Fed’s status quo fuels caution

June 23, 2011 — Mitul Kotecha

The Fed’s status quo did little to stir markets overnight although there was a decidedly negative tone to equities and commodities, perhaps spurred by the downgrading of US growth forecasts. The fact that the Fed did not indicate that it is considering further asset purchases but instead will keep its balance sheet at around $,2800 billion also acted as a drag on markets.

The major concern for markets remains the depth and length of the current ‘soft patch’. The Fed believes it will be temporary and we concur, but clearly the slide in equity markets over recent weeks, suggests that there has been a divergence between stock market expectations and reality. The USD however, may actually be finding a medium term bottom, with the fact that the Fed is not considering QE3,

The downbeat Fed stance combined with a cautious reaction to the Greek government’s passage of a confidence motion indicates that markets will remain cautious over the near term. Indeed, comments by the Greek opposition that they will not support further austerity measures dashed any hopes of unity and will add another obstacle towards an easing in Greek tensions.

As it is the continued wrangling between European officials over private sector participation in any debt rollover as well as uncertainty over how ratings agencies will react, threatens to keep sentiment under pressure. The EUR has remained surprisingly resilient but its muted reaction to the passage of the confidence motion has given way to some weakness and the currency remains a sell on rallies.

GBP was a major underperformer weighed down by the relatively dovish Bank of England MPC minutes in which some members were even discussing further asset purchases. The currency faces further risks from a the CBI reported sales data for June where a decline in sales is likely to be reported. GBP/USD looks vulnerable to a drop below its 200 day moving average around 1.6027.

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Japanese FX Intervention

September 15, 2010 — Mitul Kotecha

The Bank of Japan acting on the behest of the Ministry of Finance intervened to weaken the JPY, the first such action since 2004. The intervention came as the USD was under broad based pressure, with the USD index dropping below its 200-day moving average. USD/JPY dropped to a low of around 82.88 before Japan intervened to weaken the JPY. The move follows weeks of verbal intervention by the Japanese authorities and came on the heels of the DPJ leadership election in which Prime Minister Kan retained his leadership.

One thing is for certain that Japanese exporters had become increasingly concerned, pained and vocal about JPY strength at a time when export momentum was waning. However, the move in USD/JPY may simply provide many local corporates with better levels to hedge their exposures.

Time will tell whether the intervention succeeds in engineering a sustainable weakening in the JPY but more likely it will only result in smoothing the drop in USD/JPY over coming months along the lines of what has happened with the SNB interventions in EUR/CHF. As many central banks have seen in the past successful intervention is usually helped if the market is turning and in this case USD/JPY remains on a downward trajectory.

Although the BoJ Governor Shirakawa said that the action should “contribute to a stable foreign exchange-rate formation” it is far from clear that the BoJ favoured FX intervention. Indeed, the view from the BoJ is that the move in USD/JPY is related less to Japanese fundamentals but more to US problems.

Now that the door is open, further intervention is likely over coming days and weeks but for it to be effective it will require 1) doubts about US growth to recede, 2) speculation of Fed QE 2 to dissipate, 3) and consequently interest rate differentials, in particular bond yields between the US and Japan to widen in favour of the USD. This is unlikely to happen quickly, especially given continued speculation of further US quantitative easing. A final prerequisite to a higher USD/JPY which is related to the easing of some of the above concerns is for there to be an improvement in risk appetite as any increase in risk aversion continues to result in JPY buying.

When viewed from the perspective of Asian currencies the Japanese intervention has put Japan in line with other Asian central banks which have been intervening to weaken their currencies. However, Asian central bank intervention has merely slowed the appreciation in regional currencies, and Japan may have to be satisfied with a similar result. Japan’s intervention may however, give impetus to Asian central banks to intervene more aggressively but the result will be the same, i.e. slowing rather then stemming appreciation.

As for the JPY a further strengthening, with a move to around 80.00 is likely by year end despite the more aggressive intervention stance. Over the short term there will at least be much greater two-way risk, which will keep market nervous, especially if as is likely Japan follows up with further interventions. USD/JPY could test resistance around 85.23, and then 85.92 soon but eventually markets may call Japan’s bluff and the intervention may just end up putting a red flag in front of currency markets to challenge.

Posted in Asia, central banks, Currencies, Economics, Federal Reserve, FX, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , . 1 Comment »

Two-way FX risk returns

August 18, 2010 — Mitul Kotecha

It appears that there is a bit of a sea change taking place in currency markets. Since early June the trend in currency markets would have looked like a one way bet to most casual observers. For instance, the USD index was declining fairly steadily and predictability as US growth worries intensified and markets anticipated a resumption of quantitative easing by the Fed. This changed quite dramatically over recent days, with a significant degree of two-way risk re-entering the market as the USD shook off worries about Fed quantitative easing and instead rallied in the wake of higher risk aversion.

The introduction of two-way risk into the market will cause a rethink of the increasingly fashionable view that the USD was about to embark on a renewed negative trend. This change in market perspective has coincided with renewed concerns about European sovereign risks, even as European growth has come in much stronger than expected over Q2. Other currencies have also lost ground against the USD more recently, with the notable exception of the JPY which remains close to the psychological level of 85.00.

Until recently the move in FX markets since early June contrasted with my view that Q3 would be a period of uncertainty and volatility. Improved risk appetite reflected a decline in uncertainty but whilst I now believe that Q3 will see less of an increase in risk aversion than previously anticipated, my core views remain unchanged. I see the USD resuming an appreciation trend against the EUR and funding currencies (JPY and CHF) whilst weakening against higher yielding risk currencies (AUD, NZD and CAD) over the medium term.

Although FX markets will likely gyrate between the influences of risk aversion on the one hand and growth/interest rates on the other, risk is likely to take the upper hand over the coming weeks. The influence of risk aversion has jumped sharply over the last few weeks for almost all currencies. As risk appetite was improving as it has done for much of the period since early June, it played negatively for the USD but the recent increase in risk aversion – brought about by renewed growth concerns, sovereign worries in the eurozone, with Ireland in particular coming under scrutiny – has managed to reverse this trend. The one-way bet for investors now appears to be over.

Only time will tell if the EUR’s recent bull run has come to an end but there is sufficient evidence to suggest that plenty of good news has now been priced in and that further upside will be much more difficult to achieve. Even the recently strong growth data in the eurozone has thrown up potential problems including growing divergence as well as the potential for a slowdown over coming quarters. Further strengthening of the EUR will be a particular problem for eurozone growth, especially for exporting countries such as Germany. In any case, even the recent drop in the EUR leaves the currency at an overvalued level and susceptible to further falls. Over the coming weeks a period of consolidation is likely, with the EUR set to take a weaker tone.

The JPY in contrast has shown little sign of weakening and continues to flirt with the key psychological level of 85.00 much to the detriment of the Japanese economy, leading to growing frustration from Japanese officials. Much weaker than expected Q2 GDP data has given even more reason to engineer a weaker JPY but as yet the only intervention has come verbally and even this has not been particularly strong. In the absence of FX intervention, the Japanese authorities may be forced to consider other options such as increasing outright JGB purchases.

Like the EUR and JPY, GBP will find it tough to extend gains against the USD especially given that the doves at the Bank of England will likely remain in the ascendancy as growth moderates. GBP is also less undervalued than it was just a few weeks back suggesting that the argument for GBP strength has weakened. Nonetheless, GBP is likely to outperform against a generally weaker EUR ending 2010 around 0.78.

Similarly, CHF will likely maintain its strength against the EUR in the short term but unlike GBP this will likely give way to weakness and a gradual move higher in EUR/CHF to around 1.37 by year end. An eventual improvement in risk appetite and some relative economic underperformance will undermine the case for holding CHF.

Scandinavian currencies are likely to struggle in the short term due to market nervousness about a US double dip in an environment of elevated risk aversion. Interest rates will also play an important role in driving NOK and SEK as will be the case for most currencies eventually. Divergence in rate views for Norway and Sweden suggests holding a short SEK long NOK position. Overall, with two-way risk now much more evident as many investors return from their summer break the FX market will look far less predictable than it did before they left.

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