Lower US yields undermine the US dollar

January 24, 2014 — Mitul Kotecha

A drop in US yields has undermined the USD over recent days against major currencies although emerging market currencies remain under varying degrees of pressure. US 10 year Treasury yields have fallen by around a quarter of a percent since the end of last year, acting as a real drag on the USD.

A rise in risk aversion over recent days (the VIX fear gauge has risen by over 13% since its low on 10 January) appears to have resulted in increased demand for Treasuries and weaker equities, with markets ignoring generally firmer than anticipated US economic data this week including weekly jobless claims and existing home sales.

Emerging market currencies have come under strong pressure while the usual safe havens have strengthened most against the USD in particular CHF and JPY. The EUR has also made up some ground. Fortunately for the USD expectations of Fed tapering continue to fuel some buying of the currency, constraining any downside. Nonetheless, until US Treasury yields resume their upward movement the USD’s upside momentum will be limited.

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Risk appetite still supported

November 5, 2013 — Mitul Kotecha

Relatively subdued trading yesterday ended with stocks higher and US bond yields lower. Our risk barometer is currently around its lowest since February 2011, signifying still strong appetite for risky assets, as also reflected by the drop in the VIX “fear gauge”. After a sharp 30+% drop since early October the Baltic Dry Index has also turned higher while gold prices are holding in a relatively tight range around its 100 day moving average at USD 1320.

There are a few releases and events to give direction to markets, with the RBA policy meeting, European Commission autumn economic forecasts, and service sector confidence surveys from the UK and US, all on tap today. Overall, there will be little to dent the positive risk bias but caution will intensify ahead of the ECB Council meeting and US employment report towards the end of the week.

Following last week’s USD rally the currency is likely to consolidate its gains over the short term ahead of Friday’s US October employment report. A dip in US yields helped by a softer US factory orders report took some of the steam out of the USD as caution crept in. A series of Fed speakers overnight did little to clarify the picture regarding the timing of tapering and thus provided little direction for the USD.

Nonetheless, despite some near term consolidation the USD looks set to gain further over the coming weeks helped by the fact that the market had already squared a lot of long positions over past weeks. A renewed increase in US yields accompanied by better economic data will help the USD’s cause but much will depend on when there is greater clarity regarding the timing of tapering. Expectations of a March 2014 may yet prove off the mark, leaving the USD plenty of scope for further recovery.

AUD benefitted from the robust September retail sales report yesterday but faces another hurdle today in the form of the RBA policy meeting. Although AUD remain a loser year to date, the currency has registered impressive gains from the beginning of September, much to the chagrin of the RBA.

Although a policy rate cut is highly unlikely today (I believe the RBA is at the bottom of its easing cycle), Governor Stevens is set to warn that the strength of the currency could warrant further policy easing in the months ahead. However, such warnings may sound hollow given worries about house price inflation and recently firmer data. Given some likely restraint in the USD ahead of the US employment report, AUD/USD will find some any losses limited to support around 0.9430.

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Little respite for the dollar

October 8, 2013 — Mitul Kotecha

Given that the government shutdown has reduced the number of market moving US data releases on tap, tensions surrounding the US budget and likely debt ceiling impasse continue to weigh on sentiment. Signs that senior Republicans are becoming less focussed on defunding Obamacare hint at potential for a compromise. However, a deal looks a long way off and nervousness is set to grow ahead of the October 17 debt ceiling deadline.

Reflecting this, risk measures rose overnight, with the VIX “fear gauge” spiking higher and equity markets lower. Safe haven currencies including CHF and JPY remain well supported against this background although gold prices have been range bound. Giving some relief from politics markets will be able to focus on the onset of the US Q3 earnings season this week.

The USD is susceptible to further slippage as traction towards a US budget deal remains out of reach. The USD index has now dropped by over 5% in the last three months, undermined more recently by a potential delay in Fed tapering and lower US Treasury yields. Uncertainty about the economic impact of the budget delay and prospective failure to raise the debt ceiling over coming weeks suggests that any upside traction for the USD will be extremely limited.

What is clear is that the longer the delay in reaching a deal the bigger hit on the economy and in turn the bigger the pressure on the USD. A delay in the release of trade data originally scheduled for release today will mean that market angst over the political impasse will be the bigger driver of the USD today. The USD index is set to edge further below the 80.00 level over coming days.

JPY is a clear beneficiary of the malaise in the US over recent days and looks set to strengthen further in the short term especially as risk aversion continues to increase and US yields remain constrained. The day’s ahead will be particularly important for the JPY from a domestic policy perspective too. Japan’s parliament meets from October 15 to December 16, marking a crucial period to pass legislation on Prime Minister Abe’s “growth strategy”.

Given past disappointment with Abe’s “third arrow” markets will look for strong evidence that reforms will move Japan to a higher and non deflationary growth trajectory. This is by no means guaranteed. Further disappointment would imply a firmer JPY. Having tested its 200 day moving average around 96.72 near term technical support for USD/JPY is seen around 95.92.

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Equity outflows from Asia accelerate

June 26, 2013 — Mitul Kotecha

A slate of better than expected US data releases including May durable goods orders, new home sales and June consumer confidence data (the latter two releases reaching their highest levels since 2008) helped to boost risk appetite, spurring equity markets higher and the VIX ‘fear gauge’ lower.

Firmer US data came alongside soothing comments from China’s central bank PBoC, about liquidity conditions in the banking sector, with an official noting that it will keep money market rates at “reasonable levels”. The European Central Bank’s Draghi added to the fray by noting that Outright Monetary Transactions (OMT) was even more essential now, highlighting the ongoing backstop provided by potential ECB peripheral bond purchases.

Meanwhile the positive US data releases helped to push Treasury yields higher, with the 10 year yield breaching 2.6%. Commodities remained under pressure, with higher yields in particular weighing on gold prices.

The calendar is rather light today and will provide little market direction, with an Ecofin meeting in Europe, UK spending review and US Q1 GDP revision in tap. Expect some positive follow through from the firmer tone to European and US equities overnight which will support risk assets including EM currencies although concerns about tapering are from over.

The rout in equity markets over recent weeks has had a devastating impact on equity flows to Asia. The outflow of equity portfolio capital from Asia accelerated sharply over June. Month to data Asia has recorded $10.2 billion in outflows, a massive move out of the region given that total inflows year to data have now dropped to $8.7 billion. One more month at this pace of outflows would see Asia registering net outflows for the year.

Indonesia, South Korea and Taiwan have been hit the most over June but no country has recorded net equity inflows. Year to date India has registered the strongest equity inflows of $14.7bn while South Korea has registered the biggest outflows of $7.3bn.

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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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