Risk currencies under pressure

Risk aversion continues to edge higher. This spells more bad news for risk/high beta currencies including many highly correlated currencies such as AUD, NZD and emerging market currencies.

Greece’s travails have come back to haunt markets and the inability to form a government puts at risk the whole bailout programme and possibly Greece’s ability to stay within the Eurozone. A failure to form a government will mean fresh elections in mid June and a delay in aid disbursements.

EUR/USD began the European session below the 1.30 level but I’m not convinced its heading much lower in the short term. The fact that the market is highly short (looking at the CFTC IMM data) means that positioning has already become very negative. Moreover, as in past months, there is plenty of inherent demand for EUR below this level. The better option is to play EUR weakness on the crosses.

UK economic news was soft overnight with the BRC retail sales survey plunging by 3.3%. GBP has acted as a semi safe haven against the background of the current Eurozone malaise but the data highlights that the job of the Bank of England is not particularly clear cut. No action is expected at tomorrow’s policy meeting leaving GBP reasonably well supported.

Safe haven currencies remain favoured, leaving the likes of the USD, JPY and CHF well supported. My quant models point to more short term downside for USD/JPY with a further decline below 80 remaining in place. One other currency that looks relatively attractive is the CAD. Relatively favourable fundamentals highlight the potential for CAD outperformance on the crosses

AUD downside remains intact and a drop below parity with the USD looms. A relatively austere budget after Prime Minister Gillard dropped a corporate tax cut has opened the door to potentially bigger easing from the RBA. While a lot of easing is already priced in the market will react by pricing in more cuts. Moreover, with a likely soft jobs report expected tomorrow and AUD’s susceptibility to risk aversion it all spells more weakness for AUD.


Eurozone peripheral tensions

The USD index remains under pressure but will likely continue to consolidate. The USD continues to be undermined by adverse interest rate differentials and is gaining little support from rising risk aversion. One factor that will help dictate USD direction over coming months is the prospects for further quantitative easing once QE2 ends.

Fed officials offered varied views on the subject. Dallas Fed President Fisher hinted he would support cutting short asset purchases before the end of June, whilst Atlanta Fed President Lockhart noted he was “very cautious” about further asset purchases. Meanwhile Chicago Fed President Evans noted that he believes the hurdle for altering the asset purchase plan is “pretty high”.

Although there is a lack of first tier data releases in the eurozone this week there is certainly plenty for markets to chew on in terms of peripheral country issues, which may just prevent the EUR from extending its gains. Eurozone peripheral debt spreads have undergone a renewed widening over recent weeks as debt fears have increased and worries that Portugal may follow Ireland and Greece in needing a bailout have risen.

Meanwhile news that Ireland’s incoming government will introduce legislation allowing the restructuring of some senior bank bonds, will add to tensions. Meanwhile, the downgrading of Greece’s government bond ratings to B1 from Ba1 dealt another blow sentiment following hot on the heels of Fitch’s downgrade of Spain’s outlook to negative although the EUR proved resilient to the news. EUR/USD continues to look as though it will consolidate around the 1.4000 level, but worsening sentiment towards the periphery may open up downside as the EUR’s resilience fades.

Upward revisions to eurozone growth and inflation forecasts and of course a hawkish shift in eurozone interest rate expectations may have justified the EUR move higher over recent weeks. However, there does not seem to be much that will provide the stimulus for further gains from current levels.

The market has already priced in an interest hike as early as next month’s European Central Bank (ECB) meeting and further tightening thereafter. The risk now appears asymmetric skewed to the downside especially if tensions between the eurozone core and peripheral countries deepen. How long the EUR can ignore such tensions?

It’s not only the eurozone periphery that should worry about ratings. Japan’s ratings agency R&I has warned that it may be forced to cut Japan’s sovereign ratings before April’s local elections due to current political problems. R&I’s concern revolve around the potential for political problems to delay fiscal reforms. As usual the JPY remains unmoved by political issues and is moving to the stronger side of its recent range against the background of elevated risk aversion.

Although the JPY has not been particularly sensitive to risk over recent months shorter-term correlations shows that its sensitivity has increased. Given that Middle-East tensions do not appear to be easing the JPY will remain well supported. Indeed, speculative positioning data reveals the highest JPY net long position since November 2010. As risk appetite improves JPY positioning will be pared back but this is unlikely to be imminent, with USD/JPY set to remain close to support around 81.10.

GBP troubles, KRW too weak

The Fed FOMC minutes for the January meeting revealed that behind the unanimous vote to leave policy settings unchanged there was some unease about the completion of QE2. Nonetheless, the USD was left weaker given the Fed’s sanguine view on inflation and worries about unemployment. Inflation data will garner most market attention today but the fact that the core rate of CPI inflation is expected to remain well below the Fed’s preferred level could undermine the USD and add a further barrier to the USD’s recovery so far in February. Jobless claims data will also be of interest given the sharp drop last week. Another firm outcome will help to dispel worries about job market recovery.

As warned in my last post, downside risks to GBP were high given the long GBP speculative positioning overhang and hawkish expectations for the BoE Quarterly Inflation Report. In the event the Report revealed a downward growth forecast revision and an upward inflation forecast revision but importantly showed some reluctance to play into market expectations of an early UK policy rate hike. Following on from a weaker than expected UK January jobs report in which unemployment increased, GBP was hit on both counts. GBP/USD is unlikely to veer far from the 1.6000 level, but with markets reassessing interest rate expectations downside risks are beginning to open up.

News yesterday that Moody’s ratings agency has placed Australia and New Zealand’s major banks on review for possible downgrades went down like a lead balloon but once again AUD and NZD showed their usual resilience and acted as if little has happened. AUD and NZD have weakened since the turn of the year. Weaker data and a paring back in policy tightening expectations have contributed to the weaker performance of the AUD and NZD, but markets have gone too far in scaling back the timing and magnitude of interest rate hikes, suggesting that both currencies may bounce back as interest rate expectations become more hawkish.

Asian currencies continue to register mixed performances largely influenced by capital flows. Most equity markets in the region have registered outflows so far in 2011, with the exception of Taiwan and Vietnam. This has been reflected in Asian FX performance, with the strongest performer being the IDR, but its gains have only been around 0.72% versus USD, coinciding with the fact that it has registered some of the least capital outflows this year. Interestingly the worst performing currency has been the THB, one of last year’s star performers. Korea has also registered strong equity capital outflows but this will not persist and a resumption of inflows taken together with positive fundamentals and higher interest rates will boost the KRW this year.

US Dollar Upside, Euro tensions

Following the famine that was last week this week will see a feast of data releases, which hopefully will give some clearer direction to currency markets. The key eurozone data focus for FX markets will be the German February ZEW survey and it should highlight that investor confidence is bouncing back smartly. This will be accompanied by data showing a slight acceleration in GDP in the eurozone in Q4 2010. Good news, but the reality is that the EUR is being driven more by peripheral bond tensions and relative yields.

Although the EUR may get a brief lift from the news of the resignation of Egypt’s President Mubarak this will likely prove temporary. Given that tensions are beginning to creep higher EUR/USD may struggle to make any headway this week and will more likely slip below 1.3500 for a test of 1.3440 as sentiment sours. Even the usual sovereign interest may look a little more reluctant to provide support this week. The net long positioning overhang as reflected in the CFTC IMM data suggests some scope for a squaring in long positions, likely accelerating any downside pressure.

As usual data releases are failing to have a major impact on the JPY whilst interest rate / yield differentials suggest the JPY should be much weaker. One explanation for the stubbornly strong JPY is the strength of recent portfolio inflows to Japan, especially into its bond markets. This could reverse quickly and IMM positioning suggests that the potential for a shakeout of long positioning looms large, something that many Japanese margin traders are well positioned for according to TFX data. USD/JPY 84.51 will provide firm resistance to a move higher in the short-term.

GBP will be guided by the Bank of England Quarterly Inflation Report on Wednesday as well as the January CPI and retail sales data. The Report will reveal that inflation moderates over the medium term, even if short-term projections are shifted higher. Consequently, interest rate markets may even pare back overly hawkish expectations for UK rates, leaving GBP vulnerable. Nonetheless, markets maybe somewhat more sceptical or at least nervous in light of a likely increase in UK CPI, albeit mostly due to the increase in value added tax (VAT) at the turn of the year. Moreover, GBP may find some solace from a rebound in retail sales in January.

Overall, GBP/USD will take its cue from EUR/USD and the currency is vulnerable to a sustained drop below 1.6000 this week. The fact that GBP/USD IMM positioning is at its highest since September 2008 suggests a lot of scope for a sell-off. EUR/GBP looks like its consolidating in an even narrower range between 0.8400-0.8500.

Another positive slate of US data releases and likely more pressure on US bond markets this week suggest that the USD will find further support, with the USD index likely to take a shot at the 79.00 level. Indeed a further improvement in both the Philly Fed and Empire manufacturing surveys is expected, providing more evidence of strengthening manufacturing momentum, will be borne out in the hard data, with a healthy gain in industrial output expected. Similarly a healthy reading for US retail sales will support the evidence that the US consumer is in full recovery mode.

The positive impact on the USD may be dampened however, by benign inflation readings this week, supporting the view that US policy rates will not be raised for a long time yet. This is likely to be echoed in the Fed FOMC minutes this week. Nonetheless, speculative positioning suggests plenty of scope for short USD covering, with the latest CFTC IMM report revealing the biggest net short position since October 2010.

Econometer.org has been nominated in FXstreet.com’s Forex Best Awards 2011 in the “Best Fundamental Analysis” category. The survey is available at http://www.surveymonkey.com/s/fx_awards_2011

Euro Sentiment Jumps, USD Sentiment Dives

The bounce in the EUR against a broad range of currencies as well as a shift in speculative positioning highlights a sharp improvement in eurozone sentiment. Indeed, the CFTC IMM data reveals that net speculative positioning has turned positive for the first time since mid-November. A rise in the German IFO business confidence survey last week, reasonable success in peripheral bond auctions (albeit at unsustainable yields), hawkish ECB comments and talk of more German support for eurozone peripheral countries, have helped.

A big driver for EUR at present appears to be interest rate differentials. In the wake of recent commentary from Eurozone Central Bank (ECB) President Trichet following the last ECB meeting there has been a sharp move in interest rate differentials between the US and eurozone. This week’s European data releases are unlikely to reverse this move, with firm readings from the flash eurozone country purchasing managers indices (PMI) today and January eurozone economic sentiment gauges expected.

Two big events will dictate US market activity alongside more Q4 earnings reports. President Obama’s State of The Union address is likely to pay particular attention on the US budget outlook. Although the recent fiscal agreement to extend the Bush era tax cuts is positive for the path of the economy this year the lack of a medium to long term solution to an expanding budget deficit could come back to haunt the USD and US bonds.

The Fed FOMC meeting on Wednesday will likely keep markets treading water over the early part of the week. The Fed will maintain its commitment to its $600 billion asset purchase program. Although there is plenty of debate about the effectiveness of QE2 the program is set to be fully implemented by the end of Q2 2011. The FOMC statement will likely note some improvement in the economy whilst retaining a cautious tone. Markets will also be able to gauge the effects of the rotation of FOMC members, with new member Plosser possibly another dissenter.

These events will likely overshadow US data releases including Q4 real GDP, Jan consumer confidence, new home sales, and durable goods orders. GDP is likely to have accelerated in Q4, confidence is set to have improved, but at a low level, housing market activity will remain burdened by high inventories and durable goods orders will be boosted by transport orders. Overall, the encouraging tone of US data will likely continue but markets will also keep one eye on earnings. Unfortunately for the USD, firm US data are being overshadowed by rising inflation concerns elsewhere.

Against the background of intensifying inflation tensions several rate decisions this week will be of interest including the RBNZ in New Zealand, Norges Bank in Norway and the Bank of Japan. All three are likely to keep policy rates on hold. There will also be plenty of attention on the Bank of England (BoE) MPC minutes to determine their reaction to rising inflation pressures, with a slightly more hawkish voting pattern likely as MPC member Posen could have dropped his call for more quantitative easing (QE). There will also be more clues to RBA policy, with the release of Q4 inflation data tomorrow.

Both the EUR and GBP have benefitted from a widening in interest rate futures differentials. In contrast USD sentiment has clearly deteriorated over recent weeks as highlighted in the shift in IMM positioning, with net short positions increasing sharply. It is difficult to see this trend reversing over the short-term, especially as the Fed will likely maintain its dovish stance at its FOMC meeting this week. This suggests that the USD will remain on the back foot.

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