Macro Outlook for October 31, 2014
Correlation / Sensitivity Sheet for October 31, 2014:
Notes (since last macro update 3 weeks ago):
AUD: flat versus the USD and GBP, rose +200 vs the EUR. Overall I would say flat and choppy past three weeks.
Bullish forces for the AUD are the high relative yields and interest rates compared to other advanced countries.
Bearish forces are that China GDP continues to slow from 7.5% to 7.3% y/y. CPI y/y dropped from 3.0% to 2.3% and PPI y/y dropped from 2.3% to 1.3%, which confirms the RBA’s view that inflation would remain at or below the target even with a further depreciation of the AUD. Bad loans in China rising according to Industrial & Commercial Bank of China. If USD strengthens further, then that can cause AUD to fall, but better plays in EUR/USD and USD/JPY.
Barrier at 0.8600 in AUD/USD.
Overall, not doing anything in AUD, since there is no divergence of monetary policy. I do not see the RBA moving to raise or cut rates. Much cleaner action in the EUR and JPY, where is a monetary policy divergence to entice traders to come in to move the market.
NZD: overall flat during past few weeks. Tried to fall over -100 pips after weaker CPI
Bearish forces are that the CPI y/y fell from 1.6% to 1.0%. This confirms that the RBNZ did one rate hike too much for some parts of the economy (they hiked rates to mostly restrain house price growth). All those rate hikes, lower dairy prices, lower global commodity prices crushed inflation in NZ. So the RBNZ can potentially be on hold for most of 2015. The NZD, from a macro perspective should fall to help rebalance the economy towards higher inflation. However, there is no monetary policy catalyst for a fall as I do not think the RBNZ to cut rates. RBNZ has forceful verbal intervention, but they used up that catalyst in September, and NZD has been consolidating.
Overall, same situation with AUD. Not doing anything here, since there is no divergence of monetary policy.
CAD: overall flat.
The CPI stayed at a relatively high level of 2.0% for the month of September. It is high relative to GBP and the EUR. The BOC dropped the dovish tilt in their statement and went to a very tiny hawkish bias. They cited the higher risk of household imbalances. It was a slight change, not enough to cause any surge in CAD. CAD can be propped up by the stronger US demand.
Bearish Forces are the weaker Crude prices, which BoC Poloz says will shave 2015 growth.
Overall, not setting up anything. Same with AUD and NZD
Barriers at 1.1400 in USD/CAD.
CHF: flat for the period.
EUR/CHF looks like it wants to press lower as ECB expand their balance sheet. But better EUR/USD short rather than EUR/CHF as SNB is on the bid just above 1.2000
Only potential far out scenario is if the November 30 referendum on SNB gold reserves has negative implications for the SNB’s ability to continue the peg. Though I am not sure about that yet.
Not doing anything here.
EUR: fell -200 pips. barriers at 1.2500 knocked out.
There isn’t any bullish scenario for the EUR. There hasn’t been in many months so long as the US expansion remains on track. EUR/USD did try to bounce from 1.2500 to 1.2890 on some shorts taking profit and the market overreacted to the weaker retail sales and PPI numbers on Oct 15. A lot of shorts seem to be taking profit way too fast on their EUR shorts in my opinion. I obviously think EUR/USD to drop lower.
Bearish scenario for EUR is that the ECB has begun the covered bond purchases. This along with the ABS purchases will start to expand the balance sheet. This further reinforces the monetary policy divergence with the Federal Reserve. Fed ended QE this past week, and the ECB expanding their balance sheet. The macro imbalance between the Eurozone and United States is growing. So a rational macro reason to short EUR and buy USD.
Euro zone yields have dropped, so there should be less international demand for their debt as people look to go into the US Treasuries which have a relative yield advantage.
Various other bearish forces include: Germany cutting 2014 and 2015 GDP outlook. Germany seems to want to continue fiscal austerity. French and German CPI’s ticked lower
ECB looks like they want to wait until February – March to see the effects of their rate cuts, ABS / covered bond buying, and the EUR depreciation (which works more with a 6- month lag), to see if the inflation rate picks up. So if they will do QE, they will probably wait until 2015, unless something dramatic happens soon. The speculation is that they can buy corporate bonds instead of buying the sovereign debt.
Various other extreme bearish scenarios are if there is any turmoil with a potential Greek election in February.
If the EUR can fall another -1,000 pips, that would certainly help rebalance the Eurozone economy towards more growth and more inflation.
Short EUR/USD still my favorite as there is the macro imbalance between the two countries, and the ECB is expanding the balance sheet.
Next barriers at 1.2450 in EUR/USD, and every 50 pips lower.
GBP: flat over the past few weeks.
GBP started off falling to fresh lows as GBP/USD dropped below 1.5950 as the CPI dropped from 1.5% to 1.2% in September, then it bounced back.
There is a divergence in the BoE as the hawks think spare capacity is being used up, while most of the other members feel that there is a jobs rich recovery, but wage growth is weak and will not rise much. The doves are winning out so far.
The market is starting to believe the Fed may raise rates faster than the BoE. Though, both central banks have stated that any rate increases will be gradual and limited and peak below the historic norm.
I do not see any moves to go long or short the GBP. Cleaner plays in the EUR and JPY and USD.
JPY: First USD/JPY fell from 108 to 105.00 as S&P fell hard on fears that the weaker US retail sales and PPI signaled that the weaker eurozone growth coming to the United States. Then it rallied on stronger US data dispelling that notion, risk appetite coming back, bonds dropped slightly.
Then JPY sold off hard as USD/JPY rocketed higher on GPIF changing allocations as they cut domestic bonds from 60% to 35%.
They raised domestic stock allocation to 25% from 12%.
They raised foreign stock to 25% from 12%, and they raised foreign bond to 15% from 11%.
Since it is over a $1 trillion dollar pension fund, They are going to be buying over $50 billion more foreign bonds, and another hundred billion of foreign equities. This started the JPY depreciation and the rise in the Nikkei as it was outperforming the S&P over the past few days. I am not sure how fast the allocation changes will be made, but the market doesn’t care and is selling the JPY first, asking questions later.
The GPIF is making a big bet that Japan (and the rest of the world) is going to really be out of the deflation trap.
Then Kuroda saw that the GPIF would be dumping domestic bonds and he offered them an exit as they BoJ added more stimulus in unexpected move, and also buying more domestic equities. Both the BoJ and the GPIF are going to be tripping over themselves to buy Japanese equities it looks like. It is a bit hilarious. Do they think they are such a bargain? Huge one day move in the Nikkei of +7.50%. The equity markets don’t usually move 7.50% in one day, and when they usually move that much, there are far more drops of -7.5% than there are rises of +7.5%.
USD/JPY rocketed above the 110 level and the market was caught short vol again as people scrambled to buy USD/JPY to hedge option exposure.
I am not going to go against this up move in USD/JPY. It is a bit more financially engineered move by the BoJ, rather than letting the the more natural macro forces do the work. So I prefer short EUR/USD. That is more natural to me. Though if the USD rallies, both EUR/USD can drop and USD/JPY go up.
Barriers at 112.50, and every 50 pip up to the large ones at 115.00.
USD: Overall flat, though it started to rally during this past week.
Bullish Forces are that the Fed ended QE, and went to a very slightly hawkish language by saying that the under utilization in labor markets is gradually diminishing, and the risk of inflation running below 2.00% has diminished somewhat.
What I found most fascinating is that the CPI stayed at the 1.7% level in September, just like the CAD CPI stayed high. This is despite the 6% or so USD appreciation and the drop in energy prices. CPI inflation dropped in UK, dropped in New Zealand, dropped in Australia, but in the US and Canada, it stayed at a higher relative level. If this is a sign that there is strong underlying demand growth in the economy, then that can certainly be bullish for the USD.
There have been some companies saying that the stronger US are hurting their profits, but overall the economy seems to have handled the USD strength so far. The market still considers the US an island of stability and growth in the world, so that should help keep the USD bid.
The US economy is the only economy that can handle the USD rising a bit more as the economy and CPI inflation seem high enough to handle it. Most of the other advanced countries around the world would rather have their currencies weaken like EUR, AUD, NZD.
What is interesting is that both the S&P and USD are near their highs. Either that is a sign that the US economy can handle the current stronger USD, or there is a divergence and the stronger USD will hurt the equity markets. So far the market seems to believe the economy can handle the stronger USD as the yields are still very low and gasoline prices below $3.00 helping to boost US economy.
The Fed doesn’t even know when it will start raising rates. They kept in their “considerable time” language, which they may have to change in the next meeting or two.
Short EUR/USD my preferred way to express stronger USD view.
S&P: first it fell hard from 1900 to 1815 s the market thought for a day or two that the US economy might be slowing down like Europe. There were also some fears over Ebola. Market got very close to correcting -10% off the highs, but it never reached that level. It tripped stops below the 1880 previous daily lows in August, then the bargain hunters came back as their was decent US data, strong corporate earnings, Ebola didn’t spread, and this weeks GPIF move into global equities, ECB starting to raise their balance sheet. That combined with the low yields and lower gasoline prices helping continue US expansion. The market is under the perception that the US expansion is continuing unabated.
S&P shrugged off the Russian ruble falling, and recovered after case of Ebola in New York city. Market seems fine with China 7.3% growth rate. S&P did not fall much on the weaker US durable goods, and rebounded on stronger corporate earnings. The S&P tried to find resistance around 1955 level with the combo of the 50 and 100 daily SMA. But the market eventually powered through that and that level became support. S&P sold off initially on Fed ending QE and going slightly hawkish, but recovered losses by the end of that day, so still bullish sensitivity.
The market seems to have acknowledged the Eurozone slowdown, but they currently think it will not get worse. I cannot predict what will happen, but there are very accommodative global macro conditions. Bond yields have plummeted in Europe this year, lower energy prices, ECB did two series of rate cuts, and now they are doing ABS/covered bond purchases, and the EUR depreciated, so that should in theory, be a LOT of stimulus to the Eurozone economy, so growth it shouldn’t fall off a cliff, and they should not fall into deflation. That is what should happen, but of course I just take it day by day.
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: 30 yr bonds spiked higher in a very low liquidity, but high volume move from 142 to 148 on fears that US expansion may be slowing down. When those fears abated, people focused on the fact that the Fed continued to end QE program, and the US expansion continues.
Even after Fed ended QE program, the 30 yr bonds did not drop much. Other market participants have replaced the Fed as the buyer of Treasuries. Lots of buyers from Europe looking to US Treasuries for relative yield advantage. And now there looks to be more demand from Japan with the GPIF changes. So that is helping to prop up the downside. So any macro sellers that want to take profit in bonds or bet on higher inflation can sell into those international players coming in. Risk appetite from surging equities capping bond topside. So those scenarios are dampening both the upside and downside to bonds. Lots of choppy action as there is no clear scenario.
I do not see anything here.
Bullish Scenarios: If the Eurozone growth and inflation drop further, if US expansion slows down
Bearish Scenarios: If the US inflation rate picks up and causes the Fed to hike rates faster than the market expects, if Eurozone inflation picks up
Crude: fell from 85.00 down to 80.00 in the December contract on news that Iraq may be cutting their selling prices as well, IEA cut estimates for 2015 for the fourth month in a row, no OPEC intervention yet, and the rise in Cushing inventory started as well for two weeks in a row, further reinforcing the bearish macro. So now, there are two bearish catalysts coming into play: No OPEC intervention is combining with the rise in Cushing inventories, as well as Gulf Coast inventories still being high.
The market is consolidating between 80.00 and 83.00, trying to find out which way to move next. I can easily see a further drop down to $75.00.
Bullish Scenarios: OPEC cuts production, energy companies start decreasing production, very strong US economy causes increased oil consumption.
Bearish Scenarios: OPEC fights with each other for market share, USD rises, more additions to Cushing and gulf coast inventories, Eurozone growth falls
Gold: First rallied from 1225 to 1250 on slight USD weakness and risk aversion. But it barely rose as the S&P tumbled, so the safe haven bid was not really active. Then it fell from 1250 down to 1160 as risk appetite returned, decent US data continued, USD rose a bit.
Gold is collapsing, while bonds are not falling as much. So there is a divergence. This divergence is due to the strong international demand for US Treasuries that is supporting the bond market. And now the GPIF saying they want to buy more foreign bonds. They did not say they are going to buy gold. Gold does not have that bid in from major institutional players as it has no yield or income component.
And with all the risk appetite and stronger USD environment, not many people want to buy gold for capital appreciation either.
Not doing anything here.
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?
Any risk aversion scenarios on the horizon?