A set back for the pound

June 18, 2009 — Mitul Kotecha

The multi week rally in the pound (GBP) has hit a snag as the currency has failed to extend gains above its recent highs around 1.66 against the dollar (USD).  The surprising fall in UK retail sales, with sales dropping by 0.6% from April compared to expectations of a 0.3% increase, dealt GBP another blow.   Sales were down 1.6% from a year earlier.  This is bad news for those that had believed that the UK consumer was enduring the economic downturn with some resilience. 

The reality is that the recovery in the economy will be a bumpy ride.  Whilst there have been some signs of improvement in the economy it is by no means a broad based pattern.  I would warn at getting too carried away with recovery expectations.  There have been clear signs of strengthening in both manufacturing and service sector survey data but they still only point to a gradual recovery in the months ahead. 

Moreover, some UK housing market indicators have pointed to early signs of recovery but a lot of this is due to a lack of supply and at best the housing market is entering a period of stabilisation.   Despite the signs of economic stabilisation the British Chamber of Commerce (BCC) cut its forecasts for the UK economy to -3.8% this year compared to a previous forecast of -2.8%.  

Meanwhile, UK banks continue to restrain credit and may even need more equity capital on top of the $158 billion in capital already raised according to Bank of England governor Mervyn King in his Mansion House speech.  He also warned about a “protracted” economic recovery. The good news is that the BoE is in no rush to take back its aggressive monetary easing and £125 billion asset purchase plan, but unless banks pass the benefits of this onto borrowers the fledgling recovery could stall quite quickly.   

The desire not to act quickly to reverse monetary policy was echoed in the minutes of the June BoE meeting, which revealed a unanimous 9-0 vote to maintain the status quo on policy.  The minutes also noted that the near term risks to the economy had lessened but monetary policy committee members remained cautious about the medium term prospects.  It is likely that the BoE will take several more months to gauge how successful policy has been. 

All of this highlights that GBP will be vulnerable to periodic bouts of profit taking and reversal.  Its ascent from its lows against the USD below 1.40 has been dramatic and rapid.  I believe that much of its gain has been justified especially as it had fallen to extreme levels of undervaluation.  Moreover, aggressive policy actions, both on fiscal and monetary policy, suggest that UK economic recovery will come quicker than Europe. This implies that GBP will at the least continue to recover against the euro (EUR) despite the weak retail sales induced set back.   

I also look for GBP to extend gains against the USD over coming months, with GBP/USD likely to end the year in the 1.70-1.80 region rather than low 1.60s where it is now. Market positioning leaves plenty of scope for GBP short covering over coming weeks adding further potential for recovery.  GBP appreciation will not continue in a straight line however, but set backs going forward should be looked upon as providing opportunities to rebuild long positions.

Posted in bank rescue, central banks, Currencies, Economics, Economy, Europe, Financial crisis, Monetary Policy, UK. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Is the Asian FX rally losing steam?

June 5, 2009 — Mitul Kotecha

Asian currencies appear to have lost some of their upward momentum over recent days.  Although the outlook remains positive further out, they are likely to struggle to make further gains over coming weeks.  One the one hand strong inflows into Asian equity markets have given support to currencies but on the other hand, data releases reveal only a gradual economic recovery is taking place, with continued pressure on the trade front as seen in the weakness in recent export data in the region.  Even China has been cautious about the prospects of recovery in the country.   

Almost all currencies in Asia have recouped their losses against the US dollar so far this year, with the Indonesian rupiah the star performer, having strengthened by over 11% since the start of the year.  More recently the Indian rupee has taken up the mantle of best performer, strengthening sharply following the positive outcome of recent elections.  The rupee has strengthened by around 3.5% since the beginning of the year and its appreciation has accelerated post elections.   

Much of the gain in the rupee can be attributable to the $4.4 billion of inflows into local equity markets over the last few months, a far superior performance to last year when India registered persistent outflows. Notably in this respect, the Philippines peso is set to struggle as foreign flows into local equities lag far behind other countries in the region.  Inflows into Phililipines stocks have been just $226 million year-to-date as fiscal concerns weigh on foreign investor sentiment.   

South Korea has been the clear winner in terms of equity capital inflows in 2009, with over $6 billion of foreign money entering into the Korean stock market.  Elsewhere, Taiwan has benefited from the prospects of growing investment flows from China and in turn equity market inflows have risen to around $4.3 billion supported by news such as the recent report  that Taiwan will allow mainland Chinese investors to invest in 100 industries.  Equity inflows into these currencies are far stronger than over the same period in 2008, highlighting the massive shift in sentiment towards Asia and emerging markets in general.

Unsurprisingly stock markets in Asia have been highly correlated with regional currencies over recent months, with almost all currencies in Asia registering a strong directional relationship with their respective equity markets.  Recent strong gains in equities have boosted currencies but this relationship reveals the vulnerability of currencies in the region to any set back in equities, which I believe could come from a reassessment of the market’s bullish expectations for Asian recovery.  

Central banks in the region have been acting to prevent a further rapid strengthening in Asian currencies by intervening in FX markets but a turn in equity markets and/or risk appetite could do the job for them and result in a quick shift in sentiment away from regional currencies. The Indonesian rupiah remains one to watch in terms of further upside potential, supported by the Asian Development Bank’s $1bn loan to Indonesia.   The outlook for the Indian rupee also looks favourable as post election euphoria continues.  Nonetheless, the gains in these and other Asian currencies have been significant and rapid and I believe there is scope for a pull back or at least consolidation in the weeks ahead.

Posted in Asia, central banks, China, Currencies, Economics, Economy, equity markets, India, Indian election. Tags: , , , , , , , , , , , , , , , , , , , . 1 Comment »

US dollar under pressure

May 15, 2009 — Mitul Kotecha

The US dollar has come under major pressure, with the US dollar index (a composite of the dollar against various currencies) falling to 4-month lows.   The weakness of the US dollar has been broad based and even the Japanese yen which normally weakens as risk appetite improves, has strengthened against the USD.  The euro has also taken advantage of dollar weakness despite ongoing concerns about the European economy. The main source of pressure on the dollar is the improvement in market appetite for risk.  

As I noted in a previous post, “What drives currencies?” risk appetite has been one of the biggest drivers of currencies in the past year.   This has pushed other drivers such as interest rate differentials into the background.   In the post I also stated that we would all have to watch equity markets to determine where currencies will move, with stronger equities implying a weaker dollar.

The dollar looks particularly sickly at present and it is difficult to go against the trend.  It will need a major reversal in equity markets or risk appetite to see a renewed strengthening in the dollar.   Although I still think it will require some positive news as opposed to less negative news to keep the momentum in equity markets going (see previous post) the prospects for a stronger dollar remain limited.   

Over the coming months the dollar is set to weaken further and those currencies that have suffered most at the hands of a strong dollar will benefit the most as risk appetite improves.  It is no coincidence that the UK pound has strengthened sharply over recent days, and this is likely to continue given its past undervaluation.  Other currencies which were badly beaten such as the Australian dollar and Canadian dollar will also continue to make up ground, helped too by a rebound in commodity prices.   

Aside from improving risk appetite the dollar may also come under growing pressure from the Fed’s quantitative easing policy, especially if inflation expectations in the US rise relative to other countries as a consequence of this policy.  It will be crucial that the Fed removes QE in a timely manner and many dollar investors will be watching the Fed’s exit strategy closely.  

Although the US trade deficit is showing improvement another concern for dollar investors is the burgeoning fiscal deficit.   The US administration revised up its estimate for the FY 2009 deficit to $1.84 trillion or about 12.9% of GDP, highlighting the dramatic deterioration in the US fiscal position.  Concerns about this were highlighted in an FT article warning about the risk to US credit ratings.

The deterioration in dollar sentiment has also been reflected in speculative market positioning, which has seen speculative appetite for the dollar drop to its lowest level in several months. The bottom line is that any recovery in the dollar over the coming weeks is likely to be limited offering investors to take fresh short positions as investors continue to move away from holding the dollar.

Posted in central banks, Commodities, Currencies, Economics, equity markets, Europe, Financial crisis, US, US administration. Tags: , , , , , , , , , , , , , , , , . 6 Comments »
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