Weak USD will not persist, CHF to drop eventually

March 28, 2012 — Mitul Kotecha

Risk appetite has deteriorated slightly since the Bernanke fuelled bounce earlier this week but there does not appear to be much of a directional bias for markets either way. Interestingly Treasury yields continue to pull back even while equity markets have softened overnight.

Data has been mixed, with US consumer confidence dipping in March albeit not as much as expected while US house prices also did not drop by as much as anticipated. Data releases on tap today include monetary aggregates in the Eurozone and durable goods orders in the US. The tone will likely continue to be slightly ‘risk off’.

The USD has come under growing pressure since its mid March high, with the EUR in particular taking advantage of its vulnerability. A combination of improving risk appetite and a correction lower in US Treasury yields in the wake of relatively Fed comments have been sufficient to deal the USD a blow.

However, the outlook for the USD is mixed today as on the one hand it will be helped by a reduction in risk appetite but hit on the other by a drop in US Treasury yields overnight. Data today should be a little more constructive for the USD, with a likely bounce back in durable good orders in February.

Overall, I do not expect the weak USD bias to persist especially as it is based on unrealistic expectations that the Fed will still implement more quantitative easing. Indeed, while further Fed easing is possible it may not need to involve an expansion of the Fed’s balance sheet.

EUR/CHF remains pinned to the 1.20 ‘line in the sand’ imposed by the Swiss National Bank while the CHF has strengthened over recent weeks against the USD. Economic data has deteriorated over recent months, with the forward looking Swiss KoF leading indicator pointing to a further weakening.

We will get further news on this front on Friday with the latest KoF release, with a slight a bounce expected. In turn, bad news on the economic front is adding to pressure for CHF weakness. Market positioning in CHF is negative but there is plenty of scope to increase short positioning in the months ahead given that short CHF positions remain well off their all time highs.

Eventually as risk appetite improves and the US yield advantage widens against Switzerland, both EUR/CHF and USD/CHF will move higher.

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USD boosted by bond yields, AUD vulnerable

March 14, 2012 — Mitul Kotecha

The USD rallied further overnight helped by a Fed FOMC statement that was less downbeat than in January, with no hint of any further quantitative easing. In combination with a solid February retail sales report and upward revisions to December and January, US bond yields pushed higher. US 2-year Treasury yields hit their highest since the beginning of August 2011, which given the strong correlation with the USD, provided further support to the currency.

The highest FX sensitivity to yield differentials is found in JPY, AUD, SEK, and CAD over the past 3-months. However, among these US yields have only widened against Japan over recent days meaning this currency is the most vulnerable. For the other currencies their yields have actually been widening against the USD. Over the near term, the USD is set to remain well supported, especially as data releases over the rest of the week will maintain the tone of strengthening economic activity.

AUD looks increasingly vulnerable to further short term slippage. At least partly explaining the recent drop in AUD/USD is a narrowing in Australia’s yield advantage over the US. A spate of weaker data over recent weeks has helped to undermine the currency including Q4 GDP data which revealed a far slower pace of growth than had been expected. Weak jobs data reinforced the view that the economy is spluttering.

The net result is that Australian interest rate futures have rallied and implied yields have dropped in contrast to the US where futures have sold off in the wake of strengthening economic data. The casualty of all of this is the AUD and it appears that further downside risks are in store for the currency. Indeed my quantitative models show that the AUD continues to trade well above its short term ‘fair value’. For those wanting to take medium term long positions in the AUD I would suggest rebuilding longs around 1.03-1.04 versus USD.

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Limbo ahead of Fed FOMC meeting

March 13, 2012 — Mitul Kotecha

A mixed session overnight leaves markets with little direction ahead of the Bank of Japan and Federal Reserve FOMC meetings today. There was no stimulus for markets from the meeting of European officials yesterday while Greece’s debt swap has failed to boost confidence.

Overall there is a real hesitancy for investors to take positions, with both volumes and volatility remaining very low. For instance the VIX volatility gauge has dropped to its lowest level since May 2011 while my measure of composite FX volatility continues to languish at relatively low levels compared to last year.

The USD has little to fear from the Fed FOMC meeting tonight. If anything it may even benefit from a less downbeat statement from Fed Chairman Bernanke following the meeting. Growing speculation that the Fed will embark on some form of sterilised quantitative easing, i.e. not printing any more money, bodes well for the USD too.

Ahead of the FOMC decision a firm February retail sales report will help add to the plethora of evidence revealing stronger signs of US recovery. A key indicator to watch in this respect is the (National Federation of Independent Business (NFIB) report of small business confidence which should also strengthen. Importantly for the USD the data should also help to maintain pressure on US bonds, keeping yields elevated and in turn the USD supported.

The BoJ meeting today will not deliver any surprises, an outcome that will likely leave the JPY largely unmoved. Speculative sentiment for the JPY has shifted negatively as reflected in the latest CFTC IMM report which reveals the biggest short position in the currency since April last year.

Crucial in pushing the JPY weaker has been the widening in bond yield differentials with the US, thanks largely to a rise in US bond yields. The 2-year yield gap is now around 20 basis points, the highest gap since August 2011. This will help to keep USD/JPY supported but my quantitative models suggest that the upmove may be overdone in the short term, with a correction lower in prospect to technical support around 81.44.

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Euro on the front foot

February 27, 2012 — Mitul Kotecha

The G20 meeting of leaders in Mexico over the weekend did not make much progress in terms of increasing the size of the International Monetary Fund (IMF) or increasing support for the Eurozone. A decision on this has been delayed until the next meeting on 19-20 April. Instead attention has turned to the various bailout votes across Eurozone countries and discussions over increasing the firewall (by boosting the size of the bailout fund) around the Eurozone periphery. Germany continues to oppose any increase in the firewall. Sentiment will hinge this week on the outcome of these events rather than data releases.

The USD has come under growing pressure but this is as reflection of a stronger EUR rather than inherent USD weakness. Data releases in the US have continued on a positive track yet the USD has failed to benefit as higher US bond yields have been matched elsewhere. Business and consumer confidence measures over coming days are also likely to reveal some encouraging outcomes while the Beige Book will report improvement in economic activity but the USD will continue to be restrained.

The EUR is looking increasingly stretched from a fundamental perspective yet technical indicators show it to be on a stronger footing. EUR/USD will find strong resistance around the 1.3550 level and the currency could still stumble over coming days depending on the outcome of Wednesday’s ECB Longer term refinancinf operation (LTRO).

Various policy events will also help dictate EUR direction including national parliamentary votes on the Greek bailout and the EU Summit. Theoretically a large uptake by banks at the LTRO could result in more EUR liquidity and a weaker EUR but the reality is quite different. Improved sentiment in peripheral bond markets as LTRO funds are used to buy local debt are helping the EUR to push higher, with its short covering rally gaining more traction.

GPB has come under pressure in the wake of a stronger EUR, but we still expect EUR/GBP’s charge to falter. My quantitative models show that the currency pair is overbought and we will likely struggle to break above 0.85. If it does, EUR/GBP 0.8562 will prove to be a strong resistance level. UK data this week will likely give some support to GBP, with the manufacturing purchasing managers index (PMI) set to strengthen further. However, the release of a relatively dovish set of Bank of England (BoE) Monetary Policy Committee (MPC) minutes has helped to undermine GBP for the time being, meaning that any recovery will be limited in the near term.

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Australian and NZ Dollar Outperform

January 27, 2012 — Mitul Kotecha

The boost to EUR following the dovish tone of the Fed FOMC statement on Wednesday has faded although the EUR looks well supported against the USD, JPY and GBP. Further gains against the USD will however, be limited to around 1.3201 (21 December 2011 high and 61.8% retracement from its 1.3553 high).

Reports overnight that Greek private lenders were willing to accept a coupon rate below 4% helped to boost confidence of an imminent deal with regard to Greek debt restructruing. Ahead of next week’s EU Summit the EUR will consolidate its gains, with attention focussing on a meeting between German Chancellor Merkel, Italian Prime Minister Monti, and French President Sarkozy on Monday.

USD/JPY has become insensitive to moves in most of its usual drivers. Bond yield differentials have lost influence over recent months despite a very strong relationship in the past. Similarly USD/JPY is also not particularly sensitive to moves in the USD index or risk aversion, with these relationships also breaking down lately according to my correlation calculations. Net foreign portfolio flows should in theory be playing negative for the JPY with outflows from bond and equity flows recorded in 8 of the last 10 weeks.

However, the reality is that USD/JPY remains stubbornly entrenched in a narrow 77-78 range. While a base appears to have been formed around the 77.00 level the upside momentum for the currency pair is weak. I stand by my view of USD/JPY ending the quarter around current levels given the loss of influence of its usual drivers but still look for an eventual move higher.

AUD and NZD have performed extremely well over recent weeks recording the biggest gains among major currencies so far this year. Both currencies have been boosted by improving risk appetite and receding growth worries in China. AUD in particular looks attractive in the wake of the dovish Fed and relative high AUD yield. I continue to believe markets are too dovish on Australian policy rate expectations, with markets pricing in more rate cuts this year beginning in February. Any reversal in easing expectations will support AUD.

AUD is also benefiting from diversification flows, with Russia’s central bank noting that it may begin to buy AUD in February. Nonetheless, AUD/USD gains look overly aggressive in a short space of time, with positioning turning increasingly long. AUD/USD will face strong resistance around 1.0753 over coming days.

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