The market is jockeying for position ahead of tomorrow’s FOMC meeting, as every FOMC meeting from here becomes a test of where the Fed stands on announcing a new round of quantitative easing. Is the market expecting too much dovishness?

Election in Sweden

The election in Sweden over the weekend resulted in a setback for the Reinfeldt’s Alliance party, which will now have to rule with a minority government, though this is not unusual in Sweden’s political history. The SEK took a bit of a beating on the back of the results on the political uncertainty, but the currency quickly recovered and got back on the rally track as risk appetite had recovered sharply from the late US swoon and the SEK at these levels (now that it has unwound much of the longer term undervaluation of the currency brought about by the 2008-09 crisis) will likely trade in correlation with the direction of risk appetite.

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HIGHLIGHTS OF THE WEEK

United States

• Foreign currency policy captured headlines this week as Japan intervened to devalue the Yen, and pressures mounted on China to accelerate its appreciation of the RMB.
• Currency interventions are limiting the potential impact of U.S. export growth during the recovery. This is a challenge for America, because a rapid improvement in the terms of trade would go along way to aiding the recovery, as indebtedness impedes consumer spending.
• The prospects for quantitative easing (QE) could create an interesting dynamic in currency markets, as foreign countries react to a possible decline in the USD.
• In the end, not every economy can rely on exports to support growth.

Canada

• The robust pace of Canadian economic growth recorded since the third quarter of 2009 is likely to moderate, reflecting a slow recovery in global demand and a combination of domestic risks.
• Most notably, record levels of household indebtedness, which drove high levels of consumer spending in the past nine months, will now put downward pressure on spending as households become more cautious.
• This will have a particularly adverse impact on the housing market, which recorded massive gains over the course of 2009, driven largely by this debt-fuelled spending spree.
• We expect the cooling in consumer spending to feed into the downturn in the housing market, which has already begun and will persist throughout the remainder of 2010 and a large part of 2011.

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FX Briefing

Highlights

• Double-dip fears subside, euro firms above 1.30
• BoJ intervenes to bolster the dollar after USD-JPY plunges below 83
• SNB signals lower inflation risks, EUR-CHF soars

BoJ Climbs into the Ring

The slightly more positive assessment of the global economic outlook still prevails and is helping to strengthen the euro. The upbeat mood was reinforced by surprisingly strong Chinese industrial production and retail trade data released at the beginning of the week, but some US data – in particular the surge in retail sales – also painted a brighter picture. With regard to the FOMC meeting next Tuesday, the majority of market participants are apparently not expecting the Fed to announce any additional quantitative easing measures for the time being. The agreement on increased capital requirements for banks (Basel III) had a favourable impact on equity markets.

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USD Pulled in Different Directions

The market largely did a freeze frame today, not moving much beyond the initial bout of volatility in late Europe/early USA. Looking at the greenback at the moment, it is tough to tell whether it is strong or weak as other currencies have grabbed the spotlight.

The USD is sharply weaker vs. the Euro and the pound of late, but very sharply stronger versus the JPY and CHF and the commodity currencies are somewhere in between. That tells that the strongest two currencies at the moment are the Euro and the Pound – an interesting development considering we are stll near the highs in risk appetite of late, with major equity markets trading near the top of the range, though we’ve effectively gone nowhere there all week. We do notice, however, that German and UK two-year rates have spiked dramatically higher while US 2-year rates have headed in the opposite direction and are near their all time lows again.

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UK Retail Sales To Retreat On Higher Prices Pressure, SNB May Raise Interest Rate

A continuation to the slowdown in Europe that started to take place since the second half of the year, following a remarkable improvement that was highlighted during the first two quarters, UK and euro zone will release new data that may add fears to markets.

Starting off with the UK, retail sales for the month of August is due later in the day where the reading will retreat to 0.3% from 0.1% and to 0.2% from 0.9% with auto fuel and excluding auto fuel respectively, according to median estimates of analysts.

Still, the economic conditions are not up to their pre-crisis levels as the economy is still suffering from the repercussions of the worst economic recession that hit global economies in 2008.

Consumer spending is still weak amid the high inflation rate and sluggish improvement in unemployment rate.

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Sunrise Market Commentary

• Bonds move higher for second session in a row
  Global bonds continued to move higher yesterday in a technical inspired move. The BOJ interventions in the FX markets may have some impact on bonds. Will they push equities higher or increase the market expectation that the Fed will do some more QE?
• BOJ steps into the market
  Yesterday, EUR/USD made quite an impressive break higher as the pair cleared the 1.2923 resistance area. There was no big story behind the move, but global dollar weakness was obviously part of the explanation. This morning the BOJ finally intervened into the currency market to stop the rise of the yen. USD/JPY gained two yen.

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Dollar Sold Aggressively

U.S. Dollar Trading (USD) market speculation that the FED may introduce new Quantitative Easing as early as November. August Retails Sales were strong at 0.4% vs. 0.3% forecast m/m. Stocks struggled to extend gains though as profit taking set in towards the close. In US stocks, DJIA -17 points closing at 10526, S&P -1 points closing at 1121 and NASDAQ +4 points closing at 2289. Looking ahead, August Industrial Output is forecast at 0.2% vs. 1.0% previously.

The Euro (EUR) was the biggest beneficiary of the USD weakness surging past 1.3000 in New York. September German ZEW Current jumped to 59.9 vs. 44 previously. EUR/AUD and EUR/GBP are bouncing off month trend lows and is helping the major outperform. EUR/USD traded with a low of 1.2828 and a high of 1.3035 before closing at 1.2990. Looking ahead, August Inflation is forecast at is forecast at 0.2% vs. -0.3% previously. (more…)

HIGHLIGHTS OF THE WEEK

• This week provided fairly positive economic data, as U.S. Personal income and consumption rose in July, the ISM manufacturing index surprised on the upside, and non-farm private payrolls were also stronger than expected.
• These data support our view that the U.S. recovery will remain on track, and that growth will continue at a relatively slow pace.
• In order to experience a relapse in economic growth, U.S. aggregate demand components would have to register contractions of a magnitude difficult to justify outside of a scenario characterized by a renewed severe shock.
• Drama has been growing ahead of next week’s BOC meeting. Investors are split on the likelihood of a follow-up 25 basis point rate hike.
• Regardless of whether the Bank hikes rates, this is likely to be the last for a while, as economic growth is falling short of the central bank’s expectations.
• Real GDP for Q2 came in at 2%, below the 2.5% consensus estimate and falling short of the Bank’s 3% forecast.
• Q2 data reinforced some of the growing vulnerabilities to the Canadian expansion, including slowing consumer spending, housing activity and export growth.
• We expect real GDP growth to come in closer to the 2% mark than the Bank’s 3% forecast in the second half of 2010 and first half of 2011.

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HIGHLIGHTS OF THE WEEK

• Post-tax credit U.S. home sales plummet by 27% in July, pushing inventories of unsold homes to a new peak of 11.3 months and renewing recovery fears.
• New orders of U.S. durable goods orders rose slighly by 0.3% in Jul. Core capital goods fell by 8.0%, pointing to a slowdown in the pace of equipment and software investment in the third quarter.
• U.S. second quarter GDP was revised down to 1.6% from a previously reported 2.4%. Revisions were in higher imports and lower inventory investment. Final domestic demand, including consumption and business inevstment where revised up.
• Fed chairman Ben Bernanke’s speech in Jackson Hole discusses the ins and outs of the options available to the Fed for supporting the economic recovery and stresses that deflation seems an unlikely outcome.
• Canadian retail sales slide 0.8% in Q2, marking the worst performance since the first quarter of 2009.
• Corporate profits in Canada were down 1.8% in Q2, ending a 3-quarter string of rising profits.
• The Teranet Home Price Index showed a 13.6% Y/Y rise in existing home prices in Canada in June.
• We have scaled back our Bank of Canada interest rate forecast. We now expect the overnight rate to sit at 1.00% at the end of 2010, and 2.00% at the end of 2011. (more…)

Overview

The rush into top-rated Treasury paper continues, new record low yields set for Swiss ten-year Conf (1.05%), Bund (2.09%), German 30-year (2.58%) and US ones (3.46%%), though Brazilian, Mexican and Russian benchmark yields are up from last week’s record lows. Equity indices are lower, many for a third consecutive week, the Nikkei 225 hitting a low at 8,807 and a weekly close just below key long term support at 9000. Only the Shanghai B share index bucked the trend with its biggest daily rally since November on speculation that it will be merged with the much larger domestic A-share market. Kuala Lumpur inched to its best level since February 2008 (just under the record high 1,521 of January 2008) and Jakarta set a new record at 3,150. The yen and Swiss franc gained against all currencies, another feature of the flight to safety, hitting 85.68 and 1.0220 per US dollar, EUR/CHF a new record low 1.2971. Commodities generally sidelined though 3-month LME Tin at $21,750 is at its most expensive in a year and Nymex Natural Gas at $3.825 per MMBtu cheapest since March and close to its lowest levels this decade.

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The Week in Review

The fulcrum of the American trading week and the view of the US economy shifted down, and the dollar future rose with the weekly jobless claims on Thursday. Behind the employment concerns lies the health and postponed recovery of the housing market. Without jobs the housing sector cannot recover and begin to add to GDP.

New jobless claims for the week of August 14th increased 12,000 to 500,000. It is the largest weekly total since November 13th last year and it is the first 500,000 print this year. Economists had predicted a drop of 6,000 to 478,000. The prior week was revised up 4,000 to 488,000 from 484,000.

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FX Briefing

Highlights

• Fed to keep holdings stable, principal payments to be reinvested in Treasuries
• Eurozone posts strong GDP growth in Q2, record growth in Germany
• Growth pessimism is exaggerated

Growth Fears Weigh on Euro

Currency markets can be moody. Immediately after the release of the weak US labour market report last Friday, EUR-USD rose by 1.5 cents to over 1.33. But after the Open Market Committee decided that, given the disappointing economic recovery, the proceeds from maturing agency bonds and mortgage-backed securities held by the Fed should be used to purchase additional Treasury bonds, the euro began to lose ground. On Thursday, EUR-USD dropped below 1.28, and was around this level towards the end of the week. USD-JPY fell to a 15-year low of 84.73 initially, but then recovered to just under 86. (more…)

U.S. Review

Slower Growth Looks Certain, but Not a Double Dip

• While July’s employment report was weaker than expected, it still showed solid, yet unspectacular, gains in private sector payrolls. The unemployment rate was unchanged, but only because the labor force continued to shrink.
• The ISM manufacturing index slipped 0.7 points in July to 55.5, indicating that manufacturing activity expanded at a slightly less robust pace during the month.
• Falling food and energy prices helped lift real personal income and spending 0.1 percentage point during July. The saving rate rose to 6.4 percent.

Growth Will Slow but we see no Double Dip

This week’s economic news went a long way toward alleviating fears about an imminent double-dip recession. While a second downturn cannot be totally dismissed, we see the probability as very low and expect the economy to again show surprising resiliency. Expectations for a slowdown are built around five basic principals: the winding down of massive government stimulus, less of a boost from inventory rebuilding, slower global economic growth, cutbacks at state and local governments, and further gains in household saving. All five of these look certain to restrain growth during the next few quarters, but we expect business fixed investment, exports and consumer spending to remain solidly positive. In addition, inventories are likely to bounce back further than many people expect, as many industries are reporting bottlenecks throughout their supply chain. (more…)

A weak and weakening American economy has undermined the strength of the dollar for the entire month of July and this week’s economic information provided no relief for the US currency. Since Monday the greenback has declined more than 1% versus the euro, 1.9% against the sterling, 1.1% for the Aussie. Only the Canadian Dollar, tied by economic proximity to the US economy and the Japanese Yen, embedded in its own economic morass, were relatively unchanged in the general US decline.

In the past four weeks the euro has gained 7.1%, the pound sterling 4.9%, the Australian Dollar 7.7% at the expense of the US Dollar. Even the yen has forged 2.2% ahead. Except for the Australian currency and to a small extent the pound, these appreciations are not based in resurgence in the national economies but in a clear change in the tenor of American economic performance.

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HIGHLIGHTS OF THE WEEK

• Fed Chairman Bernanke delivers semi-annual testimony to Congress, in which he noted uncertainty in the economic outlook but stuck to his guns in continuing to prudently plan the ultimate withdrawal of the extraordinary monetary accommodation.
• Chatter of U.S. double-dip recession remains in the headlines. High frequency and leading indicators do support a slowdown, but the indicators are nowhere near levels required to flash a re-entry into a recession. A mid-cycle slowdown remains the most likely outcome.
• No sign that the housing market is breaking free from the doldrums. Starts slip more than market expectations, and while existing home sales beat market expectations, they still backtrack by 5.1% in June.
• In Canada, markets were unscathed by the widely anticipated 25 basis point rate hike by the Bank of Canada (BoC). Reactions, however, followed the ensuing dovish BoC communiqué.
• BoC affirmed that fiscal austerity measures relating to the European sovereign debt crisis appeased the risk of an adverse outcome and lifted the likelihood for sustainable long-term growth, but the global economy will recover at a more moderate pace than previously anticipated. The BoC observed that the Canadian economy has largely developed as anticipated, except for growth in business investment which seems to be constrained by uncertainties surrounding the global outlook.
• We expect a protracted renormalization of the overnight rate, with gradual hikes of 25 basis points through the latter half of 2010 and 2011, albeit interrupted by occasional pauses. The overnight rate should reach 1.25% and 2.50% by the end of 2010 and 2011, respectively.

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