Sunday, August 9, 2009



World Stock Indexes have continued to set the direction for global commodity and forex markets. So the biggest question coming into the week is: how likely are stocks to continue to rally, hold, or pullback?

Evidence for a pullback: Little has changed since last week

  • Global stocks are at or near 2009 highs, having rallied in the past two weeks based on having beaten earnings estimates in the first weeks of US Q2 earnings reports. However, these results were mostly a case of bad results beating even worse earnings estimates.
  • Most firms reported declining results from operations. Revenues and earnings are in an overall downtrend.
  • The slope of that downtrend may be leveling off, however that does not mean growth is coming any time soon.
  • The picture is arguable worse in the critical financial sector, which has been the source of every major decline and rally over the past two years. Not one major bank showed solid results from ongoing, sustainable operations. Instead, they beat estimates based on either risky trading operations or one-time asset sales. Meanwhile, continuing job losses steadily erode their loan portfolios and raise default rates for every kind of loan.
  • Stock prices ultimately rise due to rising earnings expectations, not less contraction.
  • While Friday’s NFP data was encouraging, at best it indicates a slowing loss of jobs, not job growth. In addition, US consumers are wisely cutting debt and increasing savings. This is a good long thing for the long term, but it will only exacerbate the decline in consumer spending and US GDP weakness in the near term. Even the Federal Reserve does not see the continued loss of jobs ceasing any time soon. Consumer spending generates about 70% of GDP in the US, which remains the largest market for many exporting countries, and one of the largest for most of them. Without jobs growth, there will be no real recovery in the US, or elsewhere.

Evidence for continued rally

Dogged refusal of markets to pay much attention to negative data, as indicated above.


A genuinely but very gradually improving economic picture. However we do not believe the current data justifies the extent of the rally, especially with the underlying causes of the current crisis still far from resolution, with plenty of evidence that things could either get worse or not significantly improve for years to come.

Evidence for stocks holding in a trading range

Given the range of gloom and hope seen since March, it will take some very strong new information about the state of global and regional economies to move them much beyond recent March-July ranges. Friday's NFP may provide that for a bit, but it will be this week's main economic news events detailed below that will determine market direction.

Conclusion for world equities and forex, and commodities

Given that risk assets are at the top of those ranges, and that markets revert to their means (middle area of their trading ranges over a given period) the odds continue to favor a pullback at some point.


Crude, gold, and most other easily transferable commodities (which excludes natural gas in many cases) have followed the overall direction in stocks as their indicator of future demand, thus comments above for stocks hold for commodities in the near term. Once a genuine recovery is underway, however, commodities are likely to enter a significant uptrend due to combined effects of:

  • Devaluing/inflation-eroded USD in which they are priced given the unprecedented expansion of money supply and stimulus based government debt, especially in the US and UK
  • Inflation fears feeding demand for precious metals and other stores of value
  • Energy demand outstripping supply: Supply destruction of oil production from the past years’ price declines. It will take years to get the higher cost/barrel facilities back on line, yet demand, real or speculative, can ramp up far faster
  • However, if the US economy continues to improve and the USD continues to rise along with improving US data, then commodity prices will be driven by conflicting forces. Increasing demand supporting prices, a rising USD driving them down


USD Forecast: Bullish Bias

Does the Dollar's Surprise NFP Rally Have Staying Power? YES, IF either:
  1. It begins to move with fundamentals of the US economy AND those continue to improve (likely in the longer term, but how long?) OR
  2. If it remains mostly a safe haven play and markets pull back (more likely near term)
  3. Note: if US economy continues to improve, USD will need supportive comments from Fed about easing stimulus, raising rates


  • Payrolls drop the least in 11 months and the jobless rate ticks lower for the first time since April of 2008, suggesting improvement in THE main ingredient for a sustained US recovery—employment and wages. Markets rise, and surprisingly, so does the USD, which has usually dropped with optimism and rising risk appetite.
  • USD’s surprising sharp rise against all major currencies on positive non farms payroll data again raises questions about what drives the USD. Generally, it has moved down with good news, and up on bad news as markets bought it as a safe haven. Does Friday’s unusual move up with stocks and other risk assets suggest the USD may be starting to trade on the fundamentals of the underlying US economy? Fundamentals will eventually become the primary driver of the dollar but only when
      • Markets stop focusing on the pace of contraction in the global economy slowing and start concentrating on which countries are growing the fastest, AND the US proves to be among the fastest growing. While the US certainly isn’t enjoying the pace of expansion of its Chinese counterpart; the pace and extent of its recovery are expected to beat the UK, Japan and the Euro Zone (which we will confirm with next week’s GDP numbers). Friday’s non-farm payrolls certainly bolstered this belief after the disappointing details of the 2Q GDP report. Next week’s data will certainly weigh in on this front. A confidence and retail sales report will cover consumer spending which accounts for approximately 70 percent of the economy. The trade report will fill in for global demand and the capital flows if there are decisively positive or negative results.
      • Significantly, the NFP report details were also better. They showed average hourly earnings and average weekly hours increased. Only 52k jobs were cut from the manufacturing sector, the smallest since August.
      • The US is able to ease inflation/devaluation concerns arising from its growing money supply and budget deficit
  • Consumer spending contracts at its fastest pace in four-and-a-half years, jeopardizing spending and a recovery in the short term.
  • However, consumer credit dropped 4.9% in June, twice the expected rate, suggesting consumers continue to cut debt, save, and begin rebuilding net worth, a very positive foundation for recovery and growth in the longer term.
  • The slope of the US curve yield curve was relative unchanged, but the level of the curve for 10y and 2y both rose by 10bp. This suggests that the market thinks that the US economy is normalizing to a certain extent, that the Fed will hike in due course and the economy can handle that. What would be negative for the US dollar if Fed officials don't follow up with more hawkish/less dovish commentary. Hence, the communication following this Wednesday's FOMC meeting will be important. We suspect the accompanying statement will be a bit more optimistic, that the Treasury portion of the asset purchases program will not be expanded beyond the currently planned $399 bln total, but fed funds rate will remain low for and extended period.

Weekly commitment of Trader (COT) Report shows Commercial traders, long the USD, Large Traders and Small Traders short. Generally commercial traders are the most accurate of the three groups, and small traders the least. This suggests more likelihood of a near term USD rally, though we doubt it would test support for the EUR/USD much below 1.400. While 1.4150 offered support for EURUSD on Friday, more substantial support may not come into play until 1.4080, where we have the 50 SMA and a rising trend line connecting the April and July lows.

As a well-known safe haven or funding currency, the USD typically moves in the opposite direction of stocks, commodities, and most other major currencies. Usually, we would expect this natural relationship to return in the near term, at least until trader focus moves from the current crisis to tracking which economies are growing fastest.

Main Economic Events for the USD

While the early part of the week is light on major events, later in the week, we will have the first readings on European growth, official policy statements (the BoE Quarterly Monetary Policy Report and RBA Governor’s semi-annual testimony) and the a couple rate decisions. These have the clout to alter expectations for global growth and yields; but if momentum builds through speculation before these fundamentals are absorbed, the market could once again ignore negative news.

In addition, in the US there will be the FOMC rate decision, as well as the trade balance, retail sales, consumer prices, industrial production and the preliminary University of Michigan Consumer Confidence survey for the month of August. According to Fed Fund futures, there is a 40 percent probability of a hike by December. This week’s US economic data could have significant influence on this speculation


Euro-zone Q2 GDP, CPI Could Drive Down the EUR if weaker than the US results

EUR Forecast: Bearish Bias


  • Euro-zone manufacturing PMI was revised up to a 1-year high
  • Euro-zone services PMI continued to signal a contraction in activity, but at a slower pace
  • The European Central Bank struck a neutral tone, left rates unchanged at 1.00%. From a macro perspective, the US employment numbers have led the markets to price in a greater probability of rate hikes by the Federal Reserve down the line, while the neutral tone struck by the European Central Bank on Thursday has left the euro looking like a less promising long play.

Main Economic Events for the EUR

The main event is the Thursday release of Euro-zone Q2 GDP. The advanced reading of Q2 GDP is forecasted to contract for the fifth straight quarter, this time at a rate of -0.5 percent, compared to -2.5 percent in Q1, while the year-over-year rate could fall by a record 5.1 percent. Such data would back up the ECB’s recent claims that the pace of contraction is “clearly slowing,” and if GDP falls less than anticipated, the euro could rally. On the other hand, a worse-than-expected decline in Q2 GDP could weigh on the currency. German and French GDP figures are also due out a bit earlier that day, and these two are likely to all show a similar picture, given that they account for about 50% of EZ GDP.

There will also be a handful of other indicators released throughout the week. Key ones include:

  • On Wednesday, Euro-zone industrial production is projected to rise slightly for the month of June, but after the German results reflected a small drop, there are downside risks for the broader release.
  • On Friday, Euro-zone CPI growth is projected to remain at -0.6 percent for the month of July from a year earlier, as the ECB does not anticipate that annual inflation rates will turn positive again until “later this year.” Nevertheless, lower than expected results could stir up concerns that deflation is a major risk for the Euro-zone economy.


Japanese Yen Vulnerable if Economics Overtake Risk as Market Catalyst

Forecast: Bearish Bias


  • Yen breaking support levels against most crosses, BoJ pleased because this, along with global recovery, helps exports
  • Japanese Workers’ Earnings Fell The Most in Over 18 Years
  • US Non-farm Payrolls Report Sends Japanese Yen Lower on improved Risk Appetite
  • Yen could get some near term support as Japanese exporters try to offload some USD as it the USD/JPY moves well over the key 97 level

The Japanese Yen could be set for sharp declines if economic fundamentals do indeed re-capture the attention of forex markets. The credit crises and subsequent global recession that erupted last year had introduced a new dynamic to financial markets, with virtually all asset classes locking into tight correlations on opposite sides of a directional bet on the direction of risk appetite. At times of risk aversion, this meant a stronger US Dollar and Japanese Yen; at times when traders less timid, this meant higher stocks, commodities and high-yielding currencies.

Last week the markets may have begun to transition back from this “crisis dynamic” to more normal, macroeconomics-driven trading.

Traders’ response to July’s better-than-expected US jobs report was a firm departure from crisis-induced patterns: stocks, carry trades, and most surprisingly, the US Dollar, all rallied while the Japanese Yen collapsed. The decoupling between the US Dollar and the Yen could be significant. Many have argued that the long-term US Dollar outlook would remain bullish after risk aversion faded on expectations that the States will be first to recover from recession having led the way into it, and this is precisely what post-NFP price action seems to have reflected.

The implications of fundamentals-driven price action aren’t good for the Japanese Yen. Median GDP forecasts from economists polled by Bloomberg suggest Japan will under-perform virtually every major industrial economy with the exception of the Euro Zone in 2009 and 2010. Consequently, interest rates are to remain at near-zero levels at least until 2011 even as most central banks begin to reverse course and begin raising rates in the second half of next year. This stands to inject a lot of life into the carry trade, with Yen remaining as the primary “sell” currency.

While the global recovery is sure to be sluggish and there is little doubt that equity markets are overvalued having finished July at the highest level relative to earnings since October 2003, the Yen may be at the cusp of a major long term down trend, even if it may still have some near term upside should markets make a strong pullback.

Main Economic Events for the JPY

Turning to next week’s economic calendar, the number of scheduled release is ample but none of them are likely to prove particularly market-moving. A larger current account surplus in June has been amply telegraphed by merchandise trade balance figures released two weeks ago. The Bank of Japan rate decision will surely prove to be a non-event given that rates are as low as possible already, and broad-based quantitative easing has already been extended into 2010. A handful of sentiment surveys are unlikely to surprise enough to spur volatility.


British Pound Outlook Suffers on BoE Surprise – Can FOMC Do Same?

Forecast: Bearish


  • British Pound dives as Bank of England surprises, boosts Quantitative Easing, Short-term GBPUSD momentum suggests further losses, but it will be important to monitor financial market follow-through and key UK and US economic event risk.
  • Financial markets will look to upcoming UK housing and labor market data with particular interest, while a US Federal Open Market Committee rate decision looms large over all US Dollar pairs.
  • Higher Producer Prices report fails to lift GBPUSD
  • Traders to watch BoE Statement Wednesday for info on additional QE. Trade Tuesday and employment figures Wednesday could also provide volatility, especially if negative. But as recent market reaction to US Nonfarm Payrolls data clearly shows, financial markets are mostly interested in the rate of deterioration. and we would expect similar reactions out of the FTSE 100 on a better-than-expected UK Jobless Claims release. Impressive PMI survey data suggests that risks remain to the positive side for the report, but Jobless numbers are notoriously difficult to predict.
  • It otherwise remains important for British Pound traders to watch for market reaction to the US FOMC interest rate announcement due Wednesday. Any surprise shifts in rhetoric could force substantial FX market moves. Recent US economic data has shown general improvements in domestic activity, but the same could have been said for the UK. With that in mind, we will keep a close eye on the FOMC announcement and its effects on broader financial markets.

Main Economic Events for the GBP: See above paragraphs


Bad news, Lower Oil, Rallying USD Stop CAD Uptrend

Forecast: Short Term Bearish


  • Economic Data Casts Doubt on BoC Optimism
  • Unemployment rate steady at 11 year high of 8.6%, but first time claims 3x higher than expected and 6x higher than prior month
  • IVEY PMI drops 58.2 to 51.8, showing significantly slowing growth in manufacturing

Further direction, especially with the USD/CAD, depend relevant economic events and whether the USD continues trade based on risk appetite or on US economic fundamentals.

Main Economic Events for the CAD

Tuesday’s housing starts, Wednesday trade balance.

Because the CAD’s major cross is the USD and 75% of Canadian exports go to the US, all major USD events are also key. As noted above, these include Wednesday’s trade balance and FOMC Statement, Thursday’s retail and employment data, and Friday’s Core CPI.


Traders should be focused on the news mentioned above that is most likely to move global stock indexes, especially the S&P, for clues to the overall direction of forex and commodities.

Disclosure and Disclaimer: The opinions expressed herein are not necessarily those of AVA FX. The author may hold positions in the above mentioned instruments.

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