Another Day, Another Drop In The US Dollar.

April 15, 2011 — Mitul Kotecha

The USD index is now close to breaching its November 2009 low around 74.17, with little sign of any turnaround in prospect. A surprise jump in weekly jobless claims to 412k (380k expected) did little to help the USD’s cause whilst higher commodity prices, and in particular energy prices played negatively.

Indeed, many USD crosses have experienced an increase in sensitivity to oil price movements over recent weeks, with the USD on the losing side when oil prices move higher. Commodity currencies including CAD and NOK are the key beneficiaries but EUR/USD is also highly correlated with the price of oil.

Various Fed comments overnight including supportive comments on the USD’s role as a reserve currency have done little to boost USD sentiment despite the generally hawkish slant to comments. A host of US data releases will keep markets busy.

The data are unlikely to deliver any strong surprises but given the growing FX attention on Fed policy, CPI data may take on more importance than usual. Our expectation of a trend like 0.2% increase in core CPI, which is unlikely to cause any consternation within the Fed, suggests that the USD will garner little support.

The ability of the EUR to withstand a torrent of bad news regarding the eurozone periphery is impressive. In particular, peripheral bond yields continue to rise especially Greek yields as expectations of debt restructuring grow. Comments from Germany’s finance minister have added to such expectations. News that the Bank of Spain approved the recapitalisation of 13 bank and that Spanish banks borrowed only EUR 44 billion last month, the lowest since Jan 2008, may have provided some relief.

However, given that markets are already relative hawkish about eurozone interest rates and given growing peripheral worries as well as overly long EUR market positioning, the upside for EUR/USD is looking increasingly restrained, with a break above technical support around 1.4580 likely to be difficult to achieve over the short-term.

AUD and NZD have registered stellar performances over recent weeks as yield attraction has come back to the fore and risk appetite has strengthened. The gains since their post Japan earthquake lows have been in the region of 7.3% and 10.5%, respectively for AUD and NZD.

The additional element of support, especially for AUD has come from central bank diversification, an increasingly important factor for both currencies. The gains in both currencies have been impressive and neither is showing signs of reversing but there are clear risks on the horizon.

One indication of such risks is the fact that market positioning is stretched especially in terms of AUD positioning, with CFTC IMM contracts registering an all time high. The move in AUD especially has been well in excess of what interest rate / yield differentials imply. Whilst I would not suggest entering into short AUD and NZD positions yet, the risks to the downside are clearly intensifying.

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Eurozone peripheral tensions

March 8, 2011 — Mitul Kotecha

The USD index remains under pressure but will likely continue to consolidate. The USD continues to be undermined by adverse interest rate differentials and is gaining little support from rising risk aversion. One factor that will help dictate USD direction over coming months is the prospects for further quantitative easing once QE2 ends.

Fed officials offered varied views on the subject. Dallas Fed President Fisher hinted he would support cutting short asset purchases before the end of June, whilst Atlanta Fed President Lockhart noted he was “very cautious” about further asset purchases. Meanwhile Chicago Fed President Evans noted that he believes the hurdle for altering the asset purchase plan is “pretty high”.

Although there is a lack of first tier data releases in the eurozone this week there is certainly plenty for markets to chew on in terms of peripheral country issues, which may just prevent the EUR from extending its gains. Eurozone peripheral debt spreads have undergone a renewed widening over recent weeks as debt fears have increased and worries that Portugal may follow Ireland and Greece in needing a bailout have risen.

Meanwhile news that Ireland’s incoming government will introduce legislation allowing the restructuring of some senior bank bonds, will add to tensions. Meanwhile, the downgrading of Greece’s government bond ratings to B1 from Ba1 dealt another blow sentiment following hot on the heels of Fitch’s downgrade of Spain’s outlook to negative although the EUR proved resilient to the news. EUR/USD continues to look as though it will consolidate around the 1.4000 level, but worsening sentiment towards the periphery may open up downside as the EUR’s resilience fades.

Upward revisions to eurozone growth and inflation forecasts and of course a hawkish shift in eurozone interest rate expectations may have justified the EUR move higher over recent weeks. However, there does not seem to be much that will provide the stimulus for further gains from current levels.

The market has already priced in an interest hike as early as next month’s European Central Bank (ECB) meeting and further tightening thereafter. The risk now appears asymmetric skewed to the downside especially if tensions between the eurozone core and peripheral countries deepen. How long the EUR can ignore such tensions?

It’s not only the eurozone periphery that should worry about ratings. Japan’s ratings agency R&I has warned that it may be forced to cut Japan’s sovereign ratings before April’s local elections due to current political problems. R&I’s concern revolve around the potential for political problems to delay fiscal reforms. As usual the JPY remains unmoved by political issues and is moving to the stronger side of its recent range against the background of elevated risk aversion.

Although the JPY has not been particularly sensitive to risk over recent months shorter-term correlations shows that its sensitivity has increased. Given that Middle-East tensions do not appear to be easing the JPY will remain well supported. Indeed, speculative positioning data reveals the highest JPY net long position since November 2010. As risk appetite improves JPY positioning will be pared back but this is unlikely to be imminent, with USD/JPY set to remain close to support around 81.10.

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Risk aversion spikes

March 2, 2011 — Mitul Kotecha

Increased risk aversion overnight in the wake of escalating Middle East tensions gave the USD some support but overall the USD index is gradually drifting towards its early November low around 75.631. The antithesis of USD weakness is strength in most other major currencies.

The USD is being undermined by relatively dovish expectations for US interest rates relative to elsewhere and last night’s semi annual testimony by Fed Chairman Bernanke to the US Senate did nothing to alter this tone, with Bernanke maintaining the emphasis on subdued inflation and elevated unemployment.

The USD index itself has a high (0.82) 3-month correlation with US interest rate futures and over recent weeks as the implied yield has dropped, the USD has lost ground. The prospects of higher US bond yields may eventually provide the USD with support, especially given the prospect of substantial short-covering but in the near term the USD is likely to remain under pressure.

The upbeat run of US data highlights another source of USD support over the medium term, given the likely outperformance of the US economy over coming months. Yesterday’s ISM manufacturing survey and vehicle sales data lend support to this view. Moreover, the rise in employment component of the ISM supports the view of at least a 195k increase in February payrolls.

The Fed’s Beige Book tonight and February ADP jobs report will not alter the USD’s trajectory. The Beige Book is unlikely to reveal anything to worry the Fed in terms of inflation risks although will probably reveal further signs of improved activity. The ADP report will give important clues for Friday’s February non-farm payrolls data although it’s worth noting that last month’s report was way off the mark. In any case neither release is likely to prevent a further drop in the USD.

EUR is a clear beneficiary of expectations of tighter monetary policy by the ECB and the widening interest rate (futures implied yield) differential between the US and eurozone has given the EUR plenty of support recently as reflected in the high correlation with EUR/USD. Further support to the hawkish market stance was given by the upward revision to eurozone 2011 growth and inflation forecasts by the EU. The fact that eurozone inflation increased to 2.4% YoY in February also reinforced expectations of ECB tightening sooner than later.

The ECB press conference following the council meeting tomorrow will likely shape such expectations further, the EUR has already priced in a hawkish ECB stance, limiting the prospects of further appreciation. Notably EUR/USD has failed to break resistance at its year high around 1.3861, which will prove to be a formidable cap in the short-term.

In contrast, the RBA has poured cold water over expectations of further policy rate hikes in Australia. The policy statement following yesterday’s decision to keep the cash rate on hold pointed to an extended pause in the months ahead. Despite this and perhaps because markets have already pared back Australian interest rate expectations AUD rebounded quite smartly from its post meeting low and despite some overnight weakness due to increased risk aversion it will soon verge on a break of resistance at 1.0257.

AUD/NZD has continued to charge ahead having hit a multi-year high above 1.3600. NZD underperformance has been exacerbated by the impact of the recent earthquake, with growth expectations for this year having been sharply revised lower and growing speculation of an interest rate cut. Indeed, such speculation was given further fuel by comments by NZ Prime Minister Key who noted he would welcome a policy rate cut. Nonetheless, my quantitative AUD/NZD model suggests that the cross looks over-extended at current levels, whilst relative speculative positioning supports this view.

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US Dollar Upside, Euro tensions

February 14, 2011 — Mitul Kotecha

Following the famine that was last week this week will see a feast of data releases, which hopefully will give some clearer direction to currency markets. The key eurozone data focus for FX markets will be the German February ZEW survey and it should highlight that investor confidence is bouncing back smartly. This will be accompanied by data showing a slight acceleration in GDP in the eurozone in Q4 2010. Good news, but the reality is that the EUR is being driven more by peripheral bond tensions and relative yields.

Although the EUR may get a brief lift from the news of the resignation of Egypt’s President Mubarak this will likely prove temporary. Given that tensions are beginning to creep higher EUR/USD may struggle to make any headway this week and will more likely slip below 1.3500 for a test of 1.3440 as sentiment sours. Even the usual sovereign interest may look a little more reluctant to provide support this week. The net long positioning overhang as reflected in the CFTC IMM data suggests some scope for a squaring in long positions, likely accelerating any downside pressure.

As usual data releases are failing to have a major impact on the JPY whilst interest rate / yield differentials suggest the JPY should be much weaker. One explanation for the stubbornly strong JPY is the strength of recent portfolio inflows to Japan, especially into its bond markets. This could reverse quickly and IMM positioning suggests that the potential for a shakeout of long positioning looms large, something that many Japanese margin traders are well positioned for according to TFX data. USD/JPY 84.51 will provide firm resistance to a move higher in the short-term.

GBP will be guided by the Bank of England Quarterly Inflation Report on Wednesday as well as the January CPI and retail sales data. The Report will reveal that inflation moderates over the medium term, even if short-term projections are shifted higher. Consequently, interest rate markets may even pare back overly hawkish expectations for UK rates, leaving GBP vulnerable. Nonetheless, markets maybe somewhat more sceptical or at least nervous in light of a likely increase in UK CPI, albeit mostly due to the increase in value added tax (VAT) at the turn of the year. Moreover, GBP may find some solace from a rebound in retail sales in January.

Overall, GBP/USD will take its cue from EUR/USD and the currency is vulnerable to a sustained drop below 1.6000 this week. The fact that GBP/USD IMM positioning is at its highest since September 2008 suggests a lot of scope for a sell-off. EUR/GBP looks like its consolidating in an even narrower range between 0.8400-0.8500.

Another positive slate of US data releases and likely more pressure on US bond markets this week suggest that the USD will find further support, with the USD index likely to take a shot at the 79.00 level. Indeed a further improvement in both the Philly Fed and Empire manufacturing surveys is expected, providing more evidence of strengthening manufacturing momentum, will be borne out in the hard data, with a healthy gain in industrial output expected. Similarly a healthy reading for US retail sales will support the evidence that the US consumer is in full recovery mode.

The positive impact on the USD may be dampened however, by benign inflation readings this week, supporting the view that US policy rates will not be raised for a long time yet. This is likely to be echoed in the Fed FOMC minutes this week. Nonetheless, speculative positioning suggests plenty of scope for short USD covering, with the latest CFTC IMM report revealing the biggest net short position since October 2010.

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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 »
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