Contrasting fortunes for GBP and JPY

September 28, 2009 — Mitul Kotecha

The main FX movers over recent days have been JPY and GBP. Japan’s non interventionist FX stance and the approach of fiscal half year end on September 30 have given markets plenty of appetite to push the JPY higher.  In particular a change in Japanese tax rules which waives taxes on repatriated profits suggests there will be more repatriation flows than usual ahead of fiscal half year end.  Such repatriation flows have played a role in the appreciation of the JPY.    

Even if such flows do not actually materialise the mere speculation that they exist will be sufficient to keep the JPY supported.  Helping the JPY on its way is the view that Japanese officials are not particularly concerned about a strengthening JPY although it is worth noting that Japan’s new finance minister Fujii did note that he was carefully watching the JPY’s rise.  Nonetheless, it appears that the new government’s policy in Japan is in sharp contrast to the previous government’s FX policy which favoured a weaker JPY.  

The positive shift in JPY sentiment over recent weeks has been particularly evident in speculative positioning data which reveals that net JPY speculative positions have hit their highest since 3 February 2009, a sharp turnaround from negative net positioning just three months ago.  Further JPY gains are likely over the short term as speculative appetite for the currency continues to improve. 

In contrast to Japan, UK officials appear to be more comfortable with a weaker currency. Recent comments by Bank of England (BoE) Governor King that a weaker GBP would help exporters has weighed on GBP.  Consequently, speculative sentiment for GBP deteriorated particularly sharply last week, with CFTC IMM data revealing the biggest short GBP positioning since early April 2009.  Even though the latest UK Monetary Policy Committee minutes revealed no sign that the BoE is contemplating expanding quantitative easing, GBP continues to be a much unloved currency.  

Some likely improvements in economic data this week may provide relief to GBP but it will prove limited against the weight of negative GBP sentiment.  The Hometrack housing survey revealed a further increase in UK house prices in September and data this week will likely reveal an upside revision to Q2 GDP, and an improvement in manufacturing confidence.  Overall, despite the encouraging data GBP/USD looks vulnerable to a further downside push.

Posted in central banks, Currencies, Economics, Economy, equity markets, Japan, UK. Tags: , , , , , , , , , , , , , , , , , , . Leave a Comment »

News flow to remain volatile

July 25, 2009 — Mitul Kotecha

In past posts I wrote that it will take positive news as opposed to less negative news to drive the rally in equity and credit markets forward.   Although I remain doubtful about the durability of the rally over coming months, there has been good news on the earnings front up until now, and equities have rallied strongly as a result.

Of the S&P 500 companies reporting Q2 earnings 74% have beaten forecasts.  Although there are still many companies scheduled to release earnings, if this pattern continues it would be the highest on record.  Data releases have also given reason for optimism even in Europe where manufacturing gauges and the closely watched German IFO showed some improvement.

Unfortunately, the news was not all unidirectional as Amazon and Microsoft spoiled the party somewhat with their below forecast earnings.  US consumer confidence dropped for the first time in 5 months according to the Michigan survey as rising unemployment in particular weighed on sentiment.  Meanwhile, in the UK GDP data revealed the severe and broad based nature of the recession.

The news flow will continue to remain volatile in the weeks ahead.  The bottoming out process for many economies will be drawn out and rising unemployment and tight credit will act to restrain consumers.  Banks will face spiralling defaults on credit cards and increasing loan delinquencies as some recent earnings have revealed.

Unlike past recessions emerging markets are leading the recovery, especially in Asia as recent data has revealed.  Nonetheless, unless the developed country consumer engine kicks back into life the sustainability of Asian and emerging market recovery remains in doubt.

It is telling that currency markets are not reacting too sharply to the recent positive earnings news.  On balance the usual losers, dollar and yen, in an environment of improved risk appetite, have come under pressure.  In contrast, risk currencies such as the Australian, NZ and Canadian dollars have strengthened. Other high beta currencies are also stronger. Nonetheless, for the most part currencies remain in well worn ranges and as liquidity thins further over summer, there appears to be little scope for new trends in FX markets.

I still favour some dollar resilience over coming weeks as renewed market doubts creep but this view is becoming increasingly difficult to hold.  The reality is that currencies will track equities, which in turn will be dependent on earnings.   If the current earnings trend continues the dollar will face even more pressure but not to the extent that it breaks out of recent ranges.

Posted in China, Currencies, Economics, Economy, US. Tags: , , , , , , , , , , . 1 Comment »

Watch out for the pitfalls in H2 2009

July 6, 2009 — Mitul Kotecha

Equity and credit markets have begun the second half of 2009 looking quite fatigued, which is not a good sign ahead of the Q2 earning season.   Perhaps the fact that markets have come so far in such a short period of time has itself prompted a pause. An alternative explanation is that the summer lull is kicking in, with many investors taking the end of H1 2009 as an excuse to book profits and wait until activity picks up again post summer holidays.  A more worrying and more likely explanation is that the massive improvement in market sentiment seen in H1 2009 is  giving way to uncertainty.

Relief that there will be no collapse of the global financial system is not sufficient to keep the momentum in equity and credit markets going into the second half of the year. Until now there has been plenty of less negative news and use of the now worn phrase “green shoots”, but little information to judge the magnitude and speed of recovery going forward.

There are plenty of factors that will dampen recovery in the months ahead. Higher unemployment, massive wealth loss and increased savings will provide a clear downdraft to the global economy. Banks will be increasingly laden with bad loans due to credit card delinquencies, commercial real estate defaults and other sour loans and are unlikely to step up lending in a hurry. In addition, it is still unclear how quickly toxic debt will be removed from banks’ balance sheets, which will act as another impediment to recovery.

Risks outside the US remain significant. Although the outlook for China is improving it is unclear whether the momentum of growth in the country will continue once current stimulus measures are utilised. Much will also depend on whether China and other export economies can shift growth impetus from external demand to domestic demand.

Moreover, concerns about the dollar’s use as a reserve currency continue to intensify as various large reserve holders attempt to diversify away from the dollar.  Although a dollar collapse is unlikely the risk that foreign investors reduce their exposure to US Treasuries remains a threat to the dollar.   This could push up long term interest rates and in turn mortgage rates in the US.  

The European economy is a particular riskto global recovery, with only a gradual recovery expected.  In particular, the biggest Eurozone economy Germany is struggling in the wake of a collapse in exports and a lack of domestic demand. Moreover, banking sector issues remain unresolved especially as there has been little information on European bank stress tests. The relative strength of the euro and inability of some countries in the Eurozone to devalue their way out of the downturn will also dampen recovery prospects.   These factors suggest that Europe will lag the recovery in other countries such as the US and UK where the policy response has arguably been more aggressive.  

The jobs market will lag the recovery process but there are signs that things are becoming less severe.  The pace of job losses in many countries is lessening.   In the US for example, non farm payrolls report revealed that average monthly job losses in the second quarter of 2009 at 436k were much lower than the 691k average monthly job losses in the first quarter.  The bad news however, is that unemployment rates continue to rise.  In the US the unemployment rate is likely to head to around 10% from 9.5% currently and this will be echoed in Europe where the unemployment is at a 10-year high of 9.5% currently. 

The bottom line is that the market rally may have been justified so far but there is little to carry the momentum forward. Equity valuations dropped to low levels in March but can be hardly considered cheap at present. The improvements in indicators of market stress have also reached dramatic levels and going forward there will be plenty of pitfalls in the months ahead.

Posted in bank rescue, central banks, China, Currencies, Economics. Tags: , , , , , , , , , , , , , , , , , , , . 3 Comments »

A set back for the pound

June 18, 2009 — Mitul Kotecha

The multi week rally in the pound (GBP) has hit a snag as the currency has failed to extend gains above its recent highs around 1.66 against the dollar (USD).  The surprising fall in UK retail sales, with sales dropping by 0.6% from April compared to expectations of a 0.3% increase, dealt GBP another blow.   Sales were down 1.6% from a year earlier.  This is bad news for those that had believed that the UK consumer was enduring the economic downturn with some resilience. 

The reality is that the recovery in the economy will be a bumpy ride.  Whilst there have been some signs of improvement in the economy it is by no means a broad based pattern.  I would warn at getting too carried away with recovery expectations.  There have been clear signs of strengthening in both manufacturing and service sector survey data but they still only point to a gradual recovery in the months ahead. 

Moreover, some UK housing market indicators have pointed to early signs of recovery but a lot of this is due to a lack of supply and at best the housing market is entering a period of stabilisation.   Despite the signs of economic stabilisation the British Chamber of Commerce (BCC) cut its forecasts for the UK economy to -3.8% this year compared to a previous forecast of -2.8%.  

Meanwhile, UK banks continue to restrain credit and may even need more equity capital on top of the $158 billion in capital already raised according to Bank of England governor Mervyn King in his Mansion House speech.  He also warned about a “protracted” economic recovery. The good news is that the BoE is in no rush to take back its aggressive monetary easing and £125 billion asset purchase plan, but unless banks pass the benefits of this onto borrowers the fledgling recovery could stall quite quickly.   

The desire not to act quickly to reverse monetary policy was echoed in the minutes of the June BoE meeting, which revealed a unanimous 9-0 vote to maintain the status quo on policy.  The minutes also noted that the near term risks to the economy had lessened but monetary policy committee members remained cautious about the medium term prospects.  It is likely that the BoE will take several more months to gauge how successful policy has been. 

All of this highlights that GBP will be vulnerable to periodic bouts of profit taking and reversal.  Its ascent from its lows against the USD below 1.40 has been dramatic and rapid.  I believe that much of its gain has been justified especially as it had fallen to extreme levels of undervaluation.  Moreover, aggressive policy actions, both on fiscal and monetary policy, suggest that UK economic recovery will come quicker than Europe. This implies that GBP will at the least continue to recover against the euro (EUR) despite the weak retail sales induced set back.   

I also look for GBP to extend gains against the USD over coming months, with GBP/USD likely to end the year in the 1.70-1.80 region rather than low 1.60s where it is now. Market positioning leaves plenty of scope for GBP short covering over coming weeks adding further potential for recovery.  GBP appreciation will not continue in a straight line however, but set backs going forward should be looked upon as providing opportunities to rebuild long positions.

Posted in bank rescue, central banks, Currencies, Economics, Economy, Europe, Financial crisis, Monetary Policy, UK. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Not all doom and gloom in the UK

May 6, 2009 — Mitul Kotecha

There is a particularly depressing headline in the UK Telegraph stating that Britons will have to work until the age of 70 to bring public debt under control.  The NIESR who made the prediction believes that the UK will have to take drastic measures such as raising the retirement age, drastically raising taxes, and/or sharply cutting spending to reduce the debt burden in the wake of government borrowing plans amounting to £175 billion (see A taxing time in the UK).  

All of these look unpalatable but there is little choice otherwise future generations will have to pay a heavy price and/or investor demand for government debt could collapse.   At the same time the NIESR forecasts that the UK economy will drop by a whopping 4.3% this year, which is more pessimistic than government forecasts.   

The size of the debt burden is clearly distressing but by now most of us have likely got over the shock of the budget announcements.  Although the issue will not go away quickly attention is turning to some positive signs emerging in the UK economy and the housing market.  For instance, amidst the gloom of the NIESR predictions they also forecast that the economy will begin to grow again in the fourth quarter of this year.   

There was also a separate report just released showing that UK consumer confidence rose the most in close to 2-years according to the Nationwide.  Importantly, the gauge of future expectations rose sharply, suggesting a recovery in the months ahead.  Added to evidence that mortgage approvals have risen to a 10-month high, whilst manufacturing and service sector confidence have improved, it looks as though the economy and the housing market are finally beginning to bottom out.    

All of this will take some of the pressure off the Bank of England but it does not mean that the BoE’s £75 billion asset purchase plan will be scaled back any time soon.   Moreover, interest rates are likely to remain on hold at the low level of 0.50% for several months to come, which in turn is good news for consumers and borrowers alike.   So, perhaps its time to shake off the gloom and look ahead as the worst for the beleaguered consumer has likely passed.

Posted in central banks, Economics, UK. Tags: , , , , , , . 2 Comments »
« Older posts