Global Markets Weekly Outlook Nov 9-13: Short Version-Markets Withstand US Jobs Reports

8 11 2009

Now What? Does Quiet News Week Mean Further Rally, Consolidation, or Pullback?

Note: The below is a brief summary of the full version. Those seeking details on the markets and instruments discussed below should refer to the full length version. Use this for an overview or to get an idea of what you want to look at in more depth in the full length version.

GLOBAL EQUITIES

The S&P 500 gained every session this week, with the bulk of the gain coming on Thursday following solid results from Cisco (CSCO) and a surge in nonfarm productivity. The much talked about stock market correction continues to fail to materialize with the S&P 500 just 2.9% from its 2009 highs and up 60% from its march low.

Amazingly, US large cap stocks chopped around yet managed to close slightly higher despite much worse than expected overall US employment data which seriously undermines the current US recovery picture. The smaller cap indexes got away with only modest losses. Given the light news week ahead, it will be interesting to see how markets open next week after having had a weekend to digest all the news of last week.

Friday was all about the monthly jobs report. Key Points:

They came in a bit worse than expected (-190K versus -175K expected) but investors could handle that, since positive revisions from prior months more than made up for this month’s shortfall.

The unemployment aspect of the household survey came in at 10.2%, leapfrogging expectations of 9.9% and topping that 10% level that everyone feared could get here. That is the worst showing since 1983.

The households survey (more indicative of small business jobs creation) shows small business and job creation is not happening-bad because this is where much of the initial job recovery can occur.

After trending down, average weekly hours remains stagnant at 33 hours per week, suggesting plenty of excess capacity remains to be absorbed before new hiring begins, typically once the figure gets above 36 hours/week.

See the full version for more analysis of stocks and the US employment reports.

OIL & GOLD

Gold

Gold glittered last week as IMF’s gold sales to the Reserve Bank of India spurred speculations on gold purchases by other central banks. This optimism, accompanied by continuation of low rate policy in the Fed, ECB and BOE, sent the yellow above 1100. Low interest rate environment benefits gold as it reduces the opportunity cost for owning the yellow metal.

Investors’ risk appetite diminished further after the US Labor Department reported unemployment rate soared to 26-year high at 10.2%.

Oil

WTI crude oil plunged to as low as 76.71 after US employment data disappointed the market last Friday. Given the struggles of the USD lately, this decline is mostly a matter of doubts about underlying demand vs. supply.

CURRENCIES

Compared to last week’s packed calendar, this week’s is much lighter, especially for the most widely traded currencies, the USD, EUR, GBP and JPY.

USD

Will A Delayed Reaction to US Employment Reports Spark the Long Awaited Pullback in Stocks and Other Risk Assets?

Summary

US Dollar Outlook: Bearish Long Term, Though Ripe For a Short Term Bounce

– US non-farm payrolls disappoints, unemployment rate at 26-year high of 10.2

– ISM Manufacturing Survey surprises at 55.7, reflecting continued improvement

– The Federal Reserve leaves rates unchanged, retains dovish wording that rates would remain “extremely low” for an “extended period.”

– USD’s decline appears lower than economic fundamentals and interest rate speculation would alone suggest. We suspect this gap between speculative and fundamental interest will close sooner than many expect as the dollar rises with the eventual pullback in stocks and other risk assets.

– The US unemployment reports Friday cast doubt on the meaning of the recent US GDP gains. With 70% of that GDP based on consumer spending, and consumers getting poorer and spending less, it’s clear that the Q3 figure was indeed due to unsustainable government spending than to a genuine recovery.

– Key Events: Thursday Unemployment claims w/w, Friday Trade Balance, UoM Consumer Confidence

EUR

Euro May Regain Fundamental Control with its Own With GDP Numbers

Summary

Euro Outlook: Bearish, Likely to Move Along With Stocks for Near Term

– Will Euro-zone GDP allow the EUR to move on its own merits?

– The ECB gives no guidance on rate hikes, but Trichet supports a stimulus reduction.

– The EURUSD looks overextended from a fundamental, interest rate and technical perspective. Still, as long as risk appetite hangs on, so will the EUR.

– Conflict between up-trend for the EURUSD and reversal for the risk appetite driving it.

– Tuesday German ZEW Sentiment, Friday Euro zone Flash GDP.

JPY

Yen Awaits Risk Appetite Reversal

Summary

Yen Outlook: Bullish due to coming risk aversion and signs of expansion, but growth signs may give it a chance to benefit from risk appetite

– Japanese Finance Minister Fujii: fill the tax short-fall with more debt issuance

– The interest rate outlook grows more extreme for USDJPY, yet the yen is holds its strength

– Does short-term USDJPY chop obscure a possible coming reversal?

– Key Events: Wednesday Core Machinery Orders

GBP

No “Great Expectations” From Dickens’ Homeland & THAT Makes For Possible GBP Breakouts Versus The Euro, US Dollar

Summary

Pound Outlook: Neutral/Bullish Near Term

– Events: Tuesday Trade Balance, Wed. Claimant Count, BoE Gov speaks, Inflation Report

– Rallies on Bank of England monetary policy of “only” another £25 bln QE

– Pound likely to continue appreciating versus Euro, though EUR likely to see rates increase sooner

CHF

Swiss Franc May Rise with Risk Correction –Or Not

Summary

Swiss Franc: Outlook Bearish/Neutral

– Events: Thursday ZEW sentiment, SNB Board Member Jordan Speaks, Friday PPI m/m

– Swiss Unemployment Rate at Highest in 11 Years

– Consumer Prices Drop For the Eighth Straight Month

CAD

Options Markets Pricing in Risk of USDCAD Rallies As Unemployment, and Possible Risk Aversion Could Boost the Pair

Summary

CAD Outlook: Bearish based on receding chance of rate increases, pullback expectations for oil, stocks

– Key Events: Monday Housing Starts, Friday Trade Balance

– Canadian Unemployment unexpectedly rises

– Canadian Dollar outperforms on buoyant risk appetite

AUD

Trading on Risk Sentiment Alone Now That Rate Hikes Expected

Summary

AUD Outlook: Bearish

– Key Events: Monday Home Loans, Thursday Employment Change, Unemployment Rate

– Australian Lending Unexpectedly Shrinks, Threatening Recovery

– New Home Sales See First Drop Since May, Says HIA

– Inflation Hits Decade Low in Q3, Rate Hikes Still Expected

– Business Confidence Surged to Highest in 15 Years, Says NAB

– Producer Prices Drop Most on Record on Currency Gains

– With Bullish Expectations Priced In, Only Steady or Rising Risk Appetite Likely to Support the AUD, Leaving Risk to the Downside

NZD

Bollard To World: We’re Not Australia

Summary

NZD Outlook: Bearish along with other risk currencies given the extended risk asset rally

– Key Events: Thursday Retail Sales

– New Zealand unemployment rate rose to a nine-year high of 6.5%

– New Zealand technical outlook points toward bearish potential

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Global Markets Weekly Outlook Nov 9-13:Full Version- Markets Withstand US Jobs Report

8 11 2009

Does Quiet News Week Ahead Spell Further Rally, Consolidation, or Pullback?

GLOBAL EQUITIES

Weekly Recap – Week ending 06-Nov-09 (With Excerpts from Briefing.com)

The S&P 500 gained every session this week, with the bulk of the gain coming on Thursday following solid results from Cisco (CSCO) and a surge in nonfarm productivity. The much talked about stock market correction continues to fail to materialize with the S&P 500 just 2.9% from its 2009 highs and up 60% from its march low.

Amazingly, US stocks somehow managed to close higher despite much worse than expected US employment data which seriously undermines the current US recovery picture. Given the light news week ahead, it will be interesting to see how markets open next week after having had a weekend to digest all the news of last week.

Friday was all about the monthly jobs report. They came in a bit heavier than expected (-190K versus -175K expected) but investors could handle that. The problem was that the unemployment aspect of the household survey came in at 10.2%, leapfrogging expectations of 9.9% and topping that 10% level that everyone feared could get here. That is the worst showing since 1983.

There was good and there was bad in the report for the market. The good, on top of the decent non-farm payrolls, were their revisions from August and September. There were some other bad areas that I will discuss later. Markets chopped around and in the end the bigger cap stock indexes finished with modest gains, the smaller cap indexes with minor losses.

All ten sectors advanced during the volatile week of trade, though cyclical stocks saw the most buying interest. Industrials surged 6.1%, consumer discretionary advanced 4.7% and materials gained 5.0%. Defensive areas underperformed on a relative basis, with telecom and consumer staples both gaining just 1.0%.

In economic news, third quarter nonfarm productivity surged 9.5% in its preliminary report. That is considerably better than the consensus which called for an increase of 6.5% increase. The surge marked the largest gain in productivity since 2003. It was fueled by the sharp increase in third quarter output and the considerable drop in hours worked. With job conditions still weak, unit labor costs dropped 5.2% in the third quarter. They were expected to fall 4.2%.

October nonfarm payrolls fell 190,000 in October, which was worse than the expected decline of 175,000. Meanwhile, the unemployment rate rose to 10.2% from 9.8%, which was worse than the 9.9% consensus. The rise in unemployment was not due to more workers entering the workforce — the labor force declined by 31,000 people as 259,000 workers left the workforce over the last month. The jump in unemployment was solely due to an increase in the number of unemployed. and reflects the continued challenges in the labor market

In other economic news, ISM Manufacturing Index for October came in at 55.7 (53.0 consensus), the ISM Services Index for October came in at 50.6 (51.5 consensus), construction spending in September spiked 0.8% (-0.2% consensus), and pending home sales for September made a 6.1% monthly increase (consensus unchanged).

In monetary policy news, the Federal Reserve didn’t provide much a surprise in its statement, keeping its language unchanged that low interest rates are warranted for an extended period of time. The Bank of England and European Central Bank also opted to keep their rates unchanged, as expected.

There were a fewer big names among the 94 S&P 500 companies that reported earnings this week as Q3 earnings season starts to wind down, there was . The trend of better than expected earnings continued (75 beat), with revenue failing to match the EPS performance (45 beat).

Of the larger market cap companies reporting this week — Cisco, CVS, Kraft (KFT), Qualcomm (QCOM) and Time Warner (TWX) — all reported better-than-expected results. Kraft, however, came up came up short on revenue, and as a result fell 2.7% for the week. With regard to Cisco, the tech bellwether authorized $10 billion more in share buybacks issued a solid outlook during its conference call, helping its shares rise 4.3% on the week.

In other corporate news, Warren Buffet’s Berkshire Hathaway (BRK.A) announced a cash and stock offer for Burlington Northern (BNI) at $100 per share. The news sent BNI up 29% for the week, with peers Union Pacific (UNP) and CSX (CSX) also posting healthy gains of 13%.

In commodity trading, gold gained nearly 6% to hit an all-time nominal intraday high of just over $1100 per ounce. Oil prices also gained in a volatile week of gain, up about 1% as the dollar dropped about 0.8%.

Index Started Week Ended Week Change % Change YTD %
DJIA 9712.73 10023.42 310.69 3.2 14.2
Nasdaq 2045.11 2112.44 67.33 3.3 34.0
S&P 500 1036.19 1069.30 33.11 3.2 18.4
Russell 2000 562.77 580.35 17.58 3.1 16.2

Special Section-Friday’s Jobs Reports: Non Farms Payrolls and Unemployment

This was one of the most important jobs reports in quite some time because the non-farm payrolls have been trending lower and everyone is looking to when they actually get to zero. It is the same with the weekly claims – right now, we just want it to get below 500K. Neither is working out for now.

Jobs were down more than expected (-190K. Revised -154K from -201K in August; -219K from -263K in September). The revisions more than made up for the miss on the non-farm payrolls number, so that is a positive.

The non-farm payrolls are interesting because it is mostly the large companies that they survey. They try to factor in the smaller companies and small businesses, but it is very difficult for the government to get that information accurately and quickly enough. It was worse than expected, but not drastically so, and the markets absorbed it well.

On the other hand, there is a 10.2% unemployment rate, and that is the highest since 1983. There is an argument about whether the non-farm payrolls or the household survey is more important. Greenspan always said the non-farms payroll was more important, but as we saw coming out of the recession in 2001, the household survey was more accurate. We saw that it was improving, and it was showing the right kind of improvement because there were many small businesses that were created thanks to tax incentives. We saw S corporations proliferate. The filings for those proliferated and small partnerships also surged.

We are not seeing that this time, however. There is not a surge of any kind of small businesses as the non-farm payrolls number improved, and the household number is getting worse and worse. It is my view, and the view of many smart economists, that household is more important when you come out of recession because many of the jobs are gone. JNJ and GE and those places are not going to be hiring people because they are still laying people off. The jobs are going to come from the smaller businesses, and if the smaller ones are still saying things are bad, then things are bad.

There was a 10.2 unemployment rate, but there were interesting figures with respect to the headlines below the headlines. 17.5% of the work force is either unemployed or underemployed. Underemployed means they would like to work more but cannot get the jobs. That is why we are seeing the temporary jobs growing. That is a key factor, and it has been up for two months in a row. People want to work but they cannot.

The job pool actually decreased by 500K workers. At the same time, the new unemployed increased by 1M. It was not just a factor of more people entering into the jobs market and thus pumping up the number of people out there unemployed. The number of new unemployed rose, so we have a serious problem. The headlines under the headlines are showing that things are not improving in employment, but they are worsening. Some of the anecdotal data from Challenger says that the layoffs are fewer, but those are only the big companies. They do not cover the small ones as closely and cannot cover them as accurately.

More than that, the average workweek is critical. It has to increase before there will be new hires. It stayed flat at 33.0, and that is after declining from 33.3 to 33.2, to 33.1 and now holding at 33.0 for two months in a row. We have a serious problem because it has to get up to 3.5 – 3.6 before they get to the point of thinking about adding even temporary workers.

Increases in productivity don’t help the employment picture. You can have a lot of productivity, but if companies do not feel things will get better, they are not going to hire anyway. They are just going to reap the benefits of having higher productivity and then stockpile the cash. That is good for earnings, but we are looking for jobs and getting the economy back on track. If companies are worried that jobs are going to be bad in 2010, so much so that they are not spending any of their cash on new employees, then that is a serious problem.

OIL & GOLD

Gold

Gold glittered last week as IMF’s gold sales to the Reserve Bank of India spurred speculations on gold purchases by other central banks. This optimism, accompanied by continuation of low rate policy in the Fed, ECB and BOE, sent the yellow above 1100. Low interest rate environment benefits gold as it reduces the opportunity cost for owning the yellow metal.

Investors’ risk appetite diminished further after the US Labor Department reported unemployment rate soared to 26-year high at 10.2%.

Oil

WTI crude oil plunged to as low as 76.71 after US employment data disappointed the market last Friday. The benchmark contract eventually settled at 77.43, down-2.8% over the day, narrowly the weekly gain to +0.6%. Given the struggles of the USD lately, this decline is mostly a matter of doubts about underlying demand vs. supply.

CURRENCIES

Compared to last week’s packed calendar, this week’s is much lighter, especially for the most widely traded currencies, the USD, EUR, GBP and JPY.

USD

Will A Delayed Reaction to US Employment Reports Spark the Long Awaited Pullback in Stocks and Other Risk Assets?

Summary

US Dollar Outlook: Bearish Long Term, Though Ripe For a Short Term Bounce

– Dollar index down 0.8% over the past week as risk appetite made a low volume comeback.

– US non-farm payrolls disappoints, unemployment rate at 26-year high of 10.2.

– ISM Manufacturing Survey surprises at 55.7, reflecting continued improvement.

– The Federal Reserve leaves rates unchanged, retains dovish wording that rates would remain “extremely low” for an “extended period.”

– USD’s decline appears lower than economic fundamentals and interest rate speculation would alone suggest. We suspect this gap between speculative and fundamental interest will close sooner than many expect as the dollar rises with the eventual pullback in stocks and other risk assets.

– Key Events: Thursday Unemployment claims w/w , Friday Trade Balance, UoM Consumer Confidence.

Analysis

The US dollar was easily the weakest of the majors during the past week due to

  • The Fed leaving unchanged both rates (at 0.25 %) and the key language of its statement, that rates would remain“ extremely low” for an “extended period.” This in turn causes fed fund futures to factor in a lower chance of rate increases in mid-2010.
  • Increased risk appetite, as shown by the 3 percent increase in the S&P 500 over the course of the week and the concurrent weakness in the safe haven yen and Swiss franc.

Amazingly, markets managed to shrug off a disappointing NFP report and end higher, with the AUD/USD finishing Friday higher, suggesting that risk appetite endures. Given the dire implications for consumer spending going into the critical holiday season, we don’t know whether to be impressed by the markets’ resilience or shocked at their state of denial.

Key points from the Friday employment reports showed:

  • 190K jobs lost vs. 173K forecasted
  • 10.2% Unemployment vs. 9.9% forecasted, suggesting actual unemployment closer to 20% than 10%
  • Average hours stagnant at 33/week, suggesting plenty of excess labor capacity to absorb before any new hiring. This is confirmed by the recent surge in productivity, showing companies will be squeezing out every possible unit of productivity from the employees before hiring new ones.
  • Average hourly earnings m/m increased 0.3% vs. 0.1% expected
  • Consumer credit fell for the eighth straight month, reflecting prudent reduction of debt as well as incomes, combining to mean less consumer spending

The simple facts are that the US unemployment reports Friday cast doubt on the meaning of the recent US GDP gains. With 70% of that GDP based on consumer spending, and consumers getting poorer and spending less, it’s clear that the Q3 figure was indeed due to unsustainable government spending than to a genuine recovery.

Much of that consumer spending is supposed to happen between now and the end of the year. The above does not augur well for holiday retail sales or for Q4 GDP.

It will be very interesting to see how the report sits with traders over the weekend, given that the light news week ahead is unlikely to provide reasons for markets to progress higher. Will they be able to hang on to current gains, begin to cede them, or somehow find further excuse in the current low volume momentum to keep rising?

Events

The continued correlation between the greenback and risk aversion is will be useful in the coming week of trade as scheduled event risk will be low and limited to Friday.

  • US trade balance may show a larger deficit for September, expected to reach -$31.8 billion from -$30.7 billion. Last month the deficit narrowed on rising exports and falling oil imports, as government stimulus measures around the world along with the weak US dollar helped to stoke foreign demand.
  • Preliminary reading of the University of Michigan’s consumer confidence index is expected to improve slightly in November by rising to 71.0 from 70.6. With the latest US labor market report showing that the unemployment situation continues to worsen , it will be interesting to see if the index can meet expectations.

NB: the official time of release is 10:00 ET, but it usually comes out at 9:55 ET, which can amplify any surprise factor from the actual results.

As usual, risk trends should be the dominant factor, and from a technical perspective, the convergence of a falling trend line drawn from the July highs and the 50 SMA around $ 76.50 serves as a solid resistancefor the US dollar index. Until the USD breaks above this level, its trend remains bearish.

EUR

Euro May Regain Fundamental Control with its Own With GDP Numbers

Summary

Euro Outlook: Bearish Along With Stocks for Near Term

– Will Euro-zone GDP allow the EUR to move on its own merits?

– The ECB gives no guidance on rate hikes, but Trichet supports a stimulus reduction.

– The EURUSD looks overextended from a fundamental, interest rate and technical perspective.

– Conflict between up-trend for the EURUSD and reversal for the risk appetite driving it.

– Tuesday German ZEW Sentiment, Friday Euro zone Flash GDP

Analysis

With neither exciting forecasts for interest rates nor an economic recovery likely to keep pace with the US or Japan through 2010; the world’s second most liquid currency lacks the fundamentals that can overcome risk trends in the general market and in its trading pairs, especially the USD. However, EUR events for the coming week, topped by Q3 GDP, may be meaningful enough for the EUR to move on its own fundamental merits. On the other hand, this influential release is scheduled at the very end of the week; and late breaks are rare – trend development as liquidity is draining from the market is even more uncommon. Therefore, general risk appetite will have most of the week to influence EUR trends.

As we can see through the IMF’s recent measure of the world’s central bank’s reserves, central banks and sovereign wealth funds want to diversify out of the USD as quickly as they can without driving down the value of their remaining dollar reserves.

The primary beneficiary of this shift out of the USD is without doubt the second most liquid currency: the euro. Because the EURUSD by itself comprises about a third of all fx trade these two currency’s are inextricably linked. For every 3 EUR bought, a USD is sold, and vice versa. Thus since the rise in risk appetite began in March, the EUR rise has been driven at least as much by sheer USD weakness as any other factor. Thus with the dollar now threatening a meaningful, bullish reversal after a month of congestion, the tight connection between the two currencies may begin to work against the EUR.

There are a few factors that can turn the dollar; but the most likely to actually occur is a drop in risk appetite. While it’s ultra low rates make it among the top funding currencies in the currency market; many believe the dollar has fallen lower than economic fundamentals and interest rate speculation would alone suggest. If markets do indeed pullback, expect the EUR to pullback much to the extent of the dollar’s rise as carry trades require dollars to unwind.

Events

As noted in the introduction, this week is far lighter on economic event risk than last week, particularly for the most liquid currencies. However, EUR data is at least no less prominent this week, so relatively speaking, the EUR might have enough new data to make some moves on its own merits.

  • On Monday, there’s the German Trade Balance, which could impress considering the jump in export orders, and Sentix Investor Confidence.
  • On Tuesday, the German CPI and ZEW Economic Sentiment come out.
  • Friday is the big day, with the release of both the Euro-zone and German preliminary reports on Gross Domestic Product. There is a lot hanging on these indicators, as everyone expects that the third quarter proved to be decisively more improved than the second.

Considering how the euro largely shrugged off Friday’s NFP, we could expect a more substantial rally to ensue from next week’s data even if there is only marginal improvement.

JPY

Yen Awaits Risk Appetite Reversal

Summary

Yen Outlook: Bullish due to coming risk aversion and signs of expansion

– Japanese Finance Minister Fujii : fill the tax short-fall with more debt issuance

– The interest rate outlook grows more extreme for USDJPY, yet the yen is holds its strength

– Does short-term USDJPY chop obscure a possible coming reversal ?

– Key Events: Wednesday Core Machinery Orders

Analysis

The Japanese Yen appreciated against all major counterparts Friday as investors scaled back on risk appetite after worst than expected job report from the U.S. USD/JPY once again penetrated the ever important psychological resistance of 90.00. Nonetheless, risk appetite has proven resilient. Japan’s 10-year government bond finished a five-week decline, suggesting that investors are looking into higher yielding assets as global recovery persists.

Japan’s recovery is progressing, albeit slowly. Coincident Index rose for the seventh consecutive time in September prompting government officials to upgrade assessment of the index. Japanese Cabinet Office declared that the trends are currently pointing that the “economy is in a stage of uptrend.” Meanwhile, Leading Indicators matched the steepest rise of June appreciating by 3.2% to 86.4 in August. Overall better than anticipated economic condition indexes continue to foster optimistic signs of export based recovery prompted by continuing demand from China and other developing nations.

Like other assets, however, the yen flows with overall risk sentiment, and stands to benefit most of all from any sustained pullback in global markets. Despite some competition from the US dollar, the yen is still the market’s ideal funding currency for the recovering carry trade. Japan is far more dependent on exports and thus a cheap currency, thus over the long term its overnight lending rate is almost certain to maintain a discount to the Fed Fund rate. Japan also has ample funds to attract investors looking to borrow and leverage cheaply; so it is just a matter of time before the yen will once again be the main ‘low-yielder’.

Looking at the past few weeks’ events, that time may come in the very near future. In the meantime, keep watching risk appetite, particularly the S&P 500. Though the dominant trend for this proxy gauge of risk sentiment is still bullish; momentum has clearly faded and many markets are still hovering at levels that are far higher than what their fundamentals would suggest.

The most consistent (and therefore immediate) concern for trading the yen crosses is the measure of risk in the capital markets. Over the past month, the S&P (our chosen single best proxy for the capital markets) has developed another counter-trend leg, with higher volumes on down days. What stands out is that, not only is this pullback the biggest since the downswing in June/July; but the four main corrections of the past three months are growing more extensive.

The markets have disconnected from their fundamentals long ago; and the gap seems to grow larger each day. It is difficult to tell what will spark a sustained pullback, but sentiment will be the likely primary driver for a meaningful reversal. When the market begins to unwind, panic profit taking will feed the selloff; and we will see just what percentage of the funds that have found their way back into the speculative arena are really prepared to stick it out through the normal ups and downs reserved for short-term traders.

However, if the yen is supposed to be the most robust funding currency for carry trade; why does a chart of any of the yen crosses look so different from one of the S&P 500? Why aren’t they doing better against the Yen when markets get optimistic?

There are a few factors that are altering this once close correlation. One of the main dynamic changes is the government’s record debt sales. Finance Minister Fujii has said that Japan would cover its lost tax revenue with an issuance of a record 132.3 trillion yen in government securities. This absorbs capital from the market (the capital that is usually put through to cross boarder traders). Another distortion is the US dollar. With a three-month Libor that provides a discounted yield to its Japanese counterpart; this currency is being treated as a cheaper funding currency (and every fraction of a percent counts when rates of return are as low as they are now). This is not a long term situation, however; and we will soon see US market rates recover while the Japanese equivalents stay low.

Events

Our final concern going forward is for economic data. There is little threat for volatility (much less a major turn) on the power of the JPY events through Friday. But, looking just through the weekend to the early Asian session on the 15th, we have the first reading of 3Q GDP. This will give a better picture of the state of Japan’s recovery and may spark some yen volatility in the days leading up to the report.

GBP

No “Great Expectations” From Dickens’ Homeland- Leads to PossibleGBP Breakouts Versus The Euro, US Dollar

Summary

Pound Outlook: Neutral/Bullish Near Term

– Events: Tuesday Trade Balance, Wed. Claimant Count, BoE Gov speaks, Inflation Report

– Rallies on Bank of England monetary policy of “only” another £25 bln QE

– Pound likely to continue appreciating versus Euro

Analysis

Among the top performing currencies this past week, the GBP’s relatively bullish fundamental developments helped push the currency up from major bearish sentiment extremes. The highly-anticipated Bank of England monetary policy statement sent the British Pound immediately higher on unexpectedly limited actions from the central bank. The BoE expanded its Quantitative Easing measures by ₤25 billion, half the expected amount, so the British Pound actually rallied on the relatively good news. Further moves may depend on the coming week’s UK employment numbers, but previously-extreme FX market positioning suggests that risks remain to the upside for the near future.

The EUR/GBP repeats the sterling’s strength against the USD, and is starting to descend toward a two-month low. The path in the currency pair is a bit ironic considering the fact that the ECB is much closer to unwinding such unconventional techniques.

Nevertheless, it’s all about expectations, and the GBP has done better recently relative to its admittedly lower expectations. British economic data may have given the pound an added lift. Producer Price Inputs rose to a 16-month high at 2.6%, while annual input prices increased for the first time in nine months.

Events

The middle of next week is set to produce some very important indicators for British strength, and the FX options market volatility expectations remain high. The first of which is the Trade Balance, expected for release on Tuesday. On Wednesday, we receive both the Jobless Claims change and the BoE’s Quarterly inflation report, both of which can move th GBP. Because many are pointing to the rising unemployment rate as one of the prime weak links in the UK economy, the employment report on Wednesday will obviously get added weight. The Inflation report should provide added evidence as to the BoE’s reasoning for expanding QE by only £25 billion and if we could expect an additional rise in future meetings. This recent rate announcement underlined market sensitivity to any and all shifts in monetary policy.

Clearly then GBP traders should pay close attention to the upcoming Quarterly Inflation Report release. As we just saw, any excessively dovish or hawkish rhetoric could easily force substantial volatility in forecasts and thus in the GBP.

UK Jobless Claims numbers are similarly difficult to predict, but fairly bullish market expectations arguably leave the door open for disappointments. The Bank of England is an inflation-targeting central bank and so does not technically target unemployment rates.

Yet the Unemployment rate is a major factor in the BoE’s decision-making process, so surprises in UK Jobless Claims numbers could force major moves in yield expectations.

The British Pound currently trades at fairly substantial technical resistance against the Euro and US Dollar. We have argued that previous bearish sentiment extremes would lead to a major GBP recovery, and we believe that a further correction in overextended positioning could move the GBP higher.

CHF

Swiss Franc May Decline as Path Clears for Risk Correction

Summary

Swiss Franc: Outlook Bearish/Neutral

– Events: Thursday ZEW sentiment, SNB Board Member Jordan Speaks, Friday PPI m/m

– Swiss Unemployment Rate at Highest in 11 Years

– Consumer Prices Drop For the Eighth Straight Month

Analysis

With little by way of scheduled event risk on the economic calendar and clear market expectations about monetary policy in place, the Swiss Franc is likely to continue moving with overall risk sentiment.

Overall, the fundamentals behind the Franc haven’t changed.

  • GDP probably contracted for the fourth consecutive quarter in the three months to September and is not expected to return to show even modest positive growth until 2010.
  • Inflation shrank for the eighth straight month in October, keeping the onset long-term deflationary stagnation an ongoing concern.

This means the SNB that is comfortable at record-low interest rates and is likely to push forward with quantitative easing as well as exchange rate intervention any time EURCHF nears 1.50. All this has keep the CHF stable and among the least volatile relative to the EUR.

Where active trading is likely to materialize, however, is in USDCHF, with direction being set by the markets’ overall appetite for risk.

Traders’ muted response to Friday’s Nonfarm Payrolls report, typically a major market mover, seems telling. Perhaps the markets were looking to get past the last piece of significant event risk (with all major rate decisions and US GDP all out of the way) to begin a correction of the broad rally in risky assets that has defined capital markets since early March.

Signs of a coming downturn were emerging in October as the MSCI World Stock Index fell the most in since February while the VIX index of US stock options volatility that is often seen as a proxy for investors’ risk aversion gained the most in a year. Attempts to push prices lower several times over recent weeks were frustrated by the economic calendar. With big fundamental data now out of the picture for the remainder of November, there is nothing to stop a pullback. Should this occur, capital will likely find its way back into the safety of the US Dollar, sending USDCHF higher.

CAD

Options Markets Pricing in Risk of USDCAD Rallies As Unemployment and Possible Risk Aversion Could Boost the Pair

Summary

CAD Outlook: Bearish based on receding chance of rate increases, pullback expectations for oil, stocks

– Key Events: Monday Housing Starts, Friday Trade Balance

– Canadian Unemployment unexpectedly rises

– Canadian Dollar outperforms on buoyant risk appetite

Analysis

The Canadian Dollar finished the week modestly higher against the USD, but a sharp end-of-week reversal suggests near-term momentum favors further CAD pullbacks. Sharply disappointing Canadian Net Change in Employment numbers forced a strong turn lower in the domestic currency, and the USDCAD quickly broke above its 50-day Simple Moving Average through the close. The CAD moves firstly with oil, then with stocks, then with news events. None look especially supportive going forward. We expect that dynamic to remain, and given that oil and stocks remain high, risk appears to be more to the downside.

The past week’s events suggest that the BoC’s planned mid-2010 interest rate increases may be premature given its ongoing employment woes.

Canadian unemployment rose unexpectedly to 8.6% from 8.4% reported last month and the net change in employment posted a disturbing decline of 43.2K, compared to the gain of 10,000 that was expected. The industries that weighed on the report the most were services related, indicating that a reduction in consumer spending has already taken effect. Most of all, the report adds to the list of reasons for the Bank of Canada to sit on their hands and resist the temptation to bring rates higher. Their estimates of a mid-2010 hike are actually starting to look optimistic as the severe glut in employment is sure to weigh on both prices and growth. Next week has Housing Starts in store for Monday.

Events

The Canadian Dollar’s near record-high correlation to Crude Oil and other key financial assets suggest we may see yet another eventful week of USDCAD trading.

Foreseeable economic event risk will be limited to an start-of-week Housing Starts report and an end-of-week International Merchandise Trade release—hardly the recipe for major volatility. Yet FX options markets continue to price in considerable moves in the Canadian Dollar as broader financial asset classes remain especially active. Options trader sentiment on the Canadian currency is currently near its most bearish in eight months, while recent CFTC COT Futures data shows that speculative traders remain aggressively net-long. We suspect that such a divergence leaves clear risk that Futures traders will cover Canadian Dollar-long positions—thereby forcing CAD losses. Barring any surprises, over-extended positioning leaves less room for rallies and higher risk of pullback. Thus we’re medium-term bearish the Canadian Dollar (bullish the USDCAD).

AUD

Trading on Risk Sentiment Alone Now That Rate Hikes Expected

Summary

AUD Outlook: Bearish

– Key Events: Monday Home Loans, Thursday Employment Change, Unemployment Rate

– Australian Lending Unexpectedly Shrinks, Threatening Recovery

– New Home Sales See First Drop Since May, Says HIA

– Inflation Hits Decade Low in Q3, Rate Hikes Still Expected

– Business Confidence Surged to Highest in 15 Years, Says NAB

– Producer Prices Drop Most on Record on Currency Gains

– With Bullish Expectations Priced In, Only Steady or Rising Risk Appetite Can Support the AUD, Leaving Risk to the Downside

Analysis

If risk aversion undermines demand for the high-yielding AUD, even another rate increase may not support it, given that the move is so heavily priced in already. The tone of the commentary included with October’s rate decision and the subsequent release of the minutes from the policy meeting was clear, with Governor Glenn Stevens saying that it is now time to begin “gradually lessening the stimulus provided by monetary policy” and warning that not doing so would be “imprudent”.

Traders believed Stevens. Credit Suisse swap rates indicate that investors are fully convinced that another 25 basis points is on the way. In fact, expectations of an increase have been unwavering even as the annual inflation rate declined to the lowest in a decade and producer prices fell at the fastest pace on record, hinting at little upward pressure in the pipeline. Thus the risks to the Australian Dollar seem stacked on the downside considering there is little that the RBA’s hawks can say at this point that has not been priced into the exchange rate, with the announcement having significant market-moving potential only in the unlikely event that policymakers backtrack on their aggressive posture.

Looking beyond the rate decision, the trend in risk sentiment is likely to be the dominant catalyst for price action. After two consecutive quarters of bullish momentum on questionable justifications across the spectrum of risky assets (stocks, commodities, high-yielding currencies), investors seem to have justifiably doubted how much longer the party can continue without new evidence of growth that has not already been priced into the markets.

The MSCI World Stock Index declined for the first time since June, registering the biggest loss in eight months in October; meanwhile, the VIX index of US stock options volatility that is often seen as a proxy for investors’ risk aversion jumped 23.9% on Friday, the largest one-day spike in a year, contradicting the otherwise muted market response to the NFP report.

If this proves to preface a substantial shift away from risky assets, the Australian Dollar will face tremendous selling pressure. Indeed, a trade-weighted index of the AUD’s average value against top counterparts is now 91.8% correlated with the aforementioned MSCI global stock benchmark.

If markets can manage to avoid a major pullback, the AUD will likely retain its gains as well, and benefit from any further bursts of optimism. Thanks to the resilience of the economy, the central bank predicts that Australia will grow by 3.25% over the course of 2010, which far outweighs previous estimates. Furthermore, they expect continued growth in exports which will be incurred probably as a result of Chinese purchases, a factor that should outweigh currency concerns.

Events

Australia’s unemployment report will be the big event for next Thursday, and could conceivably cement expectations for a quarter-point hike in December.

NZD

Bollard To World: We’re Not Australia

Summary

NZD Outlook: Bearish along with other risk currencies given the extended risk asset rally

– Key Events: Thursday Retail Sales

– New Zealand unemployment rate rose to a nine-year high of 6.5%

– New Zealand technical outlook points toward bearish potential

Analysis

The NZD held to a range of 0.7100 – 0.7300. Several major releases home and abroad failed to lead to any extended rallies. Risk sentiment which drives the “kiwi” continues to ebb and flow as markets look for the next catalyst to drive broader sentiment. The most significant development of the past week have been the dovish rhetoric from the RBA following their expected rate hike. The RBNZ is expected to follow the RBA’s lead and embark on their own tightening policy. Last month’s rate holds by the New Zealand central bank and the prospect that Australian policy makers slow rate increases could pressure the kiwi as yield expectations diminish. New Zealand unemployment rising to a nine-year high of 6.5% may also keep policy makers from raising rates as premature tightening could threaten the economic recovery.

As we noted earlier this week , RBNZ Governor Bollard is displeased with the New Zealand dollar’s appreciation as it threatens demand for exports and thus the recovery. The central bank leader’s statement that “financial markets treat us like Australia, but actually we are quite different,” shows his concern that recent “kiwi” strength is a product of the raised outlook for local interest rates irrationally based on the RBA’s actions. The economies are significantly different in the products that they export and the New Zealand economy isn’t expected to see the same benefits as Australia from surging growth in China. Bollard, looking to differentiate the two export driven economies and lower expectations for tightening from the central bank stated “New Zealand has had a recession and the pickup is slower and more vulnerable.”

A rise in U.S. unemployment to 10.2% could start to weigh on broader risk sentiment which could send the high yielding kiwi lower. Moreover, as central bank leaders start to lay the ground work to begin their exit strategy from current stimulus efforts, the outlook for global growth could diminish. However, bullish sentiment could prevail if traders dismiss labor reports as backward looking and point toward potential profits from leaner companies that are poised to take advantage of improving demand.

Events

This week the economic calendar will provide insight into domestic demand with retail sales figures scheduled for release. Early forecasts are for a 0.4% rise following a 1.0% gain the month prior. Last month’s gains from department store and fast food sales may be hard to duplicate with more New Zealanders out of work. A drop in consumer spending would significantly lower interest rate expectations and could generate “kiwi” weakness. Despite the potential impact on price from monetary policy , the New Zealand dollar continues to take its cue from commodity prices which should be monitored when trading the NZD.





Global Markets Outlook Oct 19-13: Risk Appetite Becoming Indigestion?

4 11 2009

The overall theme is risk assets continue to drift upward. As the rally stretches like an extended rubber band beyond fundamental support, plenty of signs of waning risk appetite. Could risk appetite finally be turning into indigestion?

STOCKS
Earnings, commodities, and the USD, in that order, drove global equities this week, as economic data took its usual backseat role when major earnings announcements begin, and could have only minor impact on markets for the next week or so until the overall theme of US earnings clarifies, barring any major surprises.

US earnings mostly overshadowed economic news throughout the week, with added attention on how the market would respond to revenue misses. The market overall reacted positively to several earnings beats, though it is clear that expectations have been raised as shares of GE (GE) and IBM (IBM) tumbled after their quarterly results.

Earnings got off to a strong start, with JPMorgan Chase (JPM) reporting a hefty earnings beat, with Q3 EPS coming in at $0.82 versus the $0.51 consensus. Goldman Sachs (GS) and Citigroup (C) reported earnings the next day, both topping estimates. But both shares came under a pressure in a “sell-the-news” trade.

Later, Bank of America (BAC) broke the trend of upside earnings surprises from the major banks, posting Q3 EPS of -$0.26 per share versus expectations of -$0.20. Banks continue to be hampered by increasing credit losses, though this was largely anticipated as poor jobs data continues to undermine consumer wealth.

Similarly, IBM and GE fell despite EPS beats. IBM’s disappointment came due to relatively weak services orders, while GE’s revenue was well short of expectations ($37.8 billion versus $39.5 billion).

Risk Appetite Turning to Indigestion?
Last Friday’s sharp decline across the spectrum of risk correlated assets on the back of disappointing earnings from Bank of America (BofA) and lower than expected revenues from General Electric (GE) could prove to be a significant signal of risk appetite turning to indigestion. The BofA has long been seen as a relatively weaker link amid the big US financial firms, so the result was not so bad for the sector as a whole considering the much better outcomes from other leaders earlier in the week; meanwhile, the GE report offered few surprises and beat expectations on the actual earnings portion of the report. Overall, it seems the fast, violent selloff that followed may have reflected a market that was looking for an excuse to take profits as recent gains increasingly look overextended.

Equities have jumped to the highest levels since 2003 relative to earnings, which seems more than a little overdone in a year when the world economy is set to see the first contraction in global output since the Second World War. If bullish momentum has in fact been exhausted, a deep correction lies ahead for risk assets in general, and so very oversold USD and other safe haven assets could move up fast.

There were some reports that the market liked, however. Google (GOOG) bested its consensus EPS ($5.89 versus $5.42 consensus), and seemed more upbeat about the economic outlook, and Intel (INTL) was also upbeat about the future.

After earnings, a major driver of trade was commodities and the dollar. The dollar tumbled to a fresh 52-week low at 75.21, giving a lift to commodities (+5.2%). As a result, gold hit an all-time nominal high of $1070.20 per ounce, and oil surged to the highest levels in 2009 at $78.75 per barrel. Crude prices also benefited by a smaller-than-expected increase in inventory levels. In turn, energy and commodity companies outperformed, with oil & gas equipment & services surging 7.8%.

Economic data had a modest impact on the market this week. Retail sales surprised to the upside with a softer-than-expected decline of 1.5% versus the -2.1% consensus. Excluding autos, retail sales increased a better-than-expected 0.5% versus the +0.2% consensus.

Initial jobless claims for the week ending Oct. 10 totaled 514,000, which was a bit below the consensus forecast of 520,000 initial claims and down 10,000 from the previous week. Continuing claims slipped below 6.0 million for the first time since March by coming in at 5.99 million. The consensus called for an even 6.00 million continuing claims, and many believe any coming declines are more due to expiring benefits than improved employment.

The Empire State Manufacturing Index for October , came in at 34.57, which beat the 17.25 consensus and boosted stocks.

Earnings will remain in focus in the upcoming week, with added attention placed to companies’ top lines and commentary regarding the economic outlook for the coming quarters.

Prominent earnings announcements for the coming week include:
Monday: AAPL (tech), HAS (toys), TXN (tech)
Tuesday: BIIB (biotech), CAT (building equip.), DD (chemicals), PFE (drugs), SNDK (tech), SYK (medical), CO (consumer), UALUA (airlines), YHOO (internet)
Wednesday: MO (consumer), AMGN (biotech), AMR (airlines), EBAY (ecommerce), LLY(drugs), FIADF.pk (int’l autos), FNF (financial services), FCX (copper), GNZ (biotech), NVLS (chips), BA (aerospace), USB (financial)
Thursday: AMZN (ecommerce), AXP (financial), BDK (consumer/construction), BGG (light gas engines), BMY (drugs), BRCM (tech), DAL (airlines), DO (oil drilling), ESV (oil drilling), MCD (consumer), MRK (drugs), PNC (financial), POT (fertilizer), HOT (hotel), DOW (chemicals), UNP (railroad), UPS (freight), GRA (chemicals)
Friday: EXC (utilities), HON (tech), IR (industrial), WHR (consumer durables)

COMMODITIES

Overall rising with stocks. Gold looking ready to break out but central banks may try to cool it off. Oil is consolidating, Natural Gas soaring. Like all risk assets, likely to pull in with stocks at some point, longer term supported by hurting USD.

CURRENCIES

USD
Ready to Rise?
Outlook for US Dollar: Bullish/Neutral

Summary
– World Demand for Long-Term US Financial Assets Up In August, Japan Ups Treasury Purchases for 3rd Month Straight
– US advance retail sales fell 1.5% in September, led by drop in auto sales
– Fed meeting minutes indicated that Bernanke & Co. were open to expanding MBS purchases in September
– US inflation reports continue to give mixed signals, with headline CPI at -1.3% and core CPI at 1.5%

Analysis
As stock markets and risk appetite continued to rise, it’s no surprise that the safe-haven USD was the second weakest currency last week, with only the bigger safe-haven JPY faring worse. Signs abound of extremes in optimism:

The DJIA index reclaiming the 10,000 level and the media’s effusive response
Other US and Global stock indexes remain at or near new highs
Gold hitting new highs
High yield currencies continue to hit new highs against the USD
High yield currency longs vs. dollar shorts remain at extreme oversold levels
USD weakness is now becoming a cover story on popular magazines such as Time and Business Week.

However, with extreme optimism comes the risk of reversal.

Events
Tuesday as US housing starts and building permits are projected to have risen for the second straight month in September to 10-month highs, with starts anticipated to hit 610,000 from 598,000 while permits may rise to 590,000 from 580,000. While the unemployment rate is still in the process of rising, the federal government’s tax credit for first-time home buyers of up to $8,000 is likely to remain supportive of demand through the end of the year. However, if the program expires as planned on December 1, the growth we’ve started to see in the housing sector could fade. Temporary government incentives can often simply shift current demand forward rather than actually increase it, resulting in far worse sales once the incentives end.

The Wednesday release of the Fed’s Beige Book report rarely moves markets but can provide some useful statistics on how the central banks 12 districts are faring economically.

Thursday’s leading indicators index is projected to rise for the sixth straight month, this time by 0.8 percent. However, gains are likely to be mostly the result of stock prices and the interest rate spread, while gauges of genuine recovery, employment and business investment should remain weak.

Friday’s National Association of Realtors’ index of existing home sales is expected to rise 5.9 percent for the month of September to an annual rate of 5.4 million, the highest in just over two years.
Supply levels and median prices have both fallen steadily to 8.5 months and $177,700, respectively. As with housing starts and building permits, the federal government’s tax credit for first-time home buyers of up to $8,000 is likely to remain supportive of demand through the end of the year, though surprise declines, as we saw in August, are not out of the question.

Prominent earnings announcements for the coming week include:
Monday: AAPL (tech), HAS (toys), TXN (tech)
Tuesday: BIIB (biotech), CAT (building equip.), DD (chemicals), PFE (drugs), SNDK (tech), SYK (medical), CO (consumer), UALUA (airlines), YHOO (internet)
Wednesday: MO (consumer), AMGN (biotech), AMR (airlines), EBAY (ecommerce), LLY(drugs), FIADF.pk (int’l autos), FNF (financial services), FCX (copper), GNZ (biotech), NVLS (chips), BA (aerospace), USB (financial)
Thursday: AMZN (ecommerce), AXP (financial), BDK (consumer/construction), BGG (light gas engines), BMY (drugs), BRCM (tech), DAL (airlines), DO (oil drilling), ESV (oil drilling), MCD (consumer), MRK (drugs), PNC (financial), POT (fertilizer), HOT (hotel), DOW (chemicals), UNP (railroad), UPS (freight), GRA (chemicals)
Friday: EXC (utilities), HON (tech), IR (industrial), WHR (consumer durables)

EUR
The EURUSD Continues to Defy Expectations for a Pullback

Summary
Fundamental Forecast for Euro: Bearish

– Market response to US earnings is the key near term driver, as the EUR rises with risk appetite
– Falling Consumer Prices force Euro Losses
– EUR/USD Sell Recommendations coming out around the 1.5035 level

Analysis
The Euro finished the week considerably higher against the US Dollar, but late-week pullbacks showed that traders were not yet willing to push it above the key 1.5000 mark. A strong week for major corporate earnings predictably more than offset fairly disappointing Euro Zone economic data, as the risk-sensitive Euro has relied on rallies in broader financial risky asset classes instead of trading off of domestic developments. Global equity indices posted yet another week of gains, and the US Dow Jones industrials Average traded above the psychologically significant 10,000 mark for the first time in nearly a year. The key question going forward is whether the Euro can trade higher on its own merits.

Traders are likely to scrutinize Euro fundamentals as it approaches fresh highs against the US Dollar. The fact that net Non-Commercial Futures positioning is at clear extremes, and the probability of a major EURUSD top has increased considerably. A relatively quiet week of economic event risk gives us little in the way of foreseeable volatility, but Forex Options markets volatility expectations have nonetheless jumped considerably on recent US Dollar tumbles.

Events
Traders will keep an eye out for German IFO business confidence data and Industrial New Orders report, but the center of attention will likely remain the US S&P 500 and broader risky assets. The rolling 50-day correlation between the EURUSD and S&P currently trades just short of record highs—emphasizing exchange rate sensitivity to broader financial flows. Key indices have likewise set fresh 2009 highs and remain ripe for corrections.

Thus the safer bet is that the Euro trades near a major top versus its US counterpart, but anyone attempting to time that reversal over the past months has paid the price, because the popular trading cliché – that markets can remain irrational for far longer than you can remain solvent – has held true for months, any sane trader will wait for some kind of reversal signals before playing the short side.

However, they should be ready with a plan for when that time comes. Given the overbought nature of risk assets vs the USD, with the EUR prime among them, the selloff could be hard and fast.

JPY
Losing its Prime Funding Currency & Safe Haven Role to the USD

Summary

Outlook for Japanese Yen: Bearish

– Like most currencies, moving with earnings driven risk appetite
– Will thus continue to drop with other safe haven assets until the fundamental and technical extreme reverses
– USD becoming the top funding currency
– How far will the yen’s slide go?

Analysis
What is the most influential driver behind the Japanese yen? The same underlying current for all capital markets: risk appetite, which is currently tracking market reaction to US earnings reports.

The yen’s relationship to market sentiment was once among the clearest fundamental relationships in the FX market. When the market wanted risk and yield, the yen would be sold against higher yielders, when fear reigned, the opposite occurred. However, the even lower USD 3 month LIBOR rates has made the USD the top funding currency for the ever-present carry trade. Thus we need to ask

1. which direction will risk appetite take?
2. how will the yen respond to sentiment trends?
3. will economic news override the influence of market response to US earnings news?

To answer the first question, we saw decreasing in risk appetite through the end of this past week; but no reversal. In fact, the seven-month rise in optimism looks as stable. However, the fundamental drag on this speculative run could soon tip the scales, as risk assets seem fully valued Capital is still finding its way into the market – and there is a lot of sidelined money to be reinvested – but the majority of those funds that are still in relatively ‘risk-free’ assets belong to those that are justifiably skeptical of the rally to this point or need true interest income rather than the promise of capital gains.

Because much of the newly invested money is looking to ride the steady rally; there is significant risk that a modest pull back could trigger a wave of profit taking that develops a new trend. The third quarter earnings season in the US could potentially fill this role if the mood turns sour, or simply doesn’t stay good enough to support higher prices. So far, the numbers have been hit-or-miss. Non-financials show the real trajectory of growth (and the comparisons to activity just two years back shows how weak conditions truly are); but the banks are what traders are really looking at. Earnings have surprised for Goldman Sachs and Citigroup; but the first owes its income to trading and the second is likely rolling loan losses into the future. Bank of America’s reading was likely the better reflection of the real health of the group. A $1 billion loss was led by significant lending right offs. If write downs are just being pushed backed and loan loss reserves not bolstered, the pain is just being delayed.

Regarding the second question, the yen has hardly abandoned its funding currency status. Taking a look beyond current conditions (where the Japanese Libor is at a premium to the United States’), many believe the Japanese rate is likely to be held at near zero for the longest of its peers. What’s more, the availability of funds is no doubt going to be much higher for Japan. A naturally high savings rate, loose monetary policy and deflation are all buffers of cash.

Events
Finally, there are few major market moving news items scheduled for release this week, so the JPY, like other safe haven currencies, should move in the opposite direction but to roughly the same magnitude, as risk sentiment

GBP
Can Bullish Momentum Overcome Fundamentals?

Outlook for British Pound: Neutral

Summary
– GBP so oversold that a few optimistic comments from BoE’s Fisher spark the sharpest rally in months
– UK jobless claims rise by the smallest amount since May of 2008
– GBPUSD rally gone too far, too fast?
– If BoE minutes and Q3 GDP don’t surprise, then overall risk sentiment should drive the GBP

Analysis
With just a few comments from a member of the Bank of England, we have seen the pound shoot higher against all of its major counterparts. When any asset reaches an extremely oversold position, it doesn’t take much to spook some latecomer profit taking from those who want to beat the crowd out the door with some profits.

Just to give some perspective as to the strength of this rally, the sterling set its biggest one day advance against its primary counterpart (the euro) in eight months. BoE Markets Director Paul Fisher’s remarks were relatively ambiguous and have neither been confirmed by any other officials, nor has there been any action to support his claim that the BoE would in fact slow its bond purchasing program to preserve options in the face of a tentative recovery from recession.

Events
However, we will soon see whether these remarks meant anything with both the BoE minutes and the advanced reading of 3Q GDP due over the coming week. We may be looking at one of the most fundamentally influential periods for the pound in months.

It’s been a long time since upcoming news could produce a meaningful change in the underlying trend of the British pound (short of extending the currencies painful tumble). However, the economic calendar ahead certainly has that potential. There are notable economic indicators on deck. In particular:

1. The minutes of the central bank’s last rate decision due on Wednesday should be the most influential of all. If there is any merit to Fisher’s forecast for the MPC to put a pause on their quantitative easing program, it could very well come from this report. If his outlook was for something later, then no mention of a change from the status quo could send a bearish ripple through the sterling crosses. The reversal that we saw last week was borne out of sheer sentiment. To sustain such a move, we need a real fundamental backing. The other scenario would be confirmation that the purchasing program has indeed been put on hiatus which would be the first genuine change in the bank’s policy tone since the financial crisis picked up steam. Such an event could truly alter the currency’s standing in the FX market.

2. The other major event for the week is Friday’s third quarter gross domestic product release. It is unfortunate, from a traders’ perspective, that this report comes out just before the weekend; because if it was released on a Monday there would be far more liquidity and time for the reaction to play out. However, as it is, there are mere hours to trade on the data before the weekend drains liquidity and rational minds can take over. This is not to mean this is going to be a non-event. Far from it. The bleak economic outlook for Europe’s second largest economy has been the source of the sterling’s weakness over the past 12 to 18 months. Should the 3Q reading report growth in the period through September, it would be a major step towards seeing a more meaningful recovery. A positive reading will be considered bullish; and the bigger the upside surprise, the more aggressive the pound’s run will be.

CHF
Lack of News Means CHF Likely to Move in the Opposite Direction of Risk Assets

Summary
Outlook for Swiss Franc: Bearish/Neutral

– Swiss Retail Sales Unexpectedly Fell in August
– ZEW Survey Shows Investor Confidence at Record High
– Speculative Sentiment Hints Swiss Franc Rally to Continue

Analysis
The Swiss Franc sees little currency-specific event risk in the week ahead, with price action likely to fall in with broad trends in financial markets’ sentiment and the US Dollar. The Franc has trended firmly higher against the US Dollar since March, as sheer USD weakness in the face of rising risk appetite overcame CHF fundamental troubles such as continuing deflation, rising unemployment, sluggish demand in key export markets, and active central bank intervention. The USD had slipped nearly 16% against the Swiss unit.

Risk Appetite Turning to Indigestion?
Last Friday’s sharp decline across the spectrum of risk correlated assets on the back of disappointing earnings from Bank of America (BofA) and lower than expected revenues from General Electric (GE) could prove to be a significant signal of risk appetite turning to indigestion. The BofA has long been seen as a relatively weaker link amid the big US financial firms, so the result was not so bad for the sector as a whole considering the much better outcomes from other leaders earlier in the week; meanwhile, the GE report offered few surprises and beat expectations on the actual earnings portion of the report. Overall, it seems the fast, violent selloff that followed may have reflected a market that was looking for an excuse to take profits as recent gains increasingly look overextended.

Equities have jumped to the highest levels since 2003 relative to earnings, which seems more than a little overdone in a year when the world economy is set to see the first contraction in global output since the Second World War.
If bullish momentum has in fact been exhausted, a deep correction lies ahead which will put firm upward pressure on the US Dollar at the expense of most of its major counterparts, including the Swiss Franc.

Events
September’s Trade Balance report is the only item of interest on the docket. Traders will be looking for clues that the central bank’s deflation-minded policy of keeping a lid on the value of the Franc, particularly against that of the Euro, is helping exports. Over 60% of all Swiss exports go to the Euro Zone.

CAD
Moving with Oil, then Risk Appetite, But May Feel Pressure from BoC Decision

Summary
Outlook for Canadian Dollar: Bearish

– Canadian CPI fell for the fourth straight month in September, the worst series of declines since 1953
– Crude oil could be setting the stage for a reversal, and will likely take the CAD with it

Analysis
The Canadian dollar eased back on Friday after the release of the nation’s consumer price index (CPI) fell for the fourth straight month in September, the longest series since 1953. Indeed, the annual CPI rate fell to -0.9 percent, but on the other hand, the annual rate of the Bank of Canada’s core CPI eased back less than expected to 1.5 percent from 1.6 percent. Still, it makes interest rate increases less likely, because the BoC has repeatedly stated that it has no plans to raise rates soon unless inflation becomes a problem, though the CAD’s strength against the USD is also a concern. Furthermore, the data highlights the Canadian dollar’s main source of event risk this coming week – the Bank of Canada’s rate decision.

Events
The BOC is expected to leave rates unchanged at 0.25 percent once again. After the Bank left rates unchanged on September 10, they said that they would maintain a neutral stance through June 2010. Overall, however, the currency is more responsive to changes oil and equities, both of which are the more likely source of CAD volatility for the coming week. Oil is hitting new highs on speculation for increasing growth driven demand, despite continually swollen inventories born of lax compliance with production quotas by OPEC members seeking greater current revenues.

That said, the key to price action will be surprise revisions, as upward changes to GDP will lead the markets to aggressively price in rate increases in 2010. From a technical perspective, daily USDCAD charts show that RSI rose from oversold levels, which has typically yielded at least a few days worth of gains since the start of 2009.

AUD
Taking a Hike?

Summary
Outlook: Bullish/Neutral

– As leading currency beneficiary of risk appetite, it’s at the most risk from a shift to risk aversion
– Australian consumer confidence at highest in two years
– Australian Dollar technicals may of reversal

Analysis
The Australian dollar was once again a top performer to finish the week’s trade as speculators poured into the progressively higher-yielding Aussie currency. The good news just keeps rolling in:
• Hawkish rhetoric by Reserve Bank of Australia Governor Glenn Stevens underlined the bank’s resolve to tighten monetary policy sooner than later, with more rate hikes on the way.
• Overnight Index Swaps are now already pricing in an impressive 200+ points of rate hikes in the coming 12 months—by far the most of any G7 central bank.

This should provide solid Australian Dollar support against lower-yielding counterparts. Yet the pace of Australian Dollar appreciation has been nothing short of impressive, and one has to wonder whether the currency can continue to meet expectations and keep up its recent advances.

Events
An effectively empty economic calendar means the AUD will likely go with the risk sentiment flow, which thus far has been very kind to the AUD. However, the AUD long positions are at such extreme levels that they are comparable to a rubber band pulled to near its limit, leaving us wondering how much longer the extension can go, or last.

Markets are now pricing in a 50 percent chance of an aggressive 50 basis point (0.50 percent) rate increase through the November meeting.

Expectations are running high for Australian Dollar yields and the currency itself.

Yet near record-high Aussie correlations to key commodity prices suggest that AUD forecasts may depend on broader moves in key financial asset classes.

NZD
Even More Vulnerable to Pullback than the AUD, Which Has Stronger Fundamentals

Summary

Outlook for New Zealand Dollar: Bullish
– Tracking risk appetite, but finally showing some fundamentals improving too
– New Zealand retail sales rose 1.1% in August, doubling expectations of 0.5%
– 3Q Consumer prices surged 1.7% from 0.6% the three months prior.
– Business NZ PMI to 51.7, the first expansion since April, 2008.

Analysis
Climbing risk appetite and a week of bullish fundamental data unsurprisingly helped drive the Kiwi to new highs last week, as equity markets continued to trend higher on a strong start to corporate earnings season with several blue chip names beating estimates. However, as noted above in the stocks section of this report, the Dow Jones Industrial Average hitting the psychological level of 10,000 and some Friday earnings disappointments led traders to take profits on fears that the rally may be a bit overdone in light of current prices.

A strong retail sales report started the week on a strong note for the high yielder as the 1.1% increase in consumption more than doubled estimates of 0.5%. The strong consumer demand calmed fears that domestic growth would lag the rise in demand from abroad. New Zealander’s increased ate out more often and increased their purchases at department stores as they sought out new clothing and furniture. The pattern of shopping demonstrates reflects the rising consumer confidence which reached a four year high in the third quarter. An improving global economy has boosted demand for exports which pushed the manufacturing industry into expansion in September for the first time in eighteen months. Strong gains in new orders and employment are strong signs that growth will continue.

Unfortunately rising prices followed the gain in growth as consumer prices rose 1.7% during the third quarter which will put the RBNZ in a difficult situation. An increase in costs for transportation and household goods may force the central bank to start tightening monetary policy sooner than they planned.

Traders are now expecting 202 bps of rate increases in the next 12 months, up from 154 before the inflation report, according to a Credit Suisse index based on swaps trading. Therefore, we may see continues support for the New Zealand dollar as long as risk appetite remains firm.

If concerns of the sustainability of global growth start to weigh on demand for risky assets then the unwinding of the carry trade will lead the NZD/USD lower. The question becomes is Dow 10,000 a catalyst to sidelined traders to seek higher returns or a barrier until growth risks subside.

Events
Fundamentally we will not have the amount of event risk as last week, with credit card spending and performance of services on tap which should leave price action to the risk sentiment. If pessimism gains momentum then a retrace back to the 20-Day SMA at 0.7270 is a possibility, especially with 0.7500 providing formidable resistance. However, rising yield expectations and an improving growth outlook may send the pair higher with a test of resistance at 0.7765-7/15/08 high a possibility

Conclusions
Barring major news surprises, expect risk assets and currencies to follow market response to the big name earnings announcements detailed above. If stocks can beat estimates AND grow top line revenues, risk appetite could continue to rule the day. Anything less makes the long extended rally in stocks, commodities, and higher yielding and commodity currencies very vulnerable to short squeeze driven pullbacks.

Disclaimer: Opinions herein stated do not necessarily reflect those of AVAFX, and the author may have positions in the instruments mentioned.
Disclosure: The author may have positions in the above instruments

Ava FX wishes you continuous successful trading.