JPY Likely to Strengthen as Risk Appetite Continues to Fade
Summary
Fundamental Outlook for Japanese Yen: Bullish
- Merchant Sentiment at highest in almost 3 years
- Annual Corporate Good prices make record drop
- Current Account Surplus Grows even while imports drop almost 44%.
- Japanese Trade Surplus Widens as Imports Sputter
The Yen and US Dollar: Compare and Contrast
- Like the USD, the near term fortunes of the JPY will depend mostly risk appetite, not underlying fundamentals for the Japanese economy. Thus the more gloom for everything else, the more these two tend to rise.
- That’s good news for both currencies, because both economies are struggling
- Given the relatively lower debt and QE levels weighing on the Yen, the Yen appears to be considered far safer than the #2 safest USD.
The Japanese Yen looks likely to advance in the week ahead as risky assets reverse lower, prompting liquidation of carry trades funded in the perennially low-yielding currency. Earnings season is upon us, and stocks look increasingly shaky having ended June trading at the highest level relative to earnings since 2004, a year when the world economy grew 4.1% in real terms.
The OECD, IMF, World Bank, and all major central banks are in agreement that the world economy will shrink this year, suggesting the markets have been more than a little overzealous and need only a little nudge from some disappointing second-quarter profit figures to topple over. Stand-by yield-seeking trades like GBPJPY and all of the Japanese unit’s pairings with commodity-linked currencies are on average over 91% correlated with the MSCI World Stock Index, meaning that any return to risk aversion is likely prompt sharp carry-trade liquidation and boost the Yen.
The economic calendar’s the modest helping of scheduled releases is unlikely to provoke much of a reaction from the market considering traders have probably priced in the underlying themes behind the likely data outcomes long ago. Consumer confidence will likely tick up for the sixth consecutive month in June, mirroring recent improvements in the Eco Watchers and Tankan Survey measures of merchant and business sentiment as the government’s record-breaking 25 trillion yen fiscal package continues to work its way into the broad economy.
The main question going forward is whether such improvements are sustainable after the flow of stimulus cash dries up. The Bank of Japan seems pessimistic on this front, noting that consumption is likely to remain weak as the “employment and income situation becomes increasingly severe.” Indeed, the jobless rate rose to the highest in over 5 years in May as the economy shed 440k jobs.
Still, near-term stabilization is delays the need for further monetary expansion, bringing Japan closer to an eventual recovery in overseas demand that will ultimately feed a rebound in the world’s second-largest economy. This means the upcoming monetary policy announcement is likely to be a non-event once more, with Maasaki Shirakawa and company saving any ammunition they may still have until they really need to use it.
GBP Gets Near Term Boost from BoE Decision to Abstain from Further QE
Summary
Outlook for British Pound: Bearish
- BoE holds rates at 0.50%, announces will not expand asset purchase program for now
- Industrial activity falls for the 20th month in the past 24
- Consumer confidence hits 8 month high, despite last week’s report that UK Q1 GDP fell 2.4%, revised lower from -1.9%
Potential Key News to Move the GBP Markets
Tuesday Annual CPI, Annual BRC Retail Sales, RICS House Price Balance
Wednesday Claimant Count Change (change in those claiming unemployment )
As GBPUSD exemplifies, the British pound was little moved against most of its major counterparts this past week. This is quiet was somewhat unexpected considering the presence of the Bank of England’s rate decision and the G8 meeting. Since both events seem to have had surprisingly little immediate impact on the sterling, it seems that trading will lack any clear trend without a strong enough catalyst to put the market in motion. There are a few notable economic releases over the coming week; but should we really expect them to finally force a breakout from GBPUSD and other range-bound sterling crosses?
Looking at the economic docket, it seems relatively light on market movers; but there is certainly fuel in the few indicators that populate the calendar. It is clear from a quick scan of the listing that event risk is heavily loaded to the front half of the week; and the last round of data due Wednesday is arguably the most influential.
Similar to the US, Britain is more dependent on consumer spending and services employment, and less so on exports. Thus employment is a critical factor in the United Kingdom’s eventual recovery from its worst recession since WWII. Market commentators often point to a rebound in credit activity and turn around in the housing sector as key steps to facilitating a broader economic recovery. However, both of these dynamics are dependent upon the health of the consumer, who requires both the means and confidence to put their money back into the economy and financial system.
Employment is critical to both nationwide wealth and sentiment; yet the trend is hardly an encouraging sign of recovery. Through May, unemployment levels hit their highest levels since 1996, and, forecasts for jobless claims suggest this metric is expected to grow. Another 40,000-plus contraction in payrolls would mark the 16th consecutive monthly contraction and no doubt push the 7.2 percent unemployment rate measured over the quarter through April higher.
Other releases for the week include two housing indicators. The DCLG price indicator is a lagging figure; but the RICS House Price Balance is a well-respected leading report. Economists are expecting this indicator to tick higher for the ninth consecutive month; but it is important to remember that the gauge has kept the housing sector deep underwater and has done so for nearly two years now. Retail sales on the other hand, measured by the BRC, have shown a positive shift recently Though this is a proprietary gauge, it in some ways has greater clout as a consumer spending indicator than even the governments own retail sales report. Finally, the June inflation numbers will factor into monetary policy officials forecasts. Both deflation and rampant inflation would create major problems for navigating an economic recovery; and central bankers the world over are crossing their fingers that neither scenario develops.
This laundry list of indicators offers some foresight into where volatility may spring up; but for sterling traders, the real risk is risk appetite. THAT is still the primary threat to the pound. The economy is still considered among most market participants to be the worst positioned, advanced economy.
While a drop in confidence that a global rebound is imminent will do little to further degrade the UK’s position; a boost in optimism would certain leverage the sentiment surrounding the country. It is important to recall that this past week’s G8 meeting acknowledged the globe is showing tentative signs of economic improvement; but that conditions still warrant a focus on fiscal positions. With the United Kingdom already overextending itself in stimulus and aid, a call for all advanced economies to focus on recapitalizing banks and working off distressed debt means the second largest European economy won’t to have to shoulder a greater portion of the burden. Taken a step further, the BoE’s decision to hold QE at 125bln may signal the worst is past.
Commodities and Equities
Summary
As noted in the first section above, these will move together with sentiment on the recovery. The past month’s stagnation of global stock markets, and an overall negative theme to the past two weeks, including:
- World Bank downgrade of economic growth forecasts
- OECD’s mildly more upbeat outlook based on a more optimistic view of the US, which is proving wrong, as shown by Thursday’s nasty picture of the US jobs and average hourly wage and hours situation, which will further batter consumer spending and ultimately the critical financial sector
The rising pessimism suggests
- Near term drop in industrial and agricultural commodities prices
- Lower earnings and thus stock prices
- Possible near term deflation , with inflation expected as things improve, especially with the unprecedented flood of new fiat bills in all major currencies and thus long term rising demand for precious metals and other hard assets as an inflation hedge
Time to Get Crude?
Range trading does not mean lack of volatility or chances to make fast money with relatively low risk. Crude recently broken $60 support, a level not visited since mid-May. It has fallen about 18% since its June 29 high. At 100:1 leverage, that can be a nearly 1800% profit if you catch most of the move. After earnings season we should have a better picture of crude’s direction. Given its recent past, we’ve seen how it can make multi-day moves in which traders can get in after the first 2 days and still catch a good chunk of the short term move.
Conclusion: So What Should An Investor Do?
Stock markets tend to be the best barometers of recovery sentiment. Thus:
1. If equity indexes rise, expect commodities and higher risk currencies and commodity currencies [AUD, NZD, CAD] related stocks to perform better against the safer currencies, the JPY and USD.
2. Expect the opposite if they fall.
Thus traders to go long the first group if the overall economic picture looks better, and short these assets if things look worse, The likely beneficiaries of further pessimism would be short positions of the first group, and long positions in the USD and JPY.
3. If stock markets come in to test March lows, that could provide an opportunity for investors,
especially buy and hold income investors, to begin taking long positions in stocks with the criteria we’ve recommended over the past half year. That is, stocks that produce a reliable dividend of over 7% tied to a diverse basket of currencies, commodities, and other hard assets.
In the longer term, as economies eventually do recover, inflation is likely to be the big concern, which would favor assets linked to commodities, other hard assets, and the currencies with the least debt and oversupply. See prior articles from May and earlier.
Just for a quick reminder consider a few of the following to place orders near November or March lows:
For more short term downside risk as energy prices pull in but more long term appreciation in price and dividend growth (though still yielding 8-9%+ even at current prices)
Enerplus Resources Fund (ERF)
Vermillion Energy Trust (OTC: VETMF, TSX: VET.UN)
For more stable yields, consider these green power producers (yielding 8-13%)
Atlantic Power Corporation (OTC: ATPWF, TSX: ATP.UN)
Energy Savings Income Fund (OTC: ESIUF, TSX: SIF.UN)
Great Lakes Hydro Income Fund (OTC: GLHIF, TSX: GLH.UN)
Innergex Power Income Fund (OTC: INRGF, TSX: IEF.UN)
Macquarie Power & Infrastructure (OTC: MCQPF, TSX: MPT.UN)
Northland Power Income Fund (OTC: NPIFF, TSX: NPI-U)
See prior articles for other high yielders with stable dividends like
CML Healthcare Inc. Fund (OTC: CMHIF, TSX: CLC.UN)
Canadian Apartment Properties REIT (OTC: CDPYF, TSX: CAR.UN)
Northern Property REIT (OTC: NPRUF, TSX: NPR.UN)
Disclosure
I have positions in most of the above mentioned investments.
Disclaimer
The views of the author are not necessarily those of AVAFX
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