Macro Outlook for August 31, 2014
Correlation / Sensitivity Sheet for August 29, 2014:
AUD: chopped around mostly last month vs USD. Rallied versus the EUR and GBP, via EUR/AUD and GBP/AUD dropping, which is causing AUD/USD to get propped up. The higher yields in Australia are causing AUD to get propped up and grind higher versus the EUR and GBP. Iron ore prices are in a downtrend, but the mining companies seemed to have made up for that somewhat by selling more volume (higher volume of resource exports), so there doesn’t seem to be a big negative for the AUD. And the market is still low sensitivity to the China data. EUR/USD a far better short than AUD/USD, since the ECB is much more dovish than the RBA. Even if the RBA decides to go dovish and cut rates, they may only cut once and thats it, while the ECB may do QE and stay low rates for 2-3 years. The RBA would very much like for the AUD to fall 1,000 pips to help stimulate the economy, though there doesn’t seem to be a clear catalyst. They prefer stimulus via AUD depreciation rather than a rate cut. This is because a rate cut may boost the housing market too much.
There is a potential DNT option barrier with an upper trigger of 0.9400 in AUD/USD.
Overall, not doing anything with AUD unless unemployment continues to rise and/or the CPI drops a lot. The big continued story in the market is the potential continuation of the bearish trend for the EUR. So I would focus more of my energy on that.
NZD: roughly flat since the last macro outlook update. The economic data that has come out has shown a cooling housing market and lower business confidence. Those four consecutive rate hikes plus the currency appreciation seem to be restraining the economy and business confidence and cooling the housing market. The higher interest rates in NZD propping up the NZD same as the AUD. I do not see any bullish scenarios. There is a potential bearish scenario if the RBNZ hiked too far and too fast and inflation and economic growth slow, which the data is in the very early stages of showing that. But nothing conclusive so far. EUR/USD a better short than NZD/USD.
CAD: choppy action. CAD recently rose last week due to some light short covering and potential for multi billion dollar M&A flows from Burger King buying Tim Hortons. Most interesting action I would say in the EUR first and foremost, then in the USD. Do not see any imbalances with the CAD. Option Barrier at 1.1000 in USD/CAD still exists.
CHF: No important economic data came out. EUR/CHF grinding lower towards the 1.2000 floor by the SNB as the EUR weakens and potential for safe haven flows from continued Ukraine – Russia tensions. SNB can easily protect the floor. CHF bullish case is limited not only by the SNB floor, but also due to the EUR/USD sliding, causing USD/CHF to go up (CHF weakening). Do not see anything here.
EUR: sold off -200 pips or so in gradual move over past few weeks. This is the big trend for the next few months and potentially next year or two. Many elements have come together. ECB cut rates in June and signaled they can stay low for 2-3 years. CPI inflation keeps dropping down to 0.3%, even though the EUR depreciated in July and August, which is a massive bearish macro sensitivity signal. It means that even with the current speed of the Euro depreciation, it is not fast enough to raise inflation… which means the Euro needs to fall farther and faster in order to help boost growth and inflation. Draghi said inflation expectations exhibited significant declines at all horizons in August.
I am not fully sure what the ECB will do next week. They could potentially do nothing, they could cut the deposit and refi rates again, or they could do QE, or hint that they are much farther along in the process and speeding things up. The ECB appointed Blackstone as an consultant for the ABS program. Even if the ECB does nothing, the Euro probably will not rise much and still fall as there is big economic divergence between Eurozone and the United States. Everyone, I mean everyone and their brother and their uncle wants to short EUR on a rally. And the rallies never come. So only people who short near the lows of the move get in.
Macro shorts have been piling into the market past few months as is evident in the CFTC data. And despite this growing short presence, the EUR can barely rally, which is another form of bearish sensitivity signal.
Germany had a weak Q2, and the continued Ukraine-Russia tensions are hurting growth (and subsequently lower inflation as there is less demand). German confidence falling. Italy and many countries still struggling with high unemployment rate.
Barriers keep getting knocked out every 25 pips lower in EUR/USD. Next barriers at 1.3100, and eventually the larger ones at 1.3000. There is virtually no bullish scenario for the EUR/USD. EUR/USD can fall on either dovish ECB, hawkish Fed / Stronger US data, and even fall on risk aversion if the Ukraine – Russia tensons weigh on the Eurozone economy and cause a bit of USD safe haven bid.
GBP: fell versus the USD, AUD. Rallied slight versus the EUR. There are some players in the market that are shorting GBP instead of shorting EUR. They may figure that the British economy may slow along with the Eurozone, and perhaps even have lower CPI readings like the Eurozone. GBP/USD fell -200 pips or so as the BoE Inflation report showed that they slashed wage growth forecasts. Many central banks are turning to wage growth to see when they should hike rates. The BoE and the Fed have indicated they are paying attention to see how much wage growth there will be. Currently, it is restrained in both Britain and United States, so that will lead them not to hike too fast, which they signaled anyways. I would say both the BoE and the Fed are afraid to be the first major central bank to hike rates. They are not sure what to expect. Though, with the way the equity market and bond market is resilient, the market doesn’t seem to care about the first rate hike.
GBP/USD had some bearish sensitivity as it could not rally even as two members voted for a rate hike.
There is some uncertainty over the Scotland vote on September 18. I have heard various analysts say that if they vote for independence, the GBP could show a knee jerk drop of -5% or -10%. No sense trying to buy GBP with such events risk and the bearish sensitivity it is showing.
There are three forces to keep track for the GBP: What the British economy and BoE will do, what the EUR/GBP will do, and what the Fed will do. Those are the three variables so far. I do not see any imbalances. I would rather short EUR/USD than GBP/USD, since EUR/GBP may go lower with EUR weakness.
JPY: USD/JPY rallied +200 pips over past three weeks, on some USD strength as USD/CHF went up as well and EUR/USD went down. USD/JPY able to rally along with bonds as well, which is a fascinating divergence. There seems to be surging demand for USD denominated assets, both equities and bonds. Many international market participants want exposure to the US economic expansion, and they can do that via a few different ways. They can go long USD/JPY, short EUR/USD, long US equities, buy US bonds for the relative yield advantage over the European counterparts.
JPY shorts have been ramped up in recent weeks according to CFTC data, as some people are shorting JPY instead of EUR. There is both dovish monetary policy in Japan and the ECB. BoJ can continue open ended QE for all of 2015 if they do not reach their inflation goals, while the Fed hikes rates by 1-3 times.
JPY has bearish sensitivity as it did not rally much on higher Ukraine – Russia tensions.
There is potential for USD/JPY to jump higher if the option players get caught short volatility if USD/JPY rises and able to breach the 105.00 barriers or so. The option players may start scrambling to buy USD/JPY to hedge all the exotic options they sold. I would favor EUR/USD shorts a bit more than USD/JPY longs, as the ECB still hasn’t pulled its massive QE trigger, while BoJ already initiated big QE.
USD: The economic data confirms a moderate expansion. Consumer confidence surging to 2007 levels. Wage growth still seems weak, and the weaker crop prices and restrained Crude oil prices will probably keep a lid on inflation, so the Fed may not need to bring forward its initial rate hike. Despite that, the market still seems to want to bid up the USD. My theory is this: The US economy is the only major economy that can sustain its currency rising +1,000 pips or +2,000 pips. If the USD rallied 1,000 pips or 2,000 pips, it probably won’t cause any problems to the US economy. However, if the EUR or GBP or AUD or NZD or CAD or CHF rallies 1,000 or 2,000 pips, that can cause problems to their economy. So the US economy seems to be the only economy that can absorb a stronger currency no problem.
So the USD is attractive, even on a relative yield advantage due to their bonds yielding more than European counterparts. Some people think that the US yields have to rise to cause more USD flows, but that does not have to be the case. Money can flow into US bonds and the USD, even as bonds rise and yields dropped. It can happen, and seems to be happening now. And the USD seems to be insulated from the geopolitical tensions across the Atlantic. So there can be international flows into US equities on steady growth, and flows into bonds with their higher relative yields, even though the bonds may not rise all that much, there can still be heavy international flows.
S&P: Made fresh highs above 2,000 as it is grinding higher. It is relentless grind higher. Bullish Sensitivity from all angles. It is shrugging off the Ukraine – Russia tensions, shrugging off Yellen comments that more labor market gains could cause a faster initial rate hike, shrugging off the 2 members of the BoE voting for rate hike, shrugged off weaker China data, shrugged off slightly hawkish Fed minutes, shrugged off hawkish Fed Bullard comments. Equities do not seem to care about the Fed winding down QE, and do not seem to care about the first Fed rate hike as they believe they will be gradual and only be done on improving economy, not due to sky high inflation.
Volume is low and contracting as the market grinds higher, signaling some disinterest among some market participants. No one wants to do any big orders either way. Most people are content with holding on to their equities.
The prospect of massive ECB QE is also helping to push equity prices higher. If the ECB does do massive QE, that can launch another huge upsurge in equity prices, similar to how the Fed QE helped cause equities to rise.
The lower bond yields and lower crude prices are very much supporting the economy.
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, inflation still low and subdued, rates to stay low for “considerable time” after QE ends, when rates do rise to be gradual and peak below historical norm, 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: Stronger US data in the context of restrained inflation and wage growth, further drop in Crude prices, more M&A Activity, higher capital expenditures by companies, ECB does QE
Bearish Scenarios: Ukraine – Russia tensions cause trade war and weaker Eurozone growth, if the ECB disappoints and does not do QE and allows the Eurozone to fall into deflation
Nikkei: S&P made new highs, but Nikkei has not made new highs from when it topped out in December of last year. The market believes that the US economy fundamentals are more robust than in Japan. The S&P is making new highs, while the Fed is winding down QE, but the Nikkei cannot make new highs even as Japan does massive QE every month. Do not see anything here. Just waiting and watching.
Bonds: Bonds rallied +2 pts or so over past few weeks. Bonds have bullish sensitivity as they are shrugging off slightly hawkish Fed comments. Bonds being boosted by some safe haven flows from geopolitical tensions, relative yield advantage over European bonds, some institutions locking in profits in equities and switching into bonds to lock in some yield.
The potential for ECB QE is causing European bonds to rally, thus lowering their yields, which causes the yield divergence to increase, which is encouraging flows into US bonds. Both German and Spanish 10 year yields hit record lows. Some people say why should I buy 10 year German bonds yielding 0.90%? Why should I buy Spanish 10 year bonds yielding 2.20% and take on the credit risk? When I can just go buy USD 10 year bonds yielding 2.30%?
There are some risk appetite sellers when Bonds rally in a ODVE move, but they are not enough to cause any big drops. Any bid drops should remain contained due to the above reasons. Only much higher inflation and much more hawkish Fed will cause any big bearish bond moves, which there isn’t any evidence for that now.
Not doing anything with bonds. EUR action seems more interesting.
Crude Oil: The October contract fell from 97.00 to 93.00 on some higher inventories at Cushing, and some higher Libya exports. Macro shorts are piling into the market and longs have reduced exposure in a sizable way. There are still big longs in the market, but I am unsure if the price will drop further. Those macro shorts can cover on any drops. And there are some Ukraine – Russia geopolitical tensions causing prices to be supported, and the stronger US economy may cause an increase in Crude consumption.
The fascinating thing is that Crude was able to rally on Friday, even on a stronger US dollar. So that is a divergence and something I will be watching. It is possible Crude can fall further if the USD strengthens and that combines with higher Cushing inventories scenario. Too confusing at the current moment. So just waiting.
Gold: Fell -30 pts or so from 1315 down to 1280 or so. Part of the drop due to the price falling below the 200 Daily SMA around 1,287 causing some tech sellers to come in. Fell due to risk appetite continuing and that is causing some people to sell Gold. They figure why should I own gold when I can buy equities and get a bit of exposure to improving US economy and even get some dividends depending on the stock? Bonds were able to make new highs, while Gold was not able to. This is due to bonds paying interest, while Gold does not. In fact, many times you have to pay money to own gold if you store in a vault or hold onto the Gold ETF’s, etc. So there is a small negative carry. Gold doesn’t pay interest. Bonds pay interest, and the dividend paying stocks pay dividends. Also, Bonds are benefiting from it being a liquid market that the institutions are willing to deal in. It is a risk appetite environment with restrained inflation, so bonds are benefiting more than Gold.
Do not see 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?