USD/JPY bracing for a rebound

February 10, 2014 — Mitul Kotecha

In the post below I look at the arguments for JPY weakness in the weeks and months ahead.

A combination of elevated risk aversion and a narrowing US / Japan yield differential have been the major contributors to the strengthening in the JPY over January resulting in safe haven JPY demand and repatriation flows. The sensitivity of the JPY to both factors has been especially strong and it will require a reversal of one if not both of these to spur another wave of JPY selling.

Improving risk appetite required
If there is not a metamorphosis of the current bout of pressure into a full blown crisis as seems likely, risk appetite will improve and the upward pressure on the JPY will abate. Any improvement in risk appetite will however, be gradual and prone to volatility, especially in an environment of Fed tapering. It may therefore require more than simply improving risk appetite to weaken the JPY anew.

Japanese equity performance will be eyed
Of course associated with any improvement in risk appetite has to be a reversal of the recent negative performance of Japanese equities. Although Japanese equities will continue to be hostage to the fortunes of global risk sentiment, assuming that “Abenomics” continues to deliver results and growth in Japan continues to pick up (our forecast this year is 2% YoY GDP growth) further fallout in the Japanese equity market may be limited.

Flows will need to reverse
Over the past several weeks Japan has registered net inflows of capital in large part due to repatriation by Japanese investors. JPY has faced upward pressure from such inflows over recent weeks. Looking ahead assuming that risk appetite improves and US yields increase net capital outflows are expected to resume, which will put further downward pressure on the JPY.

Yield differentials will be particularly important
The extra dose of JPY pressure and important determinant of renewed weakness will be a re-widening of the US / Japan real yield differential. Eventually US bond yields will resume their ascent, driving the yield differential with Japan wider, and putting upward pressure on USD/JPY. The same argument will apply for EUR/JPY, albeit to a lesser degree.

Speculation positioning more balanced
The recent short covering rally has likely resulted in a market more evenly balanced in terms of positioning, providing a solid footing for the next leg lower in JPY. Indeed, compared to the three month average, JPY positioning has bounced back and is susceptible to a rebuilding of JPY shorts over coming weeks, driving the JPY lower.

Model points to renewed JPY weakness
Combining the factors above (except positioning) and adding in forecasts for US bond yields, risk aversion and conservative estimates for a recovery in Japanese equity markets over coming months, my quantitative model for USD/JPY highlights the prospects of a major rebound in the currency pair.

Posted in Bank of Japan, Economics, Japan. Tags: , , , , . Leave a Comment »

Euro extends gains, yen pressured

February 24, 2012 — Mitul Kotecha

The EUR found another spurt of life following the release of the stronger than expected February German IFO business confidence survey yesterday. The data helped make up for the disappointment related to the manufacturing and service sector surveys. However, while it may have alleviated concerns about weakening growth in Germany it only serves to highlight the disparities in growth across the Eurozone.

I continue to believe the EUR may struggle to sustain gains. In the near term, after breaking above 1.3320 resistance, EUR/USD will face further resistance around 1.3460. Nonetheless, my 2012 year end forecast of EUR/USD 1.26 shows that despite growing growth pressures in the Eurozone economy the EUR will still find underlying support from a healthy external balance and continued EUR buying from Asian official investors.

Over the near term upcoming votes in various countries on the second Greek bailout deal will provoke some nervousness while Greek reform implementation risks will also act to dampen EUR sentiment.

JPY has faced significant degree of pressure since the beginning of February. As noted previously one of the biggest sources of upward pressure on USD/JPY has been the widening in US – Japan 2-year bond yield differentials. US bonds currently yield around 19 basis points above Japan, the highest gap since August 2011. The widening yield gap already appears to be prompting foreign outflows from Japanese bonds, with outflows registered in six of the seven past weeks. These outflows have helped contribute to the weakness in the JPY.

The fact that the BoJ will step up its purchases of Japanese government bonds (JGBs) will also add to the downward pressure on the JPY as it will mean a further widening in US – Japanese yield differentials. Over the short term USD/JPY may face some resistance above the 80 level and I suspect that it will lose some momentum but maintain my view that it will reach 85.0 by the end of the year.

Posted in eurozone, FX, Germany, Greece, Japan. Tags: , , , , . Leave a Comment »

High Hopes

October 11, 2011 — Mitul Kotecha

EUR/USD has rallied over recent days from a low around 1.3146 last week. Market hopes of a eurozone solution may fall flat but the pressure on officials has ratcheted higher, and the risks of failure are now too significant to jeopardize with half measures. Weekend promises of banking sector recapitalisation by Germany and France have helped but will not be enough should such promises prove empty. Markets will likely give the benefit of the doubt to eurozone officials ahead of the delayed October 23 EU Summit and the November 3 G20 meeting.

Consequently EUR will find some support over coming days and could extend gains as risk appetite improves; having broken above 1.3600 the next big resistance level for EUR/USD is 1.3800. The fact that EUR speculative positioning is very negative (biggest short position since June 2010 according to IMM data) highlights the potential for short covering.

Possible good news in Greece, with an announcement by the Troika (ECB, EU and IMF) on talks over the next tranche of the bailout will likely provide more EUR support. One stumbling block for the EUR could come from the Slovakian vote on EFSF bailout fund enhancement, which is by no means guaranteed to pass.

The JPY remains firm benefitting from higher risk aversion, registering one of the highest correlations with risk over recent months. However, the reason why the JPY is not even stronger is that bond yield differentials (especially 2-year) with the US have widened out in favour of the USD over recent days. If the recent improvement in risk appetite continues, combined with widening yield differentials it could push USD/JPY to finally move higher and sustain a break above 77.00.

GBP/USD has made an impressive bounce over recent days from a low around 1.5272 last week despite the Bank of England’s announcement of more quantitative easing last week and credit ratings downgrades of several UK banks. This resilience is impressive but it appears that GBP is caching onto the coat tails of a firmer EUR rather than benefitting from a domestically led improvement in sentiment. Nonetheless, there is scope for further gains in GBP given that speculative positioning in the currency moved close to its all time low early last week in anticipation of BoE QE.

Posted in bank rescue, Currencies, ECB, Economy, Europe, eurozone, Financial crisis, Fiscal/Budget, FX, Germany, Greece, Japan, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Edging Towards A European Deal For Greece

July 21, 2011 — Mitul Kotecha

The momentum towards some form of agreement at the Special EU Summit today is growing, with French and German leaders reaching a “joint position on Greece’s debt situation”. Details of this position are still unknown, however. EUR has found support as expectations of a positive outcome intensify.

However, given that positive news is increasingly being priced in, and the market is becoming increasingly long, upside EUR potential will be limited even in the wake of a comprehensive agreement. A break above EUR/USD resistance around 1.4282 would bring in sight the next key resistance level around 1.4375 but this where the rally in EUR/USD is set to be capped.

Prospects of a major US debt default or at the least a government shutdown appear to be receding as the US administration has indicated some willingness to opt for a short term increase in the US borrowing limit to give more time for a bigger deficit reduction deal to be passed by Congress. Meanwhile, there will be further news on the deficit reduction plans put forward by the “gang of six” US senators, with a press conference scheduled for later today.

Debt ceiling negotiations are likely to be the main focus of market attention, with the Philly Fed manufacturing survey and weekly jobless claims relegated to the background. A speech by Fed Chairman Bernanke is unlikely to deliver anything new today. The USD is likely to be on the back foot given expectations of a deal in Europe and improved risk appetite but we expect losses to be limited.

The JPY continues to defy my bearish expectations. Over recent days the US yield advantage over Japan in terms of 2Y bonds dropped to multi-year lows below 20bps. Given the high correlation between USD/JPY and yield differentials, this has corresponded with the fall below 80.00.

Expectations of JPY weakness versus USD is highly dependent on the US – Japan yield gap widening over coming months. For this to happen it will need concerns about the US economy and expectations of more Fed asset purchases to dissipate, something that may not happen quickly given the rash of disappointing US data releases lately.

GBP found itself on the front foot following the release of the Bank of England Monetary Policy Committee minutes, which were less dovish than anticipated. They also revealed that the BoE expects inflation to peak higher and sooner than previously expected. However, the fact that the overall tone was similar to the last set of minutes meant there was little follow through in terms of GBP.

Further direction will come from June retail sales data today and forecasts of a bounce in sales will likely help allay concerns about a downturn in consumer spending. Nonetheless, GBP is still likely to struggle to break through resistance around 1.6230 versus USD.

Posted in central banks, Currencies, ECB, Economics, Economy, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, France, FX, Germany, Greece, Interest rates, Japan, Monetary Policy, New Zealand, UK, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

EUR Becomes The Anti USD

June 8, 2011 — Mitul Kotecha

The USD is close to giving back the full extent of the gains it made during May. The USD index hit a low of around 72.696 on 4th May and looks on track to re-test this level.

It would be easy to say that the USD is being undermined by low US bond yields but whilst this is partly true only USD/JPY has had a significant correlation with bond yield differentials over the past 3-months.

The reality is that the EUR has become the anti USD at present. Whilst the EUR composes 57.6% of the USD index which would imply a high correlation between the USD index and EUR, it does not explain the fact that the correlation over the past 3-months is at an extremely high 0.98.

It is probably a relief for USD bulls that the currency is not being particularly influenced by yield differentials at present as it would be even weaker if it was so. US bond yields continue to be depressed by growth concerns, following a spate of weaker US data releases, culminating in the May jobs report last week.

Speculation about QE3 is similarly unhelpful for the USD but the prospects of this occurring are still very slim and notably whilst Bernanke highlighted the “frustrating slow” economic recovery in a speech last night he did not indicate a desire to embark on QE3.

Nonetheless, any clues about Fed policy will be closely scrutinised and this includes today’s Beige Book of regional economic conditions. Our expectation of a relatively downbeat report suggests that the USD will find no support from this source.

Ultimately USD recovery will require EUR weakness but the European currency appears to have regained its ‘Teflon’ coating as its resistance to bad news grows once again. The EUR was helped yesterday by a stronger than expected April retail sales report and will undoubtedly find further solace from confirmation of a strong start to the year in terms of Q1 GDP today.

Overall direction continues to come from news in the eurozone periphery, however. The fact that officials appear to be inching towards an agreement in Greece has clearly been appreciated by the EUR. Moreover, potential ECB backing for debt rollovers by private investors will alleviate some concerns.

Nonetheless, at current levels, with EUR/USD on the path to its 4th May high around 1.4940 it appears that a lot is already priced in and the scope for disappointment is high.

Posted in Bond markets, Currencies, ECB, Economics, Economy, Europe, eurozone, Federal Reserve, FX, Greece, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , . 4 Comments »
« Older posts