Sunday, September 20, 2009

Global Markets Outlook Sept 21-5 Part II: Risk Today, Safety Tomorrow?

GBP Drop May Suggest Longer Term UK Economic Struggles

Fundamental Forecast for British Pound: Bearish

- Per Commitment of Traders report, GBPUSD positions increasing
- UK RICS house prices rise for first time in 2 years
- The number of people looking for jobs in the UK rose the highest level since 1995
- FXCM SSI results suggest GBPUSD could be in for further declines

The British pound was easily the weakest of the majors last week as the currency fell more than 3 percent against the euro, Swiss franc, and Canadian dollar. The British pound even slumped 2.4 percent against the US dollar and 1.7 percent versus the Japanese yen!

While some indicators from the nation have shown signs of improvement, such as the RICS house price index, fiscal data has continued to deteriorate, pressuring on the British pound. In fact, public sector net borrowing in the UK jumped a whopping 16.1 billion pounds during August as income tax receipts fell 13 percent from a year ago. Even worse, the deficit reached 127 billion pounds in August from a year ago, and the steady rise suggests that the shortfall may breach Chancellor of the Exchequer Alistair Darling’s full-year forecasts for a deficit of 175 billion pounds.

According to the Financial Times, the erosion of the UK’s fiscal status has “been a result more of a collapse in revenues - total tax receipts have fallen by 11.4 percent so far this financial year compared with a year earlier - than of a jump in spending” of just 5.3 percent this year. Going forward, the further the UK’s fiscal state deteriorates, the greater the risk will grow that ratings agencies will question if the nation deserves the golden AAA credit rating, especially after Standard & Poor’s downgraded the UK’s credit outlook to “negative” from “stable” because of their budget woes back in May. However, Standard & Poor’s has also said that they would reserve any judgment on potential downgrades until the next general election, which may be held in May or early-June 2010. On the downside, this leaves a long period of time open for speculation on the prospects for the UK’s credit rating to reign supreme, which may make the already-volatile British pound even choppier.

In more immediate event risk, the minutes from the BOE’s September meeting will be released on Wednesday at 8:30 ET. However, they may not expose new information as the BOE’s Quarterly Inflation Report has already revealed dour outlooks by the Monetary Policy Committee. That said, following the latest UK CPI results, which were stronger than anticipated, Credit Suisse overnight index swaps have shifted to price in 78 basis points worth of hikes by the BOE over the next 12 months, up from 66.7 basis points on Tuesday. As a result, if the minutes highlight a clearly dovish bias by the BOE, the market's focus may shift back toward the central bank's liberal stance on quantitative easing, and the British pound could fall sharply.

Moving With Yield Prospects, Against Risk Sentiment, So Watch Stocks, Commodities

Fundamental Forecast for Swiss Franc: Neutral

- Swiss Producer Prices Rebound From Record Low in August
- Industrial Production Set Fresh Record Low in Second Quarter
- Annual Retail Sales Outperform Expectations, Grow 1% in July
- SNB Keeps Rates Unchanged, Upgrades Inflation Forecast

In trade-weighted terms, the currency has been confined to a narrow range since March, when the Swiss National Bank intervened into the markets to drive down the exchange rate and pledged to keep a lid on further appreciation as a bulwark against deflation (a stronger currency boosts purchasing power, effectively reducing prices). Markets in the Euro Zone account for close to 60% of Swiss export demand, so in practical terms, reining in the Franc in trade-weighted terms has essentially meant controlling the EURCHF rate (which the SNB has openly discussed).

Elsewhere, the Swissie has slipped against the commodity currencies and the Pound but has managed to advance against the US Dollar and the Yen. This is a reflection of the interest rate environment. The Australian and New Zealand Dollars, where 3-month Libor rates have stayed steadily above those of the Franc, have outperformed. The Pound and the Canadian Dollar have seen fewer gains because, while still in their favor, the yield gap has narrowed considerably since the beginning of the year. Finally, the Yen sold off as a rapidly shrinking rate spread erased any advantage the otherwise markedly cheaper Japanese unit had over the Franc, while the US Dollar fared worst of all as its 3-month Libor tumbled to sink below that which is paid on the Swiss currency.

We have long argued that the current rally in global stocks is way overdone, with global equities trading at levels unseen since 2003 relative to earnings. The world economy grew nearly 3% in real terms that year, whereas virtually every credible forecast calls for the first post-WWII contraction in real growth in 2009, pointing to lackluster revenues and overextended asset prices.

Further, trading volumes have steadily declined for the bulk of the equity rally (the past 5 out of 6 months). While some of this may be chalked up to a seasonal slowdown that is typical for the summer, it may also be hinting at waning conviction behind the up move and a forthcoming reversal as traders return from holiday and volumes pick up into the Fall. While timing this reversal has proven elusive, we can say that when it does occur, the accompanying liquidation in carry trade positions will likely push the Franc higher against the AUD, NZD and (to a lesser extent) the Pound and the Canadian Dollar. Meanwhile, a surge in demand for safety will likely boost the US Dollar as well as the Japanese Yen, eroding the Franc’s recent gains against those currencies.

Turning to the economic calendar, the August trade balance report will be of interest: exports look set to decline considering last week’s dismal industrial production data, but the appetite for imported goods is proving difficult to gauge. Indeed, domestic demand may have recovered a bit considering the recent moderation in retail sales figures, but the trend in receipts is undeniably pointing lower while unemployment rises and consumer confidence continues to set record lows. The release of updated economic forecasts from the government’s State Secretariat for Economic Affairs (SECO) will be notable in terms of how it compares to last week’s upward revisions to the growth and inflation outlook of the SNB.

Tracking Crude Oil in Consolidative Range

Fundamental Forecast for Canadian Dollar: Bearish

- Canadian Dollar continues driven by Oil Prices
- Loonie rallies for 3 consecutive days
- Yet late-week tumble shows CAD unable to hold gains

The Canadian Dollar finished the week modestly higher against its US namesake, but the currency’s inability to close near year-to-date highs leaves short-term momentum to the downside leading into the coming weeks’ trade. The USDCAD currency pair dropped for three consecutive trading days and briefly breached the psychologically significant C$1.0600 mark. Yet it serves to note that oil prices likewise failed to hold near fresh highs, and there is clear risk for near-term pullback. Domestic economic data proved largely better than expected but had relatively little influence on price. Instead, the USDCAD continues to track Crude Oil prices and broader risk market sentiment. Continued strength in financial market risk barometers would bode well for the Canadian Dollar, but the threat of near-term reversal looms large for the recently high-flying currency.

The Canadian Dollar has ridden the wave of renewed optimism across financial markets, rising in tandem with similarly buoyant Crude Oil prices. Yet Crude Oil itself remains stuck in a consolidative range, and its inability to break higher on several successive attempts leaves clear risk of near-term pullback. A relatively quiet week of Canadian economic event risk suggests that the domestic currency will trade almost-solely on developments in other markets. Potential exceptions include early-week International Securities Transactions and Canadian Retail Sales reports. The former is expected to show that foreigners invested a net C$9.5 Billion into Canadian Securities in July. Said number would represent a modest pullback from impressive May and June results, but an at-consensus print would nonetheless underline solid foreign demand for Canadian securities. The subsequent Retail Sales release is likewise expected to show robust consumer demand, but a recently impressive Wholesale Sales result means that only the most surprising of outcomes will elicit strong reactions out of the USDCAD.

Canadian Dollar traders should keep a close eye on developments in global financial markets—especially commodity prices and Crude Oil futures. If any of these key asset classes break their recent price ranges, the Canadian Dollar may follow suit.

Great Expectations for Interest Rate Rise Continue to Support-But Stock Pullback Could Hurt

Fundamental Outlook for Australian Dollar: Bullish/Neutral

- Second quarter dwelling starts unexpectedly fall by 3.7%.
- RBA Minutes Temper Tightening Expectations
- The Westpac Leading Index rose by 1.1%, to its highest level in seven months

The Australian dollar set a fresh yearly high of 0.8778 against the greenback during the past week before the release of the RBA minutes tempered interest rate expectations. The central bank is widely expected to be the first of the major economies to begin tightening making the already high yielder more attractive in the current environment of risk appetite. Indeed, the Australian economy emerged from the recent downturn with the least amount of scars and is poised to take advantage of global growth and the ensuing demand for raw materials. The Westpac leading index which is a gauge that attempts to forecast the economy’s performance over the next three to nine months rose by 1.1% to its highest level in seven months. Looking at the breakdown we see the bullish outlook is derived from expected positive contributions from real money supply and dwelling approvals, which would suffer if the central bank started to cut rates. Furthermore, the second quarter dwelling starts report showed an unexpected decline of 3.7% against economists forecast of a 2.0% gain. It would mark the fourth straight quarterly decline and a clear signal that higher interest rates could start to increase downside risks.

Nevertheless, the central bank stated that the Australian financial system remains strong and that the country is benefitting from exposure to China and the global economy on a sustained growth path. However, Governor Stevens recognized that there are still some warnings signs such as weak business credit conditions. Therefore, we may see policy makers reluctant to take any actions that may deter lending following the recent credit crisis until inflation risks become obvious. Markets are still pricing in 174 bps of rate hikes over the next twelve months which should keep the Aussie well supported. Yet, we have seen it slip from a high of 199 bps on September 7th, which may signal some near-term weakness for the currency.

The DEWR skilled vacancies report is due for release and softness in the labor market could give traders an excuse to take profits, but another sign of growth could add to bullish momentum. The RBA financial stability review and quarterly wage agreements are also on the horizon and could potentially impact price action. However, traders should take their cues from commodity markets and risk trends as they continue to be the dominant drivers of price action for the pair. The next level of resistance may be found at 0.8816-the 8/22/08 high where we could see the current rally stall. Conversely, we could see the pair retrace back to the 20-Day SMA at 0.8513 before another push higher.

May Weaken as Growth Rate and Trade Falter

Fundamental Forecast for New Zealand Dollar: Bearish

- New Zealand Retail Sales Unexpectedly Falls in July
- New Zealand Manufacturing Sales Slump in Second Quarter
- Business NZ Performance of Manufacturing Index Weakens in August

The New Zealand dollar rallied against the greenback for the tenth consecutive week, with the NZD/USD advancing to a fresh yearly high of 0.7161 however, the higher-yielding currency looks to be losing its footing as the economic docket for the following week is anticipated to show a 0.2% contraction in 2Q GDP. However, as investors ramp up long-term expectations for higher borrowing costs and speculate the Reserve Bank of New Zealand to tighten policy in the following year, the rise in the interest rate outlook may continue to support the rally from March as market sentiment improves. Credit Suisse overnight index swaps are up 126bp in September, which is the highest reading for the year, and investors may increase bets for a rate hike over the next 12 months as the RBNZ maintains a neutral policy stance.

The NZD/USD bounced back after slipping to a low of 0.6964 earlier in the week, and continued to trade above the 10-Day moving average (0.7037) as market participants moved into higher risk/reward investments. However, as the relative strength index remains elevated and holds above 60 for the second consecutive week, we may see the pair fall back in the coming week as the RSI approaches overbought territory.

At the same time, the economic docket is anticipated to show a drop in the growth rate, with economists forecasting 2Q GDP to fall 0.2% from the first three-months of the year, while the annualized rate is projected to contract 2.6% after falling 2.7% in the first quarter, and the data could stoke increased selling pressures on the New Zealand dollar as investors weigh the prospects for a sustainable recovery. Moreover, the current account deficit is expected to widen in the second quarter as trade conditions remain weak, while the trade deficit is projected to increase to NZ$329M in August from NZ$163M in the previous month as foreign demands falter. As the outlook for global trade remains weak, the data could weigh on the growth forecast for the $128B economy as the appreciation in the exchange rate hampers the competitiveness of New Zealand exports, and the central bank may see an increased risk for a slower recovery over the coming months as the rise in risk appetite continues to support the rally in the kiwi-dollar higher.


While the USD appears well oversold, we await a catalyst to start unwinding all the short USD positions against the EUR and commodity currencies. A stock pullback, whenever it occurs, is the USD's best hope, as stocks advance further and further beyond any rational support for their prices, as noted above in the section on stocks.

Unlike stocks, the AUD's run has some real justification, it's just overdone and presents more downside risk at this time.

DISCLOSURE/DISCLAIMER: Opinions expressed are not necessarily those of AVAFX. The author has positions in the above instruments.

No comments:

Post a Comment