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Macro Outlook for November 23, 2014
Correlation / Sensitivity Sheet for November 21, 2014:
Bonds up (could be risk appetite with lower yields)
Bonds up (could be risk aversion safe haven bid)
Notes (since last macro update 3 weeks ago):
AUD: roughly flat and in choppy range over past three weeks.
Bullish Forces: AUD cannot sustain falls on slightly weaker China data, so that is bullish sensitivity, but there is no bullish catalyst to cause it to rise, so the effect is roughly neutral (As you want the market to “act right” and have a catalyst/scenario for future movement in the direction it is “acting right.”). Property market is booming, some other areas of private demand are seeing expansion.
Bearish Forces: There was a further drop in iron ore prices. RBA says AUD is still too high, and there is spare capacity in labor markets and low income growth to keep a check on inflation. Many key commodity prices around the world have gotten hit this year, including iron ore, crop prices, crude oil, dairy, etc, so that is restraining the commodity countries growth and inflation a bit as the mining and commodity boom benefits wane a bit. China bad loans rising. If the USD strengthens further, then that can cause AUD to fall, but better plays in EUR/USD and USD/JPY.
The AUD did try to rally on the China rate cut, but no one really knows if a rate cut is going to be enough to boost China growth. It could possibly be that the Chinese government knows a bigger slowdown is coming and with the CPI low, they figure they might as well try some rate cuts in order to make sure growth doesn’t crater. So it could potentially be admission that China is acknowledging a deeper slowdown, though that is unclear as of yet. Just something to look out for.
Probably an option barrier at 0.8500 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: rallied +100 pips vs USD, even more vs EUR and GBP.
Bullish Forces: Unemployment rate dropped further to 5.4%, stronger retail sales,
Bearish Forces: Dairy prices fell further, which could cause rising loan defaults, pressures have eased in the housing market, RBNZ says exchange rate still has further to go as they would like it to depreciate another -1,000 pips, PPI inflation is weak
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.
Overall, same situation with AUD. Not doing anything here, since there is no divergence of monetary policy.
CAD: roughly flat over past few weeks. 1.1400 barrier in USD/CAD knocked out.
Bullish Forces: CPI inflation rose to 2.3% from 2.1%, but the BoC expected it and said it would be temporary and there is still slack in the economy. Stronger US economy helping to boost Canada as well as the unemployment rate dropped from 6.8% to 6.5%
Bearish Forces: lower crude prices, BoC still sees considerable slack in the economy
Overall, not setting up anything. Same with AUD and NZD
CHF: roughly flat, but EUR/CHF grinding lower to the 1.20 floor on EUR weakness
EUR/CHF wants to press lower to test the 1.2000 floor as the EUR weakness from the past few months continues and the ECB has started both covered bond and ABS purchases.
EUR/USD has more downside than EUR/CHF as the SNB can be at the bid at 1.2000 with tens of billions of dollars.
There is the gold referendum on Nov 30. If there is a YES vote, then some people say that may cause the 1.20 floor to be broken. My analysis shows that even with a Yes vote, the SNB has 5 years to reach the goal, so they do not have to panic and reduce their balance sheet by selling their EUR/CHF. Also, they can institute negative interest rates in such a scenario, and an SNB member said they would have a more powerful effect than the negative rates by the ECB, and I do believe that is an accurate assessment. So I would say the 1.20 floor will be easily hold.
Not doing anything here.
EUR: fell -200 pips, most of it this past Friday. It fell hard on November 6th as Draghi really talked down the EUR as he cited the “increasing differences in major economies economic cycles and the ECB Balance sheet will expand in coming months, while other central bank balance sheets contract.”
Bullish Forces: 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 and Eurozone CPI inflation stays subdued at the current 0.4% in October. There can be some short covering of the short EUR positions if the CPI starts ticking higher more, but there isn’t any big Eurozone growth story to buy into, so rallies can still remain limited.
Bearish Forces: CPI is still at a very low 0.4%, despite all the huge EUR depreciation, which means the current size and pace of the EUR depreciation is not enough. EUR has to fall another -1,000 pip in order to help rebalance the economy towards higher inflation and growth. ECB may expand balance sheet and buy assets over two years. So low rates can be here until the end of 2016, while the Fed can start gradual rate hikes in 2015, as is the current market expectations. ECB survey of inflation forecasts fell to 0.5% from 0.7% for 2014, and fell to 1.0% from 1.2% for 2015. Germany CPI for October at 0.7%. Italy finance minister said he expects ECB to embark on the purchase of government bonds in a bid to pep up demand in the eurozone.
ECB Mersch says the economic situation in the eurozone is “critical” amid weak growth and exceptionally low inflation.
Draghi said it is “essential to bring inflation to target without delay.”
The ECB seems content to hold off on QE for this year, as they wait to see what all the rate cuts, TLTRO’s, covered bond purchases, ABS purchases, euro depreciation, do to the inflation outlook. Currently, they haven’t worked, but they seem to be want to wait another 2-3 months to better gauge the effects.
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 1.2350 and every 50 pips down.
GBP: fell -300 pips over past few weeks from the fallout from the BoE inflation report.
Bullish Forces: The market cannot rally on the 2 members voting for rate hikes, so in order for GBP to rally, there would have to be even more signs that the GBP economy is able to weather the weaker Eurozone growth, so the market can believe that the UK is an island of stability like the US is and the expansion is continuing unabated. EUR/GBP reversing the previous rise could also cause the GBP to rally a bit.
Bearish Forces: weaker services pmi and construction pmi for October, BoE slightly cut inflation and growth forecasts. CPI at subdued 1.3% for October.
GBP showing bearish sensitivity as it fell, even though 2 members voting for rate hikes already, and despite the rise in the Average earnings index, and despite the very slightly hawkish Meeting Minutes where some members cited the strong employment data and tightening of the labour market, and that private sector pay growth has begun to rise.
I do not see any moves to go long or short the GBP. Cleaner plays in the EUR and JPY and USD.
1.5500 barrier in GBP/USD
JPY: fell-400 pips over past few weeks as the momentum from the surprise BoJ action continued to push USD/JPY higher and as risk appetite continued with more good US data, and Abe calling for fresh elections caused more JPY weakness, and the Q3 GDP was weak as the restraining effects from the sales tax hike this past spring have yet to completely wane.
USD/JPY rose more than EUR/USD dropped because it had more short term catalysts in the form of the GPIF changes, surprise BoJ expanded QE program, and then Abe calling for fresh elections and the sales tax being delayed (which the market interpreted as JPY weakness). ECB has yet to do QE, so EUR/USD not dropping as fast.
Abe has to get the mandate again so he can continue Abenomics. If he doesn’t, then the JPY can strengthen in a knee jerk reaction. The market is heavily loaded up long USD/JPY expecting Abe to win a fresh mandate. If he doesn’t, then USD/JPY can crater -500 pips or something in a single day. Eventually USD/JPY can form a bottom and continue the uptrend if the US expansion is intact, but there is tail risk associated with the new elections. So don’t get caught long USD/JPY from the fresh highs of the day or move. I may consider shorting USD/JPY at 120.00 or above one time to test it out depending on the macro situation when it gets there.
If Abe does win a fresh mandate, then USD/JPY can continue moving higher. The other question is if USD/JPY is too high priced and expecting too fast rate hikes from the Fed. If it is, then it may not want to move that much higher. That is not something I can determine at the moment.
Big barriers at 120.00 for USD/JPY.
USD: roughly flat the past few weeks.
Bullish Forces: Stronger ISM manuf, US still an island of prosperity in the world economy, unemployment rate dropped to 5.8%, mortgage delinquencies dropped, higher PPI, Core CPI (excluding food and energy) rose to 1.8% for October so perhaps that could be an early warning sign that wage pressures may be starting and a sign that there is improving domestic demand.
The USD is roughly in the “sweet spot” right now. It is not too strong and not too weak. It is “just right.” It’s recent strength is hurting some company profits, but the rally has also helped keep crude price slower, which helps boost the economy, and keep inflation flow, thus restraining Fed rate hikes, which also boosts the economy as well as they do not have to hike that fast yet. So from that perspective you can say the USD is fairly valued.
US economy still one of the few countries that can handle it’s currency appreciating by 5% or so. Most of the other advanced countries around the world would rather have weaker currencies accorded to their central banks like EUR, AUD, NZD.
What is interested again 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 and cause a sell off in the S&P. 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.
Bearish Forces: inflation likely to remain contained on lower commodity prices.
Short EUR/USD my preferred way to express stronger USD view. Alternative way is long USD/JPY.
S&P: Rose from 2017 to 2060 or so, boosted by the after effects of BoJ extra QE, low gasoline prices stimulating the economy replacing QE as the stimulatory force, good US data.
S&P actually able to rally to all time highs even as Fed ended QE, due to the markets perception that US fundamentals are strong. This is in contrast to Nikkei making fresh highs, but that was due to the JPY depreciation and more BoJ stimulus.
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 Forces: If the ECB does QE, if gasoline prices fall further, if there is continued stronger US data in the context of restrained inflation and wage costs, M&A flows, stronger Eurozone data
S&P showing continued bullish sensitivity as it is shrugging off the stronger USD and the increase in UKR-RUS tensions.
Bearish Forces: If there are heightened UKR-RUS tensions, if Chinese growth falls further, if the inflation rate picks up a lot and the the market thinks the Fed to hike aggressively, if ECB delays QE while Eurozone goes into recession / deflationary spiral, 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, if there is another severe winter
Do not buy top tick as the market is bumping up against full valuations and a bit overextended with all the Japan QE, china rate cut, and boosted on hopes for ECB QE.
Bonds: in a very tight range between 140 and 142.
The interesting thing to note is that equities are at all time highs, but bonds have not yet dropped that much as the current US expansion is not generating enough inflation to cause aggressive Fed rate hikes.
Bonds have some bullish sensitivity as they did not drop much considering equities hit new all time highs. So there are still very bid on the dips. Still lots of relative yield buyers from the low Eurozone growth and inflation. Flows from GPIF into US bonds can also be supporting prices, and with the BoJ QE, they can be pushing Japanese institutions out of Japan debt, and they may want to go buy more US debt, especially if they think the USD to rally.
Bonds rallied on November 14, despite the stronger US data. So bullish sensitivity there.
Bonds have bullish sensitivity from Friday, November 21, 2014, as when China did rate cut and there was risk appetite, bonds did not drop much and they ended up closing at the highs of the day.
Bullish Forces: if UKR-RUS tensions flare up again, if Eurozone growth and inflation drop further, if US expansion slows down, if Chinese growth slows
Bearish Forces: if there is a pickup in US inflation, if there is a pickup in Eurozone inflation with all the stimulus they are doing there
Overall, bullish on bonds from current 142-05 level, since they had bullish sensitivity from Friday, I would expect that to continue and cause them to rise, even though there is no clear bullish catalyst yet. Perhaps consider shorting them if they trip topside stops above 148.
Crude: fell from $81 to $74 in the January contract, as OPEC has no intervened yet and the market does not believe it will, Saudi Arabia lowered its cost of crude to the US,
On Nov 12, Fed Kocherlakota said he didn’t expect a further big decline in gas prices, then the next day Crude and gasoline prices dropped in a big one day move.
Even if OPEC cuts production, as long as the US production is still high, then the rallies in Crude can be sold. So it seems Saudi Arabia knows that it is foolish to try to cut production as OPEC does not have as much power as it used to with other countries increasing crude oil production.
Bullish Forces: OPEC cuts production drastically, if stronger US economy causes increased demand for crude oil, if shale oil production declines as the price drop makes certain areas unprofitable,
Bearish Forces: if OPEC does not intervene, if OPEC fights with each other for market share, USD rises, more additions to Cushing and Gulf Coast Inventories, Eurozone growth falls
Do not see anything here. The easy drop I anticipated down to $75. After that, it can be a little harder to peer into the future. Just waiting here.
Gold: rose +$25 over past few weeks.
Not sure why gold rose. Could be stealth safe haven bid with some participants expecting a risk aversion event to occur. Some people say due to Russia adding to gold reserves.
Not doing anything here. More interesting situations in EUR/USD, USD/JPY, S&P, and bonds.
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?