01/9/2011 - US jobs disappoint, but still in the right direction

US jobs disappoint, but still in the right direction

Dec. US job gains disappointed most observers, but that was mostly the result of heightened expectations following Wednesday's surge in the ADP report, a notoriously poor indicator of concurrent NFP changes. Still, that more jobs were created in Dec. represents another step forward for the US recovery, reinforcing the recent stream of better than expected US data. The decline in the US unemployment rate from 9.8% to 9.4% (exp. 9.7%) was also a step in right direction, but probably was overstated due to a 297K gain in the household survey coupled with a -260K decline in the labor force. Again, though, the trend is clearly pointing toward growing momentum for the US recovery, which we expect will continue for the next few months at least.

Following the labor report, the USD suffered set-backs against other major currencies, with the obvious exception being the Euro, which was the biggest loser for the week. Overall, though, the greenback managed to gain against 13 of the 16 major currencies to start the year (MXN, CAD, and KRW gained vs. USD), with the USD index finishing at its highest levels since late November. US Treasury yields fell somewhat following relatively somber and dovish testimony from Fed Chair Bernanke, with 10 year yields down about 7 bps to 3.32% late Friday, still above recent range lows at about 3.25%. While we expect the EUR to see lower against other currencies in the weeks ahead (see below), the USD may have more trouble extending gains against other major currencies, especially if bonds pop and yields drop below the recent lows cited above. We would also note that the US dollar index is facing stiff resistance at the 81.43/45 level, which is the Nov. high and the bottom of the weekly Ichimoku cloud. As such, we prefer to remain sellers of EUR on the crosses (e.g. EUR/CAD, EUR/GBP, or EUR/AUD), preferably on some kind of a bounce, rather than a buyer of USD, unless on a significant pullback toward recent lows. Consistent with broader USD strength, gold and silver prices look to have posted key reversal weeks, and we would now prefer to be sellers on remaining strength.

Is Europe about to implode?

After dodging a bullet before the holidays, Europe’s peripheral nations are once again getting punished in the bond markets. The spreads between German government bonds and the peripheral nations are close to record highs. Portuguese 10-year government bond yields (up 70 basis points this week) are now at critical levels. The government in Lisbon has said that 7 per cent is the threshold at which it would need to consider taking a bailout. Currently yields are 7.11 per cent, so it seems only a matter of time before Portugal is negotiating with the ECB, EU and the IMF and receiving funds.

Another worrying development is Belgium. Although it isn’t a core economy, it wasn’t considered a basket case either. Back in August its 10-year bond yield fell to 2.8 per cent, yet it is now above 4 per cent and has risen in line with other peripheral nations. So will the home of the European Union be forced to negotiate a bailout for itself in the coming months? 

There are three main reasons that investors have targeted the peripheral nations bonds with such gusto since the start of this year. The first is a wave of supply that is about to come onto the market. On 12 January Portugal will offer 2014 and 2020 bonds for auction, Italy and Spain are also holding auctions at the latter part of next week. Investors charged a hefty premium to hold short-term Portuguese bonds in an auction last week, which doesn’t bode well for the upcoming debt sales. The news that the world’s largest bond fund will not be participating in the upcoming bond auctions is another red flag in our opinion as it points towards a buyers strike. If Portugal and Europe’s other weak nations have to pay a higher yield to attract investors to purchase their debt, soon people will worry about the impact higher debt payments will have on growth, causing more investors to ditch their debt and yields to rise and so on. This seems like the start of a debt spiral to us. Next week could see some real fireworks, and as you can see in the chart below, bond spreads are close to breaking fresh Euro-era highs. 

Belgium’s problems are actually more political. It is currently without a full-time government and seven political parties are locked in discussions trying to form a government and overcome the political impasse. This is bad timing to have political meltdown as Belgium is finding out. Investors aren’t in the mood to suffer risks within the Eurozone easily and until a fulltime government is found it is unlikely there will be a let-up in the pressure on Belgium’s bonds. 

Another factor weighing on sentiment toward the periphery is the European Commission’s plans to overhaul the governance of Europe’s banking sector. One of the proposals is to give regulators the power to write down senior bank debt by any amount necessary, or to convert bank debt into equity if a bank were to get into trouble. Until the risks to the investor are set in stone, European debt is an unattractive asset to hold.The sovereign debt crisis in Europe appears to be spilling over to the euro. EURUSD is currently below 1.3000, and if the sovereign debt crisis is poised to get worse then it will be hard to muster up much enthusiasm for a stronger euro and we could see a continuing grind lower in the single currency. A convincing break below 1.2960/65 could herald losses toward 1.2900 then 1.2650 – the lows reached back in October. But the decline may not be in a straight line due to continuing demand for the single currency from Asian central banks that want to diversify away from the dollar.

Queensland flooding slows down the Aussie

The Australian dollar has fallen over 3% against the U.S. dollar since reaching record free-floating highs on the last day of 2010. This past week, massive flooding in the state of Queensland has disrupted the economy by negatively impacting resource production and allocation. Mines, roads, and railways have been incapacitated by the rising waters. As an economy that is reliant on its natural resource exports as a key driver of growth, the floods have been significantly negative for GDP growth in Q1 (Queensland accounts for roughly 80% of Australia’s coking coal exports). This downbeat outlook has reduced the RBA’s near term tightening bias and has put pressure on the AUD.

While the Queensland state government estimates that so far the floods have generated a loss of up to 5 billion AUD or about 0.4% of annual GDP, it will be some time before the damage can be fully assessed. Additionally, the Australian Bureau of Meteorology forecasts heavy rains will continue into next week. We view this as a temporary supply-side shock and note that reconstruction will generate growth in the future.

Technically, AUD/USD sees a long-term rising trend line support come in around 0.9850 and the top of its daily ichimoku cloud to lend additional support around 0.9820. This support line begins at the June lows of around 0.8080 and was most recently tested on Dec. 1. The 55-day sma is currently above that at about 0.9920 to provide initial support. The current pullback in AUD/USD may present a buying opportunity at these support levels however a break below the trendline may see towards the 100-day and 21-week sma which currently converge around 0.9710 and then towards the Dec. lows around 0.9540. A sustained move back above parity may see towards 1.0100 ahead of 1.0200 and prior highs.

Encouraging jobs data and accelerating price gains supporting the Loonie

Much has been made of greenback strength with the USD Index surging close to +2.5% for the past month to current levels near 81.00. One major exception, however, has been against the Loonie – the greenback is down -1.84% against the Loonie month to date. The fundamental backdrop behind divergent CAD strength relative to most other majors can be attributed to a dichotomy of factors.

The first is the improving economic outlook in Canada and its likely impact on policy direction. Of significant influence to this has been the spate of positive data surprises in the US – Canada’s largest trading partner. Even more influential, however, have been implications of recent domestic data releases. Starting with the labor market, Net Change in Employment for December rose to +22k from +15.2k in November. Even more encouraging were the components of the report, full-time employment rose +38k while part-time employment declined -16k, a good sign for consumer confidence and spending which is likely to have a positive spill-over effect for 4Q 2010 GDP. Additional support to Loonie strength emanates from inflation related data. Wednesday’s higher than expected rise in November industrial product prices of +0.5% in conjunction with the +3.5% rise in November raw materials prices sent USD/CAD sharply lower from above parity to lows around 0.9930.

A second significant factor supporting the Loonie is the bullish outlook for oil prices. Improving growth outlooks and tightening supply (DOE weekly crude oil inventories have dropped for the past 5 consecutive weeks) suggest higher crude oil prices in 2011. Considering 2010’s inverse correlation of -.64 between USD/CAD and WTI oil – the outlook for higher oil translates to a corresponding strengthening in the Loonie.

Further progression in price gains, a likely possibility if Canada and US data continue down the path of positive surprises, may see the BoC consider resuming monetary policy tightening sooner relative to central banks of most other developed nations. The result is likely to see a continuation of CAD strength from a divergence in future interest rate expectations and widening differentials.

Key data and events to watch next week

Unites States:

Monday – Fed's Lockhart speaks

Tuesday – Dec. NFIB Small Business Optimism, Fed's Plosser speaks, Jan. IBD/TIPP Economic Optimism, Nov. Wholesale Inventories, weekly ABC Consumer Confidence

Wednesday – Dec. Import Price Index, weekly DOE U.S. Crude Oil Inventories, Fed's Beige Book,

Thursday – Weekly Jobless Claims, Dec. PPI, Nov. Trade Balance, Bernanke Speaks

Friday – Dec. CPI, Dec. Advance Retail Sales, Dec. Industrial Production & Capacity Utilization, Jan. preliminary U. of Michigan Confidence, Nov. Business Inventories, Fed’s Lacker & Rosengren speak

Euro-zone:

Monday – French Nov. Industrial & Manufacturing Production, EZ Jan. Sentix Investor Confidence,

Tuesday – French Dec. Business Sentiment

Wednesday – German 2010 GDP, EZ Nov. Industrial Production

Thursday – EU's Van Rompuy speaks, Jan. ECB Interest Rate Announcement

Friday – German Dec. final CPI, Dec. EZ CPI, Nov. EZ Trade Balance

United Kingdom:

Tuesday – BRC December Retail Sales Monitor

Wednesday – BRC Shop Price Index, Nov. Trade Balance

Thursday – Nov. Industrial & Manufacturing Production, Jan. BOE Interest Rate Announcement, Dec. NIESR GDP Estimate

Friday – Dec. PPI

Japan:

Tuesday – Dec. Official Reserve Assets, Nov. preliminary Leading & Coincident Index CI

Wednesday – Dec. Bank Lending, Nov. Current Account, Dec. Eco Watchers Survey

Thursday – Nov. Machine Orders, Dec. preliminary Machine Tool Orders

Friday – Dec. Domestic CGPI

Canada:

Monday – Nov. Building Permits, 4Q Business Outlook Future Sales, 4Q BoC Senior Loan Officer Survey, BoC Cote speaks

Tuesday – Dec. Housing Starts

Wednesday – Nov. New Housing Price Index

Thursday – Nov. International Merchandise Trade

Australia & New Zealand:

Monday – Nov. NZ Trade Balance, Imports & Exports, AU Dec. AiG Perf. of Construction Index, AU Dec. Retail Sales

Tuesday – 4Q NZ NZIER Business Opinion Survey, Nov. NZ Building Permits, Nov. AU Trade Balance,

Wednesday – Nov. AU Home Loans and Investment lending

Thursday – Dec. NZ Business PMI, Dec. NZ Card Spending, Dec. NZ House Prices, Dec, AU Employment Report, Dec. NZ ANZ Commodity Price

China:

Monday – Trade Balance (USD)

Thursday – Conference Board China November Leading Economic Index

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06/05/2011 - Risk comes off and the USD still suffers

Risk comes off and the USD still suffers

Last week we suggested that the strength of the global recovery remained very much in doubt despite the G8’s optimistic pronouncement and that risk assets (stocks and commodities) were set to weaken further, and that this would support the USD. Stocks and many key commodities did decline on the week (S&P 500 closed below the daily Ichimoku cloud bottom at 1305/1306; CRB commodity index potentially forming an ‘Abandoned Baby Top” bearish reversal pattern on daily candles), but the USD lost further ground anyway. USD weakness is clearly attributable to fresh US data disappointments that have rekindled talk of another round of Fed asset purchases (QE3). We think QE3 is highly unlikely, but that won’t stop markets from speculating on it, which will keep pressure on the USD until we get some fresh indications from the Fed one way or the other (watch for Bernanke speaking on Tuesday). Also, Congress continues to dither on raising the US debt limit, which led Moody’s to warn of a potential downgrade to US ratings unless progress is made soon, adding further pressure to the greenback. Until a deal is reached, the political stalemate will also weigh on the buck.

But USD weakness was not equally distributed. In particular, we would note the buck was barely changed against the commodity currencies (AUD, CAD, and NZD), suggesting to us that commodity-related markets remain vulnerable. Indeed, USD weakness is typically associated with risk asset (stocks and commodities) price gains and that this did not happen reinforces our view that risk sentiment remains quite vulnerable. In this environment, our preference remains to look for opportunities to get short risk assets on remaining strength, potentially in select JPY-crosses (see the latest Weekly Strategy).

The star performer of the past week was clearly the EUR, which gained against all major currencies except ZAR. The resolution of the latest chapter in the Greek debt saga has given the EUR a healthy lift, but we will be watching closely to see if the pace of recent gains is sustained, or whether NFP-related excessiveness was too extreme. The ECB is meeting on Thursday and the expectation is that Trichet will signal a July rate hike using the ‘strong vigilance’ code words. The single currency seems most likely to remain supported in the run-up to the ECB meeting (barring any major peripheral turmoil over the weekend—see below), but if Trichet fails to signal a rate hike next month, EUR is likely to beat a hasty retreat a la the last meeting on May 5.

Greece passes its test – is the euro on its way to 1.5000?

After a month-long review the Greek Finance Ministry said that the EU/IMF and ECB had concluded “positively” on Friday. While there was little detail on what exactly was positive, it effectively means that Greece is likely to receive the next tranche of bailout funds at the end of this month and is also in the running to get a second bailout rather than return to the capital markets next year. 

It is likely that Greece has signed up to even more austerity measures and asset sales to try to bring down its debts organically, rather than having to borrow more money. This makes the public workers strike scheduled for Saturday likely to be the first of many in the coming weeks.

But what is most important to Greece right now is the EU and how supportive it is of Athens. Three dates in June are crucial. On 20th June the Eurozone finance ministers meet and Greece is likely to be top of the agenda. On the 24th European leaders meet, where they are likely to agree to a second round of financial support for Athens; then on the 29th the IMF should release its next tranche of bailout funds. 

It’s a crucial month for Athens, but after today’s announcement things have become much easier for the Southern European nation and its bond yields actually fell at the end of last week. This gave the euro the green light to rise above 1.4500 on Friday versus the greenback. Investors are rushing into the single currency after signs that the US economy is faltering as well as a cooling in financial pressure in the periphery. 

The stage is set for EURUSD to make another stab towards 1.5000. A weekly close above 1.4500 is extremely constructive for the pair and we may see 1.4670 first and then the 1.4850 highs from early May.

But there is one large caveat to this. To start with Portugal holds a snap election on Sunday. Any sign that political turmoil will threaten its deficit reduction program may weigh on sentiment towards the single currency. Banking sector stress tests are also due for release this month (though there have been reports that the Eurozone bank regulator has requested banks to re-submit fresh data, suggesting a possible delay) and Spain has set a deadline of September for its troubled Caja banks to re-capitalize. So there are potential obstacles the euro has to climb to remain well supported. But as long as the prospect of QE3 in the US remains on the table then this should favor the euro over the greenback in our opinion.

Is the BOE getting more dovish?

Last week could end up being one of the most pivotal of the year for the Bank of England. Andrew Sentance, who had voted for 12 straight rate increases (and been voted down on each occasion) left the Committee as his term on the MPC expired.

In a television interview on the day he stepped down Sentance said the Bank risked its credibility by not raising interest rates and allowing inflation to reach 4.5 per cent. However, just as his words hit the airwaves there was further evidence that the economy is slowing and weak GDP in the first quarter is seeping into Q2. 

Firstly there was the PMI manufacturing survey, which tumbled to its lowest level since September 2009. Additionally, the services sector survey, which represents the lion’s share of the UK economy, also fell in May to its lowest level since February. Cracks are starting to emerge in the UK’s growth picture and this makes a near-term rate hike extremely unlikely. 

This was reinforced when one of the more dovish members of the BOE Paul Fisher said that he was open to the idea of extending the Bank’s asset purchase program if the economy was to contract sharply. He also reiterated his stance on rates, saying that it was too early to hike. 

Of course Fisher is only one member of the Committee, but Sentance’s replacement Ben Broadbent, a former Goldman Sachs economist, seems to have a less hawkish bias than his predecessor.

Interest rate expectations for the rest of the year have fallen sharply since February and they remain back at October 2010 levels, when a rate hike was barely priced in for this year. We think that the outlook is too cloudy to pinpoint exactly when the Bank will normalize interest rates, but currently it looks like it may not be until the first quarter of 2012.

Low rates and weak economic data are weighing on the pound. While we think it will eventually grind lower against the dollar, we think it will experience a sharper move against the euro and the Swissie. Although the franc is at record highs versus the pound, we think it may move lower towards 1.3500. We also think that the pound looks more vulnerable than the euro right now, and this supports a move towards 0.9000, the highs last reached at the start of May.

Steady RBA cash rate…for now

Australia’s economy contracted -1.2% in the first quarter as the aftermath of Queensland flooding negatively impacted commodity export volumes. The drawdown in GDP alongside disappointing April employment numbers in the midst of a moderating global recovery will likely see the RBA hold its cash rate steady at 4.75% for the seventh consecutive month on Tuesday.

However, we expect the policy statement to contain hawkish undertones similar to those in the May 3rd minutes – ‘If economic conditions continued to evolve as expected, higher interest rates were likely required at some point if inflation was to remain consistent with the medium term target’ – as Q2 GDP looks set to rebound from firming domestic demand, business investment, and public consumption.

Additionally, a significant factor in Q1’s disappointing GDP print stems from the decline in net exports on the back of the tragic earthquake in Japan – Japan accounts for about 18% of Australian exports. The bulk of such export related losses are likely to remain confined to Q1 which may see external demand alongside domestic demand provide a substantial boost to second quarter growth. Accordingly, we think the RBA may begin tightening policy in July or August but we maintain a bias for an August hike as it would allow the RBA to take into consideration Q2 CPI readings.

RBNZ likely to remain on hold for an extended period

The RBNZ rate decision is set for release Wednesday with the official cash rate (OCR) almost certainly to be kept unchanged at 2.5%. Comfortable core inflation levels, downside economic impacts from the earthquakes, lower export volumes, and the elevated NZD are likely to be the determining factors in steady RBNZ monetary policy.

We think the RBNZ may signal higher rates for 2012 but the recent sharp ascent in NZD is likely to force the central bank’s hand to maintain a steady policy stance for the remainder of 2011. Further supporting the case for continued passive RBNZ policy is the elevated domestic currency – NZDUSD printed record highs this week. Sustained NZD strength at lofty levels would have substantial downside impacts on net exports. This may see the RBNZ attempt to rhetorically weaken the currency but such attempts may be of limited success considering the broader backdrop of USD weakness.

Key data and events to watch next week

United States: Monday – Fed’s Plosser speaks on Central Banking, Geithner speaks to bankers in Atlanta, Fed’s Fisher speaks in NY; Tuesday - June IBD/TIPP Economic Optimism, April Consumer Credit, Fed’s Lockhart speaks on economy in North Carolina, Fed’s Bernanke speaks on economy in Atlanta; Wednesday –Fed’s Beige Book; Thursday – Weekly Jobless Claims, April Trade Balance, April Wholesale Inventories; Friday – May Import Price Index, May Monthly Budget Statement

Eurozone: Monday – EZ April PPI, EZ June Sentix Investor Confidence Tuesday – EZ April Retail Sales, German April Factory Orders, EU Commission Assesses Euro-Area Budget Plans Wednesday – EZ 1Q P GDP, German April Current Account Thursday – ECB Rate Decision Friday – German May F CPI

United Kingdom: Monday – May Halifax House Prices Thursday – BOE Announces Rates, April Trade Balance Friday – April Industrial Production, April Manufacturing Production, May PPI Input & Output, May NIESR GDP Estimate

Japan: Monday – May Official Reserve Assets Tuesday – April P Coincident & Leading Index CI, May Japan Money Stock M2 & M3, May Bank Lending incl Trusts, April Current Account Total, April Trade Balance (BOP Basis) Wednesday – May Bankruptcies, 1Q F GDP Thursday – May Consumer Confidence, April Tertiary Industry Index, May Domestic CGPI

Canada: Monday – April Building Permits, May Ivey PMI Wednesday – May Housing Starts Thursday – April International Merchandise Trade, April New Housing Price Index Friday – May Unemployment Rate, May Net Change in Employment

Australia & New Zealand: Sunday – AU May TD Securities Inflation, AU May ANZ Job Advertisements Monday – AU May Foreign Reserves Tuesday – RBA Cash Target, AU Jun Westpac Consumer Confidence, AU April Home Loans, AU April Investment Lending, AU April Owner-Occupied Home Loans, NZ May QV House Prices Wednesday – AU May Employment Change, AU May Unemployment Rate, AU May Participation Rate, RBNZ Official Cash Rate Thursday to Saturday – NZ May REINZ House Sales

China: Thursday – May Trade Balance 6/9-15 – May Actual FDI, May New Yuan Loans, May Money Supply M0, M1, M2

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