Peripheral debt concerns intensify

November 10, 2010 — Mitul Kotecha

European peripheral debt concerns have allowed the USD a semblance of support as the EUR/USD pullback appears to have gathered momentum following its post FOMC meeting peak of around 1.4282. The blow out in peripheral bond spreads has intensified, with Greek, Portuguese and Irish 10 year debt spreads against bonds widening by around 290bps, 136bps and 200bps, respectively from around mid October.

The EUR appears to have taken over from the USD, at least for now, as the weakest link in terms of currencies. EUR/USD looks vulnerable to a break below technical support around 1.3732. Aside from peripheral debt concerns US bonds yields have increased over recent days, with the spread between 10-year US and German bonds widening by around 17 basis points in favour of the USD since the beginning of the month.

The correlation between the bond spread and EUR/USD is significant at around 0.76 over the past 3-months, highlighting the importance of yield spreads in the recent move in the USD against some currencies. Similarly high correlations exist for AUD/USD, USD/JPY and USD/CHF.

Data today will offer little direction for markets suggesting that the risk off mood may continue. US data includes the September trade deficit. The data will be scrutinized for the balance with China, especially following the ongoing widening in the bilateral deficit over recent months, hitting a new record of $28 billion in August. Similarly an expected increase in China’s trade surplus will add to the currency tensions between the two countries. FX tensions will be highlighted at the Seoul G20 meeting beginning tomorrow, with criticism of US QE2 gathering steam.

Commodity and Asian currencies are looking somewhat precariously perched in the near term, with AUD/USD verging on a renewed decline through parity despite robust September home loan approvals data released this morning, which revealed a 1.3% gain, the third straight monthly increase.

However, the NZD looks even more vulnerable following comments by RBNZ governor Bollard that the strength of the Kiwi may reduce the need for higher interest rates. As a result, AUD/NZD has spiked and could see a renewed break above 1.3000 today. Asian currencies are also likely to remain on the backfoot today due both to a firmer USD in general but also nervousness ahead of the G20 meeting.

Posted in Asia, Australia, Bond markets, central banks, China, Commodities, Currencies, Economics, Economy, emerging markets, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Interest rates, Ireland, Monetary Policy, Portugal, South Korea, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

Split personality

August 25, 2010 — Mitul Kotecha

Markets are exhibiting a Strange Case of Dr Jekyll and Mr Hyde, with a clear case of split personality. Intensifying risk aversion initially provoked USD and JPY strength, with most crosses against these currencies under pressure. Both USD/JPY and EUR/JPY breezed through psychological and technical barriers, with the latter hitting a nine-year low. However, this reversed abruptly in the wake of extremely poor US existing home sales, which plunged 27.2% in July, alongside downward revisions to prior months, a much bigger drop than forecast.

Obviously double-dip fears have increased but how realistic are such fears? Whilst much of the drop in home sales can be attributed to the expiry of tax credits, investors can be forgiven for thinking that renewed housing market weakness may lead the way in fuelling a more generalized US economic downdraft. The slow pace of jobs market improvement highlights that the risks to the consumer are still significant, whilst tight credit and weaker equities, suggests that wealth and income effects remain unsupportive.

FX markets will need to determine whether to buy USDs on higher risk aversion or sell USDs on signs of weaker growth and potential quantitative easing. I suspect the former, with the USD likely to remain firm against most risk currencies. The only positive thing to note in relation to the rise in risk aversion is that it is taking place in an orderly manner, with markets not panicking (yet).

European data in the form of June industrial new orders delivered a pleasant surprise, up 2.5%, but sentiment for European markets was delivered a blow from the downgrade of Ireland’s credit rating to AA- from AA which took place after the close. The data suggests that the momentum of European growth in Q3 may not be as soft as initially feared following the robust Q2 GDP outcome.

Japan has rather more to worry about on the growth front, especially given the weaker starting point as revealed in recently soft Q2 GDP data. Japan revealed a wider than expected trade surplus in July but this was caused by a bigger drop in exports than imports, adding to signs of softening domestic activity. The strength of the JPY is clearly making the job of officials harder but so far there has been no sign of imminent official FX action.

Japan’s finance minister Noda highlighted that recent FX moves have been “one sided” and that “appropriate action will be taken when necessary”. The sharp move in JPY crosses resulted in a jump in JPY volatility, a factor that will result in a greater probability of actual FX intervention but the prospects of intervention are likely to remain limited unless the move in the JPY accelerates. USD/JPY hit a low of 83.60 overnight but has recovered some lost ground, with 83.50 seen as the next key support level. JPY crosses may see some support from market wariness on possible BoJ JPY action, but the overall bias remains downwards versus JPY.

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Follow The Oracle

July 12, 2010 — Mitul Kotecha

Many investors are probably wishing they had the psychic abilities of Paul the octopus. The mollusc once again gave the correct prediction, by picking Spain to beat the Netherlands to become the winner of the World Cup. This ability would have been particularly useful for currency forecasters, many of which have been wrong footed by the move higher in EUR/USD over recent weeks.

Confidence appeared to return to markets over the past week helped by a string of rate hikes in Asia from India, South Korea and Malaysia, and firm data including yet another consensus beating jobs report in Australia. An upward revision to global growth forecasts by the International Monetary Fund (IMF) also helped, with the net result being an easing in double-dip growth concerns.

The good news culminated in a much stronger than forecast June trade surplus in China. However, China’s trade numbers will likely keep the pressure on for further CNY appreciation, and notably US Senators are still pushing ahead with legislation on China’s FX policy despite the US Treasury decision not to name China as a currency manipulator.

Political uncertainty on the rise again in Japan following the loss of control of the upper house of parliament by the ruling DPJ party. The JPY has taken a softer tone following the election and will likely remain under pressure. CFTC IMM speculative JPY positioning has increased but this has been met with significant selling interest by Japanese margin accounts who hold their biggest net long USD/JPY position since October 2009 according to Tokyo Financial Exchange (TFX) data.

In the absence of the prodigious abilities of an “oracle octopus” data and events this week will continue to show slowing momentum in G3 country growth indicators but not enough to warrant renewed double-dip concerns. Direction will be largely driven by US Q2 earnings. S&P 500 company earnings are expected to have increased 27% from a year ago according to Thomson Reuters.

There are several data releases of interest in the US this week but the main release is the retail sales report for June which is likely to record another drop over the month. Data and events in Europe include the Eurogroup finance ministers meeting, with markets looking for further insight into bank stress tests across the region. Early indications are positive but the scope of the tests remains the main concern. The July German ZEW survey will garner some interest and is likely to show a further slight decline in economic sentiment.

EUR/USD gains looked increasingly stretched towards the end of last week, as it slipped back from a high of around 1.2722. Technical resistance around 1.2740 will prove to be tough level to crack over coming days, with a pullback to support around 1.2479 more likely. CFTC IMM data reveals that short covering in EUR has been particularly sharp in the last week, with net short positions cut by over half, highlighting that the scope for further short covering is becoming more limited.

Conversely aggregate net USD long positions have fallen by over half in the last week as USD sentiment has soured, with longs at close to a three-month low. The scope for a further reduction in USD positioning is less significant, suggesting that selling pressure may abate.

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