Euro pressure mounts

November 12, 2010 — Mitul Kotecha

The effects of eurozone peripheral bond concerns are cascading through eurozone markets and hitting risk appetite in the process. The EUR is a clear casualty having dropped further against the USD and versus other currencies. EUR/Asian FX remains a sell in the current environment. Contagion outside Greece, Portugal and Ireland had been limited but Italy and Spain have also seen a growing impact on their bond markets. Having broke below support around 1.3734, EUR/USD will target 1.3508 support.

Speculation that Ireland will be forced to follow Greece in seeking international financial support has intensified. Although Ireland has sufficient funds to last until next spring, yields on its debt are already higher than Greek debt before it received funds a few months back. Attention is firmly fixed on the country’s budget on 7 December and the prospects of an agreement between the government and opposition in its austerity plans.

Not helping is the fact that the Irish government has a very slim majority. Even if the budget is passed there is no guarantee that sentiment will improve given the negative impact of even deeper fiscal tightening announced last week will have on economic growth. Moreover, Germany’s insistence that the cost of any Greek style bailout should be borne mostly by private investors has only added to market tension. Even the European Central Bank is unlikely to provide much support, with ECB member Stark suggesting that ECB bond purchases will remain limited.

This leaves eurozone markets in a precarious state and the EUR continues to look heavy as further downside opens up. Moreover, the problems in peripheral Europe are beginning to have a broader impact on risk appetite, with equity markets slipping, although some of this was related to a weaker sales forecast from Cisco in the US. Nonetheless, spreading risk aversion could also dampen sentiment for Asian currencies, which is why selling EUR/Asian FX looks a better bet than selling USD/Asian FX over the short term.

In contrast sentiment for the US is undergoing an improvement. Data releases over recent weeks have generally beaten forecasts and there is even growing speculation that the Fed’s calibrated asset purchases may end up being smaller than planned. Such speculation has boosted the USD but it is premature to suggest that the Fed is on the verge of scaling back asset purchases even as the program of purchases gets going. Although there are clearly some FOMC members who are opposed to significant asset purchases the probability that the Fed remains set to carry out its full $600 billion of planned purchases.

Attention today will focus squarely on day 2 of the G20 meeting and any resolution to disputes over trade imbalances and currencies. Unfortunately none is likely to be forthcoming. Despite a reported 80 minute meeting between US and Chinese leaders little agreement was reached, with plenty of finger pointing remaining in place. It appears that the mantra of moving towards “market-determined exchange rates” and efforts at “reducing excessive imbalances” as agreed at the G20 meeting of finance ministers and central bankers will be as far as any agreement reaches. As a result markets will be left with very little to chew on.

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What QE2 means for currencies

November 5, 2010 — Mitul Kotecha

The sweeping gains for the Republican party in the US mid term elections has sharply changed the political dynamic in the US, with the prospects of further fiscal stimulus looking even slimmer than before although the chances of the Bush tax cuts being extended have likely increased.

The onus is on monetary policy to do the heavy lifting and the Fed delivered on its end of the bargain, with the announcement of $600 billion of purchases of long-term securities over 8-months through June 2011.

Given the likelihood that the economic impact of the asset purchases is likely to be limited and with little help on the fiscal front the Fed has got a major job on its hands and $600 billion may end up being a minimum amount of purchases necessary for the Fed to fulfil its mandate.

The decline in the USD following the Fed decision is unlikely to mark the beginning of a more rapid pace of USD decline though further weakness over coming months remains likely. The USD remains a sell on rallies for now and an overshoot on the downside is highly probable as the Fed begins its asset purchases.

The bottom line is that the Fed’s program of asset purchases implies more USD supply and in simple economic terms more supply without an increase in demand implies a lower price. The USD will remain weak for some months to come and the Fed’s actions will prevent any USD recovery as the USD solidifies its position as the ultimate funding currency.

Nonetheless, with market positioning close to extreme levels, US bond yields unlikely to drop much further, and the USD already having sold off sharply in anticipation of QE2, (USD index has dropped by around 14% since June) those looking for a further sharp drop in the USD to be sustained are likely to be disappointed.

It is difficult however, to fight the likely further weakness in the USD even if turns out not to be a rapid decline. The path of least resistance to some likely USD weakness will be via the likes of the commodity currencies, scandies and emerging market currencies. There will be less marked appreciation in GBP, CHF and JPY against the USD.

The Fed’s actions will continue to fuel a rush of liquidity into emerging markets, particularly into Asia. This means more upward pressure on Asian currencies but will likely prompt a variety of responses including stronger FX intervention as well as measures to restrict and control such flows.

There have been various comments from central banks in the region warning about the Fed’s actions prompting further “hot money” flows into the region and even talk of a coordinated response to combat such flows.

This suggests more tensions ahead of the upcoming G20 meeting in Seoul. Assuming that at least some part of the additional USD liquidity flows into Asia, the implications of potentially greater FX intervention by Asian central banks to prevent Asian currencies from strengthening, will have a significant impact on major currencies.

Already it is apparent that central banks in Asia have been strongly using the accumulated USDs from FX intervention to diversify into EUR and other currencies including AUD and even JPY. Perversely this could end up exacerbating USD weakness against major currencies.

Posted in Asia, Australia, central banks, Currencies, Economics, Economy, emerging markets, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Interest rates, Japan, Monetary Policy, Sweden, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

Temporary relief for US Dollar

October 15, 2010 — Mitul Kotecha

Downbeat US economic news in the form of a widening US trade deficit, increase in jobless claims and bigger than expected increase in top line PPI inflation contrasted with upbeat earnings from Google. Google shares surged over 9% in after hours trading but US data tarnished the risk on mood of markets, leaving commodity prices and equities lower and the USD firmer. Higher US Treasury yields, especially in the longer end following a poor 30 year auction, helped the USD to push higher.

The USD’s trend is undoubtedly lower but profit taking may be the order of the day ahead of a speech by Fed Chairman Bernanke on monetary policy later today and the release of the highly anticipated US Treasury Report in which China may be named as a currency manipulator. A speech by the Minneapolis Fed’s Kocherlatoka (non voter) this morning sounded downbeat, even suggesting that “Fed asset purchases may have a muted effect”. Despite such comments the Fed appears likely to embark on QE2 at its 3 November meeting.

Today is also a key data for US data releases with September data on US retail sales, and CPI and October data on Michigan confidence and Empire manufacturing scheduled for release. Retail sales are likely to look reasonable, with headline sales expected to rise 0.5% and ex-autos sales expected up 0.4%. The gauges of both manufacturing and consumer confidence are also likely to show some recovery whilst inflation pressures will remain benign. Given the uncertainty about the magnitude of QE the Fed will undertake in November, the CPI data will have added importance.

The US trade will likely have resulted in an intensification of expectations that China will be labelled as a currency manipulator in the US Treasury report later today. The August trade deficit with China widened $28.04 billion, the largest on record. At the least it will give further ammunition to the US Congress who are spoiling for a fight ahead of mid-term congressional elections, whilst heightening tensions ahead of the November G20 meeting.

Indeed currency frictions continue to increase although “currency war” seems to be an extreme label for it. Nonetheless, Singapore’s move yesterday to widen the SGD band highlighted the pressure that many central banks in the region are coming under to combat local currency strength. Singapore’s move may be a monetary tightening but it is also a tacit recognition of the costs of intervening to weaken or at least limit the strength of currencies in the region. To have maintained the previous band would have required ongoing and aggressive FX intervention which has its own costs in terms of sterilization.

This problem will remain as long as the USD remains weak and this in turn will depend on US QE policy and bond yields. A lot of negativity is priced into the USD and market positioning has become quite extreme suggesting that it will not all be a downhill bet for the currency. Many currencies breached or came close to testing key psychological and technical levels yesterday, with EUR/USD breaching 1.4000, GBP/USD breaking 1.6000, USD/CAD breaking below parity and AUD/USD coming close to testing parity. Some reversal is likely today, but any relief for the USD is likely to prove temporary.

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No FX co-operation

October 11, 2010 — Mitul Kotecha

Despite all the jawboning ahead of the IMF / World Bank meetings over the weekend the meeting ended with little agreement on how deal to with the prospects of a “currency war”. US officials continued to sling mud at China for not allowing its currency, the CNY, to appreciate quickly enough whilst China blamed the US for destabilizing emerging economies by flooding them with liquidity due to the Fed’s ultra loose monetary policy stance. Chinese trade data on Wednesday my throw more fuel on to the fire given another strong surplus expected, lending support to those in the US Congress who want to label China as a “currency manipulator”.

Although the IMF communiqué mentioned countries working co-operatively” on currencies there were no details on how such cooperation would take place. The scene is now set for plenty of friction and potential volatility ahead of the November G20 meeting in Seoul. Although many central banks are worrying about USD weakness when was the last time US Treasury Secretary Geithner talked about a strong USD? US officials are probably happy to see the USD falling and are unlikely to support any measure to arrest its decline unless the drop in the USD turns into a rout. In contrast, the strengthening EUR over recent weeks equates to around 50bps of monetary tightening, a fact that could put unwanted strain on Europe’s growth trajectory, especially in the periphery.

The outcome of the IMF meeting leaves things much as they left off at the end of last week. In other words there is little to stand in the way of further USD weakness apart from the fact that the market is already extremely short USDs. Indeed the latest CFTC IMM data revealed that aggregate net USD positioning came within a whisker of its all time low, with net positions at -241.2k contracts (USD -30 billion), the lowest USD positioning since November 2007. Interestingly and inconsistent with the sharp rise in the EUR, positioning in this currency remains well below its all time highs, supporting the view that rather than speculative investors it is central banks that are pushing the EUR higher.

The US jobs report at the end of last week proved disappointing, with total September payrolls dropping by 95k despite a 64k increase in private payrolls. The data will act to reinforce expectations that the Fed will begin a program of further asset purchases or quantitative easing (QE2) at its November meeting. Data and events this week will give further clues, especially the Fed FOMC minutes tomorrow and speeches from Fed Chairman Bernanke on Thursday and Friday as well as various other Fed speakers on tap.

Recent speeches by Fed officials have highlighted growing support for QE although some have tried to temper expectations. Questions about the timing and size of any new programme, as well as how it will be communicated remain unanswered. Although November seems likely for the Fed to start QE the Fed’s Bullard suggested that the Fed may wait until December. The minutes will be scrutinized for clues on these topics. The Fed is likely to embark on incremental asset purchases with the overall size being data dependent and the USD set to remain under pressure while this happens.

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FX Tension

September 27, 2010 — Mitul Kotecha

On September 22 1985 the governments of France, West Germany, Japan, US and UK signed the Plaza Accord which agreed to sharply weaken the USD. At this time it was widely agreed that the USD was overly strong and needed to fall sharply and consequently these countries engineered a significant depreciation of the USD.

It is ironic that 25 years later governments are once again intervening in various ways and that the USD is once again facing a precipitous decline as the Fed moves towards implementing further quantitative easing. This time central banks are acting unilaterally, however, and there is little agreement between countries. For instance Japan’s authorities found no help from the Fed or any other central bank in its recent actions to buy USD/JPY.

So far Japan’s FX interventions have been discreet after the initial USD/JPY buying on 15 September. The fact that Japan is less inclined to advertise its FX intervention comes as little surprise given the intensifying pressure from the US Congress on China for not allowing its currency, the CNY to strengthen. Tensions have deepened over recent weeks and the backing of a bill last week by an important Congressional committee to allow US companies to seek tariffs on Chinese imports suggests that the situation has taken a turn for the worse.

The softly softly approach to Japan’s FX intervention and US/China friction reflects the fact that unlike in 1985 we may be entering a period in which currency and in turn trade tensions are on the verge of intensifying sharply against the background of subdued global economic recovery.

The Fed’s revelation that it is moving closer to implementing further quantitative easing has shifted the debate to when QE2 occurs rather than if, with a November move moving into focus. Clearly the USD took the news negatively and will likely remain under pressure for a prolonged period as the simple fact of more USD supply weighs heavily on the currency. Markets will be able to garner more clues to the timing of QE2, with a plethora of Fed speakers on tap over coming days.

This week the US economic news will be downbeat, with September consumer and manufacturing confidence surveys likely to register declines, with consumer sentiment weighed down by the weakness in job market conditions. Personal income and spending will also be of interest and gains are expected for both. There will be plenty of attention on the core PCE deflator given that further declines could give clues to the timing of QE2.

Attention in Europe will centre on Wednesday’s recommendations for legislation on “economic governance” from the European Commission. Proposed penalties for fiscal indiscipline may include withholding of funding and/or voting restrictions but such measures would be politically contentious. Measures to enforce fiscal discipline ought to be positive for markets given the renewed tensions in peripheral bond markets in the eurozone.

The EUR was a major outperformer last week benefiting from intensifying US QE speculation and will set its sights on technical resistance (20 April high) around 1.3523 in the short-term. Notably EUR speculative positioning has turned positive for the first time this year according to the CFTC IMM data, reflecting the sharp shift in speculative appetite for the currency over recent weeks. The EUR has been surprisingly resilient to renewed sovereign debt concerns and similarly softer data will not inflict much damage to the currency this week.

Posted in central banks, Currencies, Economics, Economy, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Germany, Interest rates, Japan, Monetary Policy, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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