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The overall theme this past week was a continuation of risk appetite, as global equities, commodities, and related risk currencies advanced while safe haven assets retreated. Extreme numbers of USD short positions leave open the chances for short term rallies on minimal justification, as seen on Friday's USD rally Friday on Bernanke's tepid hints at eventual rate rises (nothing new) and the quashing of rumors to replace the USD as the oil trade currency gave the USD a boost – for now.
Because global currency and commodity markets follow global stocks, which in turn tend to follow the S7P500, we open with a quick look at it. Key points:
Closed higher on optimism, much of it from currency markets as Australia becomes the first major central bank to raise interest rates. New was mixed. Q3 earnings season began like Q2, with very mixed news being taken as positive. For example, Alcoa reported a profit and beat expectations and the media was positive. However its revenues and EPS are all sharply down from last year, yet its share price has risen to be nearly unchanged!
A light news week ahead suggests no huge moves until Q3 earnings, unless sentiment has already turned negative enough for equities to continue to pullback on profit taking.
Will “bad results beating even worse expectations” allow stocks to rise again as they did in Q2, despite their further gains since then? Common sense says no, but it said the same thing last time.
Recovery sentiment & news over past months was heavily dependent on temporary stimulus and inventory restocking. As go, further gains will depend on genuine self sustaining recovery in fundamentals, but we don’t see that yet. Instead, much of the news is of the “slowing decline” theme.
They continue to follow equities, though not necessarily day by day or by the same magnitude. For the most popularly watched commodities like crude oil and gold, speculators, including the small, least informed ones, remain overwhelmingly long, and the reputedly more reliable commercial traders tend to be short. That suggests more risk to the downside, as does the past week’s moves in stocks combined with their already extended rally. However, I said the same thing last week, and all are up this week – gold sharply up.
Why gold's big move? The same reasons continue to be offered, perhaps explaining the trend but not the timing. Why now? Last month's jump in gold was ultimately attributed to Barrick's unwinding about $5 billion in hedges as they bet gold would go higher, and they should know, right? However, these were the same ones who made the original hedges against gold's rise. They've been wrong before.
Risk Sentiment, Rate Speculation Weigh on USD, But Extreme Oversold USD Positions Provide Reversal Potential
Fundamental Outlook for US Dollar: Bullish
- Fundamentals driving USD down trend remain
- However, dollar shorts are at very extreme levels, raising prospects for short term rally
- Rumors of a replacement for the dollar in oil deals furthers long-term fundamental concerns
- Is the market prepared to hold EURUSD’s double top?
While the fundamental drivers of the down trend in the USD remain, the latest commitments of traders report shows that short positions for the USD are getting extreme. For example, net short positions in the British pound rose against the dollar to the highest level ever while long positions in the euro rose to the highest since January 2008. Long positions in the Canadian dollar also doubled while long Australian dollar positions remained near 1 year highs.
The overloaded short side makes the USD more likely to rally on any kind of positive news, as nervous traders seek to be the first to exit with profits ahead of a growing mob of shorts. News catalysts for such a move over the coming week exist aplenty, as a number of releases could turn out better than expected. Then of course, there is the potential of rumors or leaks of good news regarding Q3 earnings, which really gets moving within the coming weeks. Bernanke's very mildly pro dollar comments Friday, along with quashed rumors about replacing the USD for oil trade were able to get the dollar moving up, so imagine what really positive news might do to at least shake out some short USD profit taking?
As for data, the economic docket holds little for event risk traders or long-term fundamental traders to really grab on to. Wednesday's retail sales and Friday's University of Michigan sentiment reports are notable readings for measuring the health of the large consumer sector. Aside from these numbers, the Thursday CPI statistics and Wednesday FOMC minutes will tune more directly into interest rate speculation. The most likely source of market moving news from the US could well be rumors or surprise early announcements about Q3 earnings from high profile names.
Moving With Equities, Weak Data, ECB Neutrality May Pressure Euro, Weak USD Supports For Now
Fundamental Forecast for Euro: Neutral
- Euro-zone services PMI rose above 50 for the first time since May 2008, signaling an expansion in activity
- Q2 GDP for the region was revised slightly lower to -0.2%, and an annual rate of -2.5%
- European Central Bank leaves rates at 1.00%, signals broadly neutral stance
-Risk of ECB intervention remains, so watch for events that could push the ECB in that direction, like Thursday's consumer prices and Friday's trade balance.
Volatility Possible On Intervention Threat, Lack of Exit Strategy
Fundamental Forecast for Japanese Yen: Neutral
- FoM Fujii Threatens Act on Currency if “Excessive Moves”
- Current Account Narrows as Exports Fall Most Since January
- Speculative Sentiment Points to Bullish Outlook for Japanese Yen
Analysis & Events
The greenback took the biggest bite out of yen strength since the strong surge on August 7th. The fact of the matter is, now that expectations for a rate hike from the Fed have increased substantially, the BoJ seems to be falling behind the pack. There have been almost no inclinations that the BoJ is ready to raise rates, or stage an exit strategy for that matter.
Will Japan intervene to drive down the Yen?
A handful of smaller Asian nations including South Korea, Hong Kong, Taiwan, Thailand, the Philippines and (possibly) Indonesia moved to buy US Dollars against their local currencies last Thursday. This gives Japan a greater incentive to weaken the yen, because orchestrated depreciations of other Asian currencies will give those countries an extra advantage in courting overseas buyers.
Traders will be looking to the BoJ rate announcement for hints of intervention. So far, Japanese authorities have shied away from stepping into FX markets despite a drop below the 90.00 figure in USDJPY, a level that had been seen by many market participants as the threshold of policymakers’ comfort zone. This suggests that perhaps the new DPJ administration has not yet made up its mind on currency policy and will perhaps attempt to talk down the Yen before resorting to a more direct approach. Two obvious opportunities to issue such comments present themselves during Bank of Japan talks with the Koreans and the Chinese and the Bank of Japan policy meeting.
Beyond these, traders will likely pay close attention to comments from any key players in the Japanese establishment, hinting at choppy volatile price action in the days ahead.
CPI Data May Hint At BoE Policy, Short GBP Positions Per COT Reports May Suggest Rally Potential
Fundamental Forecast for British Pound: Bearish
- Short GBP positions increase rally potential, but fundamentals still with bears
- GBP steady as Bank of England maintains policy
- UK Consumer Price Index figures could determine BoE Policy, or at least market's sentiment
Analysis & Events
The British Pound was the only major currency to end the week lower against the US Dollar. A generally bullish trend for UK economic data releases reversed on a gloomy Industrial Production report. Industrial output tumbled 2.5 percent in the month of August—far worse than the consensus forecast for a 0.2 percent gain. This result overshadowed bullish housing data and an effectively GBP-bullish Bank of England rate decision. It's unclear whether the Bank of England is done with its accommodative monetary policy measures, and the coming week’s critical inflation and Jobless Claims data will likely make for an exciting week of GBP trade.
Based upon the latest futures positioning from the CFTC, it appears that the short pound trade is getting just as crowded as the short dollar trade. However the momentum is on the side of pound bears along with fundamentals and technicals. Inflationary pressures are increasing based upon the latest producer price report and the trade deficit is narrowing, but compared to the rest of the world, the recovery in the U.K. has been modest. However the primary reason why the pound is underperforming is because of the dovishness of the Bank of England. All it would take is one word from the BoE and the GBP/USD could reverse its decline.
In the week ahead, there is a great deal of key economic releases due for release from the U.K. including their inflation and employment reports.
Consensus analyst forecasts call for relatively unchanged Consumer Price Index and Jobless Claims numbers. If numbers surprise to the topside, however, monetary policy hawks will once again call for moderating the BoE’s aggressively accommodative stance. The British Pound is likely to react strongly to any surprises, and it will be important for traders to watch for unexpected results.
It's also critical to watch for changes out of UK Jobless Claims figures and broader shifts in market sentiment. The past week’s impressive performance throughout global equity markets should have left the risk-sensitive British Pound higher, but one week hardly makes a trend. We suspect that the British Pound will regain its correlation to the US S&P 500 and other key risk sentiment barometers.
Thus it remains critical to watch whether the S&P can continue its recently impressive gains.
SNB Intervention Threat Keeps Outlook Neutral, Otherwise Moving With Markets
Fundamental Forecast for Swiss Franc: Neutral
- One-sided sentiment points to further USD/CHF declines
- Technical indicators suggest SNB intervention at some point
- However, continued EUR/USD strength could delay that intervention
- Swiss Franc falls as Consumer Price Index loses more than expected, raising intervention chances
- Barring SNB intervention, moving opposite risk sentiment like all safe haven currencies
Tracking Crude Oil First, Stocks Second, Inflation Data Third
Fundamental Forecast for Canadian Dollar: Bullish
- Unemployment Rate Unexpectedly Fell To 8.4%, As Economy Added 30.6Kk jobs
- The Ivey-PMI reading for September Jumped to 61.7 From 55.7, On Stronger Employment
- CAD rising on this data plus RBA rate rise helps all commodity currencies
- Poor trade deficit figures, if repeated, could raise intervention probability, hurt CAD
The USD/CAD had been trading in a wide range between 1.0600 and 1.1100 which it broke this week to test 1.0400 before finding support. The psychological level is the only barrier before a test of 1.0299-9/28/08 low which would erase the entire post-Lehman dollar rally. It appears that the level will be tested as the fear that the event generated is being priced out of the marketplace.
Following Risk Sentiment, Consolidation Possible After Rate Increase
Fundamental Forecast for Australian Dollar: Neutral
- The Reserve Bank of Australian surprised many and hiked rates by 25bps to 3.25%
- Rising further as RBA suggests more increases coming
- Australian employment unexpectedly rose by 40,600 in September
- No events of note, moving with risk sentiment
Downside Risk Grows
Fundamental Outlook for New Zealand Dollar: Bearish
- A surprise rate hike from the RBA advances speculator’s expectations for the RBNZ’s timeline
- Risk appetite leads the kiwi and all its high-yield counterparts higher
- NZDUSD momentum indicators suggest advance weakening
- Kiwi benefitting from AUD rise despite much weaker recovery, RBNZ's greater dovishness
Data has so far shown a weak recovery; and we will look for heat with the economic indicators on the docket. Retail sales, business activity and housing sales will offer a relatively complete picture of economic activity. It is true that RBNZ head has said he would hold the benchmark well into next year; but given his propensity for aggressive policy shifts, an earlier rate hike is conceivable. However, the issue here too is that he does not want to further encourage his currency to appreciate.
In the meantime though, the direction and momentum of any genuine trend for the kiwi will lie with risk appetite. It has been said that a rising tide floats all boats; and the New Zealand currency is certainly riding rising optimism.
Taking stock of direction in sentiment, the proxy for sentiment (equities) is on the cusp of new yearly highs. A breakout or reversal can develop; but there are no clear catalysts offering to resolve the standoff. This in itself is an important observation; because without an engine to keep risk appetite on a rise, the currently high levels of optimism will eventually appear extreme and will encourage at least a period of consolidation, if not retracement.
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 Alcoa example.
Of course, we've said this before, and markets can remain irrational for a while.
Thus those long risk assets can stay that way, but keep tight stop losses. We do not recommend new long positions in risk assets at this time. Those looking to open new short positions should wait for a trend shift.
DISCLOSURE/DISCLAIMER: Opinions expressed are not necessarily those of AVAFX. The author has positions in the above instruments.