FOREX TRADING

U.S. Dollar Trading (USD) saw solid strength on the back of renewed Eurozone concerns and a very weak close in US stocks sparking safe haven demand. April Existing Home Sales jumped 7.6% to 5.77m vs. 5.62mln forecast.In US stocks, DJIA +125 points closing at 10193, S&P +16 points closing at 1087 and NASDAQ +25 points closing at 2229. Looking ahead, March Case Shiller HPI is forecast at -0.3% vs. -0.1% and CB Consumer for May forecast at 59 vs. 57.9 previously.

The Euro (EUR) was under pressure for most of the day as weekend press focused on the Bank of Spain take over of a regional bank and Banking stocks in the US were hammered on heightened credit risk flowing throughout the markets.EUR/USD traded with a low of 1.2331 and a high of 1.2540 before closing at 1.2350. Looking ahead, March Industrial Orders forecast at 2% vs. 1.5% previously.

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U.S. Review

“He Was Never the Same”

• In sports, this refrain often accompanies the attempted recovery of an athlete after a serious injury. Today, we can say much the same for the U.S. and European economies.
• Moderate growth and low inflation remain the hallmarks of the outlook in the post-stimulus era. Yes, we have growth, but the pace of gains remains short of the political promises. Moreover, moderate recovery and limited private-sector job gains suggest continued large public-sector deficits and a continued need to restructure all levels of government—both here and abroad.

“He Was Never the Same”

In sports, this refrain often accompanies the attempted recovery of an athlete after a serious injury. Today, we can say much the same for the U.S. and European economies.

“We sense the convergence process to a new economic equilibrium has been more difficult than policymakers estimate. Job growth has been non-existent. Credit growth has been restrained and the recovery in housing far less significant than expected. Still inflation remains subdued as unemployment limits the acceleration in wages and unit labor costs.”

(Annual Outlook, Dec. 9, 2009, for 2010).

This week’s data highlight the change in the U.S. recovery that confirms our suspicions back in December. Housing starts jumped 5.8 percent in April as homebuyers and builders rushed to get contracts signed prior to the April 30 deadline of the homebuyer credit. Yet, building permits fell, thereby suggesting that the rebound in housing will fall short of prior business cycles. Why? For one, consumer confidence numbers indicate that plans to buy a home dropped to the second-lowest level in more than 25 years. Why? Our view is that home values remain uncertain, and there has been a shift in the way households view a home, from an investment opportunity to a shelter. The investment premium in housing is gone. Second, household income growth remains limited once the impact of transfer payments is removed. The Leading Economic Index fell in April. This was the first decline in 12 months. While such a drop is not a signal for panic, it does suggest that forward momentum in the economy may be more modest. There are two components of the leading indicators we find troubling. Building permits fell sharply, which suggests a drop-off in residential construction post-first-time homebuyer credit. This brings into question the sustainability of the housing recovery and its new equilibrium pace of housing starts. Our outlook is for 670,000–710,000 in the fourth quarter. Also, the rise in jobless claims suggests to us that private-sector job growth will remain subpar. (more…)

Risk appetite remains on very nervous legs after the US S&P500 failed to regain the 200-day moving average and closed on a low note, opening today at yet another low for the cycle. These are the kind of conditions that keep on keeping on until they stop and as long as we remain below this moving average – especially with increasing volatility, we should keep a bunker mentality. We’ll peek out again and have a look around if risk manages to close strongly at the end of the day and/or if the authorities move to improve liquidity. In FX, it is clear that the positioning coming into this situation – short the Euro against everything – is still feeling the squeeze and could continue to do so as long as risk is on its knees.

US Senate passes new financial regulation bill

It is perhaps no coincidence that the market is in such a sour mood as the US senate today passed major new legislation regulating the financial services industry. This is a major step towards both of the houses of Congress agreeing on a final version of the law. There are still some questions about the fate of banks’ derivatives business, but the main thrust of the legislation is a strong new “consumer protection” effort that is going to keep credit very crimped relative to the last two decades or more and attempt to establish a “financial stability oversight council” that will try to identify any systemic risks/too big to fail companies or hedge funds in the system to prevent systemic failure risks. It will also require that most hedge funds and private equity group register with the SEC. As always, one wonders how effective any new government bureaucracy can possibly be when the entire financial system was led into the 2008-09 disaster right under the unwitting nose of both the SEC and the Fed. It is tough to be optimistic about this program’s success, and for now, this is a risk negative due to the costs to the industry to become compliant. (more…)

U.S. Dollar Trading (USD) in a unique day of trading the Euro rallied aggressively across the market even as Risk was taken off the board. Rumors swept through the market that the ECB would make an announcement on the currency’s depreciation and although this was denied the market held on to the gains. April’s CPI fell -0.1% m/m and the Core rate at 0.9% y/y is at multi decades lows.In US stocks, DJIA -66 points closing at 10444, S&P -5 points closing at 1115 and NASDAQ -18 points closing at 2298. Looking ahead, Weekly Jobless Claims are forecast at 440k vs. 444k previously.

The Euro (EUR) Started Europe under pressure and tested day lows after Germany’s Merkal stated the Euro was in Danger but then enjoyed a stunning reversal to close above 1.2400 in the US session. The gains were aggressive especially against the risk currencies AUD and NZD. EUR/USD traded with a low of 1.2143 and a high of 1.2433 before closing at 1.2410. Looking ahead, April German PPI is forecast at 0.5% vs. 0.7% previously m/m. (more…)

Highlights

• No rest for the EUR; bearishness hits an extreme
• EU/ECB won’t give up without a fight
• Risky assets have dropped to more attractive levels
• Concerns over fiscal coherence in EMU will drive EUR lower longer-term
• EUR/GBP: a better medium to express a constructive view on the pound

No rest for the EUR; bearishness hits an extreme

The Euro’s rebound following the announcement of the EU rescue package proved exceptionally short-lived. Markets immediately smelled blood and added to EUR shorts, driving EUR/USD below additional key technical levels, most notably the 1.2450/1.2500 2009 lows, which now serves as the critical daily closing resistance zone. However, the past week’s decline came up short of the 2008 lows at 1.2330 and this level will act as the next trigger to further declines. In the midst of this EUR weakness, we are starting to get the feeling that Euro-bearishness is reaching extreme levels. That does not mean that the EUR won’t see lower in the week ahead; in fact we anticipate further declines to the 1.2150/1.2200 area in the short-run (based on an Elliot Wave count), but from there the likelihood of a base/correction forming increases greatly.

In addition to anecdotal evidence (“Business Week effect,” i.e. financial media’s intensity of reporting on EUR’s imminent demise; analysts’ forecasting declines through parity; rumors of EMU disintegration), the relative suddenness of the EUR’s decline (6+% in 2 weeks) means that many ‘real money’ asset managers have yet to establish short-EUR positions. This group is typically among the last to arrive at the party and frequently signals medium-term tops and bottoms. More concretely, 1 month EUR 25-delta risk reversals (RR’s) (option market measure of puts/calls bias) have hit extreme bearish levels (see chart) last seen at the height of the Lehman Bros. financial market meltdown (see chart). (GBP shows similar extremes.) In fact, following the announcement of the ECB debt backstop, RR’s bounced sharply and failed to make new lows even as spot prices extended losses. This divergence is mirrored in peripheral European debt yields, which have dropped back sharply on ECB bond buying and have ignored market commentator’s predictions of a Greek default. (more…)

HIGHLIGHTS OF THE WEEK

• U.S. international trade balance spot on expectations for March at -$40.4 billion. However, underlying the balance, both exports and imports come in surprisingly strong, each rising by over 3.0% in the month.
• U.S. retail sales rise for the seventh straight month, increasing by 0.4% in April. Outsized gains in building products, reflecting recent rebound in home sales contributed strongly to the gain.
• U.S. industrial production continues its V-shaped rebound, rising by 0.8% in April.
• University of Michigan survey of consumers reports a rise in consumer sentiment, albeit from a still historically low level.
• The IMF and European Commission announced a €720 billion plan to help support debt-laden European nations. This is on top of the €100 billion given to Greece.
• Canadian housing starts rose slightly to 201K units. Starts are now leveling off from strong growth over the course of the last four quarters. We expect housing starts to moderate on a trend basis starting in Q2.
• Canada’s trade surplus narrowed to $254 million in March, as exports fell by 0.8% and imports grew by 2.0%. The slump in exports was due to falling energy prices, as real adjusted exports rose by a robust 2.3%.
• Canadian manufacturing shipments rose 1.2% in March, the sixth gain in the last seven months. After adjusting for prices, the volume of sales increased by an equally robust 1.7%. The major drivers of the data were sales at food manufacturers, motor vehicles and parts manufacturers, and primary metals.

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Wakeup Call: GBP Higher As David Cameron Becomes New PM

EURGBP is expected to continue to weaken as the market’s favorite becomes new British PM.

What’s going on?

Risk sentiment improved overnight as sovereign debt fears eased. Spain presented some additional austerity measures including extra deficit cuts of 0.5% and 1.0% of GDP in 2010 and 2011, respectively.

Australia also joined the party with a solid employment report (employment change came in at 33.7K vs. 22.5K expected) though the rate of unemployment did rise to 5.4%. Full time employment rose 37.5K in April.

We are bullish on risk today amid a light calendar for companies and macro releases

Calendar (more…)

Financial markets went into a tailspin last week on concerns that the bad debt woes of the Greek government were about to go global. Investors were warily eyeing other countries like Ireland, Italy, Portugal and Spain and wondering whether those countries would end up in the same straits as the Hellenic Republic. Ominously, there were signs that the crisis was starting to affect the financial systems of countries outside of Europe. European banks have significant holdings of European government bonds. A default by one or more European governments would lead to large losses among European banks. In a worst-case scenario, a failure of a large European bank could lead to losses among American banks, thereby leading to another credit crunch. As the sub-prime mortgage crisis in the United States during 2007-2008 vividly demonstrated, problems in the financial system of one major economy can quickly infect the entire global financial system.

The realization that another global financial crisis was looming spurred the leaders of the European Union into action this weekend. The plan that was announced last evening is more aggressive than most investors had anticipated. In general the plan has three components, the first of which is a lending facility that totals €750 billion (nearly $1 trillion). If needed, individual countries in the European Union will contribute up to €440 billion in bilateral loans that could be used to finance governments that are unable to roll over their debt in private financial markets. The European Commission will establish a €60 billion emergency fund, and the International Monetary Fund will top off the lending facility with a €250 billion commitment.

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U.S. Review

Strange Days Have Found Us

• The stock market largely shrugged off good economic news this week and instead focused on the growing debt problems in Europe. This morning’s stronger-than-expected jobs report, however, did relieve some stress.
• Nonfarm payrolls added a larger-than-expected 290,000 new jobs in April, and March’s gain was revised up sharply. The unemployment rate rose, however, jumping back up to 9.9 percent.
• Data from the manufacturing sector continue to come in on the strong side, while this week’s chain store sales data hint that spending may be moderating.

Strange Days

Strange days have found us

Strange days have tracked us down

The Doors, Strange Days, Elektra, 1967

Thursday’s wild swing in the stock market and the ongoing saga over the debt crisis in Greece and other European nations overshadowed this week’s economic news. Most of the data on the U.S. economy continue to show a broadening economic recovery that should produce solid but relatively modest job gains. Reports from the manufacturing sector, such as the ISM manufacturing survey and this morning’s manufacturing employment data, tend to show more strength than reports on the services sector, while most data on private construction activity continue to show a great deal of weakness.

Much of the discussion on Thursday’s sharp midafternoon stock market selloff is focusing on the role computer trading exchanges played in generating trades at extraordinary low prices. While these trades greatly magnified the extent of the swing in the stock market, they are not the root cause. The ongoing worries about the Greek debt crisis, the violent protest associated with it and worries about the potential spillover into other economies led to a substantial reduction in risk preferences. As investors became more risk-averse, liquidity dried up in the stock market, forcing some Designated Market Makers to temporarily halt trading in a handful of stocks. Some of those stocks then traded on electronic exchanges, where the lack of liquidity led to wacky pricing. While there is a real need to fix this glitch, the real problem is what led to the lack of liquidity in the first place – the Greek debt crisis and the ongoing difficulty and growing risks in dealing with it.

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Overview

Let meltdown commence! Political instability, high unemployment, lacklustre economic growth, demonstrations, natural disasters, the future looking cloudy at best as dysfunctional banks defragment the system; no wonder many financial instruments sank and investors fled to perceived safe-havens. One only wonders why it took some so long to realise that when governments have no more money for ‘stimulus packages’, creaking rallies slip hard. The Dow Jones Industrial Average dropped 600 points in six minutes (then bounced) for a daily drop of 1000, its biggest ever one-day fall and the largest weekly one since October 2008 and 9/11/2001. This represents a roughly 10.00% daily loss, half that of the worst day in 1987; the usual suspects, including a fat finger, have been blamed. Unsurprisingly the VIX Index rose to 40.00%, where it traded several times in 2007-2008 (but well below the record 89.00% of October 2008). Likewise US TNotes and TBonds are priced for fear, not yet for Armageddon, and Spot Gold rallied to $1,210 per ounce. Front month Eurodollar, Euribor and Short Sterling interest rate futures lost around 30-40 basis points over the fortnight as the dash for cash is on; red months rallied and yield curves flattened. German Treasury yields set new record lows, 2, 5 and 10-year at 0.450%, 1.589% and 2.725% respectively, Swiss ten-year also at 1.615%. Stock indices sold off, some for the first week in many (S&P 500), others for a fourth week in a row (Brazil and Hang Seng); this week’s biggest losers, all down 11.0%, Athens, Austria, Russia and Spain. The US dollar gained against all major currencies except the yen; Brazilian real, Norwegian and Swedish krona losing over 5.00%, Hungarian forint and Polish zloty off 9.00%. Nearly all commodities traded lower, notably Crude Oil to $74.58.

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Highlights

• Ouch! Where to from here?
• German election likely to provide more evidence of Greek fall out
• Data point to continued USD strength
• UK markets need to see election ambiguity cleared
• Key data and events to watch next week

Ouch! Where to from here?

A few weeks back, in the April 16 weekly report, we suggested that the rally in risk assets (Stocks, commodities, long JPY-crosses or carry trades) was set for a correction lower. The intervening weeks were mostly sideways to neutral, but we stayed with the view that risk assets were topping and that the risks remained to the downside. (Our ‘gold lower’ view was obviously misplaced.) Just last week, we pointed to several market internals and technical signs that such a correction might unfold: (more…)

• General strikes in Greece became violent yesterday, adding strong pressure on Greece politicians against the decision to implement tough austerity measures.
• Today’s Spanish 5-year auction went relatively well. EUR 2.3bln was allocated at a yield of 3.53%. The auction was oversubscribed with bids for EUR 5.5bln.
• The ECB did not announce any new measures at the monetary policy meeting. The initial market reaction to meeting was moderately negative.
• Southern European and Irish sovereign debt markets worsened today, with spreads widening against Germany and CDS spreads increasing.
• Bank equities were hit further and the price on default protection rose further – in particular for Portuguese banks. In covered bond markets, asset swap spreads for Southern Europe countries increased again.
• Global equities continued to trade lower, with financials taking the lead.
• The Euro remained under pressure, with EUR/USD flirting with 1.27.
• Money market tensions are increasing and signs of a USD shortage are becoming more evident. Short-end swap spreads are widening.
• Emerging markets are being hit again today, with EMBI spreads widening and Eastern European currencies weakening.
• Volatility is increasing in all markets.

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UK election-difficult to imagine an enduring Sterling rally?

I thought it might be useful to run through the different possible scenarios and hazard a guess at how the markets may react. I think it’s fair to say the markets, let’s say FX, Gilts and Equities, have reacted to the surge in support for the Liberal Democrats with its attendant increased likelihood of a hung Parliament, (i.e. no single party has an absolute majority), with something approaching insouciance, in contrast to the standard expectation that even the prospect of a hung Parliament, with its supposed consequential inability to make decisions and to make swift inroads into the task of restoring fiscal probity, would lead to a Sterling rout and a fall in gilts, as markets digested the possibility of a credit down-grade for the UK.

Why then this eerie calm?

I can think of three possible explanations-

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The Reserve Bank of Australia (RBA) will hold a policy meeting on Tuesday, May 4th. The RBA hiked rates 25bps in April and in the policy statement left the door open for future rate hikes. According to the April RBA policy statement the global economy is growing, Australian growth is close to trend, global financial markets are functioning better, inflation has risen and interest rates remain somewhat below average. The RBA has raised rates by 125bps since October with current overnight rate at 4.25%. There are a number of factors that point to a 25bps point rate hike by the RBA Tuesday. Recent Australian economic data confirms improving domestic growth and rising inflationary pressures. Australia’s GDP grew at its fastest pace in two years rising 0.9% in Q1 as consumer spending has been strong. The Q1 inflation rate rose by 0.9% compared to 0.5% in the fourth quarter. Australian employers have created more than 200k jobs over the last five months and the unemployment rate is at an 11 month low of 5.3%. Australia’s industrial activity surged in Q1 rising at its fastest pace in two years. Australian swap rates rose to an eight-month high Monday and implied forwards predict a 70% chance of an RBA rate hike Tuesday up from 55% Friday. The rise in swap rates increases the odds that the RBA will raise rates.

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U.S. Review

A Solid Start to 2010

• Real GDP grew at a 3.2 percent annual rate during the first quarter, paced by inventory rebuilding and a modest gain in private final demand supported by consumer spending and business investment.
• Consumer confidence rose 5.6 points in April, with most of the increase coming from improving expectations. Opinions on the job market improved modestly.
• Weekly first-time unemployment claims fell 11,000 in the latest week but remain relatively high at 448,000.

Production Is Now Running Ahead of Final Demand

Real GDP grew at a 3.2 percent annual rate, as strong growth in consumer spending and inventory rebuilding contributed the bulk of the improvement during the quarter. Business fixed investment was supported by equipment and software spending, while weakness in structures continued. Government outlays were a mixed picture, with federal expenditures expanding but not enough to balance out the decline in state and local spending. International trade contributed positively with exports up 5.8 percent at an annual rate. Inflation remained relatively tame during the quarter, with the GDP deflator climbing just 1.4 percent on a year-over-year basis.

The strong first quarter GDP numbers reflect rebounding production. During the recession, manufacturers cut output much more than demand faltered. The net result was a protracted decline in inventories. Output has come back strongly more recently and the early data for the second quarter are encouraging. Regional manufacturing surveys from the Federal Reserve Banks of Richmond, Dallas and Kansas City all reported sharp increases in activity during the month of April. The improvement in these indices was also broadly based, with output, orders and employment all posting solid gains.

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