Macro Outlook for September 19, 2014
Correlation / Sensitivity Sheet for September 19, 2014:
AUD: Knocked out a light option barrier at 0.9400, before eventually falling on lower iron ore prices. It formed bearish sensitivity as it could not rise on stronger China exports. Nor could it sustain the bounce it made after the stronger employment growth. Market broke through the 200 SMA on the daily chart around 0.9180 or so, and the people who had loaded up long AUD/USD due to the resilient nature and search for yield after the ECB QE, started to sell and pare back their positions. Some weaker China industrial production data and stronger USD caused further weakness. RBA would like to see AUD/USD around 0.8000 – 0.8400 or so.
Part of whether the AUD will fall further is if the market starts to short it in size, like they have done the EUR and JPY. Large macro shorts in EUR and the JPY, but in AUD, not so much. Not doing anything here since I do not see the monetary policy divergence. RBA to probably keep rate steady as the housing market is hot in Australia. I prefer short EUR, short GBP or short JPY positions. Short EUR/USD, I like, since it simple and I do not need to look at more complicated currencies at this point.
Barrier in AUD/USD at 0.8900
NZD: Fell -200 pips since the last macro update. Finance Minister English said he expects NZD to soften. RBNZ stayed on hold as expected and still said the exchange rate has yet to materially adjust lower. NZD fell -700 pips going into the meeting and the RBNZ feels that is not material. So they want it to fall another -1,000 pips. Overall, it looks like RBNZ wants to wait a few months before raising rates again. They may consider raising rates again in Q1 2015 or so.
Economic growth is strong at 3.9% y/y. But inflation is still restrained at 1.6% (which the RBNZ expects to rise).
Overall, I do not see anything. Market is not responsive to BoE 2 members voting to hike rates and GBP cannot rally on that. NZD is grinding lower in the meantime, despite the high carry yield. I do not see a macro reason to short NZD or short AUD, rather than EUR or JPY. Shorting EUR or JPY seems a better trade. The only possible reason is that the market is already loaded up short EUR and short JPY. So someone could say market positioning favors a short AUD and short NZD, as the macro short presence in those is very low.
A further bearish catalyst for NZD is if milk prices drop further. I am not interested in trying to anticipate that.
Overall, I am just waiting.
CAD: chopped around for the past few weeks. Some mixed economic data. Ivey PMI fell and unemployment still at relative high of 7.0%. Building permits came out higher and CPI came out higher today. But given the drop in Crude Oil, and the potential for it to drop a bit lower over coming months, I do not see the Bank of Canada going dovish or hawkish. It is just choppy and I am not going to try to read too much into it, since there are much cleaner moves in other currencies and markets where I can read the macro better.
Overall, not doing anything here.
CHF: economic growth slowed sharply in Q2, paralleling the slowdown in the Eurozone economies. CPI inflation still very low at 0.1% y/y for month of August. EUR/CHF tried to spike higher +40 pips on rumor that the SNB might implement negative interest rates. But then fell back as they did not do it. There is no reason for the SNB to do anything now. The 1.20 floor is not threatened yet. They are wise to hold off on negative interest rates until they really need them and the floor is threatened. They have a lot of firepower to the tune of hundreds of billions to defend the floor, aka “unlimited quantities.” The 1.2000 floor may come under attack if the ECB does a large QE program. But that could be months away and I will re evaluate the situation if that happens.
Overall, not doing anything here.
EUR: Fell -300 pips since the last macro update as the ECB surprised most of the market with a deposit rate cut to -0.20% and further minimum bid rate cut to 0.0%. They are done with those policy tools. They are not going to take the further minimum bid rate lower, as that could cause negative interest rates for the common citizens bank deposits. They also announced the launch of the ABS buying program and the covered bond program. They did not call it QE, but it is a form of credit easing and further dovishness.
Whether the ECB took action or not, the EUR could have still fallen, as growth and inflation were so low. So if they didn’t take action, both growth and inflation would go lower, and not many people would want to hold such a low growth, low inflation currency. As they would be behind the curve in stimulating the economy. The ECB chose to take action to try to fulfill their mandate of price stability close to 2%, through the rate cuts and ABS/covered bond purchase program. And the macro players sold more EUR on that news.
The ECB did the ABS program because it feels it would be more effective than the sovereign bond purchases to boost the economy. The last tool they have left are the large scale QE purchases of sovereign bonds. They seem content to wait a few months to gauge the impact of their current suite of actions that they have done: the rate cuts, the TLTRO’s, the ABS / covered bond programme, and the -1,000 pip depreciation of the EUR.
The big question is will those be enough to boost inflation? In my opinion, they will not be enough as both crop prices have been dropping, and energy prices may fall further as well, which can keep inflation restrained. Despite the current -1000 pip EUR drop, ECB Noyer said they need a weaker EUR. ECB Visco said that the core inflation components are increasingly sensitive to weak demand. The TLTRO pickup results that were released on Sept 18 were not as large as expected. These are all still pointing to bearish macro sensitivity for the EUR.
The reason why the EUR is not dropping faster is because the ECB has not done a trillion dollar QE program yet. There is virtually no bullish scenario for the EUR/USD. Even with the large macro short presence, no one really wants to cover their shorts. The only possible bullish scenario is if the ECB actions, combined with the -1000 pip currency depreciation are enough to help lift inflation and economic growth, then perhaps it may pop a little, but those rallies can be sold into by the macro, if they still believe ECB to hold rates low for 2-3 years, while the FED hikes.
EUR can be the funding currency of choice for the carry trade.
Overall, still very bearish on the EUR.
GBP: First fell -500 pips on fear that Scotland may vote to be independent. Then bounced as the market was pricing in that it won’t happen. Today’s action was fascinating and shows bearish sensitivity for the GBP. Despite the outcome of the Scotland vote, the GBP gave up all its gains and still fell slightly for the day. It shows bearish sensitivity.
I thought the GBP would be bid a little bit with the BOE moving towards a rate hike, and with two members already voting for it. Unemployment rate declined to 6.2% and the average earnings index rose a bit. Carney said the point where rates need to rise has moved closer. But the market does not seem to care and is still selling the GBP slightly.
The bearish case if the slower growth in the Eurozone and low inflation, cause similar things to happen to the UK.
Not doing anything with it. I may consider long GBP/USD if it knocks out the 1.6000 barriers.
JPY: Fell -400 pips over three weeks. Due to a combination of USD/JPY rising above 105.00, causing the breakout and market to be stuck short volatility and the option players hedging their positions by buying USD/JPY, bonds yields rose a bit, and USD strength came in a bit, and potential for the GPIF japan pension fund to change their allocation strategy to buy more foreign equities and foreign debt.
JPY has bearish sensitivity due to two reasons I located. First, there were days when the JPY fell, even as bonds were flat (yields did not rise). And, the JPY rallied +50 pips intraday after Kuroda said there is no need for additional policy steps at this time, but then sold off and closed at the lows of that day. So those were two forms of bearish sensitivity active in the market.
Big barriers at 110.00.
Overall, bullish USD/JPY.
USD: Able to rally +100 to +200 pips or so past few weeks. Growth is still only moderate, but the Fed seems to have raised their year end 2015 rate forecast to 1.375% or so. That is a lot of rate hikes from the current zero level. So I am not sure what the market believes Fed dots are showing. Either the market is not pricing in the full extent of Fed rate hikes, or they are only assuming slow rate hikes due to the Fed continuing to keep the “considerable time” language. I see a divergence between what the market expects and what the Fed is signaling. I think the low inflation and moderate growth can keep the Fed more dovish than the market expects. It may take me a few more weeks to gain clarity on what is going on. It is possible the market wants to buy USD, even if the Fed doesn’t hike as fast as expected. I need some more information and time to see what is going on.
In the meantime, the USD has bullish sensitivity as it did not sell off much after mediocre NFP, and the weaker CPI, and USD still rallied even after Fed kept in the “considerable time” language.
There can be international flows into US bonds for the relative yield advantage causing USD to go up. Especially from the Eurozone as some market participants taking profits in Eurozone debt, selling EUR and buying USD to buy the higher yielding debt. Even though bonds not rallying to fresh highs yet, it is possible that the domestic market participants are selling some bonds to the international players coming in.
Overall, still bullish on the USD.
S&P: First retraced from 2000 to 1975, due to some profit takers from expectations of higher rates, potentially some more Russia sanctions, some energy shares falling on lower crude oil price, weaker China data. Valuations are a bit high. When the high valuation tech and biotech stocks got hit in March, that was also due to the combination of the Ukraine – Russia tensions and the severe US winter causing Q1 recesson. Now the market may not drop due to the economy not being in severe winter, even with the high valuations.
Then it rallied to fresh highs and grinded higher. Relentless grind higher. The ECB rate cuts and ABS/covered bond program to help support on dips. The lower crude oil price, and if it drops further, to help support equities grinding higher as gasoline prices have dropped and could drop further. Lower crop prices to restrain inflation and should cause rate hikes to be more gradual, to support equities in indirect way.
Still bullish sensitivity from all angles: it recovered from the intraday sell off after the higher FED rate dots, recovered from weaker China data, shrugged off Russia sanctions, shrugged off mediocre NFP, rose on ECB stimulus, etc.
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.
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.
US equities are still the hottest market. Last year it was Japan, this year it is US equities even though QE is being removed, as low rates, restrained Crude prices, perceived US recovery. USD is not rallying that much yet. Relative value in equities and fixed income flows into the US.
Japanese equities advanced more than US equities past two weeks due to JPY weakness. The USD strength eventually can come to restrain the US economy, though the bull market is still probably intact. It is only the early stages of the USD strength.
Another theory I developed is this: With the recent rise in equtiies, some people may have taken profits, so there may not necessarily be extended positioning. So that wave of profit taking and panic selling may not happen. There may have already been substantial pension fund rebalancing that has happened. So many of the longs that are left, are willing to hold through some retracements.
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 has only rallied a little, 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: Weaker China data, 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, another severe winter
Bonds: Fell -3 to -4 points or so over past few weeks. On expectations for some Fed rate hikes. It had some bearish sensitivity after the NFP report, as on that day it closed at the lows even with the moderate jobs data. That contrasts with previous days where it was able to close higher even on strong jobs data. So that bearish sensitivity caused the drop from 138 to 136. Today was the decent bounce.
There are lot of buyers from relative yield advantage propping the market. So, even with the potential for Fed rate hikes, I do not think bonds will drop much. Also potential for ECB to QE, to help support global bond prices. Also, David Tepper said that the bond rally is done after the ECB rate cuts. I guess he expects inflation in the Eurozone from the ECB efforts. And yes, part of what will happen with bond prices is if the ECB will be successful in reflating their economy.
If the ECB actions are enough to cause inflation to go higher and support their economy, then I would expect bond prices to drop.
But if the ECB’s actions are not successful and inflation still stays low (I would be more inclined to believe in this right now), then the bonds can be supported in price and eventually rally again with potential for higher ECB QE.
Thus, I am not chasing shorting bottom tick in bonds. Not buying top ticks of the day either. I would consider long bonds positions if they trip downside stops and I believe US inflation to remain contained and ECB growth and inflation to remain weak.
Crude: November contract fell from 95.00 to 90.00. It had bearish sensitivity on the drop as even with the withdrawals from Cushing on September 4th, Crude could not rally as it normally does, and it fell. Fell further on the stronger USD, lower UKR-RUS tensions, higher Distillate and Gasoline inventories.
Then bounced from 90.00 to 94.00 on news that OPEC can cut production to support the price. Even with this news, and the Cushign withdrawals on Sept 17th, the market was unable to continue to rise. It made a lower high on the daily chart.
US oil production is set to rise to 45 year high.
There was bearish sensitivity the past two trading days as the energy secretary said that they are evaluating the ban on crude exports, but Crude did not rise on that news and still fell for the day. So that is a bearish sign. It could be that the government is acknowledging the very high US production and supply glut.
I would expect the market to grind lower. There is a pipeline that is set to come online in October, that can cause higher Cushing inventories. So the market may want to wait for that before declining further substantially.
Gold: Fell -$70 past three weeks as the shorts piled into the market as the USD rallied, and expectations of Fed rate hikes, and the low inflation is not a macro environment conducive to Gold rising, lower geopolitical risk in UKR – RUS.
There are no relative yield buyers in Gold… because there is no dividend/interest/cashflow associated with gold! Bond prices are supported due to the relative bid from international investors. But gold is not supported in this way.
Some people may like to short Gold instead of other plays like short EUR/USD or long USD/JPY. That is their choice. I tried both of them. I tried shorting Gold one time, and it just didn’t feel right and I got out. But when I was short EUR/USD, it felt better, so I stuck with short EUR/USD. Shorting EUR/USD or long USD/JPY seems the simpler trade. And when big macro moves like this happen, I usually stick with the simpler trades, and not go to any more confusing trades.
Not doing anything with gold.
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?