USD and JPY on the back foot

December 17, 2012 — Mitul Kotecha

Running into the end of the year it is clear that the USD is turning into the biggest loser. In part this reflects year end flows but also the dovish Fed stance and uncertainty about a resolution of the fiscal cliff. Indeed, with the Fed FOMC meeting out of the way the lack of progress on averting the fiscal cliff is quite disconcerting. Market confidence of an agreement appears to be slipping judging by the weakness in risk assets at the end of the week.

The USD is unlikely to make up much ground in the days ahead despite some likely positive data releases including yet more data showing housing market recovery, gradually improving manufacturing confidence gauges as well as a revision higher to Q3 GDP.

The EUR is on the verge of ending the year in strong form (too strong for Eurozone economies) as news of agreements on Greece’s loan tranche and banking supervision have given the currency even more support. Much of the rally in the EUR is likely to come from position adjustment into year end and could reverse quickly into new year, however.

Nonetheless, there is no doubt that receding tail risk due in large part due to continued support from expected eventual ECB asset purchases (OMT) activation will limit any downside in the EUR. In the near term the EUR may still take some direction from the German IFO survey on Wednesday but assuming that this survey continues its stabilisation, EUR/USD will likely maintain gains above technical support around 1.2880.

Japan faces a new reality following elections following Shinzo Abe’s Liberal Demoractic Part (LDP) victory in lower house elections. In particular, pressure for more aggressive policy will be sustained given the two thirds majority obtained. Nonetheless, it is not obvious that coalition parties will be as welcoming while some of the rhetoric from LDP leader Abe has already softened.

As the deterioration in the Tankan survey revealed the economic picture is clearly worryingly weak. Trade data over the coming week will be scrutinised to determine the lingering impact of frictions with China as well as the strength of the JPY. On this note, a further increase in asset purchases by the BoJ this week will mean that the JPY is unlikely to retrace its losses very quickly. Nonetheless, USD/JPY will face strong resistance around 84.60.

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USD underperforms

December 13, 2012 — Mitul Kotecha

The Fed expanded its asset purchases by buying $45 billion in longer dated Treasuries following the end of Operation Twist, with total purchases at USD 85 billion per month. The Fed went a step further by changing the guidance, now anticipating that policy will be maintained at an “exceptionally low range for the Fed Funds rate” as long as the unemployment rate remains above 6 ½ % and inflation no more than ½ % above the Fed 2% goal.

Equity market reaction was limited, with any positive boost dampened by the recognition that the Fed will not be able to offset the blow to the economy from the fiscal cliff. On this front, progress has been limited as the likelihood of a deal by the end of the year is diminishing by the day.

In Europe sentiment is somewhat better as hopes that the EU Council meeting today will yield an agreement on banking union and supervision. Final approval for the delayed Greek loan tranche is likely to be delivered following the completion of Greece’s debt buyback. The better news in Europe will be reflected in a decent reception to the Spanish and Italian bond offerings today.

The USD did not take too kindly to the latest efforts by the Fed to boost the economy although there are clearly diminishing returns as far as FX markets are concerned with regard to Fed QE. Nonetheless, the USD is coming under growing pressure into year end.

Next year assuming that the fiscal cliff in the US is resolved, with a limited fiscal drag on the economy, a relatively positive growth trajectory for the US alongside an expected increase in US bond yields will mean that the USD will still enjoy gains against currencies with weaker growth paths namely the EUR and JPY.

My forecasts for the USD index based on forecasts for its constituents show a gradual strengthening over the course of the next couple of years (82.4 and 85.7 by end-2013 and -2014, respectively) largely due to the USD’s expected appreciation versus EUR and JPY. In reality, this is misleading as improving risk appetite and continued capital inflows to EM and commodity currencies will mean that the USD will underperform.

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USD under broad based pressure

December 5, 2012 — Mitul Kotecha

There remains a great deal of angst in markets due to the lack of resolution to the US fiscal cliff, which is putting pressure on overall market sentiment as reflected in the multi day rise in the VIX fear gauge over recent days. The fact that both the US administration and senior Republicans are giving little ground in discussions suggests a deal is not in sight although the pressure for compromise will intensify as year end approaches.

The news in Europe is a little better as reflected in the narrowing in peripheral bond yields. There will be little directional influence on markets today, with trading likely to be subdued ahead of the US jobs report on Friday, with any news on the fiscal cliff also closely watched.

The USD continues to come under broad based pressure, with the USD index having lost around 2% of its value since 16 November. The lack of traction in terms of resolving the fiscal cliff and the weaker US data this week, namely the November ISM manufacturing index have weighed on the currency.

How much of the USD move is due to position adjustments as year end approaches fast or renewed confidence in the EUR is debatable but it is clear that the USD looks like it will end the year in a bad state. The ADP jobs report today may give further direction but it seems unlikely that pressure on the USD will abate ahead of the November payrolls data on Friday.

While the EUR’s gains are beginning to look overdone, the momentum for the currency continues to be to the topside as short positions continue to be covered into year end. The EUR’s appreciation is taking place hand in hand with the drop in peripheral bond yields. A positive reception for Greece’s debt buy back as well as Spain’s request for aid for its banking sector has also helped the currency.

Rumours of a German debt downgrade have done little to diminish the EUR’s appeal. An upcoming meeting of EU finance ministers next week ahead of the EU leaders’ summit to try and make some progress towards banking supervision is also hoped to deliver some good news. A test of sentiment will come from a Spanish bond auction today but this is unlikely to be much of an obstacle to the EUR. Near term EUR/USD resistance is seen around 1.3172.

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Fade gains in the euro

November 27, 2012 — Mitul Kotecha

The USD’s drop over recent days has almost wiped out half its rally since October 17. Only the JPY has lost ground over this period. More modest weakness is in prospect for the USD in the short term although I do not look for the currency to drop sharply. Given their strong correlations with the USD index any decline will bode well for EUR, GBP, SEK, CHF, CAD and several emerging market currencies.

Most commentators are ascribing USD weakness to the improving risk appetite but the USD index has maintained a low sensitivity to my risk aversion barometer, suggesting that the relationship is tenuous at present. The reality is that there is probably a bout a profit taking rather than any major shift in USD sentiment and this is set to continue for the time being.

EUR/USD’s impressive resilience over recent weeks highlights the hurdles to anyone wanting to short the currency. Underling EUR support remains firm as reflected in the recent turnaround in the Eurozone basic balance position (direct investment + portfolio flows + current account) while there may also be an element of FX reserves recycling flows providing support of the EUR.

Additionally the market has been giving Eurozone officials the benefit of the doubt with regard to a Greek debt sustainability solution and the lacklustre reaction of the EUR following the Greek deal this morning highlights that much was already priced in. The deal which effectively lowers interest rates that Greece has to pay on its debt while giving it more time to pay the debt paves the way for a EUR 34.4 billion loan tranche in December.

Finally, the threat of ECB Outright Monetary Transactions (OMT) activation continues to threaten to provide a major back stop to any EUR pressure. At current levels the upside for the EUR looks far less compelling. I suggest taking profits / fading the rally on any test of resistance around EUR/USD 1.3030 and EUR/GBP 0.8120.

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USD pressured, limited gains for Asian currencies

November 26, 2012 — Mitul Kotecha

Risk assets registered a positive performance over the past week despite the plethora of events / issues that remain unresolved. However, it’s back to business today with talks over Greek’s debt sustainability and resolution towards distribution of its next loan tranche set to resume.

Meanwhile, markets will digest the results of elections in the Spanish region of Catalonia which have fuelled greater uncertainty in the wake of the gains in seats for pro-referendum parties who won 87 of the Catalan parliament’s 135 seats. However, the results did not provide the strength of support for pro independence parties as had initially been feared, suggesting some relief for the EUR.

Together with the failure to make any progress on the EU budget it is clear that there are still many layers of uncertainty lying ahead for European markets. Nonetheless, optimism appears to be winning the day as the EUR and peripheral bonds shake off such concerns. The risk going forward is that the market is hoping for too much, with the risk / reward dynamic skewed asymmetrically in the wake of any failure to reach agreement especially regarding Greece.

News of healthy US Thanksgiving spending will be followed by data releases this week that are set to provide further signs of improvement although markets will remain focussed on any progress towards resolving the fiscal cliff. An upward revision to US Q3 GDP, gains in durable goods orders, and new home sales in October will provide encouraging news contributing to a tone of firmer risk appetite. This will be echoed by the Fed’s Beige Book.

Economic news in Europe (expected lower economic sentiment index) and in Japan (fourth consecutive decline in industrial production) will highlight the comparative outperformance of the US economy while adding pressure for more aggressive policy measures elsewhere.

The net FX impact of the market’s optimism is to sell USDs leaving it vulnerable in an environment of improving risk appetite. Nonetheless, given that the market is now pricing in a resolution to several of the issues noted above, USD weakness may prove limited from current levels. EUR/USD is set to face resistance around the 1.3023 level while USD/JPY will face strong resistance around 83.20.

Asian currencies have benefitted from the firmer tone to risk appetite (most except IDR and INR are strongly correlated to risk) but gains have been limited over the past week as central banks in the region increasingly resist further strength. The lack of upward trajectory in the CNY has been a key driver for the slower pace of appreciation of Asian currencies over recent days and I expect this trend to continue.

China may even countenance some softening in the CNY into year end suggests limited upside for Asian currencies into year end despite a firmer risk tone. The INR remains the major underperformer, with the currency continuing to suffer from domestic considerations, and benefitting the least from any improvement in risk appetite.

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