Macro Outlook for August 10, 2014
Correlation / Sensitivity Sheet for August 8, 2014:
AUD: chopped around mostly past month. AUD/USD only fell -100 pips. Exotic option exposure at 0.9500, where I would consider short trades. CPI up to 3.0%, but the RBA believes that inflation will stay in check due to the low wage growth and still some time before unemployment rate will decline noticeably. And the RBA believes that the CPI will still stay in check, even with lower levels of the exchange rate. That is their belief. So that reluctance to go dovish, even though Stevens said that they still have ammunition left. RBA would like to see AUD drop -500 pips or -1000 pips, to help with economic rebalancing, but there are currently no catalysts for that yet. China is perceived to be doing just fine and on track to hit its 7.5% growth target or so. AUD is still being propped up due to some demand for AUD denominated debt as many participants are searching for yield among expectations of moderate global growth and inflation kept in check.
The market has become a bit desensitized to China data. It is only making small moves within the range. No sustained breakouts.
Bullish Scenarios are: AUD denominated debt buying supporting on dips, China expected to be just fine.
Bearish Scenarios are: Unemployment hit 6.4%, highest in many years.
Overall, not doing anything, unless there are signs that either the Fed is going to hike rates faster (in which case EUR/USD may be a better short), or the China data deteriorates abruptly and worries the market further, or the RBA signals potential rate cut. Just waiting for now.
NZD: sold off -350 pips over the past month. Due to combination of the CPI coming in lower than expected, profit taking on extended longs, exports fell in June signaling the high NZD restraining economy, RBA signaling more restrained rate hikes in the future and inserting language that due to the fall in dairy and timber prices, the NZD can be poised for a significant fall. The RBNZ would like to see the NZD fall another -1000 pips to help rebalance the economy and help boost exports, though I do not see a current catalyst for that.
Potential Bullish Scenarios are: if the Fed delays rate hikes and there is more carry trade demand
Potential Bearish Scenarios are: if the previous four rate hikes kick in and start to restrain the economy resulting in lower CPI readings, weaker housing market, etc.
Overall, not doing anything.
CAD: sold off -100 to -200 pips over the past month. It started with the loss in jobs for the month of June, and continued on the drop in Crude oil, and the flat jobs report for July, released last Friday. The BoC is counting on stronger exports to help the economy reach full capacity by 2016 or so. So the market sold CAD to help rebalancing the economy with that in mind. There is a divergence between US and Canada, as the US has experienced decent job growth over past few months and unemployment down to 6.2%, while CAD unemployment at 7.0%. So the market is bidding up USD/CAD to take into account that potential for divergence in monetary policy. Not sure if the reward risk is worth playing at current levels, unless the Bank of Canada signals more concrete steps towards a potential rate cut, or the Fed towards a faster rate hike. Barrier in USD/CAD at 1.1000.
Overall, not doing anything.
CHF: CPI inflation still subdued around 0.0% y/y. As CPI drops in Euro zone, the CPI in Switzerland is also remaining near zero. SNB still considers the 1.20 floor as a central policy tool. They haven’t had a need to defend it in a long time. No reason for them to change policy. CHF has been selling off versus the USD, as USD/CHF goes higher, but that is due to EUR/USD falling, which causes USD/CHF to go up as they are usually highly inversely correlated.
Do not see anything.
EUR: sold off -250 pip over past month in a slow grind lower. It just grinds lower by -30 pips a day, making some retracements occasionally. It fell as the macro sellers were gradually hammering the prices lower. The macro short position in the EUR has grown by a large amount over the past month. Some traders think shorting EUR/USD is the hot new trade for a big macro move of thousands of pips, similar to shorting the JPY in late 2012 and early 2013.
Euro sold off as CPI ticked lower down to 0.4%, potential for Russia sanctions and geopolitical tensions to hurt some Euro zone economies, some slight Portugal problems which remained contained but highlighted sluggish growth in Euro zone, market knocking out some barriers to the downside, the international money flows into periphery debt have abated.
There is some bearish macro sensitivity as the CPI dropped to 0.4% for July, while the EUR fell during the month. This shows that the deflationary forces are so powerful that even with a -300 pip depreciation in the EUR, the CPI still was able to go lower (though the currency depreciation effect on inflation is usually a lag). Even Hollande said the EUR has not fallen far enough. So whether the EUR is at 1.39 or 1.33, it still should fall -1,000 pip or more to help boost inflation and exports in the Eurozone. It is lacking a catalyst as the Fed still says there is “considerable time” after QE ends before they can hike rates, and the ECB is still studying QE and could be six months or more away from adopting those measures.
Also, on Thursday during the ECB meeting, Draghi talked down the EUR, but it only managed to fall -20 pips by the close of the day. He talked about diverging US and EUR economies and monetary policies, and how the CFTC data showed an increase in short EUR bets in the right direction. But the EUR barely fell by the end of the day, which showed some bullish sensitivity, and the EUR did short covering on Friday.
There is still no bullish scenario for the EUR, so rallies should be capped, though there may be some macro exhaustion of the bearish move, so I would expect the market to consolidate a bit here, until the market finds new catalysts. So I would look to fade the big moves to the upside and downside stops.
Most of the macro shorts do not want to cover their short EUR/USD positions. They are very willing to ride out some retracements, so EUR/USD shouldn’t spike higher to 1.3900 or something. The more EUR/USD rises, the more attractive it becomes to macro shorts who missed out on the previous drops. So this perception should keep EUR/USD rallies contained, assuming the Fed does not surprise to the dovish side.
EUR/USD downside barriers at 1.3325 and below every 25 pips.
GBP: tried to rally above 1.72 in GBP/USD after the hotter CPI reading, but then collapsed lower on profit taking on longs, as the market perceived the strong first half of 2014 growth, may not be matched in the second half of the year and may moderate. Also the weaker wage growth, some slightly weaker data, and market got a bit ahead of itself expecting a potential rate hike by the end of 2014.
Even if the BoE hikes rates, it will still probably like to wait many months to gauge the effect. A lot of central banks have that view as they have inserted the language that when rates do rise, they will be more gradual, and their peak may be below the historical norm. So they are trying to dampen expectations for the fast and aggressive rate hikes of the past.
Overall, I do not see anything here. It has fallen a few hundred pips, which correct the previous exuberance of rate hikes. Going forward, I am not sure how the BoE will respond to current data versus the Fed. Also unsure how the flows in EUR/GBP will unfold with the geopolitical tension and weak Eurozone growth and inflation. Just waiting.
JPY: USD/JPY tried to rally +150 pip on a burst of USD strength, even though bonds were flat. Then it fell back down on S&P sell off and some geopolitical tensions with Russia.
This contrasts a bit with EUR/JPY, which has already broken lower on EUR specific weakness. And GBP/JPY is trying to break lower as well. USD/JPY is still relentlessly bid around 101.00 level for the past six months. Not even the surge in US bonds bringing yields lower is enough to cause USD/JPY to break support. Which is a fascinating divergence. Not chasing USD/JPY topside since I am not sure the Fed is going to bring forward rate hikes. It is possible that the surging international demand for US debt, since they are yielding higher than the Eurozone peers, is causing USD/JPY to be bid.
Bank of Japan downgraded export view slightly, but they did not give any hints that it may increase the probability of more QE.
I would look to be a buyer of USD/JPY if it can break below 100.00 and trigger some barriers there. I think if the JPY can rally, say +500 pips, shown by USD/JPY dropping to around 95.00 – 97.00 level, that can potentially spur the BOJ into heightened probabilities of more QE, so I would become interested in buying there.
The other potential for JPY appreciation is if the recent Typhoon encourages some flows to return to Japan.
Besides that, I am not doing anything. Waiting for more information.
USD/JPY exotic barriers at 100.00 and below, and at 105.00 and above.
S&P: Over the past month, grinded higher to fresh all time highs, then sold off on heightened Ukraine – Russia tensions as Putin massed troops near the border and new sanctions were placed and some participants locked in profits fearing a potential trade war that may reduce global growth. There may also be some concern that ECB may not be acting aggressively enough to prevent deflation and weak growth. If Euro zone slows down, that can reduce global growth.
S&P rallied on Friday as the irrational sell off after Iraqi air strikes was reversed, and then some rumors that Russian troops were returning to bases away from Ukraine border.
The lower bond yields and lower crude oil prices helping boost and maintain the recovery.
This situation with Ukraine – Russia can still be volatile. The Ukrainian army seems to have made progress against the rebels. The rebels are encircles in Donetsk and Luhansk, and without further Russian support they may lose. Some of these rebels are ex-Soviet KGB, etc, and I am not sure if Putin wants to abandon them and cutoff support. He may look weak in his country if he abandons them. So Putin is trying to keep his options open by massive troops near the Ukrainian border. If Putin does go in, there can be further sanctions, which, depending on how they are structured, could raise further prospects of a trade war. So the S&P can still make stabs lower on rising geopolitical tensions.
Overall, the market has only had a moderate, controlled sell off. No major liquidation. No one wants to sell their equities for fear the market can keep going up and may not retrace. And if prices do retrace, it does not encourage aggressive selling yet as many participants just hold on and expect prices to rise again.
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. There are both opportunities to go long and short individual companies as those specific scenarios can play a larger role if the S&P does not make any major moves either way. The continued bullish case for equities is still attractive for foreign and domestic investors: The USD is still flattish, Fed still has a few 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.
Bullish Scenarios: if there is: further drop in crude prices, more M&A activity, stronger US data, higher capital expenditures by companies
Bearish Scenarios: Putin goes into Ukraine causing more sanctions and potential for trade war, Fed does first rate hike faster than market expects.
Nikkei: Nikkei was flat on Friday, while S&P was up, which is a divergence. There is scope for Nikkei to fall further, if the market is losing faith that Abenomics is working as exports weaken. And the Nikkei can also fall if USD/JPY decides to breakout lower. Nikkei can be a better short than S&P, if the market believes the economic fundamental for Japan are not as sound as the U.S.
Bonds: 30 yr US bonds have grinded higher +3 pts over the past month from 137 to 140. Helped by the geopolitical tensions with Ukraine – Russia, and some Israel – Gaza operations, some buyers from relative yield advantage between US bonds and Euro zone bonds, continued expectations of restrained US inflation as wage growth is weak and slack in labor market, some people taking profit in equities and rebalancing by buying some bonds.
Even if the Fed does do the first rate hike faster than expected, bonds can fall, but not a massive and sustained sell off if the geopolitical atmosphere causes safe haven bid, and the ECB is still in low rate world with option of QE.
Bullish Scenarios include: further geopolitical tensions in Ukraine – Russia, or elsewhere, if Chinese economy stumbles again, if the ECB does QE,
Bearish Scenarios include: If the Fed does first rate hike faster than expected, if inflation in US accelerates faster than expected.
Overall, not doing anything with bonds, and definitely not chasing top tick.
Crude Oil: Crude tried to rally from 100 to 103 or so, as there were inventory withdrawals from Cushing, and on heightened geopolitical tensions in Ukraine – Russia as the airliner was shot down. Then it fell from 103.00 to 97.00 as the substantial existing long position in Crude started getting pared back, and there was a refinery fire that can reduce demand for Crude oil, and cause additions to inventory at Cushing. On July 30, there were the further withdrawals from Cushing, but the market could not rally, so it had bearish sensitivity.
There are different analysts. Some say there will be additions to Cushing inventory with the new pipelines, other say there will be withdrawals. I am with the additions to Cushing inventory, which should cause Crude to go down over coming months. The wild card is what Putin will do with Ukraine. If he sends troops in, that can cause Crude to spike higher.
So overall, with Crude having tripped stops below 99.00 daily lows, I am just waiting.
Gold: rangebound behavior mostly the past month. Gold tried to make some stabs lower on higher risk appetite and some profit taking on longs, and tried to rise on some geopolitical tensions. Not chasing either side. Bonds are in demand more than gold, due to the income they provide and the deeper and more liquid markets as Gold is a tiny market compared to government debt, so the pension funds and institutional players turning to bonds more in the current environment.
Not doing anything here.
U.S. econ to strengthen or weaken?
Inflation to come back or remain subdued?
EUR to sell off to rebalance economy toward higher inflation and lower unemployment rate? ECB to do any QE?
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?