A Quick Preview of What World Financial Markets are Hinting About the Coming Week
1. Big Themes For the Coming Week
Forex, Commodities, World Stock Indexes are likely to remain in trading ranges of the past 6 weeks until further clarification about economic recovery. If nothing comes sooner, U.S. banking earnings in the coming weeks could be the catalyst for the next big move.
March rally in world stocks may be well ahead of supporting fundamentals, thus vulnerable to pullback.
- Resulting risk-aversion would be likely to include:
- Gains by safe-haven currencies (JPY, USD, CHF) against riskier and commodity-based export currencies (AUD, NZD, CAD)
- Downward pressure on commodities, stocks
2. US Dollar Nears Breakout Versus Euro, Awaits Nonfarm Payrolls Results
Overall USD Outlook: Neutral
- Markets awaiting further clarification
- Dollar Rallies on Monday stock selloff, loses gains on improving optimism
- Technical weakness in stocks suggests increasing risk aversion, USD breakout risk up
While the USD finished the week slightly down against key counterparts, and may show further short term downward momentum, markets remain indecisive as reflected by generally narrow trading ranges for USD pairs like the EUR/USD and GBP/USD.
In sum, markets appear to be waiting for news to clarify near term direction, and the coming calendar of events might provide it. The likely big news of the week is Thursday’s US Nonfarm Payrolls data, though most expect US employment to continue to worsen even as other data shows improvement. Tuesday’s Conference Board Consumer Confidence numbers may spark some movement, though improving optimism has not been influential because it has not resulted in increased spending. Wednesday’s ISM Manufacturing results, especially the ISM Manufacturing Employment index, could also set the mood coming into Thursday’s US employment report.
As noted before, stocks world-wide remain up 20-30% since the March rally began, despite any evidence suggesting that jobs, earnings, GDP, or any other meaningful metric will improve by that much in the coming year. This leaves them vulnerable to a decline which the past weeks show may have already begun. If so, declining risk appetite would likely boost the USD (also JPY and CHF) against other majors, especially those seen as higher risk (AUD, NZD) and/or linked to commodity prices (CAD).
3. Euro Volatility Likely Ahead of Central Bank Interest Rate Decision
Overall Euro Outlook: Bearish
- Despite poor growth and possible deflation prospects for 2009, ECB resisting pressure for rate cuts
- Uncertain if ECB’s loans last week to major banks will translate into cheaper, easier credit for businesses
The ECB issues a contested interest rate decision Thursday. The ECB continues to maintain that current interest rates are “appropriate” for now, while other influential voices, including the OECD are urging that rates cuts toward zero similar to those of the U.S.
Credit Suisse’s overnight index swap index shows traders are now pricing in a 56.5% chance of a 25 basis rate cut, a noticeable reversal from the 62.7% chance of a rate hike showing just two days ago. Besides the admittedly global phenomenon of sickly economic growth in 2009, arguably the most pressing reason to reduce the cost of money is to check the onset of deflation, which recent Euro zone PPI and CPI suggest could be a real threat.
Although the ECB did offer an unprecedented 442 billion euro in 12-month bank loans as a means of de-facto monetary easing and will also move forward with a 60 billion bond-buying scheme announced at the last policy meeting, these measures may prove woefully inadequate.
There is no guarantee that banks will lend out the funds and thereby stimulate the broad economy. Indeed, banks may chose to hang on to the cash as a buffer against $1.1 trillion in as yet unrealized losses linked to the subprime mess, per the IMF, as well as the fallout from a developing currency devaluation in Latvia. Alternatively, they may use the funds to reduce other obligations and shore up their balance sheets.
Still, the ECB seems willing to concede economic performance to ensure low inflation, with ECB member Jurgen Stark openly suggesting that GDP growth may say low “for years to come”. Thus traders could punish the Euro as they price in expectations that the region will substantially lag behind other industrial economies in recovering from the current downturn, forcing interest rates to stay lower for longer than elsewhere.
Euro Zone Economic Confidence figures are expected to tick up in June, though some recovery in sentiment is to be expected as governments’ fiscal efforts filter into the broad economy.
The big question for now is whether growth is sustainable after stimulus cash dries up.
4. JPY Likely to Strengthen as Risk Appetite Fades
Fundamental Outlook for Japanese Yen: Bullish
- Japanese Consumer Price Tumble Lower in May, Raising Risks for Deflation
- Manufacturing Confidence Rebounds From Record Low
- Japanese Trade Surplus Widens as Imports Falter
Similar to the USD, the near term fortunes of the JPY will depend on how optimistic markets are feeling about the recovery, and the ensuing level of risk appetite. The greater the fear level, the better the JPY will do, and vice versa.
The World Bank further lowered its already dismal growth outlook on Monday, which prompted a world-wide selloff in virtually everything except the JPY and USD. As the week progressed markets chose to focus on what positive news there was, including, a modestly more upbeat forecast from the OECD, was based on a more optimistic forecast for U.S. recovery to outweigh worsening conditions elsewhere.
While the Bank of Japan forecasts some economic recovery in the latter half of 2009, retail spending is expected to contract for the ninth consecutive month in May, with the unemployment rate projected to increase to 5.2% during the same period, which would be the highest since 2003. This data could create a weakening outlook for the world economy as the downside risks for growth and inflation intensify.
5. Disappointing Growth Figures Threaten British Pound
Outlook for British Pound: Bearish
- House prices fell by 0.4% in June, which was the first decline in five months
- The British Banker’s Association reported an increase in mortgage approvals in May to 31,162, the highest since April 2008
- OECD lowered its growth forecast for the U.K. to -4.3% from -3.7%
The British Pound finished the week on a positive note after a week of inconsistent price action as it found support from increasing appetite after Monday’s selloff in stocks. Also, the first decline in house prices in five months raised questions over the scope of a U.K. recovery and added to sterling weakness to start the week. The OECD downgrading their growth outlook for the U.K. economy to -4.3% from -3.7% furthered the dour outlook for the economy. A mid week head & shoulder’s pattern and a break below the 20-Day SMA appeared that the pound was head for a significant retrace before it regained its footing.
The BoE warned on Friday that the banking system is still vulnerable to any new economic or financial tensions and that banks will need to be able to survive without government help. It expressed concerns about the ability of banks to extend enough credit to support economic growth if new market strains appeared. Additionally, the central banks cautioned lenders that the level of government aide will dwindle as it becomes less effective, leaving them to fend for themselves. Therefore, if we see the pace of the recovery slow then the downside risks for the GBP could increase exponentially.
The UK economic calendar may give us some insight into the pace of the recovery and the depth of the hole that it finds itself in. Final 1Q GDP figures are expected to be revised lower to -4.3% from -4.1% as the recession deepened during the period. Preliminary GDP readings showed a 12.1% drop in total production which was already double the decline from the fourth quarter.
Forward looking forex traders may not rely on past performance. Rather they may focus on the upcoming PMI readings. The manufacturing gauge is expected to improve for a fifth straight month to 46.4 from 45.4, which would be the highest level since July 2008.
However, the service sector is predicted to fall to 51.5 from 51.7 which is similar to what we saw in the Euro-Zone figures. This sector accounts for much more of the U.K. economy, as much as 70%, and may have a greater impact on sentiment. If we see an upside surprise in the service data then we could see sterling continue its gains with a test of 1.665 the June 3rd high. Meanwhile, weakness in both sectors could be the catalyst for a retreat of the GBP. The GBP/USD has been supported by the 20-Day SMA and a clean break below that level would be a strong signal of more bearish potential with a possible test of 1.600.
6. Commodities and Equities
As noted in the first section above, these will move together with sentiment on the recovery. Optimism suggests
- Growing demand for industrial and agricultural commodities
- Better earnings and thus rising stock prices
- Possible inflation, especially with the unprecedented flood of new fiat bills in all major currencies and thus rising demand for precious metals and other hard assets as an inflation hedge
7. Conclusion: So What Do You Do?
Stock markets tend to be the best barometers of recovery sentiment. Thus:
1. If equity indexes rise, expect commodities and higher risk currencies and commodity currencies [AUD, NZD, CAD] related stocks to perform better against the safer currencies, the JPY and USD.
2. Expect the opposite if they fall.
Thus traders to go long the first group if the overall economic picture looks better, and short these assets if things look worse, The likely beneficiaries of further pessimism would be short positions of the first group, and long positions in the USD and JPY.
Investors, especially buy and hold income investors, need to take a longer view that reflects the big themes mentioned in section 1 above, which we suspect will endure for the coming months. Their income investments should be tied to a diverse basket of currencies, commodities, and other hard assets.
In the longer term, as economies eventually do recover, inflation is likely to be the big concern, which would favor assets linked to commodities, other hard assets, and the currencies with the least debt and oversupply.
8. Disclosure & More Info
Disclosure: I have positions in most of the above mentioned investments.
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