Ukraine fallout

March 4, 2014 — Mitul Kotecha

So far most of the damage from the escalating crisis in the Ukraine and growing tensions between the West and Russia has been inflicted on Russian markets but global asset markets are also feeling increasing pain from the fallout. The most recent developments highlight that tensions have worsened further.

Equity markets in Europe were next in line for selling pressure, with sharp declines registered while US stock also dropped, but to a lesser degree. Commodity prices have also felt the shock, with European natural gas prices rising sharply and oil also higher. Gold has been a major beneficiary extending gains to around USD 1350.

US Treasury yields settled around 2.6% while the USD bounced as risk aversion spiked. My Risk Aversion Barometer rose over 3% while the VIX “fear gauge” jumped. Asian markets are likely to feel some pressure today although the impact is likely to be much less significant than elsewhere. Nonetheless, the lack of first tier data releases means that most attention will be focussed on developments in Ukraine over today’s trading session.

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US dollar restrained further

March 3, 2014 — Mitul Kotecha

The USD will continue to be restrained by poor weather conditions and lower US Treasury yields (around 2.6%), especially against the JPY which has also been supported by higher risk aversion and consequent safe haven demand. The USD index is at threat from dropping to its October 2013 lows around 78.998 (currently 79.828)

A similar story applies to the CHF, with USD/CHF hitting its lowest level since late 2011 around 0.8783. This pattern will not change in the short term, especially given the potential escalation in tensions in the Ukraine, keeping the CHF under upward pressure as safe haven inflows increase. EUR/CHF has dropped sharply as a result, with the resolve of the Swiss National Bank to support its line in the sand at 1.20 set to be tested shortly.

Risk currencies in contrast will likely come under growing short term pressure including AUD, NZD and many emerging market currencies. AUD/USD will likely trade with a heavy tone even though the RBA is unlikely to cut policy rates at its meeting tomorrow.

EUR benefitted from the upside surprise for Eurozone inflation but has run into resistance around 1.3800 versus USD. Speculative EUR positioning has continued to rise but the fact that CFTC IMM positioning has risen to above its 3 month average suggests that further EUR gains will be more limited.

Indeed although the USD continues to be restrained by weaker data and lower US yields, the potential for a dovish surprise from the ECB will limit the ability of the EUR to capitalise on USD weakness this week. Strong technical resistance for EUR/USD will be found around 1.3894 (2013 high).

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It’s all about the weather

February 28, 2014 — Mitul Kotecha

Fed Chairman Yellen helped allay concerns that something more sinister than bad weather was impacting the US economy in her speech to the Senate Banking Committee yesterday. While highlighting that tapering will go on unabated and likely end by the fall, the comments gave hope that the poor run of US data will come to end soon, once the weather impact reverses.

Risk assets liked what they heard, with US equities closing at record highs and the VIX “fear gauge” edging lower. Reduced safe haven demand helped US Treasury yields to move lower undermining the USD in the process. Against this background markets will ignore a likely downward revision of US Q4 GDP today, which will be seen as largely backward looking.

The relief from Yellen’s comments was sufficient to outweigh the increasingly precarious situation in the Ukraine where the regional parliament in the largely Russian speaking region of Crimea was overtaken by armed gunmen hoisting the Russian flag. Subsequently Crimea has now set a referendum to decide whether to opt for sovereignty for the region.

Given the increased jawboning by Russia and military exercises along the border with Ukraine, together with warnings by Western nations for Russia not to get involved in the situation, the risk of a further escalation of tensions are high. Indeed, the scenario increasingly resembles the type of stand off taking place during the “cold war” and markets may be underestimating the potential impact.

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USD undermined, GBP supported for now

February 27, 2014 — Mitul Kotecha

Despite its overnight bounce the USD index is trading close to its lowest levels this year undermined by a series of weaker economic data and related to this a failure of US bond yields to push higher. Alongside this relatively soft USD tone is a generally subdued and range bound tone to FX markets in general.

Even my quantitative models suggest little impetus for big moves in EUR/USD and USD/JPY. However, I expect this to change over coming weeks. Once the US economy shakes off the shackles of poor weather conditions the USD will be in a better position to recoup its recent losses.

In the near term Fed Chairman Yellen’s testimony today will garner some attention but the speech is unlikely to break the USD or FX markets out of their malaise.

GBP is holding up well, taking advantage of a subdued USD tone. As a consequence of firmer data the market appears to be gearing up for an eventual rate hike, with Bank of England members sounding more upbeat, even if it is unlikely to occur anytime soon.

Consequently over the near term GBP looks well supported although eventually we expect the currency to settle back to earth. In particular 3 month interest rate differentials with the USD appear to suggest that GBP/USD gains are overdone.

This doesn’t mean that its time to sell now but market positioning has turned more positive over recent weeks, above its 3-month average, suggesting further short term gains will be more gradual, with strong GBP/USD resistance around 1.6745.

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China worries inflicting damage globally

February 26, 2014 — Mitul Kotecha

A combination of worries on both sides of the pond has inflicted damage on risk assets globally. US equities closed lower, Treasury yields dropped, USD was weaker while gold prices rose. In Asia, China growth concerns, overexpansion of credit, and currency weakness are increasingly infiltrating markets globally.

Meanwhile in the US, consumer confidence surprisingly slipped in February, albeit from a high level while the annual pace of house price gains slowed slightly in December. The data added a further layer of pressure on stock markets and US January new home sales data will not help matters as it is likely to give further evidence of slowing housing momentum.

While it is now easy to blame much of the weakness in US economic data on adverse weather conditions hopes / expectations that US data will improve going forward will be tested soon. In the absence of first tier data today, attention will remain firmly fixed on events in China and in particular whether the CNY and CNH registers further declines.

Given all the attention on the Chinese currency, major currency markets have been lulled into tight ranges, with our measure of composite implied G3 FX volatility declining further. Our implied volatility index has now dropped to the lowest levels since the end of October last year.

USD/JPY is likely to face some downward pressure in the short term given the rise in risk aversion and lower US yields overnight. EUR/USD remains supported but remains susceptible to downside risks given the potential for easier monetary policy at the upcoming European Central Bank meeting next week.

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