Macro Outlook for June 22, 2014:
Correlation /Sensitivity Sheet for June 20, 2014:
AUD: flat for the week. AUD has slight bullish sensitivity since it shrugged off the small job losses and is trying to rise on higher consumer sentiment data and go along with the rise in NZD. AUD would like to rally a few hundred more pips, with the high carry yield to help support it. But the RBA doe snot want to signal a hike yet as they seem to want to give the economy another 6-12 months to see how the spare capacity in the labor market, and fall in mining investment and fiscal consolidation will work its way through the economy. So they do not want to hike prematurely, sort of like the Fed. So that is dampening foreign exchange volatility and limiting AUD and USD gains. Market is also operating under the assumption that Chinese economy risks somewhat diminished as some Chinese officials said they will maintain 7.5% growth rate. With AUD CPI at 2.9% already, a bounce back in Chinese growth can help to convince the RBA to hike rates. Though AUD is at the top of the range, so overall, I am not chasing AUD strength. Just waiting for more information.
NZD: rallied +50 pips for the week as it is trying to flex its carry yield muscles as it is the highest yielding currency as the RBNZ has hiked rates 3 times in a row in response to GDP growth near 4.0% y/y. Not chasing NZD strength either. I do remain concerned about the 3 rate hikes and the high NZD can keep a lid on inflation which is only at 1.5%. I do not see a play to short it either, as I would only consider that if the NZD rallies to fresh highs above 0.8800 in NZD/USD. Just overall, waiting for more information.
CAD: was the star performer last week as it rallied 100+ pips. Mostly due to the combo of the higher CPI and retail sales on Friday. My previous scenario was to consider buying USD/CAD when it breached the 1.0800 barriers, but that was also assuming a subdued inflation situation in Canada, and the stronger CAD adversely impacting the economy. With the combo of the higher CPI and retail sales, and the market assuming China has stabilized, I am not going to short the CAD. Just waiting.
EUR: overall flat to rallied slightly by +30 pips for the week. Some macro shorts are trying to add to EUR/USD shorts under the assumption it will grind lower on the macro scenario that the Eurozone has low inflation and they can keep rates low into 2016, while the Fed is going to hike rates in 2015, and the US CPI just hit 2.0% y/y. So the closer the market gets to the Fed rate hikes, and the more the market realizes the ECB can be on hold into 2016, the more EUR/USD can grind lower.
The bullish scenario for EUR is that the macro is piling on shorts, but the price doesn’t go down that much, only by -50 to -100 pips or so. So there can be some short covering. And also the Fed doesn’t seem to be a hurry to raise rates and they shrugged off the higher inflation numbers last week. So getting sustained USD strength can be difficult. And the ECB is nowhere near QE yet. Interpreting multiple ECB member comments, they seem content with the rate cuts and will want to wait many months to see how they work. And Draghi said over the weekend that they need to see a further deterioration of inflation expectations over the medium term before doing QE. So this translates into the macro model of do not short EUR/USD at bottom tick.
EUR/USD downside obviously restrained by the lack of quick Fed rate hikes and the lack of QE by the ECB.
Overall, I would wait for EUR/USD to go above 1.3700 to consider shorting it.
GBP: rallied +50 pips or so for the week and knocked out the 1.7000 barriers. It does have some bullish sensitivity as it is shrugging off the drop in the CPI to 1.5%, as well as trying to spike higher on the MPC minutes saying that the decision is becoming more balanced as to whether to hike rates or not. Carney first hinted they may hike rates faster than the market expects, then speakers Weale and McCafferty also made similar statements. So if the market expectation was for a hike in Q2 2015, then a faster version would be Q1 2015 or by end of 2014.
The rise in GBP is obviously helping to cause the CPI to drop a bit, and may restrain it further. Part of whether the GBP can strengthen or not is if the BoE wants to hike rates to cool the housing market like the RBNZ has done. Another potential scenario is for the GBP CPI to drop in similar fashion like the Eurozone CPI, where many parts of Europe experience a lower level of inflation than usual. Though it is too early to tell from just one month of data.
Topside barriers in GBP/USD at 1.7100 and above.
Overall, GBP can potentially grind higher. Though I would not chase top tick.
JPY: flat for the week. JPY is flat, even though risk appetite is gaining momentum. This is due to the fact that bonds are still stuck in a range as well.
I do think USD/JPY can potentially be in a multi year up trend similar to equities. But it is looking for a catalyst to go higher. Either something from Japan, or Fed rate hikes, etc. Equities can move higher without any further Fed action, as they can benefit from the low interest rates and moderate growth.
USD/JPY on the other hand, doesn’t want to go much higher on the moderate US growth. It is looking for faster Fed rate hikes, drop in bonds to cause yields to rise, further easing from the BoJ, diversification of the GPIF into foreign assets.
JPY not rising due to tensions in Iraq or Ukraine. So not risk aversion catalyst yet. And I do not expect bonds to drop too much, so I am not doing anything here. Just waiting.
USD: there was stronger US data in the form of the CPI hitting 2.0%, higher manufacturing gauges, but the USD does not want to rally as the Fed is not convinced it wants to bring forward the rate hikes. Just waiting.
I am not sure if the rise in CPI is due to temporary factors, or whether it is due to the strong economic growth fueling more demand in the economy.
S&P: Rallied strongly for the week on stronger US data and the Fed shrugging off the rise in inflation, M&A activity. The market believes there is a decent progress on the economy and that the Fed will not need to speed up taper as there is still low inflation. Equities also seem to be getting a boost from the drop in bond yields from the beginning of the year.
So the emergence from the sever winter with better US data, and the lower yields of the past few months, and the ECB rate cuts, and the perceived reduction in Ukraine – Russia tensions, and the China growth not being an issue has all led to higher equity prices. American wealth hit a record in the first quarter as home values and equity prices soared. So there can be a virtuous cycle of the higher equity prices and home prices wealth effect leading to continued bull markets.
If I had to articulate the bearish macro scenario, it would be that the market is bumping up against general full valuations. There were some valuation concerns a few months ago restraining the market with the severe winter. Now that it has passed, the market has run up more, but there can be some macro sellers from the general full valuations, which means that the market participants feel equities are too high priced relative to their anticipated revenue and profit streams. The other bearish catalyst can be the rise in Crude oil, particularly Brent, hitting $115, which can help to restrain global growth.
The bullish scenario is that the market is shrugging off the Iraqi Al Qaeda tensions. Another theory is that the market is treating the rise in Crude oil as bullish for energy stocks and is bidding them up helping the broader market. Another macro theory is that the higher inflation is encouraging a bit of outflows from the bond market and into equities so the market participants can beat the inflation rates through equity exposure, assuming a growing economy. Higher inflation, in its early stages, can be bullish for equities if there is decent growth to back it up, especially if the Fed rate hikes are far away, which can encourage market participants to go into equities to help them beat the inflation rate. That seems to be the scenario the market is focusing on. With the market shrugging off the Iraqi – Al Qaeda and higher Crude oil prices, equities have bullish sensitivity. So I would expect a further grind higher.
Market volatility is low as the market is not pricing in a rapid rise in interest rates. So the market can continue to grind higher in the absence of risk aversion events. No one wants to chase top tick and no one wants to take profit as they fear the market can just keep grinding higher and may not retrace. I wouldn’t chase top tick either.
Overall, this is the year where stock pickers shine as individual stocks will have better reward/risk characteristics than a plain, vanilla long S&P position. The continued bullish case for equities is still attractive for foreign and domestic investors: The USD is still flat/weak, Fed still has 5-6 months of QE left, inflation still low and subdued, there seems to be an energy boom over the past few years, housing may have room to grow further as the unemployment rate drops, the wealth effect of rising home prices and higher equity prices, interest rates to rise only gradually in 2015.
Bonds: flat for the week. They fell one day on the higher inflation, then bounced back on safe haven bid still propping on the dips from Iraqi Al Qaeda tensions, as well as some people finding relative value in US bond yields, still sluggish growth. Bonds have not collapsed yet because the Fed is shrugging off the higher inflation rate and not looking to hike faster than expected. So only a tiny portion of the macro selling on the higher inflation rate entered the market for a day or so. More potential macro flows are waiting on the sidelines. They could sell bonds if inflation moves even higher and/or the Fed signals faster rate hikes. Not buying top tick, nor shorting bottom tick. Just waiting.
Gold: Rallied on the combo of the safe haven bid from Iraqi tensions and short covering after the technical traders shorted the breakout lower and piled on shorts and got caught. Some of them covered after Gold rallied above 1,300. The stops above 1,300 were the sizable ones. Not sure if the rally can run further.
Crude: broke out above $105 helped by the tensions in Iraq. Heating Oil and RBOB Gasoline and Brent Crude are rallying more than the WTI Crude. With the tech breakout combined with the tensions in Iraq, no one wants to sell Crude in big size. Even though the are large long positions already established, no one seems to want to sell. I would expect it to grind higher, though I cannot predict what will happen in Iraq.
U.S. econ to strengthen or weaken?
How fast and how much will Fed taper?
Mediocre U.S. data and low inflation to cause Fed to delay further taper?
Mediocre U.S. data and low inflation to cause Fed to expand bond buying?
Fed to taper hard and fast, by 20bln?
Inflation to come back or remain subdued?
EUR to sell off to rebalance economy toward higher inflation and lower unemployment rate?
Japan growth and inflation to disappoint after sales tax hike? Will that cause the BoJ to do more QE? Will the JPY have to weaken further?
Any risk aversion scenarios on the horizon?