Euro Still Vulnerable

February 18, 2010 — Mitul Kotecha

Markets have become rather skittish, with attention gyrating between sovereign deficit/debt concerns on the one hand and better news on the corporate and economic front on the other.  This week the latter appears to be gaining the upper hand helped by an easing of concerns about Greece. Although the Greek saga is by no means close to an end, especially given the new deadlines set by the EU Commission on adherence to budget cuts, the chances of the worst case scenario of default or pull out from the EU looks to have diminished. 

Renewed attention on other EU members, especially in light of the derivatives transactions carried out by Greece and potentially by other European countries to disguise the extent of their budget problems suggests that there is still more pain ahead. Nonetheless, it is increasingly clear that investors are differentiating between Europe and the rest of the world much to the chagrin of the EUR.  

Differentiation between the eurozone and the US was particularly apparent in the wake of stronger than forecast earnings and data in the US. Two more companies joined the three-quarters of S&P 500 companies beating earnings forecasts whilst economic reports including US January industrial production and housing starts came in ahead of forecasts.  This pattern is set to continue today, with the US Philly Fed manufacturing index set to increase to around 17 in February from 15.2 in January. 

In contrast, data in Europe has been much less impressive, with for example, the February ZEW survey of investor confidence recording its 5th consecutive decline in February.  The eurozone economic news may look a little better in the form of likely increases in manufacturing Purchasing Managers Indices (PMIs) but unless the data reveals particularly strong readings the growing perception that Europe is falling behind in the recovery process will remain in place.

Despite the improvement in risk appetite the USD has taken a firmer tone, appearing to react more to positive data and implications for a reduction in policy accommodation by the Fed.  In particular, the USD was spurred by the FOMC minutes of the January 26-27 meeting, in which the Fed debated its exit strategy from quantitative easing.  Some officials even went as far as pushing for asset sales in the “near future” to reduce the size of the Fed’s balance sheet.

Even though the USD has taken a firmer tone it will continue to be buffeted by the conflicting forces of improved risk appetite and shifting interest rate expectations.  Correlations reveal that risk is still the dominant FX factor suggesting that there may still be some further downside left for the USD as risk appetite improves. 

Although commodity currencies have also come under pressure due to the generally firmer USD tone overnight, the downside in these currencies is likely to prove limited especially given strong data releases.  For example, data overnight revealed that business confidence rose to its highest level in 15 years in Australia.  Added to upbeat comments from RBA deputy governor Lowe and strong labour market data, it highlights the growing probability of a March rate hike by the RBA.

The EUR remains the weak link and although it may benefit from easing Greek concerns the growing evidence of a relatively slower economic recovery in the eurozone suggests any upside in the EUR will be limited.  Having dropped below technical support around 1.3580, EUR/USD looks vulnerable to a further push lower in the short-term.

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

Post US Jobs Data FX Outlook

December 5, 2009 — Mitul Kotecha

The massive upside surprise to US payrolls could prove to be a significant indicator for the USDs fortunes in the months ahead.  To summarize, payrolls dropped by 11k, much less than expected. Net revisions totaled +148k, the workweek rose and the unemployment rate fell to 10%, also better than forecast and likely a surprise to the US administration who hinted at a rise in the unemployment rate.

Equity and bond market reaction was as would be expected; equities rallied and bonds sold off.  Gold prices dropped sharply too.  However, and this is what was most interesting, the dollar strengthened. Why is this odd? Well, over the past 9 months any news that would have been perceived as positive for risk appetite was associated with dollar weakness.  This reaction clearly did not take place following the jobs data. 

It’s worth noting that going into the payrolls data markets were very short USDs as reflected in the CFTC Commitment of Traders IMM data which revealed the biggest aggregate net short USD position since 25 March 2008. The bounce in the USD could have reflected a strong degree of short covering especially against the JPY where net long JPY positions had jumped to close to its all time high.  Going into year end expect to see more position adjustment, perhaps indicating a return of the JPY funded carry trade is back on the cards.

The dollar’s reaction to the payrolls data was reminiscent of its pre-crisis relationship of buying dollars in anticipation of a more aggressive path for US interest rates and indeed markets brought forward expectations of higher rates following the data.  It is probably too early to believe that the dollar’s movements are once again a function of interest rate differentials but it is a taste of things to come. In any case, markets will be able to garner further clues from a speech by Fed Chairman Bernanke today.

The post payrolls dollar reaction could have also reflected the fact that EUR/USD failed to break above the 1.5145 high over the week resulting in a capitulation of stale long positions, especially as the move towards reducing liquidity provision by the ECB also failed to push the EUR higher. If the S&P 500 stays above 1100 EUR/USD could retrace higher for the most part a broad 1.48-1.51 range is likely to dominate over the week.  Nonetheless, a break below 1.4820 could provoke an accelerated stop loss fuelled drop in EUR/USD.  ECB President Trichet speaks today and may reiterate that the ECB’s measures to begin scaling back its liquidity provision should not be taken as a step towards monetary tightening.

USD/JPY proved interesting last week pushing higher in the wake of strong rhetoric by the Japanese authorities threatening intervention to prevent JPY strength. The BoJ’s attempt to provide more liquidity to banks also helped on the margin to weaker the JPY but the impact of the move is likely to prove limited. Nonetheless, exporters and Japanese officials may be more relaxed this week, if USD/JPY can hold above 90.00.  However, a likely sharp revision lower to Japanese Q3 GDP tomorrow will help maintain calls for a weaker JPY.

Posted in Bond markets, central banks, Currencies, Economics, Economy, equity markets, Europe, FX, Interest rates, Japan, Monetary Policy, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

Buffer for risk trades

November 25, 2009 — Mitul Kotecha

Firmer data, most recently in the form of the stronger than expected US consumer confidence and dovish Fed comments as reiterated in the Fed FOMC minutes will provide a buffer for risk trades, supporting the USDs role as the prime funding currency over coming weeks.  Nonetheless, any improvement in sentiment will have to push against the weight of position adjustment into year-end as investors book profits on risk trades.  The net effect could be an increase in volatility especially in thinning liquidity expected in the wake of holidays in Japan and the Thanksgiving holiday in the US.

This could make it difficult for many asset markets to sustain key psychological and technical levels.  Whether the S&P 500 can hold gains above 1100 could prove significant as could EUR/USD’s ability to hold onto gains above 1.50.  The expiry of last week’s EUR/USD 1.48/1.51 option may provoke a move out of its range but there seems to be little appetite for a sustained break above the 23rd October high around 1.5061.  Even so, an upside bias is more likely given the likely softer tone to the USD. EUR/USD looks well supported around 1.4865.

Position adjustment towards the end of the year has been particularly evident in FX markets.  For instance, the latest CFTC Commitment of Traders’ data revealed that speculative investors have sharply reduced net long EUR positions into last week whilst there was a significant degree of short covering of GBP positions.  It is worth noting however, that aggregate USD net short speculative positions actually increased, largely due to a sharp jump in net JPY positioning, suggesting that overall sentiment for the USD remains very negative.

It is difficult to see a strong reversal in USD sentiment into year-end and the Fed’s commitment to maintaining interest rates at a low-level for an “extended period” taken together with hints of extending asset purchase programmes suggests little support to the USD over the short-term unless there is a more significant increase in risk aversion and or profit taking/book closing into year-end.  It seems that the impact of improved risk appetite is winning for now, giving no respite to the USD.

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

US dollar and equity gyrations

October 21, 2009 — Mitul Kotecha

Although there appears to be some consolidation at present the USD remains on a steady downward path and is likely to continue to face a combination of both cyclical and structural negative forces.  Cyclical pressure will come from the extremely easy monetary policy stance of the Fed as well as the ongoing improvement in risk appetite. The structural pressure on the USD continues to come from the diversification of new FX reserve flows (mainly from Asian central banks) as well as concerns about the reserve value of the USD in the wake of massive US fiscal and monetary stimulus.

Although risk aversion is no longer as correlated with the USD as it was a few months ago there is no doubt that the USD is still highly sensitive to equity market movements. Correlations between the USD index and the S&P 500 are consistently high (and negative) over 1M, 3M and 6M time periods. The relationship reveals just how closely the fortunes of the USD are tied to the gyrations in equity markets.  

Much will therefore depend on the shape of US Q3 earnings. The fact that the majority of earnings released so far have beaten expectations has provided equities with more fuel whilst the USD has come under greater pressure. Should as is likely the trend in earnings continue to beat forecasts the USD is likely to weaken further, pushing through key resistance levels.   In particular, a sustained break above EUR/USD 1.50 could see a swift move substantially higher, with little in the way of technical resistance on the way up to 1.60

The real test will come when the lofty expectations for economic recovery match the reality of only sub-par growth in the months ahead. In the meantime, the firmer tone to global equity markets may encourage capital outflows from the US into foreign markets by investors who had repatriated huge amounts of capital during the crisis.

As risk appetite improves, the hunt for yield will intensify. The USD has easily taken over the mantle from the JPY as funding currency of choice for investors, pointing to further pressure on the USD. The timing of monetary policy reversal in the US will be crucial for the USD but it is highly unlikely that the Fed will hike rates next year.

As would be expected in this hunt for yield interest rate differentials are beginning to show a growing influence in driving currencies as the influence of risk appetite begins to wane.  The prospect of US interest rates remaining at a low level for a long time does not bode well for the USD, at least until markets begin to price in higher US rates which is at least a few months away.

Posted in central banks, Currencies, Economy, equity markets, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , . 1 Comment »

Earnings in focus

October 19, 2009 — Mitul Kotecha

The majority of US Q3 earnings have beaten market expectations resulting in a boost to risk appetite and further pressure on the US dollar. At the time of writing, 61 companies have reported earnings in the S&P 500 and an impressive 79% have beaten forecasts according to Thomson Reuters. This week there are plenty of earnings on tap and although a lot of positive news appears to be priced in the overall tone to risk appetite remains positive. This implies a weaker US dollar bias given the strong negative correlation between US equities and the USD index.

Aside from the plethora of earnings there are plenty of data releases on tap this week including housing data in the US in the form of building permits and starts as well as existing home sales. The data will likely maintain the message of housing market stabilisation and recovery in the US. There will also be plenty of Fed speakers this week and markets will once again scrutinize the speeches to determine the Fed’s exit strategy.

Highlights this week also include interest rate decisions in Canada and Sweden. Both the BoC and Riksbank to leave policy unchanged and expect a further improvement in the German IFO in October though at a more gradual pace than in recent months. There will be plenty of interest in the UK MPC minutes given conflicting comments from officials about extending quantitative easing. RBA minutes will be looked at for the opposite reason, to determine how quickly the Bank will raise interest rates again.

The USD index managed a slight rebound at the end of last week but is likely to remain under pressure unless earnings disappoint over coming days. US dollar Speculative sentiment became more bearish last week according to the CFTC IMM data, with dollar bloc currencies including the AUD, NZD and CAD benefiting the most in terms of an increase in speculative appetite. GBP short positions increased to a new record but the rally towards the end of last week may have seen some of these short positions being covered. Overall any recovery in the USD this week may just provide better levels to go short.

Posted in central banks, Currencies, Economics, Economy, Interest rates, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
« Older posts
Newer posts »