ADP, GDP, FOMC, Whoopee!

This afternoon Ben will be speaking
And pundits will do their critiquing
But ere that occurs
The stat he prefers
Will show the economy’s creaking

Welcome to Wednesday, the first big data day of the week! But both tomorrow, with the BOE and ECB decisions and Friday with the US payroll report are set for excitement as well. Early on today we will see the ADP Employment figures (exp 180K) then Q2 GDP (1.0%, down from 1.8% in Q1). Chicago PMI will probably be lost in the shuffle (54.0) and finally, this afternoon at 2:15, the FOMC Rate Decision (no change at 0.25%) and more importantly its accompanying statement. All eyes will be on the statement as market participants await clues for the next move by the Fed and the corresponding impact those moves will have on every market. What we have learned since the last meeting is that the Fed has begun to seriously consider the issue of ending QE. However, given the tangle of policy initiatives; QE, rates and forward guidance, they have had some difficulty fine-tuning the exact process. It has been 2 weeks since Bernanke testified before both the House and Senate, and we have not heard very much in the interim. Markets have seemed to stabilize during this period, but there remains significant uncertainty over when and how monetary policy will be adjusted further.

With all that said, I think this morning’s data should be seen as quite important. After all, the Fed has made it clear they are watching the data closely and have created formal data triggers for policy adjustments. The ADP data should be seen as a harbinger for Friday’s numbers, and the GDP data is important as a gauge of the Fed’s success. Strong numbers should lead to a stronger dollar, at least somewhat, but this data is really just adding to the body of knowledge with regard to when QE is going to end. And of course, this afternoon’s statement will have a much more direct influence on that. I continue to like the idea I mentioned yesterday, put forth by Professor Tim Duy of Oregon, that the Fed is trying to adjust the mix of policy but not the amount of ease. We shall see.

It is no surprise that the overnight session has been rather dull as everyone awaits today’s news. G10 currencies are all trading within recent ranges with only the AUD on the verge of a breakout. It has slipped a bit more after yesterday’s RBA comments.

In EMG, LATAM currencies seem to be the worst performers of late, especially BRL which has traded to its weakest point in almost 5 years. The situation there is starting to get out of control. President Rousseff seems to be losing her authority, the people are demonstrating in the streets, inflation is trending higher and growth continues to slow. This is not a combination of events that favors a strong currency, and as I wrote back on June 21, the odds of USDBRL rising to 2.50 or beyond are growing. We have just breached the highs made that day and it feels as though there is plenty of momentum for further movement right now. But it is not just BRL that is weak, both MXN and CLP are amongst the worst performers in the emerging markets during the past week as well.

What I have observed of late is that there is no broad dollar trend. Rather than simple risk-on/risk-off, we are seeing markets differentiate between specific national risks, like Australia’s pending rate cuts weakening the AUD or Poland’s move to a Current Account surplus leading to a stronger PLN. On the whole, this is a healthy situation as markets do a better job of allocating risks and assets in this environment. Alas, my concern is that the Fed will have the ability to undo this process by its statement this afternoon. We are about to embark on several days of significant information flow, and I think the only thing of which we can be sure is that FX markets will not be at the same levels Friday afternoon as they are right now.

As I type here are the rates:
EUR – 1.3260
JPY – 97.75
GBP – 1.5205
AUD – 0.9030
BRL – 2.2825
MXN – 12.7050
INR – 60.374

Let’s see where they are Friday afternoon.

Good luck

Australia’s Not Spain

Down Under the problems remain
(Though nothing at all like in Spain)
Investment is falling
So Stevens is calling
For rate cuts to limit the pain

As I scan the FX markets this morning two currencies jump out as interesting, AUD and INR, and the rest have much less to recommend. The G3 currencies are essentially unchanged and most other currencies have seen only limited movement. So let’s talk AUD. Last night, RBA governor Glenn Stevens made a speech where he intimated that as the mining investment boom of the past 3 years wanes, nothing else has picked up the slack. He also noted that inflation was well below target and that the RBA’s previously mentioned scope for further interest rate cuts was likely to be utilized. In other words, look for the RBA to cut at least 25 bps next Monday night, and I would now put a modest probability on a 50bp cut. Market reaction was predictable and immediate with Aussie falling one cent almost instantly and then grinding lower from there. At this point, AUD is less than 1% away from its 3-year lows at 0.8999, but as I have written before, I feel it is just a matter of time before that level is breeched and we head toward the longer term average near 0.80. The combination of further RBA easing and potential Fed tightening (we will get back to this in a moment) will be too much for the AUD to withstand.

As to INR, the decline was pretty steady throughout the overnight session as the market responded to comments by the RBI’s Governor, Duvvuri Subbarao. Last night he was talking about many things, including the Rupee, which he claims the RBI will be able to manage effectively, at least with respect to mitigating volatility. Of course, last night’s 1.7% decline may call that ability into question, but given the ongoing issues in India, with a growing C/A deficit, slowing growth and rising inflation, it will take all the central bank’s skills to keep the currency from tumbling. Frankly, though I have been sanguine about the problems in India in the past, I am losing faith in their ability to manage things at this point. Given the overall slowdown in global growth and the policy paralysis that continues to exist in India it is difficult to be overly optimistic about the currency. I think the RBI will do all it can to mitigate the decline, but at this point, I have come to believe that the INR has further to fall. Could we reach 65? I think the answer is yes.

Now back to the idea about potential Fed tightening. As we all know, this morning the FOMC begins a two-day meeting with the next policy statement to be released tomorrow afternoon at 2:15pm. The Fed is not going to change policy in any way tomorrow, of that I am certain. But the nuances of what they are doing are worth discussing. University of Oregon Professor Tim Duy has made a very interesting observation about the Fed’s policies. ( Right now, policy consists of zero interest rates, QE and forward guidance, each designed to add to easy money. However, there is a growing concern, both inside and outside the Fed, that QE may have reached the end of its usefulness. As I have written, along with many others, unwinding QE will be a very big issue with significant ramifications in the market including increased volatility and likely sharp declines in asset prices. Professor Duy’s observation is that it seems that Bernanke is trying to alter the mix of policies while keeping the same total amount of monetary easiness in place. So the talk of tapering asset purchases is to be taken hand-in-hand with additional forward guidance. In this way, he can start to remove the policy piece that is getting out of hand, while still supporting the market as aggressively as he has been doing all along. This would likely take the form of a reduced economic outlook or even more definitive guidance on when rates are likely to rise again based on further information. Remember, the taper was based on the idea of growth increasing toward 3.0%-3.5% next year. If that outlook is moderated, then the market will expect tapering later, although it would be unlikely to see an increase in QE. But it also could be that a diminished outlook for growth simply means that the taper happens and rates stay at zero for even longer. It is worth reading Professor Duy’s piece for the full explanation. It is quite interesting.

So today is shaping up to be fairly dull with only Case/Shiller and Consumer Confidence. Look for limited activity today, but be prepared for tomorrow, as we open with ADP Employment and then get Q2 GDP and the FOMC statement as the day moves on.

Good luck

The 7% solution?

The market has found something new
Upon which its traders can chew
Will Chinese growth slow
To levels below
The 7% hitherto?

It seems that my time away has been marked by dollar disgust as the greenback has fallen against all the G10 currencies and most of the key EMG ones since I wrote Thursday morning. The US data since then has been mixed, with Initial Claims pretty much as expected, Durable Goods better as a whole, but led by the transport sector with the ex-transport result much worse than expected. Michigan Confidence printed higher than expected, so on the whole I believe this would have been more dollar supportive. However, it seems the market continues to look elsewhere for its cues with concerns over Japanese Fiscal policies evident as well as questions about the state of growth in Europe and China. I also believe that we have seen some position unwinding as the market prepares for this week’s onslaught of new information. Not only do we get the employment situation on Friday (with ADP on Wednesday), we have the FOMC meeting tomorrow and announcing any new policies on Wednesday afternoon. We also will see the first look at Q2 GDP Wednesday morning, so plenty to work with this week.

Tuesday S&P/Case Shiller 12.4%
Consumer Confidence 81.0
Wednesday ADP Employment 180K
GDP (Q2) 1.0%
Core PCE (Q2) 1.1%
Chicago PMI 54.0
FOMC Rate Decision 0.25%
Thursday Initial Claims 344K
Continuing Claims 3000K
Constuction Spending 0.40%
ISM Manufacturing 52.0
ISM Prices Paid 54.0
Friday Non-farm Payrolls 185K
Private Payrolls 187K
Manufacturing Payrolls 0K
Unemployment Rate 7.5%
Avg Hourly Earnings 0.2%
Personal Income 0.4%
Personal Spending 0.5%
PCE Deflator 1.3%
PCE Core 1.1%
Factory Orders 2.3%

Aside from the data we have to look forward to, the key market stories seem to be from both China and Japan. In the former, the announcement of an audit of local government debt has led to further concern over the growth trajectory there. Remember, the Chinese goal for 2013 is 7.5%, and for the decade as a whole it is 7.0%. We have already seen a number of economists release estimates below those numbers and last night we got the newest thoughts, with some scenarios pointing out a decline to 3% could be possible with correspondingly significant impacts on other economies as well as on commodity prices. (While this is not the baseline case, it was given a 1/3 probability, not insignificant.) Concerns over the pace of growth in leverage there have led to worries over ratings cuts as well as an overall destabilization of the country. Not in the sense of revolution, but more in the sense of an increase in protests and more pressure on President Hu and Premier Li to make changes forced by circumstance rather than ideology. It seems that even the Chinese central planners cannot control human nature and all its foibles. The significance here is that a much slower growing China will lead to much slower growth in most of the commodity exporting nations (Australia, Brazil, South Africa, Chile, etc) and corresponding financial concerns alongside likely currency weakness. It will also impact the global growth situation, one of the features highlighted by both the Fed and the ECB in their policy guidance (not to mention the RBA which features it prominently). In my view, this is the type of thing that will lead to longer term USD strength as the US finds itself far less reliant on the Chinese market for growth than almost every other nation around the world.

The Japanese story is also of keen interest to traders with comments from BOJ Governor Kuroda last night indicating that Japan can withstand the Sales Tax increase that is planned for next April. Remember, this has been a background issue as Japan finds itself caught between encouraging growth, which the tax rise will not help, and raising money to rein in the growth in the debt/GDP ratio, which is already the highest in the developed world at over 220%. While there has been much discussion in Japan over whether or not to delay implementation, it seems that with the BOJ on board, nothing will stop the tax increase. You can expect a significant increase in GDP in Q1 of next year as purchases will be brought forward ahead of the hike. The real question will be how the country handles more fiscal drag over time, and given the delicate nature of the current growth path, it is not clear all will work out well, especially if the situation in China lives down to the worst expectations. Right now, the market continues to buy yen on the prospects, but I see no reason to believe that the longer term path in the yen is anything but lower. The realities of a massive money supply expansion will continue to undermine any yen strength. And if anything, tighter fiscal policy will only lead to looser monetary policy, a combination which historically leads directly to currency weakness.

All this has left the euro as the least interesting place to be right now, and while it is marginally stronger over the past several sessions, it feels more like it is heading to the top of its trading range at 1.34, than preparing to break out to new highs for the year. Nothing has changed my view here either about eventual weakness, but I have a feeling that we may have another 1% or so of strength before bringing out the sellers.

Good luck

English Excitement (an oxymoron?)

In England excitement still reigns
As Princess Kate went to great pains
To finally apply
A name to her guy
We’re glad its not John Maynard Keynes

Meanwhile for the rest of her nation
The news was of growth and reflation
The GDP there
Has gone on a tear
Compared to the euro’s stagnation

Dull continues to be the watchword in the FX markets as we passed yet another session of minimal movement in the dollar. Right now we see the dollar modestly stronger vs. most currencies, but the movements have not been very large. The data overnight showed UK GDP growth of 0.6% in Q2, as expected, but confirming a much better number than we are likely to see anywhere else in the G10. However, the pound, in a classic sell the news response, is lower by almost 70 pips as I type. The contrast between the better data in the UK and the still weak data throughout the Eurozone continues to be a daily occurrence.  For instance, Spanish unemployment (non-seasonally adjusted) fell to 26.3%, from its Q1 level of 27.2%. While that is certainly good news on a relative basis, it remains absolutely horrible! More than one-quarter of the Spanish workforce cannot find a job, and it appears the decline in joblessness is a result of temporary work in the leisure industry. So while the Spanish are trying to spin the improvement as important, it seems to me Spain remains a disaster. German IFO data was mixed with the Current Assessment slightly better but the Expectations slightly worse. Again, it is hard to get excited about Europe’s rebound, although certainly yesterday’s PMI data was almost uniformly positive. No matter what happens in the next several months on the continent, it seems clear that the ECB is going to keep short-term rates at their current level for quite a while yet in stark contrast to the US situation. It will be interesting to see how they respond if inflation in the Eurozone starts to pick up given their sole inflation mandate, although that doesn’t seem to be a worry for now.

At the same time, the US data continues to be mixed with yesterday’s New Home Sales numbers a bit stronger than expected, but that followed weaker than expected Existing Home Sales and Housing Starts data in the past week. We saw Philly Fed numbers the strongest in more than 2 years, but Richmond’s corresponding numbers fell back to their weakest in a year. In other words, the US situation is one of an economy transitioning from weakness to stability, and then hopefully stronger growth. At the end of the day, however, all eyes remain on Bernanke and his brethren on the Fed as the prime movers of both policy and markets. And so, the question remains, what will the Fed do when they meet next week? Certainly there will be no rate change, and it doesn’t appear there will be any change in the QE program right now, but the statement will almost certainly have to address the taper, as that concept has received so much attention during the past two months. My guess is they will mention the idea and maintain it remains a future endeavor based on the economic data. Given the pretty violent response by the markets to the idea, I am sure they will want to be as benign as possible and despite Bernanke’s ‘efforts’ to enhance clarity, I think the statement will go in for a little Greenspanian obfuscation. Until then, I think the dollar remains on better footing for lack of alternatives.

Today we see Initial Claims (exp 340K) and Durable Goods (1.4%; 0.5% ex transport), neither of which is likely to move the FX market but both of which will add to the overall discussion. However, the equity markets may see a bit more movement based on the numbers. Yesterday I wrote that I expected the equity markets to suffer based on the idea that stronger EU growth would result in the end of QE sooner rather than later. I was only marginally right yesterday, but equity markets have fallen further overnight and with the better UK data confirming this mini-trend, I would expect a strong Durable Goods number this morning to result in even worse equity performance. In addition, the earnings numbers have not been stellar, further weighing on the equity market and the entire endeavor continues to appear untenable to me. Remember, my thesis is that the equity market (and by extension most markets) is supported entirely by the concept of QE going on forever. Talk of the taper confirmed that hypothesis, especially as the Fed walked back the message. But if growth starts to pick up, we are in for a much more intense dialog on monetary policy, which can really only get tighter from here. And as I have written many times in the past, tighter monetary policy will lead to a stronger currency and weaker equities.  I think in the current situation, this is especially true, so future USD strength (and equity weakness) remains on the cards.

There will be no poetry tomorrow morning, but I will be back on Monday to see if I have learned anything new (at all?) about the markets.

Good luck and good weekend

Problems Still Ooze

While markets seem rather subdued
The one thing that we can conclude
By reading the news
Is problems still ooze
From countries both stupid and shrewd

Once again a roundup of the overnight news highlights the weakening growth in China (HSBC PMI 47.7, exp 48.2) contrasted to the surprisingly stronger data from Europe (Eurozone PMI 50.1, exp 49.1).  While there are ongoing financing problems in Spain, it seems the FX market remains quite comfortable with the single currency for now.  The funny thing about the stronger EZ numbers is that I think the market will make the following assumption:  Bernanke mentioned weaker EZ growth as a downside risk hence reducing the chance of a quick taper => equities rallied; but now, EZ growth is picking up and a quicker taper is back on the table ergo selling equities seems a better bet.  As I type, SPU’s are modestly higher, and European equity markets have rallied about 1%, but as the US walks in and the day progresses, I suspect that the equity markets may find themselves selling off somewhat today.

FX markets, however, continue to lag the action.  The China story remains the current fixation, with both the JPY and AUD falling after the PMI data was released. And though the euro is modestly higher this morning after the PMI data there, in truth the movement across the other major currencies, besides AUD and JPY, has been tiny, about 10bps.  So FX players remain sidelined, as I forecast, and are awaiting what they perceive as important data, like next week’s employment report.  Problems around the world have not moderated at all, but they have not accelerated either, so at the margin, things are just not that interesting.  Given this environment it is difficult to forecast substantial short-term movement in the FX markets.  However, a quick roundup of the longer term problems that still exist shows that the financial crisis that began 5 years ago remains with us today:

  1. Spain is drawing down its National Pension assets, thus removing one of the only buyers of Spanish bonds from the market.
  2. There are no buyers for Greek government assets.
  3. The Portuguese government remains on shaky footing with no ability to choose between flouting their promises to the Troika or imposing austerity at home.
  4. The Italian Grand Coalition has passed no new legislation addressing the massive structural problems internally.
  5. The Germans remain unwilling to finance the bill for greater Eurozone integration until at least after the election in September.
  6. Bank regulators around the world are proposing higher capital and leverage ratios for large banks because the risks to the financial system remain significant; and finally
  7. US politicians are proposing easier standards for banks to issue mortgages because higher rates have reduced both supply and demand for home mortgages.  (It strikes me that this and the demand for more capital are in direct competition for the same funds.  I wonder how this will turn out!)

None of this would lead me to believe that the world is different today than it was six months ago, and most of the problems extant then remain in place.  So, what does this mean for FX?

EUR – I still like it lower, as the Fed taper comes back on the table and the ECB remains firmly entrenched on an easing path.  While I have been impressed with the resilience of the single currency, the fundamentals still point lower in my mind.

JPY – A weaker yen is still on the cards.  Doubling the money supply and rising inflation will serve to do the job.  I continue to like 110 by year end.

GBP – This is likely the only currency that will hold its own as the growth story seems to be more stable than in the rest of Europe, and I believe that Carney will be responsive to that data as time progresses.

AUD – There is nothing to encourage anything but a further decline.  Slower Chinese growth and more rate cuts will undermine any ideas over ‘safety’.  0.80-0.85 by the end of the year.

LATAM – These currencies will continue to suffer as the year progresses.  Neither Mexico nor Brazil is showing signs of positive economic performance and in Brazil the inflation situation is becoming uncomfortable.  BRL = 2.30-2.35 at year end. MXN = 13.50-13.75 by then.

Other EMG – we have already seen 1/3 of the hot money that went into these markets during 2012 and Q1 2013 flow out in the past 2 months.  More will leave and these currencies will suffer accordingly.  While I expect that most EMG central banks will look to smooth the declines, these currencies are going to weaken further vs. the dollar.

This morning’s US data brings New Home Sales (exp 484K) but I don’t think it will matter to the FX folks.  Today is likely to be another day of limited movement overall.

Good luck


The Chinese Have Set out a Floor

As growth round the world slows some more
The Chinese have set out a floor
Of Seven percent
So they can prevent
The social unrest they abhor

It is shaping up to be another very dull session in the FX markets today as a dearth of news and data combined with the ongoing summer vacation schedule has kept traders on the sidelines. The most interesting news overnight were the newest comments from Chinese Premier Li Keqiang, who has established 7.0% as the floor for growth that is acceptable to the leadership. My reading of the constant changing (lowering) of this ‘target’ is that the growth numbers are falling and they are trying to get ahead of the announcements so they can claim all is well with their programs. What does appear to be ongoing in China is a greater reliance on the domestic consumer and less export focus, but it remains to be seen how long the government there will be willing to go down this path, especially if the employment situation worsens and they find themselves with many millions of unemployed young men. That is their nightmare scenario, and one which they will do anything to avoid, including significant economic pump-priming. As such, we will need to watch the events there with increasing interest. What we do know is that hot money continues to fly out of China, and emerging markets in general, as concerns over slowing growth combine with better opportunities in the developed markets. From an FX perspective, I would expect this activity to support the US Dollar as Treasuries, at their current yields, are the most likely place for capital flows.

As such, it is no surprise that the dollar is marginally stronger this morning against most currencies, but the operative word here is marginally. The biggest mover has been the yen, falling about 0.5% and just getting back to 100.00. The other major currencies are all mere pips from yesterday’s levels and showing no signs of moving. The overnight data showed only that French Business Confidence was a bit better than expected, and later this morning we see Canadian Retail Sales. This is not the stuff that moves markets. So what will be the next driver? My money is on the next comments we get from Bernanke or other Fed members, or perhaps Draghi and his ECB cohorts. With nothing scheduled for today, it appears that we have achieved the very definition of the summer doldrums.

One thing to note has been the decline in currency implied volatilities during the past several weeks. This does represent an opportunity for hedgers who purchase options to take advantage of relatively cheap pricing. But otherwise, look for limited movement for the day. As I wrote yesterday, all eyes are starting to turn toward next Friday’s employment situation report, and we may not see very much activity between now and then.

Good luck

Not Quite a Landslide

Not quite a landslide
But ‘nuf for Abenomics
To take the next step

The PIGS feel austerity stinks
More protests are coming methinks
The Portuguese pain
Is mimicked in Spain
How long before one of them blinks

The weekend brought two stories of note to light; the outcome of the Japanese Upper House election and the ongoing struggles within the European peripheral countries as they attempt to reinvigorate their economies. The broad based market response has been a slightly weaker US dollar, mixed equity markets and very modest gains in the bond market.

Let’s start with Japan. To no great surprise, the LDP in conjunction with their coalition partner New Komeito, have won a majority in the Upper House of the Diet, which now gives them control of both houses of government and a mandate to continue PM Abe’s attempts at jumpstarting growth there. One of the concerns with the election results was that the voting turnout was the second lowest on record at just over 52% of the eligible population. That hardly smacks of enthusiasm, but despite that, Abe now has the opportunity to relaunch his ‘third arrow’ and address structural changes that need to be made in Japan in order to enable future growth. I was disappointed in the FX market reaction where the yen has strengthened a bit, right back to 100.00, despite a modest rally in the Nikkei and the increased hopes for further action. I attribute this move to a ‘buy the rumor, sell the news’ effect and fully expect that the yen will weaken over the course of the summer. There was modestly encouraging news overnight as Supermarket Sales in Japan rose 2.7% Y/Y in June, up from a reading of -1.2% in May. This represents further progress on the economy, but the real news will come Thursday when we receive CPI data with current expectations for 0.1% Y/Y as a headline number and -0.3% ex food & energy. If those numbers print higher than expected, I would look for a USDJPY boost. However, until then, I imagine the yen will trade either side of 100.

The other news of note over the weekend was the failure of Portuguese President Anibal Cavaco Silva’s attempts to create a national unity government to help implement the necessary austerity measures still in store for that nation. The Troika is insisting on an additional €4.7 billion of spending cuts in the coming fiscal year and unremarkably the Socialists, who oversaw most of the descent into fiscal crisis, are not willing to go along with the demands. Austerity in Portugal, Greece, Spain and Ireland is becoming too great a strain on the national psyche and we continue to see an increase in the protests by ordinary citizens. This message seems to be getting through to the G20 leadership as their statement over the weekend was that they were committed to fostering growth with a secondary effort to insure fiscal responsibility sustainability. It appears that Lord Keynes continues to hold sway over the entire policymaking universe, at least the part of Keynes that said priming the pump was a good idea. In fairness to Keynes, he always called for fiscal prudence during strong economic periods, alas that part of his discussion gets short shrift from politicians of most stripes.

So in what is shaping up as a quiet start to a quiet week, the most likely catalyst for movement will come from Fed commentary or bond market gyrations. The data this week will tell us more about the housing market and its response to recently increased mortgage rates, as well as further manufacturing data in the form of Durable Goods.

Today Existing Home Sales 5.25M
Wednesday New Home Sales 485K
Thursday Initial Claims 340K
Continuing Claims 3022K
Durable Goods 1.1%
-ex Transport 0.5%
Friday Michigan Confidence 84.0

But it is to next Friday’s payroll data that the market is turning its eyes as that is the information most closely watched by Bernanke and his colleagues on the FOMC. Until then, I see little reason for substantial movements given the combination of a lack of news and summer vacation season. So leave orders at comfortable hedge levels and enjoy the lack of excitement for now. It will return, I promise!

Good luck