USD to edge higher

October 15, 2012 — Mitul Kotecha

The surprise rise in the US University of Michigan sentiment survey to its highest level in 5 years provides a better backdrop for asset markets at the start of the week although the follow through is likely to be limited. Chinese exports data may help sentiment its worth noting that Chinese imports were weak. Overall, it appears that the appetite for taking on equity risk is easing as prospects of disappointing US Q3 earnings and lingering growth concerns weigh on sentiment.

Markets may nonetheless, be given some encouragement from economic data this week including likely gains in September US retail sales, industrial production and October Empire State and Philly Fed manufacturing surveys. This will be echoed in Europe, with a second straight increase in the German ZEW investor confidence survey expected to be revealed in October. While the data will do little to ease global growth concerns it will at the very least suggest a renewed downturn is not on the cards.

Economic data may however, take a back seat once again as attention will turn to political developments around the EU Council meeting on 18-19 October. Any major developments are unlikely to emerge from the meeting although Spain and Greece will be on high on the agenda. The lack of progress in the eurozone towards a bailout in Spain and the distribution of Greece’s next loan tranche will once again restrain any positive tone to markets, leaving most asset markets within ranges.

Currencies do not look as though they are about to break out of recent ranges. Nonetheless, the USD will likely continue to edge higher against the background of growing cautiousness towards risk assets. Indeed, there has been some major short covering in the USD over the past week as reflected in CFTC IMM data and I expect the trend to continue as QE3 USD fears increasingly fade. Conversely, EUR short positions are building up once again and the lack of traction towards resolutions in Spain and Greece, point to growing EUR downside risks in the days ahead.

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USD buffeted, JPY firming, AUD risks receding

October 9, 2012 — Mitul Kotecha

A lacklustre day for equity markets yesterday saw many indices close lower and risk aversion edge higher, with the VIX ‘fear gauge’ being a prime mover, Some encouraging signs for global activity continue to emerge from the rise in the Baltic Dry Index but market growth fears remain high. Attention remains firmly focussed on events in Europe, with the Ecofin meeting today likely to see further discussions on a wide range of issues. As yet there is no breakthrough regarding a Spanish bailout or next tranche of Greek loan disbursement, with the latter only likely to be confirmed in November. A visit by German Chancellor Merkel to Athens today is unlikely to result in any breakthroughs. US corporate earnings will also garner greater attention as the week goes on, with Alcoa set to begin the earnings season tomorrow.

The USD is being buffeted by conflicting factors at present. QE3 is likely to cap any gains in the currency but the expansion of balance sheets by other central banks suggests that a weaker USD outlook is by no means a foregone conclusion. Moreover, from a growth perspective the USD comes out on top. Even though US recovery is a weak one by historical standards the economic outlook still looks better than in Europe, notwithstanding the looming US fiscal cliff. Further evidence of recovery will be gauged from the release of the September small business optimism survey today. A likely third straight gain will provide encouraging news although the survey still remains lower than levels it was at earlier in the year. Over coming days I expect the USD to edge higher as it capitalizes on the various strands of uncertainty in the Eurozone.

As Japan returns from an extended weekend USD/JPY has reversed its recent break higher and is verging on another test of 78.00. There seems little in terms of directional influences to give any major impetus to the currency pair especially as many JPY correlations have broken down lately. JPY speculative long positions remain relatively high suggesting scope for some reduction and JPY selling but I suspect that USD/JPY will remain stuck in its current 77.77 – 79.00 range for some time to come. Nonetheless, JPY bears may be encouraged by recent signs of strong bond outflows adding to data showing equity outflows over recent weeks. Indeed, in the week to 28 September 2012 Japan registered its biggest net equity and bond outflows since early May.

AUD has been a major underperformer this month, with pressure intensifying following last week’s surprise RBA rate cut. Although a further sharp drop appears unlikely hefty long speculative positioning suggests that upside traction will be limited. Nonetheless, my quantitative models show that the AUD is looking increasingly oversold against the USD. The market is already pricing in another RBA rate cut by the end of the year suggesting that the reaction to upcoming data will be asymmetric. In other words the AUD will rally more in the wake of positive data than it will weaken in the wake of soft data. Business and consumer confidence indicators will provide further direction over coming days, but the main driver will come from the September jobs report on Thursday where a further drop in employment is expected. I continue to look for strong support for AUD/USD around the 1.0100 level, with 1.0285 a barrier to any upside break.

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US dollar Fed debasement begins

September 17, 2012 — Mitul Kotecha

Unsurprisingly risk appetite improved sharply in the wake of European Central Bank (ECB) and Federal Reserve actions as well as the many other events that have passed without incident. Indeed, the long list of events including German constitutional court decision on the ESM bailout fund, and Dutch elections, did not result in any obstruction to sentiment. Instead markets have been left to digest the impact of monetary policy actions.

The Fed did not disappoint in this respect and the $40 billion per month of Mortgage Backed Securities (MBS) purchases will and already has gone a long way to spurring risk assets, combined with the impact of the ECB bond buying programme. Although there are still plenty of doubts, especially as both Spain and Italy have yet to request a formal bailout, which would enable the ECB’s bond purchases to actually begin, the market tone will be ‘risk on’ over the short term. Indeed, our risk aversion barometer has shifted decisively into risk loving territory.

Data and events this week are unlikely to change this perspective although the risk of profit taking has grown given the pace and magnitude of recent moves. Although Eurozone flash purchasing managers indices (PMI) are likely to remain in contraction territory, the German ZEW investor confidence survey is set to bounce as it reacts to recent events. US housing market data will also look encouraging revealing further signs of recovery, although US manufacturing surveys in the form of the Philly Fed and Empire surveys for September will remain weak.

There will be plenty of scrutiny on the Bank of Japan which will be under a lot pressure for more aggressive policy action to reach the 1% inflation goal, especially following the steps taken by the Fed and ECB. Nonetheless, further easing by the BoJ looks unlikely this week. Meanwhile, in the UK softer inflation data and weaker retail sales will keep the door open to further Bank of England quantitative easing.

The USD will remain on the back foot in the wake of more Fed QE, but the USD index will find some support around the beginning of May low around 78.603. Notably USD short positioning has already increased sharply over recent weeks, suggesting that at least some of the Fed’s QE is in the price. Conversely EUR short positions have been cut sharply and while the momentum in EUR/USD is still to the upside, it will face resistance around the 1.3180. As long as there is not a sharp correction higher in peripheral bond yields, the EUR should remain supported.

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JPY firmer ahead of Fed decision

September 12, 2012 — Mitul Kotecha

The USD has come under growing pressure ahead of tommorow’s Fed FOMC decision. While by no means a done deal the majority of market participants are looking for the Fed to embark on a fresh round of quantitative easing or QE3. The Fed is also expected to shift its guidance to maintaining highly accommodative monetary policy into 2015 from 2014. There is a non-negligible risk of no action at the FOMC meeting which if correct will result in market disappointment, with an attendant sell off in risks assets.

Heading into the Fed meeting, comments by Republican House speaker Boehner that he was ‘not confident’ about reaching a deal with President Obama on avoiding the fiscal cliff as well as renewed warnings by Moodys ratings on the US AAA credit ratings, dealt the USD a further blow. It seems unlikely that the USD will be able to make much of a recovery if the Fed pulls the trigger for more QE. However, it should be noted that with so much in the price, should the Fed not deliver on expectations, the USD may actually bounce.

One currency that has felt the consequences of a weaker USD has been the JPY, which finally broke through the 78.00 level against the USD yesterday. A stronger JPY was greeted with plenty of disquiet in Japan (I’m in Tokyo this week) at a time when economic indicators are turning south. The fact that both the European Central Bank and the Fed are outpacing the Bank of Japan in terms of balance sheet expansion means that any JPY weakness is likely to be limited, with further upside risks to the currency prevailing.

Much will depend on the impact on US Treasury yields from Fed QE. Currently Japanese investors are disinclined to pour money overseas at a time when the yield advantage of US Treasuries or German bunds versus Japanese JGBs is limited. If US yields remain low, the prospects for further JPY weakness will also be limited while the pressure on the Japanese authorities to act to meet their 1% inflation goal and weaken the JPY will grow.

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So much in the price

September 10, 2012 — Mitul Kotecha

The weaker than expected US August non farm payrolls data at the end of last week punished the USD and reinforced expectations that the Federal Reserve will announce a fresh round of quantitative easing at this week’s FOMC policy meeting. The shift in expectations for QE has been rapid over recent weeks and the jobs data acted as the icing on the cake. In part USD weakness reflects both QE expectations and the positive reaction to the European Central Bank’s bond buying plan announced last week. In this respect a lot is already priced in to currency markets and EUR/USD will struggle to sustain a move above 1.28 in the short term.

From a risk / reward perspective there are potentially plenty of stumbling blocks this week aside from the FOMC meeting that could skew market direction towards risk rather than reward. These include the German constitutional court decision on the ESM permanent bailout fund and Dutch elections both of which take place on Wednesday. The German court decision is the last needed before the ESM comes into force. Legal experts expect the court to approve the ESM but with tough conditionality. Should the ESM not be approved it would leave any more bailout funds to come only from the cash left in the temporary and dwindling EFSF. Separately the Dutch elections look set to end in weeks if not months of coalition building. These events occur gainst the backdrop of talks between the Greek government and its creditors following failure to agree on spending cuts between Greece’s coalition partners.

Ahead of these events the European Commission will reveal details of plans towards a single banking supervision mechanism. The G20 meeting in Mexico and Ecofin meeting at the end of the week will also garner attention, with any discussion on a European banking union of interest. Meanwhile, following the ECB’s announcement last week the ball is in the court of Spain and Italy to formally request An EU bailout and in turn accept various conditions and targets necessary to receive a bailout. Only then will the ECB commence its ‘unlimited’ bond buying. No date or deadline has been set for such requests for a bailout but given the sharp drop in peripheral Eurozone bond yields over recent weeks in anticipation of ECB bond purchases there is certainly scope for disappointment, with market patience likely to run thin.

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