Does Quiet News Week Ahead Spell Further Rally, Consolidation, or Pullback?
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%.
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 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%.
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.
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.
Will A Delayed Reaction to US Employment Reports Spark the Long Awaited Pullback in Stocks and Other Risk Assets?
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.
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?
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.
Euro May Regain Fundamental Control with its Own With GDP Numbers
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
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.
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.
Yen Awaits Risk Appetite Reversal
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
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.
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.
No “Great Expectations” From Dickens’ Homeland- Leads to PossibleGBP Breakouts Versus The Euro, US Dollar
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
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.
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.
Swiss Franc May Decline as Path Clears for Risk Correction
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
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.
Options Markets Pricing in Risk of USDCAD Rallies As Unemployment and Possible Risk Aversion Could Boost the Pair
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
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.
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).
Trading on Risk Sentiment Alone Now That Rate Hikes Expected
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
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.
Australia’s unemployment report will be the big event for next Thursday, and could conceivably cement expectations for a quarter-point hike in December.
Bollard To World: We’re Not Australia
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
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.
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.