US dollar surges through key levels

May 13, 2013 — Mitul Kotecha

Demand for risky assets continues to strengthen as reflected in various indicators including my Risk Aversion Barometer which has moved deeper into risk loving territory while equities remain on an upward trajectory. Central banks are providing the main source of support for investor risk appetite, with a combination of lower policy rates and quantitative easing providing a major fillip.

Additionally various central banks appear to be talking down their currencies and/or intervening (note RBNZ and Riksbank) adding to the downward pressure versus USD. In Japan’s case the G7 appeared to give its blessing to Japanese policy over the weekend, aiding in the decline in the JPY.

Usually the USD would not benefit in times of improving risk appetite but it is finding plenty of support from the fact that Fed policy is set to diverge with other central banks, with the currency breaking key levels against major currencies including EUR (below 1.30), JPY (above 100) and AUD (below 1.00). The surge in US Treasury yields is underpinning the USD helped by firmer US economic data in particular on the jobs front.

According to a Wall Street Journal article over the weekend the Fed is already formulating an exit strategy from QE although the timing is still being debated, another factor supporting the USD at the beginning of this week. Various Fed speeches over coming days will likely provide more clues on any timing or plans for an exit policy. Meanwhile, higher US yields and a firmer USD continue to pile on the pressure on gold prices.

There may be a little caution in pushing the USD higher this week as US data releases are likely to look softer, with retail sales, industrial production and housing starts set to record declines. Nonetheless, any pull back in the USD or yields may simply provide better levels for investors to go long the USD and short Treasuries especially as data elsewhere will not look much better. Indeed, while in Europe there will be a likely bounce in the German ZEW investor confidence index in May, Q1 Eurozone GDP will record a contraction for the sixth consecutive quarter.

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Fed shift hits the dollar

May 2, 2013 — Mitul Kotecha

The economic trajectory into Q2 continues to worsen, a factor which likely played into the statement from the Federal Reserve that it is “prepared to increase or reduce the pace of its purchases” of assets, a marked shift from the previous stance of assessing the timing of a reduction of Fed asset buying noted at the March FOMC meeting.

Reinforcing the view was the weaker than expected increase in private sector payrolls in the April ADP jobs report (119k versus 150k consensus), implying downside risks to the consensus for tomorrow’s April non-farm payrolls data. Indeed, we now look for a 120k increase in payrolls compared to 150k previously expected.

March US construction spending was also weaker than forecast while the ISM manufacturing index dropped, albeit remaining in expansion territory (above 50). The data led to a further drop in the USD, commodity prices, equities and lower US Treasury yields.

Little change in market direction is expected today, with caution ahead of tomorrow’s US jobs report. Ahead of this, a likely 25bps cut in policy rates by the European Central Bank will capture attention. Although by no means a done deal, the majority of the market has shifted towards such an expectation in the wake of weaker data.

The real surprise from the ECB could come from any further hint or announcement of non conventional measures. In turn any such hint could dent the EUR limiting its ability to capitalise on a weaker USD tone. In any case sellers are likely to emerge on any rally in EUR/USD to resistance around 1.3220.

Final readings of purchasing managers’ indices in Europe, US March trade data and Q1 non farm productivity will account for the remaining releases today although none of these are likely to be market movers, leaving the USD under pressure ahead of tomorrow’s jobs report.

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Dollar undermined by lower yield

April 29, 2013 — Mitul Kotecha

Risk assets in general appear to have gained traction on the basis that central banks will maintain or expand highly accommodative monetary policies via further asset purchases and balance sheet expansion. The Federal Reserve and European Central Bank will likely provide more fuel to the fire this week, with the former set to maintain its policy settings including USD 85 billion in asset purchases while the latter is set to cut its policy refi rate by 25bps to 0.50%.

Weaker data into Q2 in the US (and the softer than expected reading for Q1 GDP annualised 2.5% QoQ pace revealed last Friday) effectively seals the case for maintaining ultra easy policy at least until later in the year when the Fed is set to taper off asset purchases. As for the ECB are mere rate cut may not be sufficient with attention on any prospects for non conventional easing and rebuilding the monetary transmission mechanism.

Weekend news in the Eurozone was positive, with Italy finally forming a government following two months of deadlock but the week should begin quietly with holiday in Japan and China. In any case market activity is set to be limited ahead of central bank policy decisions and the US April jobs report at the end of the week where a 150k increase in payrolls.

As the US Q1 GDP report revealed the impact of the Sequester via massive spending cuts is increasingly biting into growth and while expectations of ongoing monetary accommodation is helping to buoy markets, growth recovery will need to strengthen to justify the current optimism built into markets. At least there is some realisation, finally in the Eurozone, that recovery may need to be reinforced with less austerity.

FX market activity will remain hesitant ahead the key events this week but overall it appears the USD will lose further wind out of its sails especially as US bond yields continue to drop. The US 10 year Treasury yield dropped to is lowest level this year, a factor that has particularly undermined the USD against the JPY where a failure to test the 100 level has also contributed to a drop in the currency pair. A test of USD/JPY 100 is off the cards unless and until US yields rise again. Lower US yields are helping EUR/USD to stay above the 1.3000 level although this is being mitigated by the fact that German 10 year bund yields are also declining.

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GBP jumps, CHF drops

April 25, 2013 — Mitul Kotecha

A weaker than expected reading for March US durable goods orders maintained a run of soft US data releases, reinforcing concerns of an economic slowdown over coming months. Indeed, US growth is tracking closet to 1% in Q2 after a more robust looking growth rate in Q1. The data will play into the hands of doves in the Federal Reserve, with the FOMC set maintain its highly accommodative policy settings at next week’s policy meeting.

The bigger than expected drop in the April German IFO business confidence survey yesterday echoed the weakness in US data but if anything markets reacted positively as the data helped to intensify expectations of a European Central Bank (ECB) policy rate cut which could come as early as next month. Despite the weaker data equity markets and risk assets look generally well supported, with US Q1 earnings releases and monetary policy stimulus expectations helping to maintain the positive tone.

The USD has shaken off both weaker growth data and the subsequent decline in US Treasury yields but may struggle to make much headway until a more positive growth outlook is revealed by data releases. In this respect Friday’s Q1 GDP data will be somewhat backward looking despite a likely robust outcome of a 3.0% QoQ rate of growth set to be revealed. Markets instead will focus attention on next week’s manufacturing reports and jobs data.

Ahead of the US payrolls data we’ll be able to digest the Fed’s thinking on the “soft patch” on the economy and whether they believe it will extend much further. The USD index will likely consolidate ahead of these events, with the early April high of 83.494 likely to cap gains.

GBP/USD has struggled to make much headway over recent weeks. Nonetheless, the downgrade of the UK’s credit ratings by Fitch to AA+ from AAA+ had very little impact. The release of firmer than expected UK GDP data today, with the UK economy missing a triple dip recession has helped GBP to bounce strongly. I remain constructive on GBP but would prefer to play GBP versus CHF where the upside momentum is strengthening.

Both EUR/CHF and USD/CHF have made substantial headway over recent weeks and look to extend gains over the near term. Notably the improvement in risk appetite and resilience in Eurozone peripheral bonds highlights the reasons for the lack of CHF demand.

The selection of a new prime minister in Italy will ease political concerns and add to the pressure on the CHF. Additionally a likely softening in the Swiss April KoF leading indicator tomorrow, the 7th straight decline, will reinforce domestic pressure to weaken CHF. EUR/CHF is set to head towards the year high around 1.2690 over coming weeks.

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Gold stabilizes, euro drops

April 18, 2013 — Mitul Kotecha

The FX world has become somewhat more disturbing over 2013. Implied currency volatility has risen relatively sharply over recent months breaking its relationship with the VIX ‘fear gauge’ in large part due to the sharp drop in the JPY. Additionally the trend of improving risk appetite that was conducive to lower FX volatility has come to an end.

The inability of risk appetite to improve further has led to a declining correlation between various assets including currencies. This opens the door to other factors driving FX markets, with investor discrimination based on relative yield and growth differentials expected to take increasing prominence over coming months.

A big mover overnight was the EUR which slid on comments from European Central Bank official Weidmann that Europe’s recovery from the debt crisis may take years he hinting at a rate cut. He was joined by the ECB’s Smaghi who noted that the ECB must find ways to avoid EUR gains. EUR is likely to remain under pressure over the short term, especially on the crosses against the likes of GBP. Eventually I expect its ECB Outright monetary Transactions (OMT) threat led resilience to fade as Europe’s weak growth trajectory weighs on the currency, leading to an eventual move to EUR/USD 1.25 by end 2013.

The CHF and JPY languish at the bottom of our forecast grid in the medium term as would be expected given both their low yield and relatively lack of sensitivity to global growth. Both currencies will face pressure from relatively higher yields elsewhere given the growing attraction of yield and they are set to regain their lustre as funding currencies. In this respect the USD will begin to lose its allure as a funding currency especially as markets become increasingly nervous of a tapering off of Fed asset purchases later in the year.

The price of gold has stabilized over recent days in a USD 1365-1395 per ounce range following its sharp fall, with buyers creeping back in especially from jewelry demand, with strong purchases from India and China reported over recent days. My quantitative model suggests that the recent decline in gold prices is overdone and it may bounce back slightly. Nonetheless, the prospects for gold prices in the months ahead are still downbeat as expected strength in the USD, higher US bond yields, and expectations of a paring back in the Fed’s asset purchases weigh on the commodity.

News that Cyprus proposes selling its gold reserves over coming weeks will also fuel nervousness that other peripheral Eurozone central banks will follow suit. Finally, exchange trade funds (ETF) and speculative demand according to the CFTC IMM data continue to show a decline in investor demand. Consequently I we have revised down our forecasts for gold prices to reach USD 1350 per ounce by end 2013

Posted in Cyprus, ECB. Tags: , , , , , . 1 Comment »
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