Background
Before Thursday’s U.S. employment data, there were many who could still see global markets heading higher. For the near term, that opinion now appears out of favor. The debate is now whether markets will continue their mostly horizontal tight trading ranges of the past month or more, or if their retreat from May’s highs will now prove to be the beginning of a new down trend to test support levels.
For those who missed the fireworks, here’s a recap.
Most Markets (Risk Assets) Rise Through May, Consolidate in June
Having spent most of the year rising, global forex, commodity, and stock markets stopped rising and spent June in tight trading ranges, reflecting uncertainty about whether the gains thus far were justified by the very mixed fundamental evidence that employment, earnings, GDP, or any other major measure of growth would in fact show similar growth within the coming year. The next big clue was this week’s U.S. monthly new non-farm unemployment claims report.
Is July the Turning Point? Or Just Another Move Down Within Price Channels?
Markets were nervous on Thursday before the Non-Farms Payrolls report came out, with Asian, and European stocks already solidly down on Thursday before the report came out. The results confirmed the fear.
The U.S lost 467K jobs in May, about 29% more than the 363K forecasted and 45% above April’s surprisingly small (at least in today’s market) loss of only 322K jobs. This report, issued at the beginning of June, had fed hopes that the worst might be over, and kept world stock and commodity markets mostly, trading in a horizontal range near their highs for the year, awaiting further news to justify the 20-30% gains in stocks since the beginning of March and nearly 100% gain in crude oil since 2009 began.
This report dashed those hopes, causing a predictable sell off in US trading on Thursday in “risk-appetite” assets that appreciate with optimism about the world economy stocks, commodities, and higher risk currencies (the AUD, NZD). Safe haven assets, particularly the JPY, USD, and CHF currencies rose against other currencies deemed riskier.
Friday’s trading was mixed as the markets stabilized to digest the news and await further data.
Big Themes For the Coming Week
Thus until the next big news hits, the likely best scenario is for continued trading in ranges established over the past 4-8 weeks, as riskier assets approach and test the low end of their price channels for support and safer currencies possibly drift up to test the upper price ranges.
If nothing comes sooner, earnings guidance and announcement in the coming weeks could be the catalyst for the next big move. Most important will be from the financial sector, which has been the source of major market moves over the past two years.
Thursdays’ much anticipated and very disappointing monthly new non-farm unemployment claims report gave us perhaps the biggest clue about the recovery (or lack thereof)since the IMF issued its downward revision of growth prospects for most of the world’s economies about two weeks ago. The OECD followed days later with a slightly more upbeat forecast based on a more optimistic view of the U.S. economy, which it predicted would provide enough improvement to outweigh the admittedly worsening picture elsewhere. The OECD view appears less likely in view of the much worse than expected US jobs picture for May.
Thus the rally in world “risk assets” like stocks, commodities, and riskier currencies like the AUD and NZD may indeed be well ahead of supporting fundamentals, and 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, and stocks, either in the form of an outright downtrend, or continued trading in the current ranges established over the past 4-8 weeks, with risk assets approaching or testing support levels, and safe haven assets like USD, JPY, and CHF currencies moving in the opposite direction
- If March lows tested in global stocks, possible long opportunities, especially for buy and hold income stock investors
US Dollar: Still in Horizontal Channel, But Risk Appetite Will Decide
Risk Appetite has Been the Key Factor in Currency Markets, So Rising Fear Could Boost the USD Toward Its Upper Range
Summary
Overall USD Outlook: Neutral – But More Fear Could Well Boost the USD
- Thursday’s non-farm payrolls disappoint badly, suggest accelerating job, spending, and bank asset decline. Supporting the sense that the US jobs picture is indeed worse than expected was the lack of rise in average hourly wages and decline average hours worked. Thus even the officially employed are overall, earning less.
- ISM manufacturing shows contraction continuing to slow down, but still below 50, for 17th straight monthly decline
- US consumer confidence data disappoints due to lack of evidence of growth, especially job and wage growth. Not good, but not so bad, since recent incidents of positive news on confidence has not translated into increased spending, which is the primary value of this data.
USD Rises on Fear, Not Fundamentals
Risk aversion, certainly not fundamentals, made the USD the strongest of the majors. In May there were those who questioned whether the dollar was still seen as a safe haven. Both the World Bank downgrading of world economic growth and the recent US jobs data driven market drops have reaffirmed the USD’s safe haven status.
Since the current crisis began, bad news, especially from the still most economically important US, has paradoxically strengthened the dollar in the short term because it is still seen as a safe haven. However, given the worsening employment and wage picture, the longer term picture for the USD is worrisome, since fewer jobs and lower earnings means less consumer spending, which is about 70% of the US GDP. Of course that means lower exports to the US for the rest of the world’s economies, which would also weigh on their currencies. Thus the dollar need only be the least ugly currency of the bunch to be the strongest.
It’s also a major problem for the US banks, as poorer consumers mean declining value for both residential and commercial mortgage portfolios. The bank stress tests assumed a worst case 8.9% for 2009, and we’re already officially well above that. The real figure could easily be worse.
Perhaps the biggest news Monday is the US ISM Non-Manufacturing Purchasing Managers index (PMI), which is expected to improve from 44 to 45.9, that is, show decreasing contraction. This figure is a leading indicator for about 70% of economic activity in America, and includes the huge US services, retail, and financial sectors. A positive surprise could at least help keep markets in their multi-week trading ranges. The opposite could add fear to an already nervous currency market, and trigger more risk aversion and USD strengthening.
Euro Volatility Likely Ahead of Central Bank Interest Rate Decision
Summary
Overall Euro Outlook: Bearish
- Despite poor growth, rising unemployment and possible deflation prospects for 2009, ECB leaves rates unchanged
- Euro Zone Industrial data indicates weak domestic demand
- Yet German Retail Sales provide some optimism on domestic consumption.
Neither the ECB’s refusal to lower rates, nor the nasty US jobs picture, could get the EUR/USD out of its recent tight trading range, as if they both seem to become less appealing at the same relative rate. Thus the 1.400 support level has held.
Potential Market Movers for the EUR
News that might move the pair this week includes:
- The US ISM Non-Manufacturing report. As noted above, a disappointment would likely up the anxiety levels, drop stocks, and boost the Buck
- Final Revisions to Q1 Euro Zone and British GDP
JPY Likely to Strengthen as Risk Appetite Fades
Summary
Fundamental Outlook for Japanese Yen: Bullish
- Japanese Consumer Prices Drop in May, Raising Risks for Deflation
- Manufacturing Confidence Rebounds From Record Low
- Japanese Trade Surplus Widens as Imports Sputter
The Yen and US Dollar share two key similarities
- Like the USD, the near term fortunes of the JPY will depend mostly risk appetite, not underlying fundamentals for the Japanese economy. Thus the more gloom for everything else, the more these two tend to rise
- That’s good news for both currencies, because both economies are struggling
While the Bank of Japan forecasts some economic recovery in the latter half of 2009, retail spending is expected to shrink 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.
GBP, Already Pounded by Growth Figures, Political Uncertainty, May Take Further Abuse from BoE Rate Decision
Summary
Outlook for British Pound: Bearish
- UK Q1 PMI Service drops in June from 51.7 to 51.1
- June UK manufacturing PMI rose from 45.4 to 47.0, but the above services drop outweighs it
- UK Q1 GDP fell 2.4%, revised lower from -1.9%
Time to whip out that stiff upper lip, they’ll need it (as do we all).
The Sterling had jumped higher to start the week after Nationwide showed house prices gained 0.9% in June which spurred hope that the housing sector stabilization would lead the way to a recovery. However, the depth of the first quarter contraction shook forex traders as they realized that Britain would need to dig itself out of a deep hole. Although manufacturing reach its highest level since May 2008 at 47.0, it remained below the 50 boom/bust level for the fifteenth consecutive month. Adding to the bearish sentiment was the key service sector regressing to 51.5 from 51.7, which, similar to the US, accounts for 70% of GDP.
Nevertheless, the sector remained in expansion territory so not all is lost. Also, the BoE reported that Brits are paying down mortgage debt at a record pace. Good in the long term, though bad for key consumption figures in the short term.
Potential Key News to Move the GBP Markets
The upcoming Bank of England rate decision could be the major event risk for the week if we see the central bank issue a statement addressing its future intensions regarding quantitative easing. It is widely expected that they will leave their benchmark rate at 0.50% with signs that downside risks remain for the economy. Some believe the next step for the BoE is to develop a plan to unwind its quantitative easing policy. However, MPC member Tim Besley said this week that 'there is no sense in which there is a specific timing discussion,' when asked about QE and how to get out of the policy.
Manufacturing, consumer confidence and inflation data this week will provide insights into the state of the U.K. economy and the scope of a recovery. Slower output growth and declining prices will add to the bearish outlook that is beginning to form, while an increase in consumer confidence will give hope. Additionally, the Visible Trade Balance report will show us that state of demand for British goods.
The GBP/USD has broken below the 20-Day SMA which it hadn’t closed below since 4/29 adding to the signs that we may see continued losses for sterling this week. However, improving fundamental data and a positive BoE help the GBP.
Again however, the big force in forex is risk appetite/aversion. If global markets move down, so might the GBP/USD
Commodities and Equities
Summary
As noted in the first section above, these will move together with sentiment on the recovery. The past month’s stagnation of global stock markets, and an overall negative theme to the past two weeks, including:
- World Bank downgrade of economic growth forecasts
- OECD’s mildly more upbeat outlook based on a more optimistic view of the US, which is proving wrong, as shown by Thursday’s nasty picture of the US jobs and average hourly wage and hours situation, which will further batter consumer spending and ultimately the critical financial sector
The rising pessimism suggests
- Near term drop in industrial and agricultural commodities prices
- Lower earnings and thus stock prices
- Possible near term deflation , with inflation expected as things improve, especially with the unprecedented flood of new fiat bills in all major currencies and thus long term rising demand for precious metals and other hard assets as an inflation hedge
So What Should An Investor 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.
3. If stock markets come in to test March lows, that could provide an opportunity for investors,
especially buy and hold income investors, to begin taking long positions in stocks with the criteria we’ve recommended over the past half year. That is, stocks that produce a reliable dividend of over 7% 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. See prior articles from May and earlier.
Disclosure
I have positions in most of the above mentioned investments.
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