I’ll post a video later this week, taking into account any new developments.
Macro Outlook for December 16, 2014
Correlation / Sensitivity Sheet for December 16, 2014:
Bonds up (as lower yields help economic expansion)
Bonds up (as a sign of safe haven bid from risk aversion)
Notes (since last macro update 3 weeks ago):
AUD: fell -400 pips or so on iron ore price drop, rise in Chinese bad loans and perceived continued China slowdown, unemployment ticking higher as GDP growth not enough
Bullish Forces: Property market is booming, some other areas of private demand are seeing expansion. There really isn’t much bullish catalyst.
Bearish Forces: Rumor that Chinese growth is below 7% y/y, iron ore prices dropped to lowest since 2009, China may be acknowledging a deeper slowdown by cutting rates, inflation set to stay subdued, AUD GDP growth slowed for Q3. 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.
Various barriers in AUD/USD knocked out on the downside. Next barrier at 0.8200.
Overall, do not see anything special in the AUD to the upside or downside. The AUD has depreciated closer to its “fair value” around 0.7500 that the RBA thinks it should be closer to. It is still overvalued by 500 pips or so, as it is true that with the lower inflation rate and slack in the labor markets, a further AUD depreciation would help rebalance the economy. But the RBA is probably not going to raise or cut rates, so no divergence of monetary policy. 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: Fell -100 pips or so over past few weeks as the dairy prices dropped further, general commodity currency weakness. It tried to make ground and rally after slightly hawkish RBNZ where they switched to a bit more hawkish as they said “some further increase in the OCR is expected to be required at a later stage.”
Bullish Forces: RBNZ may hike once or twice in 2015, growth expected to remain at or above trend through 2016,
Bearish Forces: drop in dairy prices, general commodity currency weakness, RBNZ still says it is very overvalued and would like to see it fall -1,000 pips, still low current CPI.
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. The NZD tried to rally on slightly hawkish RBNZ, but with the drop in dairy prices and the strong verbal intervention, that is capping NZD rallies.
Overall, the battle of scenarios shows no clear winner and the NZD has been chopping around.
Not doing anything here, since there is no divergence of monetary policy.
CAD: fell -300 pips over past few weeks, due to collapse in oil prices, general commodity currency weakness.
Bullish Forces: Don’t see any.
Bearish Forces: the big drop in crude prices may shave off -0.30% to 0.50% off CAD GDP growth in 2015. Unemployment rate rose to 6.6%
The drop in crude oil will probably be more stimulative to the US economy, rather than the CAD economy. So USD should benefit more and that is showing in USD/CAD going higher.
Overall, do not see anything here.
CHF: flat for the past few weeks.
Bullish Forces: do not see any
Bearish Forces: CPI at 0.0%, PPI at -1.6% and they downgraded inflation projections for 2015 and 2016, so the SNB can keep on printing money to defend the 1.20 floor as much as they want.
There may be light pressure building on the 1.20 floor, but, the SNB can defend it with tens of billions, and if they want to they can do negative rates, and this type of EUR selling is a bit different from the 2011 version. The 2011 version was due to fear of EUR collapse, so it was really aggressive EUR/CHF selling. In today’s environment, it is more in the context of some risk appetite with the U.S. equity markets performing decently.
Overall, I don’t see any big moves either direction. EUR/CHF to probably stay near 1.2000
Not doing anything here.
EUR: overall flat over past few weeks. EUR/USD made a new low on the stronger US data, then retraced a bit.
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 0.3% in November. 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: There is Bearish Macro Sensitivity as the CPI came in at 0.3% for November, even after all the current ECB measure and the current EUR depreciation. So the EUR is not falling far enough nor fast enough. Germany wants fiscal austerity and ECB Nowotny sees massive weakening of eurozone economy. The Russian recession is probably going to spillover into weaker Eurozone growth and inflation. Buba Weidmann said the German CPI may even go negative. Spain CPI at -0.5% y/y for November. There are some reports that the ECB is struggling to raise it’s balance sheet as the current market of ABS and covered bonds is very small. So in order for the ECB to raise its balance sheet by hundreds of billions of dollars, the only markets capable of doing that are in sovereign government debt and corporate bonds. And they have said that they can adjust the size, pace and composition of the asset purchases if needed, and they do have people researching those options. They just want to wait until next year to make a decision on those. Draghi said it is essential to bring inflation back to target without delay. Draghi has signaled EUR depreciation for the next year as he tries to talk up the divergence in monetary policies between the US and Eurozone.
The rise in EUR/JPY and EUR/AUD, not helping the Eurozone economy.
Overall, I think the EUR/USD should fall another -1,000 pips to help the economy rebalance to higher inflation and more growth. EUR/USD should be closer to 1.15, rather than 1.25 in my opinion, so long as the Fed doesn’t go dovish. I think the shorts in EUR/USD are taking profits too fast in my opinion.
Next option barrier at 1.2200
GBP: overall flat the past few weeks. GBP/USD made fresh low on stronger US NFP, then bounced
Bullish Forces: BoE said they will look through short term effects of oil price drop on inflation. If the current benign wage pressure start ratcheting higher. GBP rose a bit today, even as CPI dropped, which is bullish sensitivity, but I don’t see any compelling catalyst to back it up.
Bearish Forces: CPI fell to 1.00%, and may drop further in coming months. Lower Eurozone growth and inflation and Russian recession may spill over into UK economy. GBP can’t rally even as two members already calling for rate hikes.
Overall, I do not see any clear scenarios, so not doing anything here.
1.5500 barrier in GBP/USD.
JPY: first fell -300 pips, then rose +300 pips, to be roughly unchanged for the period. USD/JPY knocked out 120.00 and 121.00 barriers helped by strong US NFP, before selling off on some profit taking and some risk aversion from drop in S&P and the rise in bonds.
Bullish Forces: There aren’t any macro reasons to be long the JPY. You can try shorting USD/JPY when it makes a new high, or knocks out a topside barrier to play for a drop based on some extended market positioning, but no macro reasons so long as the Fed continues on its rate hike path.
Bearish Forces: CPI stripping out the sales tax, is still only 0.9%, sales tax may have weakened economy, lingering macro effects from more BoJ QE, and the GPIF changes to boost foreign equities and bonds still in play, Abe won the elections so he can continue his reflationary policies. Lots of Japanese money coming in to the U.S. to buy up US equities and bonds.
Overall, I am bullish on USD/JPY and bearish on EUR/USD. Those are the two clear macro trades so far.
USD: flat over the past few weeks. It tried to rally +100 to +200 pips or so on the very strong NFP, but unable to sustain gains as the market is unsure if that data will lead to more aggressive rate hikes.
Bullish Forces: Growth for Q3 was very strong at 3.9%, strong ISM Non-manufacturing PMI for november, strong NFP for November, average hourly earnings rose, stronger retail sales for November. PPI stayed flat for December, which is interesting, since Crude oil prices have been dropping a lot. Is that a sign that there is strong demand growth inside the country, and potential wage pressures are building? Lower gasoline prices supporting expansion
Bearish Forces: inflation likely to remain contained on lower energy prices.
With the yields being very low – and may drop further as bonds rise, and low gasoline prices, which may drop further, and the job gains, etc, this should all help to support continued US expansion.
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 prices lower, 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.
Another theory that I have is that the drop in Crude oil may not lower inflation in the US, if it is leading to massive increase in domestic consumption as the consumers have more money to spend. It may be a wash, or even lead to some slight inflationary pressure. It is just a theory I have for now, but it is something I will be looking out for.
Short EUR/USD my preferred way to express stronger USD view (as ECB may launch QE bazooka). Alternative way is long USD/JPY.
S&P: fell -5% off the highs due to eventually succumbing to a weakening Russian / emerging market / oil countries, drop in energy shares, some drops in foreign stock markets such as China, Dubai, Russia, Greece, and the current Russian Ruble collapse.
Bullish Forces: Overall, with the stronger US economic data in the context of still restrained inflation, and the lower yields, and the lower gasoline prices, that should support the downside, and eventually cause another rally to occur. The market sold off on some emerging market fears in early 2014, but then it recovered after the US emerged from the severe winter. The market currently believes the US is an oasis of prosperity in a world of uncertainty and turmoil. There is no current evidence that external risks are effecting the U.S. economy. Also, if the ECB does a trillion dollar QE program, that should give the market another upsurge, as the BoJ is doing QE as well.
Lower gasoline prices, lower yields, M&A flows, can cause further rises.
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.
Bearish Forces: If signs start to form that the US economy is starting to be negatively effected by international developments. 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.
With the big drop in crude oil, there are potential risk aversion catalysts that can come into the picture. If countries such as Russia, any emerging market countries, any countries heavily dependent on oil, if they suffer recessions, and forms of social unrest, their currencies plummet, etc. That could be a source of risk aversion.
It is also possible that the lower oil prices are indicative of weak global demand from China, Europe, etc, which can eventually hit US equities. Overall, the market currently thinks the US is avoiding these global risks.
Overall, don’t short bottom tick on the S&P if it trips downside stops and makes fresh retracement lows. The market is trying to form a bottom, just like it did in the previous retracement phase.
Bonds: 30yr bonds rose a large +6 pts from 140 to 146 on the March 2015 contract, due to the drop in crude oil causing lower inflation expectations, and some Russian recession and ruble collapse turmoil, and the Eurozone bond yields plummeting so the market buying the higher relative yield US counterparts.
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, if Russia / Emerging market / oil countries face crises
The stronger USD, weaker china growth, and the commodity glut, that is pushing inflation lower globally. Lack of wage growth globally is keeping inflation in check so far.
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, still bullish on bonds. The German 10 year yield at 0.60%, while the US 10 year is at 2.06% or so. So there is a lot of foreign demand coming into the US to buy the higher yielding debt, from Europe, Japan, etc. So bonds have that benefit. They are rising on perceived low inflation environment. They can rise on safe haven bid from any Russia / Emerging market / oil countries face crises.
It is possible that Putin may start flailing around and cause geopolitical tensions, which can cause bonds to rise further. The drastic rate hike by the Russian central bank wasn’t really able to stop the ruble collapse. The Russian markets are so illiquid that people are unsure what to price it at. So that uncertainty should keep bonds bid.
Crude: Fell sharply from 75.00 to 55.00 after OPEC did not cut output, and they said they can keep output unchanged for the first half of 2015. That injected even more fresh downside momentum, as the market came to the realization that OPEC may not do anything even if crude drops to $60 to $50 or even $40. And the current drop is not decreasing US shale oil production yet. The potential for OPEC cut and the decrease in US shale production were the only things propping up the market, but that does not seem to be happening any time soon, so Crude prices plunged.
Bullish Forces: some short covering, 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: Saudi Arabia, Iran, Iraq, Kuwait, are all offering more and more discounts for their Crude to Asian customers. They are fighting to keep market share. OPEC cut 2015 demand forecast. Saudi Arabia oil minister continued to say they are not going to cut output. They correctly interpreted that it was foolish to cut production when the macro was bearish, as they would just lose market share. If Eurozone and China econ growth get weaker.
Overall, I would not touch this on the long side as a swing trade. If you want to try to go long if it makes a fresh low for an intraday trade, that’s fine. But this can keep grinding lower and lower. It could go to $50, $40, even the $30’s. You just don’t know.
Gold: overall flat over the past few weeks. It tried to pop higher on some short covering along with Crude on Dec 1st and the fall in equity markets on Dec 7. But it gave up those gains and is choppy. It was not able to sustain the rally today, in contrast to bonds which did sustain the rally. With Fed QE having ended, and the low inflation environment, Gold is just kind of sitting there not doing much. Crude is falling, because it has much cleaner macro catalysts.
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?