EUR Supported, AUD dives, NZD jumps

June 9, 2011 — Mitul Kotecha

Today is probably not the best day to sell EUR given that the ECB policy decision looms on the horizon. Whilst there is a risk of a ‘buy on rumour, sell on fact’ impact on the EUR following the European Central Bank (ECB) decision later today the relatively high probability that the ECB flags a rate hike in July will likely give further support to the EUR especially as it is not fully priced in by the market.

Of course should ECB President Trichet fail to mention “strong vigilance” in his press conference the EUR could suffer but this is likely to be a lower probability event. Some justification for higher rates will come from an upward revision in the ECB’s inflation forecasts. Consequently EUR/USD looks well supported around 1.4450.

The Bank of England is unlikely to deliver any surprises today, with an unchanged policy rate outcome and asset purchases target likely. The outcome will keep GBP restrained versus USD but given the likely contrast with the ECB, EUR/GBP could head higher as the currency pair continues to set its sights on the 0.90 level.

Even against the USD, GBP is unlikely to extend its gains, with 1.6474 likely providing a near term technical cap. The dichotomy of weaker activity and higher inflation is clearly causing a problem for policy makers but we still believe a rate hike is likely later in the year. In the meantime GBP remains vulnerable to further data disappointments over coming weeks.

There was more bad news for the AUD today in the form of a weak than forecast May employment report. The data will reinforce expectations that the RBA will not hike interest rates over coming months, with July and August effectively ruled out, though a hike in September remains probable.

The data had major impact on AUD which dropped sharply below the 1.0600 handle versus USD. Clearly the combination of the RBA statement and weak jobs data has resulted in a major headwind against further near term AUD appreciation. AUD will remain under downward pressure in the short-term, with technical support seen at 1.0440.

Unlike the RBA the Reserve Bank of New Zealand (RBNZ) opened the door for higher interest rates following its unchanged policy decision today, with the Bank stating that “a gradual increase in the overnight cash rate over the next two years will be required”. Despite noting some caution about the strength of the NZD and its impact on the economy the Kiwi strengthened versus the USD

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EUR Becomes The Anti USD

June 8, 2011 — Mitul Kotecha

The USD is close to giving back the full extent of the gains it made during May. The USD index hit a low of around 72.696 on 4th May and looks on track to re-test this level.

It would be easy to say that the USD is being undermined by low US bond yields but whilst this is partly true only USD/JPY has had a significant correlation with bond yield differentials over the past 3-months.

The reality is that the EUR has become the anti USD at present. Whilst the EUR composes 57.6% of the USD index which would imply a high correlation between the USD index and EUR, it does not explain the fact that the correlation over the past 3-months is at an extremely high 0.98.

It is probably a relief for USD bulls that the currency is not being particularly influenced by yield differentials at present as it would be even weaker if it was so. US bond yields continue to be depressed by growth concerns, following a spate of weaker US data releases, culminating in the May jobs report last week.

Speculation about QE3 is similarly unhelpful for the USD but the prospects of this occurring are still very slim and notably whilst Bernanke highlighted the “frustrating slow” economic recovery in a speech last night he did not indicate a desire to embark on QE3.

Nonetheless, any clues about Fed policy will be closely scrutinised and this includes today’s Beige Book of regional economic conditions. Our expectation of a relatively downbeat report suggests that the USD will find no support from this source.

Ultimately USD recovery will require EUR weakness but the European currency appears to have regained its ‘Teflon’ coating as its resistance to bad news grows once again. The EUR was helped yesterday by a stronger than expected April retail sales report and will undoubtedly find further solace from confirmation of a strong start to the year in terms of Q1 GDP today.

Overall direction continues to come from news in the eurozone periphery, however. The fact that officials appear to be inching towards an agreement in Greece has clearly been appreciated by the EUR. Moreover, potential ECB backing for debt rollovers by private investors will alleviate some concerns.

Nonetheless, at current levels, with EUR/USD on the path to its 4th May high around 1.4940 it appears that a lot is already priced in and the scope for disappointment is high.

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US Economic Data Disappointments

June 2, 2011 — Mitul Kotecha

Risk gyrations continue, with a sharp shift back into risk off mood for markets driven in large part by yet more disappointing US economic data as the May ADP jobs report came in far weaker than expected at 38k whilst the ISM manufacturing index dropped to 53.5 in May, its lowest reading since September 2009. This was echoed globally as manufacturing purchasing managers indices (PMI) softened, raising concerns that the global ‘soft patch’ will extend deeper and longer than predicted.

The market mood was further darkened by news that Moodys downgraded Greece’s sovereign credit ratings to Caa1 from B1, putting the country on par with Cuba and effectively predicting a 50% probability of default.

The resultant jump in risk aversion was pretty extensive, with US Treasury yields dipping further, commodity prices dropping led by soft commodities, and equity volatility spiking although notably implied currency volatility has remained relatively well behaved.

Global growth worries led by the US have now surpassed Greek and eurozone peripheral country concerns as the main driver of risk aversion, especially as it increasingly looks as though agreement on a further bailout package for Greece is moving closer to being achieved. Moreover, it seems as though a ‘Vienna initiative’ type of plan is moving towards fruition involving a voluntary rollover of debt.

The lack of first tier economic data releases today suggests that it will be a case of further digestion or perhaps indigestion of the weak run of US data releases over recent weeks and the implications for policy. For instance, it is no coincidence that QE3 is now being talked about again following the end of QE2 although it still seems very unlikely.

Bonds may see some respite from the recent rally given the lack of data today although this may prove short-lived as expectations for the May US jobs report tomorrow are likely to have been revised sharply lower in the wake of the weak ADP jobs data and ISM survey yesterday, with an outcome sub 100k now likely for May US non-farm payrolls.

Meanwhile, FX markets are caught between the conflicting forces of higher risk aversion and weaker US data, leaving ranges to dominate. On balance, risk currencies will likely remain under pressure today and the USD may get a semblance of support in the current environment.

This may be sufficient to prevent EUR/USD from retesting its 1 June high around 1.4459 as markets wait for further developments on the Greek front. Once again the likes of the CHF and to a lesser extent JPY will do well in a risk off environment whilst the likes of the AUD and NZD will suffer.

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Risk on, risk off

May 27, 2011 — Mitul Kotecha

The USD has lost some upward momentum as risk appetite improved but FX markets remain skittish as sentiment gyrates between ‘risk on’ and ‘risk off’. The fact that US Q1 GDP was left unrevised whilst jobless claims surprisingly increased together with ongoing Greece concerns suggests that a risk off mood may filter into markets despite positive US earnings. Although the USD has not particularly benefitted from any rise in risk aversion lately, worries about the next IMF tranche being withheld from Greece will likely play more positively for the USD.

Nonetheless, lurking in the background and helping to keep the USD restrained is the Fed’s ongoing asset purchases as QE2 remains in place until the end of June. Moreover US data disappointments points to risks that the Fed will only slowly embark on its exit strategy. Additionally any agreement towards extending the US debt ceiling appears to be far off, and threatens to go down to the wire all the way to August 2. US debt markets and the USD appear to be downplaying this issue at present but it remains a clear threat to US markets.

Continuing to limit any upside in the EUR is the fact that officials and markets continue to gyrate on whether Greece will or will not restructure its debt. Apparent divisions between the view of some officials and the ECB are adding to the confusion whilst fresh worries about the IMF withholding funding for Greece will likely keep EUR/USD capped.

Peripheral worries as well as growth concerns are clearly weighing on confidence and a broad based decline in economic and business confidence in various eurozone May measures is expected to be revealed in data today . Weaker data taken together with ongoing concerns about the eurozone periphery will likely see the EUR struggle, with the currency set to settle into a range versus USD over the short-term, with technical support around 1.3968 and resistance at 1.4210.

The loss of USD momentum has also been exhibited in USD/JPY which has turned lower following its recent upward move hitting a low around 81.09. The big news was the fact that April nationwide core CPI recorded its first YoY increase since December 2008. At the margin may reduce the pressure on the Bank of Japan (BoJ) to enact more aggressive policy measures, which in turn is positive for the JPY. A big factor contributing to keeping the JPY supported over recent weeks is the ongoing inflow of foreign capital into Japan’s bond and equity markets, with Japan recording six straight weeks of net inflows.

USD/JPY is one currency pair where the correlation with US – Japan 2-year bond yield differentials is holding up well over the past 3-months. The fact that the yield differential has dropped to its lowest level since November 2010 at around 30bps reveals the declining US yield advantage, and plays for a lower USD/JPY. Against this background the JPY is likely to remain supported in the short-term, but will find it tough to break through technical support around USD/JPY 80.15.

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Risk off mood

May 23, 2011 — Mitul Kotecha

A ‘risk off’ tone is quickly permeating its way through the market psyche as tensions surrounding the eurozone periphery reach fever pitch. This is reflected in the sharp jump in equity volatility as indicated by the VIX ‘fear’ gauge. Equity markets and risk trades in general look set to remain under pressure in the current climate.

Moreover, the EUR which is finally succumbing to bad news about the periphery will continue to face pressure over the short-term. Against this background economic data will likely be relegated to the background this week but it worth noting that what data there is on tap, is likely to send a weaker message, with data such as durable goods orders in the US as well as various purchasing managers indices (PMI) data in the eurozone today likely to show some slippage.

The Greek saga remains at the forefront of market attention, with restructuring speculation remaining high despite various denials over the weekend by Greek and European Central Bank (ECB) officials. News that Norway has frozen payments to Greece, whilst Fitch ratings agency’s downgrades of Greece’s ratings by 3 notches and S&P’s downgrade of Italy’s ratings outlook to negative, have all contributed to the malaise afflicting the periphery.

This weekend’s local election in Spain in which Prime Minister Zapatero and his Socialist Party suffered its worst defeat in more than 30 years leading to a transfer of power in the Spanish regions, will lead to concerns about the ability of the government to carry out much needed legislative changes.

It is difficult to see any improvement in sentiment towards the peripheral Europe and consequently the EUR over the short-term. In Greece, Prime Minister Papandreou will attempt to push through further unpopular austerity measures through parliament this week in advance of a 5th bailout tranche of EUR 12 billion scheduled for next month. This comes at a time when opinion polls show the government losing more support and 80% of those surveyed saying they would not accept more austerity measures.

The deterioration in sentiment for the EUR has been rapid as reflected in the CFTC IMM data, with net long speculative positions now at their lowest since 15 February and heading further downhill. Conversely, USD short covering has been significant though there is still a hefty USD short overhang, which points to more USD short covering as EUR sentiment sours.

Nonetheless, the USD still has plenty of risks hanging over it including the fact that it still suffers from an adverse yield differential (note that 2-year Treasury yields have fallen to the lowest since 6 December 2010). Safe haven currencies in particular CHF are the key beneficiaries and notably EUR/CHF touched a record low around 1.2354 and is showing little sign of any rebound.

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