat more relaxed tone to the strength of the CHF and any comments on the currency will be scrtunised for hints of intervention.

It probably isn’t much of a shock to expect Greece to remain in the spotlight this week as markets continue to deliberate whether Greece needs financial aid and if so, whether it will be provided by EU countries such as Germany and/or France, at least in terms of some form of debt guarantee.

Further tensions within Greece, with more strikes in the pipeline will test the resolve of the government to carry through austerity measures while likely acting as a cap on any EUR upside over coming days. I still think EUR/USD 1.3789 is a tough nut to crack.

Meanwhile, GBP/USD looks like it will find it tough going to gain much traction above 1.50 with political uncertainties in the form of a likely hung parliament as well as what looks like various efforts by the BoE officials to talk GBP down, likely to prevent an real recovery.

Posted in Australia, central banks, Currencies, Economics, Economy, Europe, Financial crisis, Fiscal/Budget, FX, Greece, US. Tags: , , , , , , , , , , , . Leave a Comment »
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