FOREX TRADING

U.S. Review

Some Good and Not So Good Data This Week

• The panic that gripped global markets over the past two weeks appears to be easing a bit. It helps that the economic data coming out of the United States suggest a sustainable recovery is now well underway. On the positive side, consumer confidence rose more than expected in May. The April durable goods orders and the May Richmond Fed survey confirmed that the U.S. manufacturing expansion continues to gain traction.
• Less good was the slight and unexpected downward revision in Q1 U.S. GDP growth, and U.S. home price data that reveal home prices beginning to roll over again.

Two-Speed Recovery Continues

The U.S. economic recovery continues to show its Dr. Jekyll and Mr. Hyde sides. Perhaps that is a factor behind the schizophrenic stock market behavior of late. An “unbalanced” or “two-speed” recovery remains the current state of affairs. This is disappointing to the bulls that have been rampaging on Wall Street since March 2009, trumpeting the strong return of corporate earnings, while whispering the recovery is looking stronger than the consensus had expected. There were plenty of reminders this week that the bulls’ case for a normal or robust recovery from deep recession remains a long shot.

On the labor market front, initial jobless claims refuse to drop to levels that would suggest a swift return of a normal private sector payroll growth during an economic recovery. The four-week moving average of initial jobless claims, a more stable indicator of job trends than the weekly number, has risen for two consecutive weeks now, even though initial claims dropped by 14,000 to 460,000 in the latest week. Initial claims have clearly been trending around the 450,000 level for months now, when we would like to see them slip back to the 350,000-400,000 level that often characterizes a normal labor market during economic expansion. Thankfully, other employment indicators are not quite as scary. The monthly payroll data have indicated positive job growth for four consecutive months now. The household survey data are indicating an even stronger return of job creation, although one third of those new jobs are part-time. Indeed, we expect the May jobs report that is to be released next week will reveal even more job gains than in April, though much of the strength will likely be from temporary census hiring.

We also got confirmation that despite Herculean efforts to support the housing market through homebuyer tax credits, mortgage modifications and record low mortgage rates, the ability to stabilize home prices at current levels appears fragile. The Office of Federal Housing Enterprise Oversight (OFHEO) released its monthly purchase-only home price index report for March, showing an increase of 0.3 percent from February after a string of three consecutive monthly declines. However, this home price index is still down 1.9 percent from a year ago. By contrast, the seasonally-adjusted national Case-Shiller index revealed renewed weakness in home prices in the first quarter. The Case-Shiller index plunged at an annualized 5.05 percent rate in the first quarter, even though the year-over-year figure improved to a 2.13 percent home price gain. In the wake of the homebuyers’ tax credit expiration and the rise in the U.S. foreclosure rate, further declines in national home prices can be expected. (more…)

A zero sum gain happened on Thursday, as the major pairs split 20-30 pip between them in 24 hours of trade, and with none able to break the previous session of trade ranges. The instigator of initial Usd buying was the S/P futures market going lower in pre-market trade, but things reversed as Wall Street cash trade got underway, and the long side of equities was seen, reversing the selling seen in the major currencies.

The swing point on S/P trade that will draw in further Usd buying is at 1165 as support, with Usd selling probably gearing up if 1190 is broken and held for a day. Until one or the other price points are broken, the range-bound trading environment will remain in place.

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Overbought Test Of Resolve

Gbp/Usd moved 100 pips higher during the European session after reports from the U.K. labor market hit the newswires that were better than expected. The minutes from the recent Bank of England rate meeting revealed that nothing much had changed from the previous month, and that CPI and inflation reads were as much to do with a weaker pound than instigated by internal growth.

The MPC minutes suggest that interest rate increases are just as far away in the U.K. as any other major region, with the exception of Australia. This news had a positive effect on the major currencies, but the pound is the only pair to make a substantial breakout. (more…)

The FOMC will hold a one-day policy meeting on Tuesday, March 16th. This will be the first scheduled single day policy meeting for the Federal Reserve since the start of the financial crisis in September 2008. In February the Fed raised the discount rate 50bps to 0.75% and stated that the discount rate hike was not a signal of tightening of monetary policy. According to the Fed the discount rate hike will encourage financial institutions to rely more on money markets than on the Fed for short-term borrowing. The discount rate hike has encouraged speculation over whether the Fed is nearing the end of its accommodative monetary policy. Investors want to know if the Fed will soon hint that the end of easy money is near.

The key focus of Tuesday’s FOMC meeting is whether Fed maintains in its policy statement the language, keeping interest rates at exceptionally low level for an "extended period". Recent statements from Fed officials suggest that the weak labor market, uncertainty about the sustainability of the US recovery and subdued inflation will encourage the Fed to hold policy steady at Tuesday’s meeting.

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U.S. Review

Growth & Credit: On the Road to Singapore (Recovery)

• Economic growth and finance are both in recovery mode as evidenced by the gradual upturn in jobs and the gains in leveraged loan issuance. Yet, like Bing Crosby and Bob Hope, the economy never seems to be able to reach the happy land of Singapore.
• This recovery is still subpar for housing and the consumer as the pace of recovery still leaves many homeowners underwater in certain areas and many workers underemployed or unemployed. Skies are getting clearer but we remain far away from a sunny day.

On the Road to Singapore

In their most famous “road picture,” Bing Crosby and Bob Hope vow never again to repeat past mistakes and head off to Singapore. Of course, they do repeat their past mistakes and never do get to Singapore. For the U.S. economy the pace of improvement appears maddeningly slow and yet there is improvement.

Employment losses have steadily declined over the past six months. In fact, private sector jobs (ex-construction) have risen over the past two months. There is a cyclical recovery in private sector jobs while the structural problems in real estate limit the recovery. Job gains have also appeared in manufacturing sectors such as machinery, primary metals and electrical equipment. Meanwhile the index of hours worked has risen over the last three months, consistent with sustained economic growth. Combining hours worked and average hourly earnings, our income proxy has broken into positive growth territory. This suggests positive income and therefore spending gains in the months ahead.

Structural – Not Cyclical – Challenges to Employment

While the employment data suggest cyclical recovery, there are also suggestions of structural challenges that will limit our progress on the road to Singapore. We see this clearly in the unemployment rate by education and the duration of unemployment data. The stark reality of the unemployment situation is that higher education levels are associated with lower unemployment – and vice versa unfortunately. Unemployment for college graduates is 5 percent – for high school drop outs the rate is 15 percent. Meanwhile, the average duration of unemployment remains high at 30 weeks. There is a significant skills mismatch in the U.S. economy. It is not as though there are no jobs. More precisely, there are no jobs for many willing workers who do not have the skills to compete in the 21st century workplace.

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USD Higher, Recovery Hope Versus Rate Outlook

• USD: Higher, Greek debt troubles, optimism about US economy, NABE upgrades US GDP forecast
• JPY: Higher, S&P says there is a low chance of Japan being downgraded this year
• EUR: Lower, German finance Minister denies that the EU plans a 25bln aid plan for Greece
• CHF: Lower, SNB’s Jordan ready to act on excessive CHF strength
• GBP: Lower, UK election polls point to the risk of a hung parliament
• CAD and AUD: AUD & CAD lower, Australian vehicle sales decline, commodity prices mixed

Overview

The USD traded mixed to slightly firmer Monday as focus returns to Greece and the NABE upgrades its US 2010 GDP forecast to 3.2%. There was a report in overseas trade that the EU had agreed to a 25bln aid plan for Greece. The German finance minister denied the report and the USD rebounded from early overseas lows. The NABE upgrade of its US GDP forecast and outlook for continued improvement in the housing market and jobs growth generates optimism about the US recovery. There were no major US economic reports scheduled for release today. Focus turns to Tuesday’s release of US home prices and consumer confidence with durable goods and Q4 GDP to be released later in the week. The trade will also be closely monitoring Fed Chairman Bernanke’s testimony before Congress on Wednesday and Thursday. The trade will be looking for clues to the Fed’s decision last week to hike the discount rate. Fed officials indicate that the rate hike was primarily a technical measure and not an indication of a change in policy. The USD traded lower in early overseas trade pressured by diminished Fed rate hike speculation sparked by weaker than expected US CPI report Friday and the Feds assurance that the discount rate hike was not a sign of imminent tightening of Fed policy. USD price direction is caught between recovery hopes and interest rate outlook. (more…)

Weekly Economic and Financial Commentary

U.S. Review

The Fed Moves to End its Extraordinary Policy Ease

• Regional manufacturing surveys showed a stronger rebound in orders and production than had been expected. Industrial production also rose solidly.
• January’s inflation data were mixed, with import prices and pipeline inflation up sharply and the Consumer Price Index rising slightly less than expected.
• The Federal Reserve raised the discount rate by a quarter percentage point late Thursday afternoon.

When Ben Bernanke Talks, People Listen

Sometimes Ben Bernanke does not even have to speak. Just one week after the Fed Chairman released his testimony, in which he stated that “‘before long” the Fed would raise the discount rate and return it to the spread over the federal funds that existed before the crisis, the Fed acted. We now know the meaning of “before long,” at least as it relates to Fed policy.

Our initial read from the Fed’s move is that it intends to stay very close to the script Ben Bernanke laid out to reverse the extraordinary actions it put in place to fight the financial crisis. Those actions contributed to an enormous expansion of the Fed’s balance sheet and heightened concerns about whether the Fed could adequately contain or reverse this extraordinary stimulus without putting the recovery at risk or creating an environment, in which inflation might accelerate.

Bernanke noted that returning the discount rate back to its normal relationship to the federal funds rate should not be seen as a tightening move but rather a return to a more normal monetary policy. Maybe that is why the Fed chose to announce its move along with the regular weekly release of the monetary aggregates, whose influence the Fed has also traditionally downplayed. Specifically the Fed noted its policy actions were “not expected to lead to tighter financial conditions for households or businesses and do not signal any change in the outlook for the economy or monetary policy.” Monetary policy is still extremely easy, with the federal funds rate close to zero. All that has changed is that the era of extremely cheap money is beginning to end.

There was a pretty full set of economic reports released this week, including a number of reports on the manufacturing sector. Most of the regional manufacturing surveys, including the New York Fed’s Empire Manufacturing Survey and the Philadelphia Fed survey, came in stronger than expected. The Empire Survey rose nearly nine points to 24.9. The employment component rose for the second month in a row and is now solidly positive at 5.56. Manufacturers also seem to have a better handle on inventories.

Industrial production rose 0.9 percent in January, with solid gains across most categories. Output in the manufacturing sector rose 1.0 percent, with output of consumer goods and business equipment rising solidly. Production of IT equipment remains a notable bright spot, with production climbing 1.7 percent. Utility output, which surged in December, rose a much more moderate 0.7 percent in January. February’s cold temperatures should send output even higher in next month’s report.

The inflation data were clearly mixed. Import prices continue to rebound off last year’s sharp declines. The overall index jumped 1.4 percent in January, while prices excluding petroleum rose 0.6 percent. The Producer Price Index also registered a larger-than-expected gain, climbing 1.4 percent. The Consumer Price Index was much tamer, however, rising just 0.2 percent overall and falling 0.1 percent after excluding food and energy items. Sharply lower prices for hotels and lodging accounted for the smaller-than-expected overall rise and most of the drop in the core. (more…)

A Roadmap for the Fed’s Exit

• The Fed is moving towards an exit of its very easy monetary policy, and the first steps to reduce liquidity have already been taken There are several more steps on the road to the first fed funds rate hike, but the Fed will prepare markets well in advance.
• The unwinding of alternative easing measures has so far been smooth and we see the biggest risk for a destructive market reaction from the termination of the MBS/Agency purchase programme by end March. A surge in mortgage yields could potentially delay the first rate hike.
• Fundamentals would call for an unchanged fed funds rate through 2011, but given its extremely low level, the first hike is expected to arrive late this year. That said, the Fed will be cautious not to tighten too aggressively and is likely to pause hiking close to the 1% level in 2011.

Exit already in progress

This week a testimony by Chairman Bernanke to the House revealed the Fed has progressed further in its move towards the exit. During the crisis the Federal Reserve System implemented several alternative policy measures to cope with the seizure of money market liquidity and to ease financial conditions for the real economy beyond what could be obtained by a zero interest rate policy. With signs of an economic recovery becoming increasingly convincing, the debate about how and when the Fed will tighten monetary conditions has intensified.

While the Fed will not fully complete its purchase programme for mortgage assets before 31 March, the unwinding has already begun. By 1 February, most short-term liquidity and some lending facilities were terminated. Further, the Fed has laid out a plan for the unwinding of the remaining liquidity and short-term lending programmes. According to this plan, all these measures will be terminated by end H1, as illustrated by the timeline below. (more…)

USD Lower on Rumor of a €20 Billion Greek Bailout Plan

• USD: Lower, equities and commodities rally, risk appetite improves on Greek rescue rumors
• JPY: Lower, tracking equities and selling in cross trade
• EUR: Higher, Greek rescue speculation and technical bounce on record net spec short on the IMM
• GBP: Higher, trade balance widens, retail sales decline, house prices rise
• CAD and AUD: AUD & CAD higher, improving risk sentiment, reduced Australian budget deficit forecast

Overview

USD traded lower Tuesday pressured by Greek rescue speculation. A report that ECB President Trichet would return one day early from a BIS meeting in Australia to attend an EU Council Meeting fueled speculation that a Greek bailout plan may be soon announced. The EUR traded at an eight-month low versus the USD late last week pressured by concern of sovereign debt default risk in Greece. Today’s speculation of Greek rescue plan sparked an improvement in risk appetite, rebound in equities and commodities prices and selling of the USD. The latest rumor is that a €20bln Greek bailout plan may be soon announced. EUR gains were limited by a statement from the ECBs Nowotny that ECB can’t bailout Greece because bailout of governments is not part of the ECB charter. The USD decline may also reflect technical factors which include last week’s CFTC commitment of trader’s report which said that spec short EUR position on the IMM was at a record high. This may be an indication that investors were getting too bearish the EUR and the EUR may have reached oversold technical conditions. In reaction to the sharp increase in EUR short positions economist Stiglitz called on Europe to teach speculators a lesson. Short covering was the main driving factor for today’s EUR trade. GBP traded higher but underperformed in reaction to report a weaker UK retail sales and new election polls which suggest the risk of a hung parliament. Commodity currencies traded higher tracking the improvement in risk appetite and higher commodity prices. AUD was supported by report that Australia’s fiscal budget deficit for 2009/10 may be 15bln less because of stronger than expected growth and hawkish comments from RBA Governor Stevens. Stevens warned that keeping rates to low for too long may make it harder to prevent asset bubbles. JPY traded lower pressured by improving risk appetite. US economic data was mixed with wholesale sales rising and inventories falling. Focus turns to Wednesday’s testimony by Fed Chairman Bernanke before the House on unwinding of liquidity measures. The WSJ reported Monday that Bernanke will lay out a plan to raise rates as the economy improves with the first focus on the interest rate on excess reserves. Main focus for FX trade remains risk sentiment and debt default risks in peripheral European countries, Greece, Spain, Portugal, and Ireland. (more…)

FOMC Meeting Wednesday, No Change Expected

The FOMC will conclude a two-day policy meeting on Wednesday the 27th of January and announce its policy decision at 14:15 PM ET. The FOMC is widely expected to maintain steady rate policy and 0.0 to .25%. At the December FOMC meeting the FOMC concluded that economic conditions warrant maintaining yields a low level for an ‘extended period’ and the economy is strengthening. The FOMC is expected to reaffirm commitment to maintaining low yields for an extended period at Wednesday’s policy meeting. If the Fed were to surprise and drop the extended period language from statement it would be a sign that the Fed is shifting monetary policy and preparing its tightening cycle. This is unlikely at Wednesday’s policy meeting because there has not been a significant change in the US economic outlook since the last policy meeting. In December Fed officials said that the economy is improving and that inflation pressures were likely to remain subdued. Recent US economic data has been mixed with Christmas retail sales weak, improvement in the housing market slowing and December unemployment disappointing.

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USD Pares Gains as Consumer Confidence Rises

• USD: Higher, spike in risk aversion as China’s tightens monetary policy, consumer confidence rises
• JPY: Higher, China to hike reserve ratios on two major banks, BOJ policy unchanged, cuts deflation forecast
• EUR: Lower, above forecast German IFO fails to boost demand
• GBP: Lower, UK GDP disappoints, UK crawls out of recession, Pimco’s Gross says avoid UK debt
• CAD and AUD: AUD & CAD lower, China’s reserve ratio hike discourages demand for high yield currencies

Overview

USD traded higher Tuesday supported by a spike in risk aversion as equity markets decline in reaction to report that China hiked reserve ratios on some of its banks. Tightening of monetary policy in China generates concern about the global recovery. GBP was pressured by a report of weaker than expected UK Q4 GDP.EUR traded lower despite report that German IFO came in above forecast. GBP and EUR were pressured by selling in cross trade to the JPY with JPY supported by safe haven flows as equity markets decline. JPY traded higher despite S&P lowering of Japans bond outlook to negative from stable. S&P placed Japan on negative watch due to concern about Japan’s rising debt load and lack of flexibility to deal with reducing the debt. Commodity currencies traded lower tracking the spike in risk aversion and weaker commodities with crude oil prices falling below $74 a barrel. There was limited reaction to report that Fed officials are considering adopting a new benchmark interest rate to replace the one used for the last two decades (Fed funds). According to a Bloomberg report Fed officials are considering interest on reserves as the new benchmark rate. Today’s US economic data was mixed with case Shiller home price index down and consumer confidence rising. USD came off its high after the consumer confidence report. Focus turns to Wednesday’s FOMC meeting and President Obama’s State of the Union address. (more…)

U.S. Review

Disappointing Economic Data Continue in January

• The economic data this week largely disappointed equity investors and missed analyst expectations.
• Homebuilder confidence has ebbed as new home sales remain sluggish and buyer traffic has dropped since September.
• A pull-back in the January Philly Fed index has raised concerns about the strength of the economic recovery in the first quarter.
• Expect slower economic activity in January following robust improvement in the fourth quarter.

Reality Bites

Political upheaval in Washington with the election of Republican Scott Brown to the Senate turned conventional wisdom on healthcare reform and financial sector reform on its head this week. Regulatory risk has risen against the banking industry as the Obama Administration tries to score political points off of popular anger over bank bailouts and executive compensation and bonuses. At the same time, the economic data released this week pointed to weaker expansion as the first quarter gets underway.

The NAHB/Wells Fargo builders’ sentiment index dropped another point in January to 15 from a post-bubble peak of 19 last September. The index is still seven points above where it was a year ago. Prospective buyer traffic has dropped five points since September’s first time homebuyer credit surge. Regionally, the biggest declines in the housing market index since September have come from the Midwest followed by the Northeast and South. The regional index in the West has been comparatively steady.

Housing starts took a step backward in December dropping 4.0 percent as rough weather seems to have hampered single-family starts, which dropped 6.9 percent. On a more encouraging note, multi-family starts jumped another 12.2 percent in December after a steep 70 percent increase in November. The permits data continue to point toward a sustainable recovery in housing activity. Housing permits have risen for two consecutive months, gaining another 10.9 percent in December. Total housing permits are now running 15.8 percent above year ago rates with single-family permits running a whopping 37.3 percent above last year’s rates.

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Currency Currents

Quotable

“It isn’t that they can’t see the solution. It is that they can’t see the problem.”

G.K. Chesterton

FX Trading – US Dollar Index Failing? Follow-Through Would Be Nice

The week was mostly shaped by China news – go figure!

As an encore to the week prior when they increased the interest rate on one-year bills and upped the required reserve ratio on banks, they ratcheted up the rate on one-year bills again. Then top officials talked about getting tougher and stopped rampant speculation before it might become a problem. Then they reported fourth-quarter GDP numbers that blew expectations out of the water.

The market responded to the 10%+ GDP number as another sign that China will keep getting tighter on lending, effectively slowing down money flow and likely dampening future readings on GDP. And when China is widely viewed as the leader of global economic recovery, investors don’t feel quite as comfortable tossing their money into “potential” growth and “greater” risk.

Thus, money has come back into the US dollar as it typically does when risk appetite ebbs.

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Investors are jumping off the risk-on bandwagon today and scrambling to get into fixed income as risk aversion rears its head. While Asian equity markets were buoyant overnight with Japanese investors returning after a long weekend the focus migrated to the actions of China’s central bank, after it raised its reserve requirement staring next week and engineered a lift in short term rates through an auction of one-month bills. That was the second consecutive such move and together the central bank is clearly demonstrating that it will back its words of warning when it comes to taming the dragon. The near double-digit pace of growth recently prompted government officials to forewarn that it would take remedial measures to contain the impact of a surge in bank lending.

The interest rate move from the Chinese central bank caught investors off guard and at this point it’s tempting to predict that the path of risk aversion down which investors are running today will prove to be a blind alley. The switch from riskier plays to the safety of bonds is largely inspired by today’s Chinese rate move aimed at curbing excessive bank lending and does not stem from any signs that growth is waning. Indeed yesterday’s domestic Chinese data depicted a voracious pace of growth.

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USD Lower as Fed Seen on Hold for Quite Some Time

• USD: Lower, diminished Fed rate hike speculation, optimism about the global recovery
• JPY: Higher, gains limited by selling in cross trade, EUR/JPY tops 134.00
• EUR: Higher, improving risk appetite, shrugs off of possible downgrade of Portugal’s debt rating
• CHF: Higher, strong Swiss retail sales, gains limited by threat of SNB intervention
• GBP: Higher, business optimism improves, Tories pledge to cut UK budget deficit more than Labor
• CAD and AUD: AUD & CAD higher, China’s exports surge, strong Australian jobs & Canadian housing data

Overview

The USD traded lower to start the week pressured by fallout from Friday’s report of an unexpected decline in US nonfarm payrolls and in reaction to improving optimism about the global recovery as China’s exports surge. The decline in nonfarm payrolls will force the Fed to maintain low yields. The Fed’s Bullard said Monday that US interest rates are likely to stay low for quite some time. The surge in China’s exports sparked a rally in Asian equities to a 17 month high and contributed to improving risk appetite. CHF was supported by report of strong Swiss retail sales with gains limited by threat of SNB intervention. EUR traded higher despite report Portugal’s debt rating may be downgraded. GBP benefits from the Tories pledge to cut the UK budget deficit more than the Labor Party. Commodity currencies surge in reaction to stronger metals and crude prices with gold trading $20 higher and crude prices topping $84 a barrel. AUD was also supported by strong ANZ jobs report and the CAD by strong Canadian housing starts. CAD gains were limited by selling in cross trade to Australia and Europe. Strong economic data from China and Australia fuels speculation that interest rates may be heading higher in Asia. No major US economic data was released in today’s trade. Focus turns to the start of the US earnings season and the release of US retail sales and Thursday’s ECB policy meeting. USD is vulnerable to long liquidation pressures as investors pare back speculation that the Fed will bring forward interest-rate hikes.

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