US Dollar Upside, Euro tensions

February 14, 2011 — Mitul Kotecha

Following the famine that was last week this week will see a feast of data releases, which hopefully will give some clearer direction to currency markets. The key eurozone data focus for FX markets will be the German February ZEW survey and it should highlight that investor confidence is bouncing back smartly. This will be accompanied by data showing a slight acceleration in GDP in the eurozone in Q4 2010. Good news, but the reality is that the EUR is being driven more by peripheral bond tensions and relative yields.

Although the EUR may get a brief lift from the news of the resignation of Egypt’s President Mubarak this will likely prove temporary. Given that tensions are beginning to creep higher EUR/USD may struggle to make any headway this week and will more likely slip below 1.3500 for a test of 1.3440 as sentiment sours. Even the usual sovereign interest may look a little more reluctant to provide support this week. The net long positioning overhang as reflected in the CFTC IMM data suggests some scope for a squaring in long positions, likely accelerating any downside pressure.

As usual data releases are failing to have a major impact on the JPY whilst interest rate / yield differentials suggest the JPY should be much weaker. One explanation for the stubbornly strong JPY is the strength of recent portfolio inflows to Japan, especially into its bond markets. This could reverse quickly and IMM positioning suggests that the potential for a shakeout of long positioning looms large, something that many Japanese margin traders are well positioned for according to TFX data. USD/JPY 84.51 will provide firm resistance to a move higher in the short-term.

GBP will be guided by the Bank of England Quarterly Inflation Report on Wednesday as well as the January CPI and retail sales data. The Report will reveal that inflation moderates over the medium term, even if short-term projections are shifted higher. Consequently, interest rate markets may even pare back overly hawkish expectations for UK rates, leaving GBP vulnerable. Nonetheless, markets maybe somewhat more sceptical or at least nervous in light of a likely increase in UK CPI, albeit mostly due to the increase in value added tax (VAT) at the turn of the year. Moreover, GBP may find some solace from a rebound in retail sales in January.

Overall, GBP/USD will take its cue from EUR/USD and the currency is vulnerable to a sustained drop below 1.6000 this week. The fact that GBP/USD IMM positioning is at its highest since September 2008 suggests a lot of scope for a sell-off. EUR/GBP looks like its consolidating in an even narrower range between 0.8400-0.8500.

Another positive slate of US data releases and likely more pressure on US bond markets this week suggest that the USD will find further support, with the USD index likely to take a shot at the 79.00 level. Indeed a further improvement in both the Philly Fed and Empire manufacturing surveys is expected, providing more evidence of strengthening manufacturing momentum, will be borne out in the hard data, with a healthy gain in industrial output expected. Similarly a healthy reading for US retail sales will support the evidence that the US consumer is in full recovery mode.

The positive impact on the USD may be dampened however, by benign inflation readings this week, supporting the view that US policy rates will not be raised for a long time yet. This is likely to be echoed in the Fed FOMC minutes this week. Nonetheless, speculative positioning suggests plenty of scope for short USD covering, with the latest CFTC IMM report revealing the biggest net short position since October 2010.

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Data and earnings focus

January 17, 2011 — Mitul Kotecha

Friday’s round of US data were generally upbeat, highlighting that consumer spending is coming back to life. Inflation pressures however, remain benign at least on the core reading highlighting the Fed’s concern that inflation is running below the level consistent with its mandate. In other words it will be a long time, probably late into 2012 before policy rates increase.

While the Fed is no hurry to raise rates despite a few hawkish rumblings within the FOMC the European Central Bank (ECB) in contrast appears to have become more eager to pull the trigger for higher rates. ECB President Trichet’s hawkish press conference last week set the cat amongst the pigeons and marked a clear shift in ECB rhetoric towards a more hawkish stance.

A very big problem for the ECB is that the eurozone economy is not performing along the lines that its hawkish rhetoric would suggest, especially in the periphery. Growth momentum in the core in contrast, as likely reflected in the January ZEW investor confidence and IFO business confidence survey data this week in Germany, remains positive. Both surveys are likely to stabilize at healthy levels but how long can the likes of Germany drag along the eurozone periphery?

There will be relatively more attention on the meeting of Eurogroup/Ecofin officials, with focus on issues such as enlarging the size of the European Financial Stability Facility (EFSF) bailout fund and development of a “comprehensive plan” to contain the eurozone crisis. Don’t look for any conclusive agreements as this may have to wait until the European Union (EU) Council meeting on 4 February assuming (optimistically given ongoing German resistance) some agreement can even be reached.

Following the success (albeit at relatively high yields) of the eurozone debt auctions last week, sentiment for peripheral debt will face further tests this week in the form of debt sales in Spain, Belgium and Portugal.

The US Martin Luther King Jr. holiday will result in a quiet start to the week for markets but there will be plenty to chew on. This week’s key earnings reports include several banks scheduled to release Q4 earnings. Financials are a leading sector in the rally in equities at present and these earnings will be critical to determine whether the rally has legs.

The US data slate includes January manufacturing surveys in the form of the Empire and Philly Fed, both of which are likely to post healthy gains whilst existing home sales are also likely to rise. This will not change the generally weak picture of the US housing market, with high inventories and elevated foreclosures characterizing conditions. As if to prove this, housing starts are set to drop in December. On the rates front, the Bank of Canada is likely to keep its policy rates on hold this week.

After coming under pressure last week much for the USD will depend on the eurozone’s travails to determine further direction. Concrete evidence of progress at the Ecofin may bolster the EUR further, with resistance seen around 1.3500 but don’t bank on it. The ability of eurozone officials to let down often lofty expectations should not be ignored. In any case following sharp gains last week progress over coming days for the EUR will be harder to achieve.

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The Week Ahead

December 13, 2010 — Mitul Kotecha

As markets make the last strides towards year end it appears that currencies at least are becoming increasingly resigned to trading in ranges. Even the beleaguered EUR has not traded far from the 1.3200 level despite significant bond market gyrations. Even news that inflation in China came in well above expectations in November (5.1% YoY) and increased prospects of a rate hike is likely to prompt a limited reaction from a lethargic market.

At the tail end of last week US data provided further support to the growing pool of evidence indicating strengthening US economic conditions, with the trade deficit surprisingly narrowing in October, a fact that will add to Q4 GDP growth, whilst the Michigan measure of consumer confidence registered a bigger than expected increase in November to its highest level since June.

The jump in consumer confidence bodes well for retail spending and highlights the prospects that US November retail sales tomorrow are set to reveal solid gains both headline and ex-autos sales driven by sales and promotions over the holiday season. Other data too, will paint an encouraging picture, with November industrial production (Wed) set to reveal a healthy gain helped by a bounce in utility output. Manufacturing surveys will be mixed with a rebound in the Empire manufacturing survey in December likely but in contrast a drop in the Philly Fed expected.

The main event this week is the FOMC decision tomorrow the Fed is expected to deliver few surprises. The Fed funds rate is expected to remain “exceptionally low for an extended period”. Despite some recent encouraging data recovery remains slow and the fact that core inflation continues to decelerate (CPI inflation data on Wednesday is set to reveal a benign outcome with core CPI at 0.6%) whilst the unemployment rate has moved higher means that the Fed is no rush to alter policy including its commitment to buy $600 billion in Treasuries including $105 billion between now and January 11.

In Europe there are also some key releases that will garner plenty of attention including the December German ZEW and IFO investor and manufacturing confidence surveys and flash purchasing managers indices (PMI) readings. The data are set to remain reasonably healthy and may keep market attention from straying to ongoing problems in the eurozone periphery but this will prove temporary at least until the markets are convinced that European Union leaders are shifting away from “piecemeal” solutions to ending the crisis. The EU leaders’ summit at the end of the week will be important in this respect. A Spanish debt auction on Thursday will also be in focus.

Assuming the forecasts for US data prove correct it is likely that US bond markets will remain under pressure unless the Fed says something that fuels a further decline in yield such as highlighting prospects for more quantitative easing (QE). However, following the tax compromise agreement last week this seems unlikely. Higher relative US bond yields will keep the USD supported, and as I have previously noted, the most sensitive currencies will be the AUD, EUR and JPY, all of which are likely to remain under varying degrees of downward pressure in the short term. The AUD will also be particularly sensitive to prospects of further Chinese monetary tightening.

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Caught In The Headlights

November 15, 2010 — Mitul Kotecha

For a prolonged period of time market attention had firmly focused on the Fed and prospects for quantitative easing (QE2). Now that QE has been delivered with little surprise, as the Federal Reserve arguably did a good job of living up to market expectations, it is Europe that is back in the limelight. Until recently the major surprise about Europe was how well the economy and the EUR were doing and how quickly the European Central Bank (ECB) would diverge from the Fed in its policy path.

This all looks premature and as if to confirm the shift in outlook the slowing in eurozone growth in Q4 (0.4% QoQ) revealed last week is likely to mark the beginning of a sharp and diverging deceleration in growth over coming quarters. The EUR may still have some life left in it given the ongoing purchases via recycled intervention flows from Asian central banks but weaker growth and peripheral worries are undermining this vestige of support.

Unfortunately for Europe the region is now not being caste in a good light and the peripheral trio of Ireland, Greece and Portugal are all staring into the headlights with nowhere to run. A crash of sorts seems inevitable but will there be any casualties? Markets are being whipsawed as they determine what will happen next in this slow motion saga.

Irish officials have maintained they do not need any aid package following discussions held over the weekend. Any bailout would likely come from a EUR 60 billion fund from the European Commission meaning a quick distribution but Ireland’s refusal will likely see pressure resume on peripheral debt markets in Europe as well as the EUR.

Portugal is also in the spotlight following comments by its foreign minister that the country may be forced to abandon the EUR if there is a failure to adopt a broad coalition government to deal with the crisis. This sounds like scaremongering but nonetheless highlights the political tensions in the country.

In Greece the second round of regional elections reveals the ruling Pasok party candidates are in the lead, reducing the prospect of early general elections. Nonetheless, this will do little to alleviate pressure as the EU is set to revise higher Greece’s 2009 deficit and debt estimates implying even more difficulty in meeting this year’s targets.

An EU/IMF team will visit Greece to assess progress as well as decide on whether the country should receive its 3rd instalment of a EUR 110 billion loan. Suggestions from PM Papandreou that he does not rule out having to extend the repayment of the loan will not auger well for sentiment. Finally, the government is set to present its 2011 final budget on Thursday, suggesting plenty of event risk this week.

A meeting of EU finance ministers tomorrow and Wednesday will also garner attention. Germany’s stance that investors will only have to take the brunt of losses from debt rescheduling only from 2013 still remains a contentious issue amongst officials even though it is a slightly softer stance than previously stated. Agreement on this as well as pressure on Ireland to accept funding will be key points of discussion.

Event wise, an auction of T-bills in Greece tomorrow as well as a Spanish debt auction on Thursday will be watched to determine how far the contagion of Irish woes have spread. The news is unlikely to be good, with higher yields likely. Unfortunately tomorrow’s German November ZEW investor confidence survey will provide further signs of retreating investor sentiment in the wake of renewed peripheral debt concerns.

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Exhausted

September 14, 2010 — Mitul Kotecha

No the title is not meant to describe how I felt this morning when I woke up but how I feel the market is looking at present in terms of risk trades. Firmer than feared economic data in the US and China and the agreement in Basel on new bank capital ratios boosted risk appetite but the moves are already beginning to fade. It would be easy to jump on the bandwagon but after the sharp gains registered over recent days I would suggest taking a cautious stance on jumping into risk trades at present.

The EUR has played a degree of catch up to risk currencies, rallying sharply against the USD, helped in part by the European Commission which raised its forecasts for the eurozone economy from 0.9% for 2010 to 1.7%. Although the change in forecasts should come as little surprise give that it is now in line with the European Central Bank’s (ECB) expectations the news bolstered the view of economic resilience in the eurozone. Unfortunately as the ECB noted following its last meeting there are plenty of downside risks to growth next year and upcoming data releases will be viewed to determine how sharply growth momentum will slow into next year.

One currency that strengthened was the JPY and this was mainly due the view that Prime Minister Kan will win the contest for leadership of the governing DPJ party in Japan. The race remains very close, with Prime Minister Kan having a slight lead according to Japanese press. The FX market will pay particular attention to the result given that the other contender Ichiro Ozawa has stated his willingness to drive the JPY lower as well as increase fiscal spending. The results of the election will be known shortly and should Ozawa win USD/JPY will likely find support although the bigger influence is likely to be a shift in relative US/Japan bond yields which due to the sell off in US Treasuries over recent days has become more supportive of a higher USD/JPY.

GBP has lagged the move in many risk currencies, failing to take advantage of the weaker USD. There was some relief overnight from an increase in consumer confidence in August according to the Nationwide index, which rose 5 points to 61, from a 14-month low in July. However, any boost to GBP sentiment will have been outweighed by a fall in UK house prices according to RICS, which revealed the sharpest one-month fall in August since June 2004. The data supports the view that the rally in UK house prices could soon be over. Weaker housing activity will also likely limit any further improvement in consumer confidence. Some of this is already priced into GBP however, and over the short-term EUR/GBP may struggle to breach the 0.8400 level.

Another underperformer overnight was the NZD which was hit by disappointing retail sales data for July, which fell 0.4%. Although the drop followed a strong gain in the previous month the data supports the view that the consumer remains cautious in New Zealand, a factor that will likely play into the view that New Zealand’s central bank, the RBNZ will keep policy on hold when they meet tomorrow. NZD slipped off its highs around 0.7347 overnight and also managed to dampen the upside momentum for AUD/USD which will likely struggle to sustain a break through resistance around 0.9350.

Today’s data will provide further direction for the days ahead, with the September German ZEW survey of investor confidence likely to be closely scrutinized. A drop in the economic sentiment gauge to around 10 is expected from 14 in August, highlighting that eurozone growth momentum is beginning to wane. Hard data in the form of eurozone industrial production will also record a weaker performance, likely to drop 0.3% in July. The data will likely cap the EUR today.

In the US the main release is the August retail sales report for which a 0.3% gain in both headline and ex-autos sales is expected. Sales will have been helped by back to school spending although major discounting will have weighed on retailers’ profits. Nonetheless, any gain even if modest will be a welcome development for Q3 growth in the US.

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