What goes down must go up

September 2, 2010 — Mitul Kotecha

What goes down must go up! A day that began with a stronger than forecast increase in China’s purchasing managers index (PMI) and firm Australian Q2 GDP continued with a surprise jump in the August ISM manufacturing index. The ISM rose to 56.3 from 55.5 in July an outcome that contradicted most of the regional US manufacturing surveys. It was not all positive in terms of data, yesterday however, with a weaker UK manufacturing PMI and unexpected drop in the August US ADP employment report casting a shadow over markets.

Nonetheless, for a change the market decided to act on the good news, with risk assets surging. Despite the improvement in risk appetite it still feels as though the market is grasping for direction. The jump in equities is unlikely to prove durable in an environment characterized by various uncertainties about growth and policy, especially the US.

The next hurdle for markets is the US payrolls data tomorrow. Although the ADP jobs report revealed a surprise 10k decline the employment component of the ISM manufacturing survey strengthened to 60.4, suggesting an improvement in August manufacturing payrolls. Ahead of the payrolls release the US data slate today largely consists of second tier releases including July pending home sales, August chain store sales, weekly jobless claims, and factory orders. It is worth paying particular interest to jobless claims given that the four week moving average has been edging higher, suggesting renewed job market deterioration. The consensus is for a 475k increase in claims, which will still leave the 4-week average at an elevated level.

Given that one of the biggest debates raging through markets at present is whether the Fed will embark on further quantitative easing comments by Fed officials overnight were closely scrutinized for further clues. In the event, Fed Governor Kohn highlighted that the Fed’s reinvestment of the proceeds from mortgage-backed securities will not automatically lead to further QE, suggesting some hesitancy on his part. Meanwhile, Dallas Fed President Fisher noted his reluctance to expand the Fed’s balance sheet until fiscal and regulatory uncertainties are cleared up.

Both sets of comments highlight the difficulty in gaining a consensus within the FOMC for a further increase in QE, suggesting that the hurdle for further balance sheet expansion will be set quite high. Moreover, such comments put the onus on Congress to move quickly in clearing up fiscal policy uncertainties.

As markets flip from risk on to risk off almost on a daily basis the question for today is how sustainable the rally in risk trades will prove to be against the background of so much policy and growth uncertainty. Unfortunately today’s data will provide few clues and markets will turn their attention to tomorrow’s US non-farm payrolls report for further direction. To an extent this suggests that it may be a case of treading water until then. Nonetheless, I still maintain that risk trades remain a sell on rallies over coming weeks

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US payrolls clues

September 1, 2010 — Mitul Kotecha

Most investors will be glad to see the back of August, a month that marked the biggest monthly decline in US stocks in nine years. The main imponderable is whether September will be any better. A series of manufacturing surveys globally today will do little to restore confidence although there was some good news in a slight increase in China’s official August purchasing managers index (PMI) as well a stronger than forecast increase in Australian Q2 GDP, which will likely provide some short-term relief for risk trades.

There was also some slight solace for markets in terms of US data at least from the point of view that the data was not as disappointing as many recent releases. Although the August Chicago PMI slipped (to 56.7) consumer confidence increased (to 53.5) though admittedly confidence remains at a relatively low level. The job market situation detailed within the consumer confidence report was more pessimistic in August than the previous month, however, with those reporting jobs hard to get moving higher. This sends a negative signal for Friday’s payrolls data.

There will be more clues to Friday’s US jobs report today which will enable any fine tuning of forecasts to take place in the wake of the August ADP employment report and ISM manufacturing survey. Consensus forecasts centre on a 15k increase in private jobs. Despite the slight increase in the Empire manufacturing survey in August, the falls in other manufacturing surveys point to some downside risks to the ISM today, with a simple average of the three pointing to the ISM closer to the 50 mark, which will highlight a loss in US manufacturing momentum.

Manufacturing surveys elsewhere will also be in focus, with the final PMI readings scheduled to be released for the eurozone and UK. There is likely to be confirmation of the slight drop in the eurozone PMI to 55.0 in August while the UK PMI is likely to drop to around 57.0 over the month. Both surveys remain at a relatively high level but it is clear that activity is moderating in H2 2010 from a healthy level in H2. The data will give little support to the EUR but the currency has found a degree of stability over the last couple of days. Nonetheless, a further downward move is in prospect.

The Fed FOMC minutes provided little for markets to get excited about. The minutes noted concerns about large scale asset purchases from some Fed officials, indicating resilience to increasing quantitative easing despite acknowledging increased downside risks to the growth and inflation outlook. It is unclear exactly what will be the trigger for further QE as acknowledged by Fed Chairman Bernanke last week.

The minutes will do little to help market confidence given the hesitancy to pursue further QE and provide further stimulus to the economy but the USD is likely to benefit from the fact that the Fed may not be as eager to expand its balance sheet further. Other currencies that remain beneficiaries in the current risk averse environment are the JPY and CHF. The JPY may find further upside more difficult given ongoing intervention fears but the trend remains for a lower USD/JPY in the coming weeks.

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Bernanke Boost

August 30, 2010 — Mitul Kotecha

Last week ended with a downward revision to US Q2 GDP. The data clarified that growth momentum going into Q3 was indeed quite weak though it probably didn’t take the GDP revision to tell us this nugget of information, something that has been evident from the run of weak data over recent months.

Softer growth in Q2 placed particular attention on the Jackson Hole speech by Fed Chairman Bernanke in which he acknowledged the slowing in the pace of growth, but also forecast a moderate economic recovery in H2 2010. Importantly if the Fed is proven wrong he noted the FOMC would undertake unconventional (quantitative easing) QE II measures if needed.

The net impact on Bernanke’s speech and the smaller than expected downward revision to US Q2 GDP was to provide a boost to risk appetite. Sentiment will at least begin this week on a positive note in the knowledge that the Fed stands ready to act although double dip fears are far from over.

One trigger for Fed action will be a further deterioration in job market conditions and markets will pay close attention to the August US jobs report at the end of the week. Bloomberg consensus estimates forecast a 100 drop in payrolls, with private payrolls up 47k and the unemployment rate edging higher to 9.6%. Such an outcome would do little to boost confidence in a jobs market recovery.

The week begins with all eyes on Japan however, with an emergency Bank of Japan (BoJ) meeting in focus. USD/JPY has already jumped higher on the belief that concrete action will emerge to weaken the JPY. The risk of disappointment is high and at most the BoJ will announce measures to extend loans to banks. A lack of other action especially in the form of FX intervention alongside a likely increase in risk aversion once the Bernanke bounce wares off, will result in a renewed USD/JPY move lower, with a breach of 85.00 likely. As seen in the chart below a decisive turn in the Japanese stocks will be a key factor in helping to eventually drive USD/JPY higher.

Two other central bank meetings of note this week are the European Central Bank (ECB) and Sweden’s Riksbank meetings on Thursday. No change in policy by the ECB will be of little surprise but the release of new staff projections, with growth likely to be revised up in 2010 but left unchanged for 2011, will be of interest. Developments regarding open market operations will also be of attention. In contrast, the Riksbank is widely expected to hike rates by 25bps on the back of a firming economy and house price inflation.

A UK holiday today will likely keep liquidity thin and as noted above risk currencies including AUD, NZD and CAD as well as Asian currencies will start the week firmer but will struggle to hold gains as the week progresses. EUR/USD has benefited little from improved risk appetite and will have a hard time this week making much any headway although potential EUR/CHF buying from the SNB may give some, albeit limited support.

A renewed downside move to support around EUR/USD 1.2455 remains on the cards in the short term. Overall USD sentiment has become less negative as reflected in the CFTC IMM positioning data in contrast to a renewed deterioration in EUR speculative sentiment. We look for more of the same.

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Split personality

August 25, 2010 — Mitul Kotecha

Markets are exhibiting a Strange Case of Dr Jekyll and Mr Hyde, with a clear case of split personality. Intensifying risk aversion initially provoked USD and JPY strength, with most crosses against these currencies under pressure. Both USD/JPY and EUR/JPY breezed through psychological and technical barriers, with the latter hitting a nine-year low. However, this reversed abruptly in the wake of extremely poor US existing home sales, which plunged 27.2% in July, alongside downward revisions to prior months, a much bigger drop than forecast.

Obviously double-dip fears have increased but how realistic are such fears? Whilst much of the drop in home sales can be attributed to the expiry of tax credits, investors can be forgiven for thinking that renewed housing market weakness may lead the way in fuelling a more generalized US economic downdraft. The slow pace of jobs market improvement highlights that the risks to the consumer are still significant, whilst tight credit and weaker equities, suggests that wealth and income effects remain unsupportive.

FX markets will need to determine whether to buy USDs on higher risk aversion or sell USDs on signs of weaker growth and potential quantitative easing. I suspect the former, with the USD likely to remain firm against most risk currencies. The only positive thing to note in relation to the rise in risk aversion is that it is taking place in an orderly manner, with markets not panicking (yet).

European data in the form of June industrial new orders delivered a pleasant surprise, up 2.5%, but sentiment for European markets was delivered a blow from the downgrade of Ireland’s credit rating to AA- from AA which took place after the close. The data suggests that the momentum of European growth in Q3 may not be as soft as initially feared following the robust Q2 GDP outcome.

Japan has rather more to worry about on the growth front, especially given the weaker starting point as revealed in recently soft Q2 GDP data. Japan revealed a wider than expected trade surplus in July but this was caused by a bigger drop in exports than imports, adding to signs of softening domestic activity. The strength of the JPY is clearly making the job of officials harder but so far there has been no sign of imminent official FX action.

Japan’s finance minister Noda highlighted that recent FX moves have been “one sided” and that “appropriate action will be taken when necessary”. The sharp move in JPY crosses resulted in a jump in JPY volatility, a factor that will result in a greater probability of actual FX intervention but the prospects of intervention are likely to remain limited unless the move in the JPY accelerates. USD/JPY hit a low of 83.60 overnight but has recovered some lost ground, with 83.50 seen as the next key support level. JPY crosses may see some support from market wariness on possible BoJ JPY action, but the overall bias remains downwards versus JPY.

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Week Ahead

August 23, 2010 — Mitul Kotecha

The market mood can be characterised as uncertain and somewhat downbeat, as reflected by the downdraft in US equity markets which posted their second weekly loss last week. Conversely, there has been a bullish run in government bonds, with the notable exception of peripheral debt. Over the last week markets had to contend with more data disappointment, in the wake of soft Japanese Q2 GDP, and a plunge in the August Philly Fed into negative territory, its first contraction since July 2009. Additionally a jump in jobless claims, which hit 500k highlighted the slow improvement in US job market conditions currently underway.

Despite all of this, the USD proved resilient and instead of the usual sell-off in the wake of soft data it benefited instead from increased risk aversion. The USD is set to retain some of this resilience though range-trading is likely to dominate over much of the weak. Reflecting the USD’s firmer stance, speculative positioning in the form of the CFTC IMM data revealed a reduction in aggregate USD short positioning in the latest week and although positioning is well below the three-month average, the improvement over the latest week and current magnitude of short positioning, highlights the potential and scope for further short-covering.

Negative data surprises have forced many to downgrade their forecasts for growth and policy implications, especially in the US. Markets will look for further clarity on the economic outlook this week but it is not clear that anything conclusive will be delivered. At the end of the week Q2 GDP will be revised sharply lower and whilst the data is backward looking it will reveal the weaker momentum of growth going into the second half of the year.

US Housing data will be mixed, with existing home sales set to drop in July as the impact of the expiration of home buyers tax credits continues to sink in whilst new home sales will likely increase but only marginally and will remain well below the April levels. Overall the picture of housing market activity remains bleak and this week’s data will do little to shake this off. On a more positive note July durable goods orders and August Michigan confidence will rise, the latter only marginally though. There will be plenty of attention on Fed Chairman Bernanke’s speech at the Jackson Hole Fed conference at the end of the week, especially given speculation of more quantitative easing in the pipeline.

The European data slate kicks off today with the release of manufacturing and service sector PMIs. Both are likely to register small declines, albeit from high levels. Nonetheless, taken together with a likely drop in the August German IFO survey on Wednesday and weaker June industrial orders tomorrow, the data will highlight that the momentum of growth in the region is coming off the boil, with the robust GDP outcome registered in Q2 2010 highly unlikely to be repeated. Against this background EUR/USD will find it difficult to make any headway. Technically further donwnside is likely over the short-term, with a test of 1.2605 support on the cards

Japan releases its slate of month end releases including jobs data, household spending and CPI. A slight improvement in job market conditions and increased spending will be insufficient to allay growth and deflation concerns, especially with CPI remaining firmly in negative territory. The onus will remain on the authorities to try to engineer a weaker JPY, which remains stubbornly around the 85.00 level versus USD. Talk of a BoJ / MoF meeting today has been dismissed, suggesting the prospect of imminent action is small. Meanwhile, speculative JPY positioning has dropped slightly in the last week but remain close to historical highs.

Aside from various data releases this week markets will digest the outcome of Australia’s federal elections. From the point of view of markets the outcome was the worst possible, with no clear winner as both the incumbent Prime Minister of the ruling Labour Party and opposition Liberal-National Party leader Tony Abbot failed to gain an outright majority. The outcome of a hung parliament will likely keep the AUD on the back foot, with trading in the currency likely be somewhat volatile until a clear outcome is established as both candidates try to garner the support of a handful of independents. However, it is notable that apart from an initial drop the AUD has managed to hold its ground. Nonetheless, the given the fluidity of the political situation there will be few investors wanted to take long positions at current levels around 0.8900 versus USD.

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