Tarnishing The Euro

February 11, 2010 — Mitul Kotecha

I am just finishing up a client trip in Japan and waiting to take a flight back to Hong Kong. The time ahead of the flight has allowed some reflection on my meetings here. One thing that has been particularly evident is the strong interest in all events European. Some I have spoken to have wondered out loud whether this the beginning of the end of the European project.  At the least it is evident that fiscal/debt problems in Greece and elsewhere in Europe have tarnished the image of the EUR.

Markets continue to gyrate on any news about Greece and the potential for support from the Europe Union and/or IMF. The divergent views between European countries about how to deal with the problem has intensified, suggesting that reaching an agreement will not be easy. Some countries including the UK and Sweden have suggested enrolling the help of the IMF but this has been resisted by other European countries. Germany and France are trying to rally support ahead of today’s crucial meeting of European officials.

The EUR reacted positively to news that some form of support package is being considered but nothing concrete has appeared yet, leaving markets on edge. The EUR has been heavily sold over recent weeks; speculative market positioning reached a record low in the latest week’s CFTC Commitment of Traders’ IMM report. The fact that EUR positioning has become so negative suggests that the EUR could rebound sharply in the event that some support package for Greece is announced.

Any package will not come without strings attached, however, as European officials will want to avoid any moral hazard. A couple of options hinted at by German officials include fresh loans or some form of plan to purchase Greek debt. Either way, any solution to Greece’s problems will not be quick and will likely result in a sharp contraction in economic activity as the government cuts spending especially as Greece does not have the option of the old remedy of devaluing its currency. Meanwhile, strikes and social tensions in the country could escalate further. A solution for Greece will only constitutes around 2.5% of eurozone GDP will also not prevent focus from continuing to shift to Portugal, Spain and other countries with fiscal problems despite comments by Moody’s ratings agency to differentiate between the countries.

Even if the EUR rebounds on any positive news about support for Greece any relief is likely to prove temporary and will provide better levels to sell into to play for a medium term decline in the currency. Ongoing fiscal concerns, a likely slower pace of economic recovery, divergencies in views of European officials, and the fact that the EUR is still overvalued suggests that the currency will depreciate over much of 2010, with a move to around EUR/USD 1.30 or below in prospect over coming months.

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PIIGS fears fuelling risk aversion

January 29, 2010 — Mitul Kotecha

Risk aversion has come back with a vengeance over the last 10 days driven by a host of concerns that continue to damage market sentiment. As has been evident over the past year the USD and JPY remain the best currency plays against the background of rising risk aversion and both currencies look well supported.

Market concerns are not going away quickly but some of the fears plaguing markets have at least receded especially on the US political front, with Obama’s State of the Union address, Geithner’s testimony on AIG and Bernanke’s reappointment all passing without too much incident, at least from a market perspective. I still believe that market fears are overblown but it is clearly evident that the market is not in the mood to concur. More pain is likely in the weeks ahead.

Euro-sovereign spreads continue to suffer from the ongoing Greek saga whilst the other major fear remains further monetary tightening in China. Rumours that China is about to imminently revalue the CNY are also running rife. The bigger than expected hike in the reserve ratio in India reflects the fact that Asia is on a faster track to tighten policy than Western economies.

As regular readers probably noticed, my articles on econometer.org have been sporadic recently. This is due to the fact that I have been on the road for the last two weeks giving client seminars across several countries in Asia. Without giving too much away it is evident that pessimism is pervasive and most investors I polled are looking for a “W” or “double dip” profile for economic growth in the G7 economies over coming months. Hardly anyone looked for a “V”.

The other casualty emanating from Greece’s woes, as well as worries that other European PIIGS (Portugal, Italy, Ireland, Greece, Spain) face ratings downgrades, is the EUR. EUR/USD slipped below the psychologically important level of 1.40 this week and is showing no sign of turning around. Warnings by S&P ratings that Portugal faces challenges on the fiscal front show that these sovereign concerns will be with us for a long while yet.

After letting investors believe that the European Commission would offer no support for Greece, there appears to be a growing realization that Greece is not simply a local problem but a Euro wide problem, as noted by European Commission President Barroso. Whilst this may be good for Greek debt the path to recovery is still likely to be a massively painful one, and the EUR may gain little support from this news.

The UK has not escaped the clutches of ratings agencies and warnings by S&P that UK banks are no longer among the “most stable and low-risk” in the world highlights the headwinds faced by GBP at present. The weaker than expected out-turn for Q4 GDP (0.1%) highlights the fact that UK economic recovery is fragile, which in turn plays negatively for the banking sector. This news has put a break on GBP but there appears to be plenty of demand for GBP above 1.600 vs USD.

Posted in Asia, Bond markets, central banks, China, Currencies, Economics, Economy, emerging markets, Europe, Financial crisis, Fiscal/Budget, FX, Greece, India, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

AUD and NZD outperformance

December 10, 2009 — Mitul Kotecha

Just as the euro looked as though it was showing some signs of rebounding following the battering it received in the wake of the downgrade of Greece’s credit ratings, S&P placed Spain on credit watch negative from neutral, which helped drag EUR/USD all the way down again. Expect more to come as sovereign risk concerns / fiscal deficit remain in focus. EUR/USD was helped by the usual sovereign demand, preventing a test of technical support around 1.4625 but another push lower is likely over the short term.

Despite a tough budget from Ireland yesterday, it alongside the likes of Latvia, Ireland, Hungary and Portugal will remain on the ratings agencies’ hit lists. Eurozone periphery bond spreads have widened sharply against bunds but even larger countries in Europe such as Italy have seen an increase in funding costs. Added to these concerns are the lingering uncertainties about Dubai as reflected in the continued rise in CDS.

In contrast, growth worries are receding quickly in Australia where another robust jobs report was released. Employment rose 31.2k in November, with an upward revision to the previous month, to 27.2k from 24.5k initially. The details looked good too, with much of the jobs increase coming from full time hires (30.8k). The jobless rate fell to 5.7% compared to 5.8% in October. Taken together with the hawkish slant to the RBNZ statement, the data will help keep the AUD and NZD resilient to any sell off in risk trades.

The decision by the RBNZ to leave interest rates unchanged at 2.5% came as no surprise. However, Governor Bollard did shift away from the earlier pledge not to hike interest rates until H2 10 and stated that a hike could come around the middle of 2010. The RBNZ also upgraded its growth forecasts. A rate hike could come even earlier in my view, a factor likely to keep the NZD well supported.

Markets will digest more interest rate decisions today, in the UK and Switzerland. No change is likely from both the BoE and SNB but the issue of QE will remain at the forefront, especially given the split decision by the BoE MPC at the last meeting. As for the SNB the usual concerns about CHF strength are likely to be expressed but the tone of the SNB’s comments are likely to remain dovish, expressing little urgency to begin implementing an exit strategy.

The US data slate is light but does include weekly jobless claims and October trade data. There will be more interest than usual on the claims data given the surprise in last week’s payrolls report. Claims have been on an improving trend declining at a more rapid pace than previous recessions and markets will eye the numbers to determine whether they point to further improvement in payrolls or whether they suggest the November data was merely an aberration.

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Ratings Concerns Hit Euro

December 9, 2009 — Mitul Kotecha

Post payrolls euphoria has faded quickly this week. Fed Chairman Bernanke’s cautious comments about growth had weighed on US markets earlier but it is now eurozone concerns that have come to the forefront. Markets were faced with a further reality check following a sharp drop in German industrial production and news that S&P put Greece on watch for a downgrade, with Fitch going a step further and downgrading Greece’s ratings to BBB+ with a negative outlook.

Greece with a budget deficit of 12.7% of GDP was picked on by the ratings agencies but sovereign debt / fiscal concerns apply to several countries across the eurozone. Indeed, since the recent Dubai shock, which continues to weigh on markets following a report today about an accelerated payment clause on $2 billion debt issued by the Emirates utilities provider, concerns have moved quickly to the health of government balance sheets. The potential for more European ratings cuts will keep sentiment towards eurozone markets cautious.

The UK should not be ignored in this respect and attention will turn to the UK pre-budget report though it’s difficult to see what Chancellor Darling can say that will help GBP. Other economic news has been disappointing with Australia registering a bigger than expected trade deficit in October and Japan recording a sharp downward revision to Q3 GDP, all of which will act to contribute to the “risk off” tone to markets today.

Although the direct brunt of the ratings downgrade was felt on Greek bonds the EUR has come under strong selling pressure registering a further sharp move lower from the 1.5141 high printed last week. Capitulation at the failure to break above recent highs led to some selling and this was exacerbated by the negative data and ratings news. EUR/USD is likely to have further to go on the downside but sovereign interest and bargain hunting will likely prevent a more severe decline. EUR/USD technical support is seen around 1.4623.

Posted in Bond markets, central banks, Currencies, Economics, Economy, Europe, FX, Middle East, US. Tags: , , , , , , , , , , , , , , , , . 1 Comment »

Contemplating Rate Hikes

October 28, 2009 — Mitul Kotecha

The market mood has definitely soured and risk appetite has faltered.  This is good for the USD but bad for relatively high yielding/commodity risk trades. The USD is set to retain a firm tone over the near term even if is temporary, which I believe it is.  

Whether it’s profit taking on crowded risk trades, a lot of good news having already been priced in, fears that other countries will follow Brazil’s example of taxing capital inflows to dampen currency strength, or a reaction to weaker economic data, it is clear that there are many reasons to be cautious. 

It is also unlikely to be coincidental that the rise in risk aversion and drop in equity markets is happening at a time when many central banks are contemplating exit strategies and when many investors are pondering the timing of interest rates hikes globally following the moves by Australia and Israel. 

One of the reasons for the worsening in market mood is that some parts of the global economy may not be ready for rate hikes.  Certainly there is little chance of a US rate hike on the horizon and perhaps not until 2011 given the prospects of a sub par economic recovery.  This projection was given support by the surprise drop in US consumer confidence in October.

It is not just the US that is unlikely to see a quick reversal in monetary policy.  As indicated by the bigger than expected decline in annual M3 money supply growth in the eurozone, which hit its lowest level since the series began in 1980, as well as the drop in bank loans to the private sector, the ECB will be in no hurry to wind down its non-standard monetary policy measures. 

The chances of any shift in policy at next week’s ECB meeting are minimal, with the ECB’s cautious stance emboldened by the subdued money supply and credit data.  As long as EUR/USD remains below 1.50 ECB President Trichet is also unlikely to step up his rhetoric on the strength of the EUR.  

Although the major economies of US, Eurozone, Japan and UK are likely to maintain current policies for a long while yet, the stance is not shared elsewhere.  The Reserve Bank of India did not raise interest rates following its meeting this week but edged in this direction by requiring banks to buy more T-bills. Other central banks in the region are set to move in this direction.

In terms of developed economies, Norway was the latest to join the club hiking rates by 25bps and adding to the growing list of countries starting the process of policy normalisation.   Australia is set to hike rates again at next week’s meeting although a 50bps hike looks unlikely, with a 25bps move more likely. 

Posted in Asia, Bond markets, central banks, Commodities, Currencies, Economics, Economy, emerging markets, equity markets, India, Interest rates, Japan, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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