FX position squaring

November 18, 2009 — Mitul Kotecha

It is becoming apparent that as the end of the year approaches market players are squaring FX positions rather than putting new risk on. The USD has failed to show any sign of sustaining a recovery over recent weeks but may be benefiting from short covering into year end, with the USD index pivoting around the 75.00 level. Supportive comments from US officials and international calls for the US to act to prevent the currency from being debased may also be helping on the margin.

Nonetheless, the USD’s outlook is still mired by a combination of both cyclical and structural concerns and it will fail to recover on a sustainable basis until it loses the mantle of preferred funding currency. This is unlikely to happen soon given the repeated commitment by the Fed to keep interest rates low for long as repeated this week by Fed Chairman Bernanke.

USD/JPY continues to gyrate around the 89-90 level and is showing little inclination to move either side though a run of positive economic surprises and the move in interest rate differentials (versus US) suggest that the JPY will trade on the firmer side of 90 over the short term; USD/JPY has been the most highly correlated currency pair with interest rate differentials over the past month. JPY speculative positioning is not particularly onerous at present, suggesting some room for an increase in JPY positioning.

The EUR continues to struggle to make any headway and is likely not being helped by European policy makers’ attempts to talk the USD higher. ECB President Trichet repeated his comments that a strong USD is in the world’s best interest though by now such comments are nothing new. It will need a clear break above 1.5061 in EUR/USD to renew the uptrend in the currency. For now, a reported 1.48-1.51 option expiring on Friday suggests range trading, with EUR/USD looking heavy on the top side.

GBP is set to remain firm despite the slightly dovish November MPC minutes. GBP looks resilient against the EUR against which it has benefited from a favourable move in interest rate differentials as a well as an adjustment in positioning where the market has decreased its GBP short positions and also decreased EUR long positions. EUR/GBP has been leading the way, and like USD/JPY this currency pair has become increasingly correlated with interest rate differentials, which has played positively for GBP. This has helped it to pivot around the 200 day moving average around 0.8871, a level that will prove important to determine further downside potential in EUR/GBP.

Posted in central banks, Currencies, Economics, Economy, FX, Interest rates, Japan, US. Tags: , , , , , , , , , , , , , , , , . 3 Comments »

Key events for FX markets this week

September 21, 2009 — Mitul Kotecha

Key events this week include the Fed FOMC and G20 meetings .  The G20 meeting is likely to be a non-event as far as markets are concerned.  There will be plenty of discussion about co-ordinating exit strategies but officials are set to repeat the commitment to maintain stimulus policies until recovery proves sustainable.  

There is likely to be little emphasis on currencies despite the fact that the dollar is trading around its lowest level in a year, except perhaps at the fringes of the meeting, with focus in particular on Japan’s new government’s pro yen policy.  

Regulation will also figure high amongst the topics debated but this will have little impact on markets over the short term.  Another topic that could be debated is protectionism, especially in light of the US decision to impose tariffs on Chinese tyres.

Ahead of the G20 meeting the Fed FOMC meeting is unlikely to result in any change in interest rates but the statement is likely to be cautiously upbeat in line with Fed Chairman Bernanke’s recent comments that the recession is “very likely over”.  The statement will be scrutinised for clues to the timing of policy reversal, especially given recent speculation that a couple of FOMC members were advocating an early exit.  Given that the dollar has suffered due to its funding currency appeal, any hint that some Fed officials are turning more hawkish could give the currency some much needed relief but we doubt this will last long. 

In contrast to speculation of a hawkish shift in thinking by some Fed members the Bank of England appears to be moving in the opposite direction.  The MPC minutes on Wednesday will be viewed to determine just how close the BoE was to extending quantitative easing and reducing interest rates on bank reserves at its last meeting. 

Sterling (GBP) has been a clear underperformer over recent weeks and a dovish tint to the minutes will act as another factor weighing on the currency as speculation over further action intensifies ahead of the next meeting.  

Sterling is also struggling against the euro having hit a five month low.  A combination of factors have hit the currency including concerns about quantitative easing expansion, the health of the banking system, and the latest blow coming from a the Bank of England in its Quarterly Bulletin where it states that GBP’s long run sustainable exchange rate may have fallen due to the financial crisis.   

Against this background it is not surprising that sterling was the only major currency against in which speculative positioning actually deteriorated versus the dollar last week (according to the latest CFTC Commitment of Traders report).   It is difficult to see any sterling recovery over the short term against this background, with a re-test of the 9 July low just under GBP/USD 1.60 in focus.

Posted in central banks, Currencies, Economics, Economy, Financial crisis, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Japanese yen and FX sensitivity to interest rates

September 16, 2009 — Mitul Kotecha

Interest rates have some way to go before they take over from risk aversion as the key driver of currency markets but as noted in my previous post, low US interest rates have played negatively for the dollar. As markets have continued to pare back US tightening expectations and US interest rate futures have rallied, interest rate differentials have moved against the dollar. 

The most sensitive currency pair in this respect has been USD/JPY which has been the most highly correlated G10 currency pair with relative interest rate differentials over the past month. It has had a high 0.93 correlation with US/Japan interest rate differentials and a narrowing in the rate differential (mainly due to a rally in US rate futures) has resulted in USD/JPY moving lower and the yen becoming one of the best performing currencies over recent weeks.

Going forward the strong FX / interest rate correlation will leave USD/JPY largely at the whim of US interest rate markets (as Japanese rate futures have hardly moved). Fed officials if anything, are adding to the pressure on the dollar as they continue to highlight that US interest rates will not go up quickly. San Francisco Fed President Yellen was the latest official to do so, warning that the prospects for a “tepid” recovery could fuel inflation risks on the downside.

This echoes the sentiments of other Fed officials over recent weeks and suggests that the Fed wants to prevent the market pricing in a premature reversal in US monetary policy.   It looks increasingly likely that the Fed will maintain interest rates at current levels throughout 2010 given the massive amount of excess capacity and benign inflation outlook, suggesting that interest rate differentials will play negatively for the dollar for several months to come.

As for the yen its path will not only depend on relative interest rates but also on the policies of the new DPJ led government. If Japanese press speculation proves correct the new Finance Minister may favour a stronger yen which will benefit domestic consumers rather than a weaker yen that would benefit exporters. Against this background, markets will largely ignore comments by outgoing Finance Minister Yosano who said that further yen strength would be detrimental for exporters.

The market certainly believes that the yen will strengthen further as reflected by the sharp increase in speculative positioning over recent weeks; net CFTC IMM long yen positions have reached their highest since 10 February 2009. Although USD/JPY has pushed higher since it’s low around 90.21 the upside is likely to be limited against this background and a re-test and likely break back below the key 90.00 psychological level is likely soon.

Posted in central banks, Currencies, Economics, Economy, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , . Leave a Comment »

The best funding currency

September 13, 2009 — Mitul Kotecha

The dollar was beaten up over the past week, finally breaking through some key levels against many major currencies; the dollar index touched 76.457, the lowest since September 25, 2008.  The usual explanation for dollar weakness over recent months has been an improvement in risk appetite.  However, this explanation fails to adequately explain the drop in the currency over recent days.   

Although we have seen a multi month trend of improving risk appetite it is not clear that there was any further improvement last week.  On the one hand the ongoing rise in equity markets points to a continued improvement in risk appetite; the S&P 500 recorded its biggest weekly gain since July.  Equity volatility has also declined, reflected by the decline in the VIX index.   

On the other hand, other indicators reveal a different picture.  The ultimate safe haven and inflation hedge, namely gold, registered further gains above $1000 per troy ounce. That other safe haven, US Treasuries underwent the strongest demand in almost 2 years (bid-cover ratio 2.92) for the $12 billion 30-year note auction, whilst the earlier 10 year note auction also saw solid demand (bid-cover ratio 2.77) as well as strong interest from foreign investors.  

The massive increase in bond issuance to fund the burgeoning fiscal deficit continues to be well absorbed by the market for now, whilst the drop in the dollar does not appear to be putting foreign investors off US assets.  The strong demand for Treasuries could reflect a lack of inflation concerns but may also reflect worries about recovery, quite a contrast to the move in equities.

The fact that the Japanese yen and Swiss franc strengthened against the dollar also contrasts with the view that risk appetite is improving.  The yen was the biggest beneficiary currency during the economic and financial crisis but has continued to strengthen even as risk appetite improves.  USD/JPY dropped close to the psychologically important level of 90 last week which actually indicates a drop in risk appetite.  Perhaps the move is more of an indication of general dollar pressure rather than yen strength.  

A likely explanation for the drop in the dollar is that it is increasingly becoming a favoured funding currency, taking over the mantle from the Japanese yen; investors borrow dollars and then use it to take short positions against higher yielding currencies.  US dollar 3-month libor rates fell below those of the yen and Swiss franc for the first time since November, effectively making the dollar the cheapest funding currency and fuelling broad based weakness in the currency.

Although the historically strong relationship between currencies and interest rates has yet to establish itself to a significant degree, ultra low interest rates suggests that the dollar will remain under pressure for a while yet, especially as the Fed continues to highlight that US interest rates are not going to go up in a hurry.

Posted in Bond markets, central banks, Commodities, Currencies, Economics, Economy, equity markets, Financial crisis, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , . 2 Comments »

Chinese stocks enter bear market

August 19, 2009 — Mitul Kotecha

Markets can only be described as fickle as they gyrate back and forth depending on the latest news or earnings report and as a result direction is changing not just daily but also intra-day.  Investors in most asset classes will continue to focus on stocks especially the recently underperforming Chinese equity market (Shanghai A share index) which officially moved into bearish territory after falling by over 20% from its early August high. 

Various reasons for the drop can be cited including regulator’s curbs on the stock market, high valuations, absence of new fund launches, limits on institutional buying,  high level of new accounts adding to volatility, tighter regulations on real estate, etc, but whatever the reason the direction has been clearly downwards and the impact is being felt across markets.

The turnaround in equity markets during Wednesday’s sessions was dramatic and was led by the turnaround in Chinese stocks which dragged other Asian bourses down with it.   This outweighed any positive sentiment from Market positives so far this week including a strong reading for the German August ZEW survey which surpassed forecasts by a large margin.  This followed the extension of the TALF by the Fed, and a jump in the US Empire manufacturing survey at the beginning of the week.  

Aside from weaker equities the usual FX beneficiaries including the dollar and yen strengthened on the back of the Chinese stock rout.   S&P’s affirmation of China’s credit ratings and positive comments from China’s stats office about the economic outlook in the months ahead  failed to support sentiment.  This would have been expected to provide a positive backdrop for Asian markets but Chinese stock market jitters provided a strong headwind to local markets. 

Overall most measures of risk have seen a substantial improvement over the past few months but there is no doubt that nerves are creeping back into the market.   This time the nervousness is coming from China and worryingly it is swamping the effect of any good news on the global economy and earnings.   This may prove to be a blip on the long road to recovery in risk appetite but it is difficult to ignore such a sharp fall in Chinese stocks without looking at the potential contagion to other equity markets.  

On the FX front those currencies that are most correlated with risk aversion such as the Australian dollar, New Zealand dollar, South African rand, Indonesian rupiah, Brazilian real and Mexican peso will gyrate in relation to the moves in risk appetite.   These currencies have had the highest correlations with risk aversion over the past month and in the current environment will come under some pressure at least until risk sentiment changes again, which in this market could happen at any moment and without warning.

Posted in Asia, Bond markets, central banks, China, Currencies, Economics, Economy, equity markets, India, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . 2 Comments »
« Older posts
Newer posts »