Macro Outlook for October 12, 2014
Correlation / Sensitivity Sheet for October 10, 2014:
USD up (could be considered risk appetite if it rises on stronger US economy)
USD up (Could be considered risk aversion, if it rises on safe haven bid)
AUD: Since last Macro update, AUD fell about -200 pips. It fell mostly due to the USD strength and the risk aversion as equity markets have fallen. Other potential reason was the further fall in iron ore prices. One analyst said iron ore prices have dropped -40% this year. Australia state commodity forecaster cut its iron ore price estimate. China data does not yet look like it is falling off a cliff. It seems moderate growth is in order, no big deviation from the normal expectations. The market is currently, far, far more worried about the economic situation in Europe, than it is about China. RBA would like to see AUD/USD fall more towards 0.8000 to 0.8400.
AUD tried to rally +100 pips or so after RBA kept rates steady, and they did not have forceful intervention language like the RBNZ has done. And inside the statement, the RBA removed language about the AUD being above most estimates of “fundamental value.” But that rally was not able to be sustained. The only other bullish scenario is if the housing prices continue to rise, combined with the AUD depreciation cause inflation to rise and the RBA to want to hike rates to ward off imbalances in the housing market. But, the stronger USD scenario can cap AUD gains. And low wage growth and drop in some commodity prices may keep inflation restrained. So the battle of scenarios does not look like it has a clear winner in my opinion at this moment in time.
The employment data from Australia has been very volatile. A big 121k job gain the previous release, was revised lower to 32k when the new numbers came out on October 8th. So the market may need a few months to regain faith in that data set.
Barriers at 0.8500 and below in AUD/USD.
It is possible that commodity prices stay suppressed for several years, but I cannot forecast such long range macro decisions. Despite the fall in key commodity prices, I do not think the RBA is going to cut rates. Which means I do not see any big monetary policy divergence to short the AUD. Various reasons to short it include that the macro short presence in AUD is lower than the EUR. Overall, I would still prefer short EUR positions over short AUD, which has been my preference over past few months.
NZD: Fell -400 pips since last update. All of it due to NZD specific bearish catalyst in the form of RBNZ Wheeler releasing a statement that had more forceful language about why the NZD is too high, etc. NZD was already falling prior to that statement, but I guess the RBNZ did not deem it fast enough and they wanted to put out the more forceful language. So that statement encouraged short term bearish flows for a few days, then that was the extent of the move so far and the NZD consolidated.
RBNZ would like to see the NZD/USD fall another -1000 pips or so down to 0.6800 – 0.7000, to help rebalance the economy towards higher inflation and help exports.
Housing market in NZD seems to have moderated a bit. Business Confidence fell further for the month of September and the third quarter. The moderation in global growth outside the U.S, the four consecutive rate hikes by the RBNZ, and the big fall in dairy prices all weighing on confidence in the NZ economy.
I do not see any macro imbalances. Currently, the RBNZ probably going to be on hold for 4-6 months or so as they asses the impact of rate hikes, the dairy price drop, see if the CPI rises with the NZD drop. I prefer short EUR over short NZD.
CAD: Dropped -200 pips versus the USD, but was flat vs the EUR and GBP.
CPI was a bit higher for August, and the unemployment rate dropped to 6.8% from 7.0% in the month of September, and stronger Ivey PMI data for September. But against the backdrop of the fall in Crude oil prices, the rising USD, I do not see any macro opportunities to trade the CAD. Very convoluted situation. Even in the CFTC data, both the longs and the shorts added positions. So they are confused as well.
Overall, not doing anything here as I prefer opportunities in the EUR and GBP.
CHF: Was flat during the past three weeks. Nothing has changed in the macro situation. SNB can still easily defend the 1.20 floor if they want to so far. They are holding off on additional measures to see if the ECB QE’s and if the 1.20 floor is threatened. SNB would like to see the EUR/CHF at 1.30 rather than 1.20, but they are probably not going to take any action to do so, unless the inflation outlook and Swiss economy deteriorate very sharply.
Just a wait and see mode.
EUR: Fell -300 pips versus the USD and JPY. EUR/USD tried to rally on some short covering and temporary USD weakness after market interpreted FOMC meeting minutes as being less hawkish than it anticipated, but the EUR/USD only managed a +250 pip rally, which has been the largest in a long time, but the macro sellers returned. 1.2500 barriers are still intact and they are the next target.
There are many market participants that are waiting for the EUR/USD to rally into the 1.2900 to 1.3000 range for them to short it. But I do not think it will rise to that level. The macro imbalance between the Eurozone and US economies is growing, though, this is not translating to faster Fed rate hikes yet.
Over the past few weeks, many ECB officials have been saying that the Eurozone recovery is losing momentum. This spooked the equity markets as they fell. All these Eurozone officials talking about how the recovery is already losing momentum, but they have not said that they are close to doing QE. In fact, this past Friday, ECB Nowotny said that QE is not being discussed. So the ECB has done these rate cuts as much as they can, they are starting the ABS/covered bond purchases, and they are going to be in wait and see mode for the next 2-3 months to see how it works out. German business climate, manufaturing PMI, industrial production, factory orders, exports have had weak readings, and this is all while the ECB has cut rates and the EUR has already depreciated by -1000 pips! CPI was at 0.3% for September, even with the big EUR depreciation. German Finance Minister said economy is weakening.
The way I interpret this is bearish macro sensitivity, because even with the current pace and scale of the EUR depreciation, it is not enough to boost inflation or growth in the Eurozone. Thus, the Euro has to fall further to help rebalance the Eurozone economy towards higher inflation and more growth.
German yields are at record lows with the 10 year at 0.90% or so. These are getting towards Japanese style yields where the market is expecting low growth and deflation for many many years. With US 10 year yields above 2.00%, there can be international money flowing out of the Eurozone bonds, and into US Treasuries to lock in the relative yield advantage, and avoid the EUR depreciation. I do not think money will flow into an economic zone that has recession risk and potential to tip into deflation. ECB has been behind the curve by 6 months or so, and so far, it looks like they are still 6 months behind the curve with regards to stimulating their economy. The fall in energy prices should further keep CPI restrained.
The ECB has signaled that they would like the EUR to fall for the next year, and that is what the market has caught on to. So short EUR/USD is the most natural and simplest choice to express that view.
GBP: Fell -200 pips against the USD. Fell -400 pips vs the JPY. Flat versus the EUR. GBP/USD knocked out the 1.6000 barriers, then bounced on USD weakness.
GBP continues to show bearish sensitivity since last macro update. It is still much lower even after Scotland voted to stay in the UK. Part of this is because the market is concerned that their is still some political devolution risk, as more powers may be ceded to Scotland, and the market perceives that as restraining the GBP. So there is still lingering uncertainty over Scotland even though the vote is complete. There is also the risk that the weak Eurozone growth and inflation causes weaker UK growth and inflation readings. I would expect the UK economy to be more influenced by the Eurozone, compared to the US and Eurozone relationship.
Carney said that the point at which interest rates start to rise is getting closer, but the market doesn’t seem to care and the GBP is still trading very weak. I would not try to buy GBP/USD. There was a play after the 1.6000 barriers were knocked out for a quick flip, but with the continued bearish sensitivity, GBP/USD may drop alongside EUR/USD, especially if the BoE delays the first rate hike past spring 2015. The USD strength is overshadowing any GBP strength.
Still prefer short EUR/USD over any GBP plays so far.
JPY: USD/JPY rose to knock out the 110.00 barriers, then some profit taking kicked in and risk aversion sellers kicked in to knock it down a bit as the S&P did fall. USD strength propping up USD/JPY.
Overall, USD/JPY has some bullish sensitivity in the form of the S&P tumbling a lot, bonds being bid up to new highs, but USD/JPY is not dropping that much. Over the past two days S&P tumbled, but USD/JPY only down -50 pips or so. But it is lacking a specific catalyst for further appreciation.
The GPIF reforms and Japanese investors can have substantial amounts of money flowing into US bonds on the very large relative yield advantage. Japanese data was weak a bit, but the BoJ did not give any indication that it has a heightened probability of more QE. There were some mixed comments from Abe and Kuroda. Kuroda said that he does not think anything abnormal is happening with the current JPY weakness. But Abe said that the weaker JPY hurts households. I thought Abe wanted a weaker JPY and higher inflation, didn’t he? These are conflicting comments. So I am no longer bullish on USD/JPY until I get more clarity on this situation.
Therefore, I was bullish on USD/JPY, but the risk aversion capping the topside for now. Since I am not sure how long the risk aversion to last, I prefer short EUR/USD to long USD/JPY, since it is possible the EUR/USD drops on risk aversion if the USD is bid up on continued US growth. And if the ECB does hint at higher chance of QE, that can cause a lot more EUR depreciation.
USD: Rallied +200 pips against most currencies, but roughly flat versus the JPY.
USD first rallied on the stronger NFP and drop in unemployment rate down to 5.9% from 6.1%. Then USD sold off a bit on some profit taking and the FOMC meeting minutes showing that the Fed can be concerned about the USD strength impact on inflation. But then the USD buyers came back.
Overall, the data confirms a moderate recovery. The USD is grinding higher as a result. The theory is that with some parts of the world slowing down (particularly Europe), the U.S. is showing itself as an island of stability and growth, and relative yield advantage). The interesting thing to note is that as the S&P fell -5%, the USD rose +200 pips. So currently the market believes USD is a sort of safe haven similar to the JPY. Therefore, depending on what type of risk aversion occurs, the USD can rally, if the market assumes that the US economy will be somewhat shielded from that risk aversion.
I do not expect the Fed to hike rates as fast as the market expects. In fact, inflation can be restrained even as the unemployment rate gets closer to 5%. Wage growth is modest, and the USD is getting stronger, agricultural prices are low, energy prices are plummeting. All this should act to restrain inflation and give the Fed more room to delay rate hikes. The end of QE in October is a done deal. The market will be looking to see if they remove the language of “considerable time” or not. And if the weakness in Europe can eventually be felt in the U.S.
Therefore, overall, I do not think the Fed will be as hawkish as the market expects, BUT, the market currently doesn’t seem to care and is bidding up the USD. The U.S. is the only economy that can continue to handle it’s currency appreciating by another +500 or +1000 pips. Lots of international money flowing into US Treasuries to snap up the relative yield advantage and seeking safety from the weaker Eurozone economy.
EUR/USD looks to go lower. Here are two simple reasons why: ECB Draghi said last week that they see the modest eurozone recovery already losing momentum. And Fed Bullard said that the economy is growing at a rapid clip right now. That should favor EUR/USD going lower, even though the ECB has yet to QE, and even though Fed may restrain rate hikes.
S&P: S&P fell -5% over past three weeks. Primarily due to the market worried over the slowdown in Eurozone, and their belief that the ECB is not going to do QE any time soon (next 1-2 months). All these EU officials talking about EU slowdown, and no further action to address that issue, got the equity markets worried and they sold off from their all time highs.
Various other reasons included energy shares dropping, Hong Kong protests, Russian Ruble falling, etc.
The drop in oil prices could be considered an economic stimulus or an as economic shock. Currently, it is being treated as an economic shock as the lower oil prices a symptom of weaker global demand, and energy shares dropping sharply. The bearish macro is winning out for now due to the lack of ECB QE to address fears over Eurozone slowdown.
However, the low bond yields and the lower gasoline prices are supporting the economy to continue the moderate expansion. So there are bargain hunters buying equities on the dips to play the continued US moderate expansion scenario. But the risk that EU may tip into recession and deflationary spiral and the ECB may not do anything, is the more overriding concern as of this moment and it is impairing equity values around the world. This is a big concern for the market as Eurozone is very important to world economy. The market is currently pricing in that without further ECB action, growth will suffer and inflation may fall further. There is also the horrific scenario that what if the ECB does QE and it is not enough to boost inflation and growth? But that is something to consider for mid 2015 scenario.
Market volatility was very low three weeks ago, but now it has increased a bit due to the above mentioned reason. It looks like the ECB is going to wait a few months before considering QE, and these few months look to be volatile, with a further drop in equity prices possible if the ECB delays action and the economic data and inflation deteriorate in Europe. October is historically a volatile month for equities and I would expect it to continue. The market wants to be reasonably confident the Eurozone is not going to tip into recession/deflationary spiral, in order for it to boost US equities to new highs and play the continued US recovery.
Overall, this is the year where stock pickers shine as individual stocks will have better reward/risk characteristics. 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 moderately, inflation still low and subdued, 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 Eurozone data, ECB does QE, stronger US data in the context of restrained inflation and wage growth, if the strong US economy is somehow able to support the rest of the world.
Bearish Scenarios: ECB delays QE while Eurozone goes into recession/deflationary spiral, Weaker China data, Russian economy and Ruble tumble on recession risk and oil price drop and trade war, any other emerging market economies and currencies fall, if US economy succumbs to weaker Eurozone growth, if Ebola virus spreads
Bonds: Bonds rallied +4 pts to fresh highs. Primarily due to the risk aversion from the drop in equities on concern about weaker EU growth. This caused market to bid up German bunds, and as a consequence US Treasuries rose as well on the relative yield advantage.
Bonds showing bullish sensitivity as even when the S&P rallies, bonds did not go down that much, showed by when the S&P surged on October 8th, bonds were flat on the day. Bonds also showed bullish sensitivity after the very strong NFP report, as they were able to close at the highs of the day, rather than the lows.
The bonds rose, even with the ECB not doing QE. The economic growth fears of lack of QE, were enough to cause bonds to be bid higher. So bonds can be bid if the ECB does QE or doesn’t do QE. If they do QE, then bonds can rise on relative yield (though risk appetite may cap extraordinary gains in such a scenario). If the ECB does not QE, then global growth may suffer and bonds can be bid on that.
Bonds obviously do not currently care about the end of the QE program and do not really care about a gradual rate hike or two in 2015.
Overall, not going against this upmove.
Crude: First tried to rally from 91.00 to close to 95.00, then sold down to 84.00 on the stronger USD, economic weakness in Europe, Saudi Arabia cutting prices may cause price war for market share, lack of OPEC intervention, US EIA cutting 2014 and 2015 crude price forecasts.
Market participants expect the world to be well supplied in the current situation. Market tumbled, even though Cushing additions to inventory did not really start. Market found other potent bearish catalysts with the potential for OPEC to have a price war for market share.
Eventually, if the Crude price keeps dropping, it will drop to a point where it discourages further oil production as various drilling wells become unprofitable. And oil production can eventually start to drop. I am not sure at what price that will happen, but the market can seem to fall some more if the ECB does not QE, and the USD strengthens, etc. The macro seems bearish enough, that even if OPEC cuts production, Crude may spike higher for a few days, but the macro sellers can come back to bring price down again.
Bullish Scenarios: OPEC cuts production, energy companies start decreasing production
Bearish Scenarios: OPEC fights with each other for market share, USD rises,
Gold: Fell below $1,200 on stronger NFP, then rebounded to be flat during the past three weeks. Equity markets have fallen -5%, but Gold is flat, as the USD has rallied slightly. It is possible that Gold may have rallied on other historical falls in the stock market, if the market believed that would lead to looser Fed policy, more Fed QE, etc. But now the macro environment is different as the Fed is winding down QE.
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.
I do not see anything here. Not doing anything.
U.S. econ to strengthen or weaken?
Inflation to come back or remain subdued?
EUR to sell off further to rebalance economy toward higher inflation and lower unemployment rate? ECB to do any QE? If they do QE, will it be successful in boosting growth and inflation?
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?