G20 fissures eerily reminiscent of the 1987 crash

Nick Beecroft, Senior Markets Consultant

On ‘Black Monday’, Monday, October 19, 1987, stock markets from Hong Kong to the US crashed, with the Dow Jones Industrial Average (DJIA) dropping by 508 points to 1738.74 (22.61%).

Those were nervous times; in the weeks preceding the crash the markets had become increasingly concerned about the deterioration in macro-economic indicators, including the US trade deficit and inflation, (uncomfortably high), and the dollar was disturbingly weak, implying imminent increases in US interest rates. US Treasury yields also seemed to be on the point of exploding, but perhaps the straw that broke the camel’s back was US Treasury Secretary James Baker’s comment over the weekend to the effect that the US would drive the dollar down further, (to address the burgeoning trade deficit), unless the Germans changed their monetary policy, halting interest rate increases, which he believed were stifling growth and causing excessive Deutsche Mark strength.

This very public policy rift between the politicians and central bankers of West’s largest economies was extremely unnerving for already febrile markets.

The parallel with the present day is obvious and perhaps very disturbing; i.e. the major rift that was apparent at the recent G20 meeting, with the US cautioning against excessively brutal and precipitate austerity measures and almost unanimous opposition from the nineteen other countries present, who displayed the characteristic zeal of new converts, in this case to fiscal probity.

Moreover, the debate also rages at the very heart of the Obama administration, with Budget Director Peter Orszag resigning last week, ostensibly to spend more time with his family, but by all accounts in reality over his concerns at the US budget deficit trajectory, or rather at the lack of urgency shown by the administration in devising a plan to cut same.

Once again, the main dispute could be said to be between the US and Germany, with the latter intent upon ‘hair-shirt’ fiscal policies, even though Germany’s bunds are still seen as a safe-haven amid Europe’s debt crisis, and its budget deficit is a very respectable 60% of GDP.

The last thing the markets need or want right now is to have to face the possibility that the world’s finest economic brains are utterly divided as to the best way to proceed. Yes, as in 1987, these are nervous times, as evidenced by the surge in the price of gold. This time the buyers of gold are not primarily driven by fears of inflation, this time they’re just party to an all-pervading fear that something very unpleasant is out there, probably driven by the debt crisis, which has now morphed from a private debt problem to the infinitely more worrying sovereign debt variety - as one commentator put it rather pithily recently, ‘who’s going to bail us out now the governments have run out of money, the Martians?’

This time US should be, and indeed is, more afraid of deflation and a strong US dollar. Judging from the Fed’s post-meeting statement last week, and previous meetings’ minutes, the FOMC is certainly concerned about the possibility of deflation. A strong dollar will do nothing to help President Obama’s plan to double exports over the next five years and it will bear down on inflation.

Right now, the US needs Germany to boost domestic consumption and, as we move further into the second half of this year, the fiscal policy debate between the ‘spendthrift’ US and ‘prudent’ Germany/Europe will become ever more heated. Suspicion will grow amongst the usual suspects in Congress that the EU is quietly very happy to see the Euro depreciate massively against the dollar, and soon we will hear strident comparisons with China.

Expect, at best, lack-lustre equity performance, and continuing safe-haven buying of the US dollar and Treasury bonds or, at worst, a crash. 

FX Closing Note: Back to the brink - how deep is the abyss?

John J. Hardy, FX Consultant, Saxo Bank

FX Closing Note: Back to the brink - how deep is the abyss?

The storm of risk aversion that began in Asia overnight swept around the world and completed its destruction of all major markets with a miserable session on Wall Street, as the major US equity indices fell back below Dow 10,000 and the US S&P500 looks to notch its lowest close on the year - around 1040 and right on the neckline of a rather scary head and shoulders formation. Cursory projections suggest a high risk of a fall toward the 900 area or below if the cold winds of risk aversion continue to blow.

So how would such a continuation of this move in risk aversion affect FX? After some degree of surprising resilience in especially the AUD of late despite generally negative risk tendencies elsewhere, the commodity currencies fell like a trio of lead zeppelins today vs. especially the USD, JPY and CHF. (In EURCHF, we suspect that the time horizon for declines like we have seen in the last three days may only stretch another day from here, as similar markets in the past show that four large days of declines is often the most you get in parabolic kinds of market action. The tricky aspect here is more the price than the time, since acceleration is sometimes at the highest as the trend comes to an end before someone finally steps into the breach.

Apparently it took negative implications from China and a commodity sell-off to get things rolling for the bears on these currencies as the market had perhaps been distracted enough by the weak US economic data to avoid buying greenbacks for a time (perhaps some tired old EM decoupling thinking going on out there?). But today showed the folly of that tack, as an absolutely horrific US Jun. Consumer Confidence surprise (doubly so from the confusing improvement in the Michigan data) triggered a further collapse in market confidence that rewarded the USD rather than the pro-risk currencies - the old pattern, in other words.

The US Consumer Confidence number is made of two equal parts: present situation and expectations. The present situation component moved to a three month low and - very much like the weekly ABC number - has never come very far off the near historic lows established last year. The expectations component dropped to a three-month low after posting a new 20-month high in May.

In the recent past we have theorized that the Euro might eventually be rewarded to some degree for its liquidity whenever a risk sell-off gets particularly steep. This was certainly the case back in mid-May, the first time risk aversion caught the overly short Euro FX market by surprise and saw a huge squeeze in Euro shorts, despite the fact that most of the market's misery was seen as triggered by trouble in the EuroZone sovereign debt market. That's the way the market's twisted logic works sometimes, and this time around we could see tremendous upside for the likes of EURAUD, EURCAD, etc.. if the  head and shoulders scenario for risk plays out and the bear continues its fearsome growl

EURAUD
The huge short squeeze from May only yielded to a grind back toward the cycle low, which is also the record low for this currency pair. This echo rally could set up a sequence of another 1000 pips or more higher as long as risk aversion remains the theme.

EURAUD and rate spreads
Here's a chart showing EURAUD vs. 2-year swap spreads. Of course, some of the divergence here suggesting that EURAUD is underpriced is due to the sovereign debt issue that Australia has almost entirely escaped, but the last squeeze showed us that market positioning can sometimes trump all else.

Looking ahead
Let's see how the weekly US ABC consumer confidence number compares with the monthly Conference Board number. We suspect there may have been a drop in the former considering the latest Obama poll ratings, the action in the markets, and the sense of utter helplessness stemming from the oil spill, not to mention continued high joblessness.

Again - watch out for the Australian housing data tonight, with a poor showing in either prices or volume potentially offering further reason for a capitulation in Aussie longs (and any rally a possible excuse for new bears to lever up now that the 0.8550 area has fallen). Tomorrow we have Canada's GDP number for April, the US ADP employment report for June, and the June Chicago PMI.

Stay careful out there as always.

FX Update: Will the USD make a stand this week?

John J. Hardy, FX Consultant, Saxo Bank

FX Update: Will the USD make a stand this week?

The G-20 provided little grist for the market's mill, with global leaders mostly focusing on attempting to show unity on the fiscal austerity front with a pledge to cut budget deficits in half by 2013, while at the same time attempting to stem the market's worry that too much simultaneous fiscal austerity would damage growth prospects. And at least two of the major sinners in the fiscal department - the US and Japan - objected to some of the language on deficit reduction pledges. Regardless, the winds of austerity have been blowing around the world for some time, so this is by no means market-moving news. The G-20 leaders also claimed that agreements were on the way for establishing international standards on capital reserves for major international banks, though there seems to be wide agreement from commentators that any new framework will not have much bite. On the most contentious issue - China's manipulation of the yuan level, the G-20 swallowed China's bait, hook, line and sinker and China received considerable praise from other members for its recent move, though it insisted on the removal of a sentence in the final communiqué that singled out and praised its efforts on currency reform, and continued to suggest that any moves on currency were entirely its own business.

Looking ahead:
Looking at G-10 FX this week, it is clear to us that the over-riding technical focus for the week will be whether the US dollar can make a stand this week through the heavy economic data calendar and as the 55-day moving average in the USD index approaches. The question is particularly pertinent in the USD/commodity currency crosses, where the recent sell-off in risk has failed to generate as much support for the greenback as one would expect - particularly in NZDUSD and AUDUSD. The tanking NBNZ Business Confidence overnight was a bit of worry for the kiwi.

Chart: NZDUSD
NZDUSD has a long history this year of playing cat and mouse with the 200-day moving average and now finds itself sandwiched between that level and the 55-day moving average (black and red lines, respectively). This week is likely to see a resolution to the tension one way or another. We generally favor the downside barring a rally in risk.

Economic Calendar Highlights this week

With the relative lack of new developments over the weekend, we take the chance to preview a few of the highlights from this week's relatively busy an interesting economic calendar below.

Tuesday

• Japan May Industrial Production/Household Spending/Jobless Rate - The month-on-month rates for Industrial Production appear headed back to zero growth as we look for signs of whether the inventory rebuilding cycle is over. Household spending is beginning to look uninspiring again on year-on-year comparisons , but end demand in Japan always looks like it it in terminal decline.
• Sweden Retail Sales - posted the worst year-on-year number since the crisis months of 2008 and 2009. The data needs a rebound or we begin to worry about the fate of the domestic economy in Sweden, especially the implications of a potential housing bubble unwind -and the Riksbank is warming up for its first rate hike later this week.
• UK May Mortgage Approvals - mortgage approvals have tapered off this year from 2009 levels (though they have been essentially flat for several months), even as prices have advanced higher - a sign of topping out in the housing market? A double dip in housing is an imminent danger in the UK as well, as its earlier bubble never has been fully unwound.
• EuroZone Jun. Industrial/Consumer/Economic Confidence - the EuroZone crisis has seen remarkably little impact on confidence surveys, which have largely managed to improve up to this point - can this continue?
• US Apr. S&P/Case-Shiller Home Price Index - month-on-month figures just barely dipped into negative territory in Feb. and March, and we will likely see very ugly numbers through at least June for this index - which is still considered the best house price index despite its tardiness.
• US Jun. Conference Board Consumer Confidence - why is confidence surging even as retail sales have fallen sharply, Obama's popularity is nose diving, and the oil spill continues to spew? Will this survey match the strong gains evident in the Michigan survey? The weekly ABC survey remains range bound, but the Conference Board number contains an expectations component.
• US Weekly ABC Consumer Confidence - see above. This survey has been mired in a very low range for over two years.

Wednesday

• Australia May HIA New Home Sales - the Australian housing market is a ticking time bomb and we have seen higher prices at lower volume in this market in recent months - a troubling sign. The RBA is hiking and most mortgages are financed with variable rates - which are now 150 bps higher than they were a year ago.
• Germany Jun. Unemployment - German official unemployment levels are close to the lowest they have been since....shortly after the 1991 reunification. Can this be possible? The low unemployment level is a result of Germany kurzarbeit program, which allowed more workers to stay on the payrolls, even as hours and wages were reduced, as well as to the global inventory rebound, which is a boon to German production and export industries. As well, Germany never suffered a distorting housing bubble. These factors are worth consideration if the DEM is ever spun off from the Euro.
• US ADP employment change - this number is more worth following than the NFP number as it doesn't include the egregious degree of statistical correction. Worryingly, it appears from this number that payrolls gains topped out earlier this year and only expanded slightly in June.
• Canada Apr. GDP - Canada has been on a torrid growth pace. This could slow in coming months as the housing market tops out and if energy prices remain well below 80 dollars a barrel.
• US Chicago PMI - it appears the inventory building cycle may be topping out. This is the final major regional survey before Thursday's ISM survey.

Thursday

• Australia Jun. AiG Performance of Manufacturing Survey - still strong in May, in contrast with the very bad, and more worrying services survey (due up on Monday).
• Japan Q2 Tankan - likely reasonably strong as Q2 was the heart of the global inventory building phase. This survey is never particularly timely or leading due to its infrequency.
• Australia May Retail Sales - one of the world's most indebted consumers seems happy to keep on spending, though interesting that the recent services survey was so weak.
• Australia May Building Approvals - one of the indicators to watch for signs of the Australia housing bubble rolling over.
• Sweden Riksbank Interest Rate decision - looking for the Sweden to be the final G-10 central bank to join the "hikers" with a 25-bp move as the country. The market is looking for 125 bps of tightening in the year ahead - but will the Riksbank join the RBA, BoC, and Norges Bank in adjusting expectations lower due to the economic uncertainty and the particular EuroZone challenges?
• UK Jun. PMI Manufacturing - recent months were likely the highest this survey will reach for the cycle, though anything over 50 still represents improvement
• US Weekly Initial Jobless Claims - this survey needs to start posting sub-400 levels consistently to upgrade the outlook for US employment. Until then, stagnation at best.
• US Jun. ISM Manufacturing - the manufacturing recovery won't get any stronger than the May number - the question is how quickly the survey drops from here.
• US May Pending Home Sales - this is the first month after the home-buying tax incentive, so it will naturally fall off a cliff, just like we saw with New Home Sales data for May, but this is widely expected.
• US Domestic Vehicle Sales - interesting that, while vehicle sales volumes have risen on average this year, we are still at sales rates consistent with...the mid-1980's. Remarkable.

Friday

• US Jun. Change in Nonfarm Payrolls - this number looks to come in negative due to the distortions from the census hiring and firing, which is why focus has shifted to the "private payrolls" number, which worryingly dropped in May. Let's hope a new downward trend is not on the way. Consensus expects a stronger June reading in private payrolls, though claims data suggests otherwise.
• US Jun. Unemployment Rate - likely to tick back higher from census effects. The worrying thing here is the sustained high level of unemployment, which has never been seen in any post WWII recession in the US.

Economic Data Highlights

• UK Jun. Hometrack Housing Survey saw prices rise +0.1% MoM and +2.1% YoY
• Japan May Retail Trade fell -2.0% MoM and rose +2.9% YoY vs. -0.1%/-4.0% expected, respectively
• New Zealand Jun. NBNZ Business Confidence fell to 40.2 vs. 48.2 in May
• Sweden May Trade Balance out at 2.7B vs. 7.5B expected and 6.4B in Apr.
• Sweden May Household Lending rose 9.1% YoY vs. 9.2% in Apr.
• Germany Jun. CPI rose +0.1% MoM and +0.9% YoY vs. +0.1%/+1.0% expected, respectively
• US May Personal Income rose +0.4% MoM vs. +0.5% expected
• US May Personal Spending rose +0.2% MoM vs. +0.1% expected
• US May PCE Core rose +0.2% MoM and 1.3% YoY vs. +0.1%/1.2% expected, respectively

Upcoming Economic Calendar Highlights

• US Dallas Fed Manufacturing Activity (1430)
• US Fed's Warsh to Speak (1645)
• New Zealand May Building Permits (2245)
• Japan May Overall Household Spending (2330)
• Japan May Jobless Rate (2330)
• Japan May Industrial Production (2350)
• Japan Jun. Small Business Confidence (0500)

How to Beat the Stock Market with Less Risk

By Dr. Steve Sjuggerud

Eight hundred thirty six percent.

That's how much you'd be up if you'd invested with hedge-fund manager Dan Loeb from the start of his fund in late 1996.

For comparison, the S&P 500 is only up 4.5% a year since then.

Even better, Dan earned those returns with less risk – less volatility – than the stock market.

He has only underperformed the S&P 500 twice since inception. Importantly, he didn't lose money in either of those two years. His average gain was 11%.

His track record continues this year… He's up by double digits (percentagewise), in a flat stock market.

What's his secret for 2010? What's his big theme?

He's trading Obama…

Earlier this month, in a letter to his hedge-fund shareholders, Dan complained, "the rules are continually changed, and the goalposts repeatedly moved. The Administration appears unable, or unwilling, to let free-market capitalism resume."

He says it's not health care or financial reform that's caused stress in the markets. It's the "continued politicizing of the regulatory process."

Loeb says the Obama Administration doesn't understand that its "regulatory volatility" is killing confidence. "Main Street is not independent of Wall Street," Loeb wrote. "We are each part of an intricate ecosystem and the failure to lay out clear rules of the road in intellectually honest tones is beginning to show signs of sabotaging the overall recovery."

Loeb gave examples of cheap stocks he's avoided thanks to regulatory volatility. Dan sold banks and health care companies because of this. He said: "We have come to the realization that from a risk management perspective, the anti-business, short-term politically motivated activities we're seeing in Washington make investments in certain industries simply impossible to evaluate."

Where to from here? Is there any good news?

Loeb says "the good news is that the bad news seems to be out in the sunshine: we all know that Europe has 'issues'; China may or may not be slowing down or turn out to be a bubble (we think not); the government hates Wall Street; taxes are going up; there has been a catastrophic oil spill in the Gulf of Mexico; Japan's economic situation is not sustainable; and so on."

Loeb thinks stocks are cheap.

"…we remain optimistic that we can continue to put up solid returns. We have not seen equity valuations this cheap in ages, with the S&P trading at 12.5x 2010 forecast earnings."

I agree with him. The bad news is out in the sunshine, and blue chips are cheap.

Dan Loeb's track record is fantastic. I want to know what the best-performing investors like Dan are thinking. So I like to read their letters to shareholders.

A great place to find hedge-fund manager letters, for free, is www.hedgefundletters.com.


Good investing,

Steve 

FX Closing Note: Financial reform relief boosts risk trades

John J. Hardy, FX Consultant, Saxo Bank

FX Closing Note: Financial reform relief boosts risk trades

Odd moves today and odd data. It is very difficult to fathom the University of Michigan data, which showed the strongest level for confidence in the survey since 8 months before the Lehman bankruptcy despite the weekly ABC survey continuing to show confidence mired in recessionary depths. A Zerohedge blog post rains cynicism on the data point and lists all of the reasons why this confidence reading looks fishy. We're allergic to conspiracy theories, but the data does look strange in light of the daily drumbeat of oil spill news and its mounting negative effect on Obama's popularity, as well as relatively ugly equity markets over the past month and signs that housing and consumption are hitting the skids. Let's see if next Tuesday's Conference Board confidence number for June matches the increase we have seen in the Michigan data.

It's hard to take anything away from today's market moves, as it seems the market doesn't want to commit directionally ahead of this weekend's G20 meeting, though it was interesting to note the market's warm embrace of the US financial reform bill as US financial stocks rallied strongly on the day. Worse was apparently feared, but the weekend's G-20 meeting is likely to remind us that not only the US is tightening the rules for banks. The rest of the world is increasingly moving this way as well, as the recent UK moves show. The next target for the major powers could be offshoring, a significant further risk for the financial industry - and therefore a risk for risk as well. Otherwise, we have no specific expectations for this G20, the most important subject on our radar being the sharpness of any anti-China rhetoric after such a blatant political ploy from the Chinese regime ahead of this weekend's meeting. (see Krugman's column in the NY Times on the yuan as well for one perspective.)

Regardless of what is moving the market in today's trading, moves like the dip in USDCAD and snapback rally in AUDUSD do not at all match the goings on in interest rates, where the market continues to unwind forward expectations. BoC expectations for a year from now just hit a new low for the month and RBA expectations are also sharply lower over the last few days. This looks fishy, along with the current environment in which USDJPY stays lower while the commodity currencies rally. One of the market moves out there is the right one and the other is wrong.  CAD traders might be focusing on oil prices because of the potential for a hurricane disrupting Gulf of Mexico oil supply and hampering the oil spill stoppage efforts - but we've been through that drill before. As for AUD - it appears AUD traders are focused more on the rallies in financial stocks and copper at the moment, both of which surged today. 

Chart: AUDUSD and rate expectations
Looking at the last couple of months of data, it is interesting to note that the forward rate expectations are now much closer to where they were when AUDUSD was trading at 0.8100 - though there are, of course, other aspects to the picture, including a new surge in copper prices, dark clouds gathering in the US economic data, the Chinese "reval" giving Aussie a boost, and the new Australia PM's review of Rudd's overly burdensome mining tax. 

 Looking ahead

The USD remains extremely weak technically on the close today. EURUSD snapped back from a test of support, GBPUSD bounced strongly after touching the critical 55-day moving average, and USDCHF headed to a new low. AUDUSD posted a strong reversal, etc. If this weekend's G-20 events can't give the greenback a strong upswing on Monday, the retrenchment could deepen. Next week's calendar features the US ISM manufacturing data and the US employment data for June, which looks to be rather underwhelming judging from recent data trends. We'll look at week's calendar on Monday.

In the meantime, have a great weekend and stay careful out there.

FX Update: AUD falls despite Rudd exit

John J. Hardy, FX Consultant, Saxo Bank

FX Update: AUD falls despite Rudd exit

AUD drops on new PM
Australia's PM Rudd made a quick exit after it became clear that he had lost his party's confidence, and the new PM Gillard has promised to review the mining tax - though it seems less certain from the news flow today whether the tax faces elimination or simply new terms. Of course, she swept to power suddenly at least partly over the controversy of this mining tax, so its terms will likely become far more lenient on the mining industry. But remember before we get too bullish on the Aussie implications, that the new PM also gained power because Rudd abandoned plans to implement a carbon trading scheme. Australians are, after all, a bit more prone to believe in global warming/climate change propaganda since they have experienced dramatic droughts and other climatic events in recent years. It's more than a bit ironic for the world's biggest exporter of raw carbon per capita in the form of coal to want to implement this kind of thing with its currency having recently soared to all time highs. Aussie adjusted lower as it should have on the risk aversion evident elsewhere and on shrinking interest rate spreads. Still, a more neutral level for the currency given current circumstances is probably a good deal lower still (as we discussed in yesterday's post where we looked at AUDUSD vs. US bond yields, for example.)

US Economic Data
The recent ugly streak in US data has the market expecting ugly data, so today's relatively in-line data looked downright positive and saw risk trying to make a bit of recovery at the open of US equity trading. But there should be little impact from these numbers specifically after a tremendous dark cloud created by the housing data and ugly retail sales data of late. More important data awaits next week, when we have the ISM report and the June employment numbers, which are unlikely to show improvement after the constant stream of 450+ jobless claims data and no census hiring to support the payrolls number next Friday.

Chart: EURGBP
The pair probed the lows for the cycle today, though it was unable to hold the new lows. With sovereign spreads improving within Europe a bit today (more on this below), the pair may have a harder time taking out new lows for the cycle. Also of interest is GBPUSD, which has grinded higher and had a look at 1.5000 in today's trade. That rally is looking a bit overambitious. These main GBP pairs may roll into a range trading environment.

Chart: USDCAD
USDCAD is pounding on the 200-day moving average as of this writing. A close above here on continued risk aversion could see it continue to rush higher to the top of the recent range and beyond. Carney yesterday said he was watching the loonie's strength and volatility. Speculators and central banks have been completely gaga on this currency for all of the obvious fundamental reasons, but none of those reasons will hold water if the global outlook sours, and crowded trades make for ugly squeeze situations, so if risk remains in the meat grinder in coming weeks, we could see this pair rush to 1.11+ in a hurry. The first key support is the Asian low at the 1.0375 daily pivot.

Looking ahead:
The outlook for risk remains negative - the CEE currencies are sharply weaker vs. the Euro in today's trading, a sign that risk is being taken off in EM and in EM FX. EM spreads closed wider yet again yesterday, and corporate credit and junk bond spreads are also looking shaky in recent days. We've also got a strong surge in the VIX. Key benchmarks in FX land for whether the keel is tipping for another rush lower in risk aversion include the 200-day moving average in USDCAD around current levels (1.0430) and the 89.00 level in USDJPY, which was the previous low when equities put in their lows in May. One interesting thing to note on the risk front is that EuroZone spreads don't seem to be the cause of the more general risk aversion, as Spanish and Italian sovereign spreads are actually tighter today. This could give the likes of EURCAD and EURAUD significant upside if the risk aversion trade remains on elsewhere.

Today we also see the results of the 7-year US treasury auction as the 10-year US yield benchmark is down probing its lowest levels in a year just above 3.00%. Tomorrow's economic calendar is largely devoid of interest, with only the final University of Michigan confidence number on tap.

Economic Data Highlights

• New Zealand Q1 GDP rose +0.6% QoQ and 1.9% YoY as expected
• Japan May Adjusted Merchandise Trade Balance out at ¥416.1B vs. ¥627B expected and ¥508B in Apr.
• Australia Q2 Westpac-ACCI Survey of Industrial Trends fell to 56.6 vs. 57.0 in Q1
• EuroZone Apr. Industrial New Orders rose +0.9% MoM vs. +1.6% expected
• US May Durable Goods Orders fell -1.1% MoM and rose +0.9% MoM ex Transportation vs. -1.4%/+1.0% expected, respectively
• US Weekly Initial Jobless Claims out at 457k vs. 463k expected and 476k last week
• US Weekly Continuing Claims out at 4548k vs. 4550k expected and 4593k last week

Upcoming Economic Calendar Highlights

• New Zealand May Trade Balance (2245)
• UK BoE releases Financial Stability Report (2301)
• Japan Jun. Tokyo CPI and May National CPI (2330)

FX Update: UK budget plan boosts sterling

John J. Hardy, FX Consultant, Saxo Bank

FX Update: UK budget plan boosts sterling

Yesterday's move in risk aversion followed through slightly into this morning and is having the usual effects on the currency market, if we look away from the gold market at least, which is an interesting story unto itself. Bonds have rallied enough to bring yields back to below Friday's closing levels - especially interesting for US treasuries, as this falsifies the entire kneejerk reaction of "yuan revaluation means the Chinese will buy fewer treasuries" logic. This has supported the JPY, which is making a bid to push USDJPY back below the 200-day moving average after that pair tried to post a bullish reversal yesterday. The USDJPY has been a mess in recent weeks, with endless fibrillation in a tight range full of critical technical levels, yet no decisive outcomes. Not surprisingly, this has been the case in the US treasury market as well.

Canadian CPI data came in a shade higher than expected, and this kept CAD from crumbling further versus the USD after yesterday's reasonable bullish reversal attempt. The strong German IFO (new high for the cycle unbelievably) failed to support the Euro. The IFO respondents must be focusing on the DAX, which yesterday nearly reached a new post-Lehman high. The heady action in the DAX has in turn been a product of the weak Euro, which is a boon to German exporters. It's surprising that this aspect of the situation has trumped the worries about the European credit system, and the "pick your poison" situation of either having German tax payers pay for a southern Europe bailout, or having German banks take an enormous hit to do the same.

Chart: EURUSD and DAX
Devaluing your way to high confidence! The German IFO came in strong today as survey respondents reveled in the weak Euro and its implications for Germany's vital export industry. The Chart below shows how this has also helped boost the exporter-heavy German DAX relative to the likes of the US benchmark S&P500. This move in the European currency can only be a one-off boon to confidence and is likely to fade as the EUR devaluation slows at some point in coming months

In other news, about half or yesterday's strong move in the yuan yesterday was erased by China today, as it underlines that any new "float" of the currency will remain a very tightly managed one. Also, speaking of trying to manage a currency's level, the SNB's Jordan was out in an interview saying that intervention by the SNB was no longer needed because the threats of deflation are no longer in place. A great excuse! In any case, this has allowed EURCHF to swoop to new record lows into today even as the SNB feebly remarked that it will intervene if it sees the threat of deflation rising again. The speed of the descent on this news is rather slow relative to what Mr. Jordan said. From here on out, we can hopefully look for a EURCHF level that is set by the market - some kind of equilibrium point will likely be reached rather soon. In the USDJPY instance from 2003, the steep part of the sell-off after the MoF abandoned intervention was over after four days, then a new trading lows was established about a month later, followed by an ugly and very slow grind lower for another three or four months as the market got over-positioned. Left to its own devices, we could seea similar behavior for EURCHF, though in the latter's case, we've already seen significant devaluation in fits and starts, so the timeframe may be compressed.

UK Budget
The focus today in the UK is on the new budget presented by Chancellor Osbourne. The budget proposal suggests that the UK can balance its budget by 2015. The austerity measures with this budget are impressive - the VAT will rise back to 20% from 17.5% in January of 2011, capital gains tax will rise to 28% from 18% on higher income taxpayers. On the spending side, the public sector's higher paid employees will see a two-year wage freeze and housing benefits policies and welfare will face cuts. From a sovereign debt/fiscal prudence angle, this looks good for the pound, as it is an impressive attempt to shore up credibility. Indeed, the pound is responding and EURGBP looks like it wants to probe back toward the 0.8200 low. The question going forward will be how much these measures will hamper growth and whether the tax revenues can live up to expectations and if growth projections are realistic.

Looking ahead
So far, yesterday's reversals aren't looking as compelling as they did on the close last night as US equity averages try to make a comeback ahead of the US open  - let's see how the market follows through on yesterday's moves. Normally one would expect a bit of range trading ahead of the FOMC meeting (this Wednesday as we have a two-day meeting this time around), but does any surprise really await us on Wednesday from the FOMC? It would seem that the direction in risk appetite and bond yields are the more important indicators to watch for the moment.

Stay careful out there as always.

Economic Data Highlights

• New Zealand May Credit Card Spending rose 3.4% MoM and 1.9% YoY vs. -1.6% YoY in Apr.
• Japan May Supermarket Sales fell -5.3% vs. -4.9% in Apr.
• Switzerland May Trade Balance out at +0.82B s. 2.06B in Apr.
• Sweden May Unemployment Rate fell to 8.8% vs. 9.4% expected and 9.5% in Apr.
• Germany Jun. IFO Business Climate out at 101.8 vs. 101.2 expected and 101.5 in May
• EuroZone Apr. Current Account was out at -6.9B vs. +1.3B in Mar.
• Canada May Consumer Price Index rose +0.3% MoM and 1.4% YoY vs. +0.2%/+1.3% expected, respectively, and vs. +1.8% YoY in Apr.
• Canada May Core CPI rose +0.3% MoM and +1.8% YoY vs. +0.3%/+1.7% expected, respectively, and vs. 1.9% YoY in Apr.

Upcoming Economic Calendar Highlights

• US May Existing Home Sales (1400)
• US Apr. House Price Index (1400)
• US Jun. Richmond Fed Index (1400)
• EuroZone Jun. Consumer Confidence (1400)
• US Weekly API Crude Oil and Product Inventories (2030)
• US Weekly ABC Consumer Confidence (2100)
• New Zealand Q1 Current Account Balance (2245)

Gold Recovers while Oil Dips ahead of FOMC, Housing Data

Written by Oil N' Gold

Gold price edges higher while crude oil trades a tad lower amid renewed worries over European deficits problems and the impacts on economic growth. At the FOMC later today, the Fed will leave the policy rate unchanged at 0-0.25% and reiterate current economic conditions warrant to keep interest rates at 'exceptionally low' levels for 'an extended period'. As the previous meeting was held before sovereign crisis in the Eurozone elevated, the market will watch closely the Fed's comments on the issue and its impacts on the US and the world economy. In fact, US exports to the Eurozone account for just 1% of US GDP. Therefore, slowdown in Eurozon economy will have mild impact on the US. However, we expect Fed Chairman Ben Bernanke will deliver a slightly more dovish statement as domestic economic data (housing, jobless claims, retail sales and CPI) released recently have been somehow disappointing. In our opinion, a dovish statement may delay market expectations of a Fed rate hike. This would be positive for gold price as low rate environment reduces opportunity cost of owning gold. However, slowdown in growth and inflation should weigh on prices of energies and base metals as demands will be affected. The BOC minutes unveiled that Andrew Sentence, an MPC member, favored to raise the policy rate, by +25 bps, to 0.75% as inflation would be resilient after recession. The MPC voted 7-1 to keep the policy rate unchanged at 0.5% and unanimously for maintaining the asset purchase program at 200B pounds. The pound extends rally after the minutes Although the 6-month moratorium that US President Obama put in place on May 27 was lifted, oil companies with operation in the deep waters of the Gulf of Mexico have no plans to resume drilling until the issue has been clear. The While House will certainly appeal. Interior Secretary Kenneth Salazar said he will issue 'a new order in the coming days that eliminates any doubt that a moratorium is needed, appropriate, and within [their] authorities'. The lift does not change our view that the overall impact of the moratorium on production is limited IF the drilling ban ends 6 months later, given the high inventory level and huge spare capacity in the country. However, the overhang is if the government will extend the moratorium beyond 6 months. Economic data that worth attention includes US new home sales which probably plunged to 430K in May from 504K a month ago. Canada's retail sales are expected to have contracted -0.4% m/m in April, after gaining +2.1% a month ago.

China - Mission Accomplished?

Andrew Robinson, FX Analyst, Saxo Capital Markets

China - Mission Accomplished?

The timing of the announcement from China that it was to revert to a managed float of its currency was a welcome surprise to markets, but has failed to really ignite a confident, bullish rally in risk and associated markets. The question is, why?
In the aftermath of last weekend’s developments, initial analysis suggested that the plan was caged in vague terms and offered neither an absolute commitment, nor a definite timescale for any adjustments. Indeed there were suggestions the announcement was intentioned to deflect pressure ahead of the G20 meeting this weekend and the pending July 15 US report on currency manipulation.

Market Reaction
From the outset on Monday morning, markets were prepped, poised and positioned for a strong rally in risk with equity markets opening higher, commodity currencies surging and adventurous year-end CNY levels being discussed. The jolt came when the morning CNY fix by the PBOC was kept at Friday’s levels (6.8275) and traders had to re-think as markets reversed. Indeed, by the end of the day most currencies had given back all of the euphoric gains. Was this a case of the PBOC wanting to control markets? Ie prevent traders having the “guaranteed trade” or the one-way bet? Or was merely a question of market mechanics? Tuesday perhaps gave a bit more clarity with the USDCNY fixed almost 0.5% lower (coincidentally the maximum allowed under current policies) and risk was given another (albeit short-term fillip).

Market Outlook
With the first “revaluation” under our belts, do we have a longer-term trend in place or just a short-term “placating” fix? The forward market is currently pricing in less than 2.5% further appreciation for the coming 12 months. That latter forecast could move to as high as 5% if the market looks for the rate of appreciation formerly established for the crawling peg in the 2005-2007 period. It is certain that we are in a phase of gradual revaluation with the G-20 meeting this weekend and the July 15 deadline major milestones. The announcement from the Chinese seemed as pains to remind that the “flexibility” could go either way (ie a CNY devaluation along the way is not out of the question). A higher fix within an established downtrend would not necessarily mean a reversal in trend, merely the PBOC attempting to smooth “unwanted volatility”.

Macro Implications
It will be important to see how much of the criticism China will have blunted with this weekend's move. The very weak Euro of the last six months has taken plenty of pressure off the European side of the equation - they actually had the most reason to criticize China previously. But what about the US as it approaches mid-term elections and is looking for a scapegoat for its economic ills? Certainly one would expect some of the wind being taken out of the sails of US Congress and their drift towards protectionist policies. But how long will it take before the US import lobby goes to Congress moaning about imported inflation? Let’s have our cake and eat it!

However, the fact that China chose to revert to its managed float (they have reiterated ad nauseum that such a move would only happen when China deemed it to be in it s own best interest) suggests that they feel more comfortable with a shift in its economy to a more domestic-focused one from the export-driven one previously. But what about the Chinese exporters who are seeing the value of their returns diminishing? The Chinese Ministry of Commerce also said it would monitor the implications for exporters but likely has no power to react. Or would a pickup in domestic demand be enough to offset lower export returns? This is more of a longer-term issue and something that data will confirm or refute along the way. Implications for growth? At this juncture we would suggest minimal, though that would be dependent on domestic consumption.

From here?
Generally we would view the developments as constructive and once the “noise” of the initial to-and-fro in markets has died down we should see more support into the risk appetite scenario. We expect USDCNY to resolve lower in coming months (but not a one-way street), preferring a move closer to 2.5% rather than 5% over the next 12 months. The down-move will likely drag other USD/Asia currency pairs along with it and invoke further FX intervention from Asia Ex-Japan central banks to slow the appreciation of their own currencies.

FX Closing Note: Was that the end of the squeeze?

John J. Hardy, FX Consultant, Saxo Bank

FX Closing Note: Was that the end of the squeeze?

The risk rally today in the wake of this weekend's moves by China on its yuan policy looks increasingly like it may have been a blow-off rally for the short term, as the equity and risk rally starting in Asia and following through in Europe turned into a vicious rout in the US, though we had enough of an "algo-bounce" to remind bears how wary we need to remain of this artificial, and perhaps even malevolent, market. The other interesting development on the day was the swoon in gold, which remains close to its low on the day after reversing thirty dollars lower from a record high earlier in the day on news of a strong build in Saudi gold reserves. All who believe that the Saudi central bank is a good market timer, raise your hand.

Reversal City
So after the day's action we have reversal city, with compelling bullish reversals for the USD and to a lesser extent for the JPY vs. a number of other currencies. EURUSD and GBPUSD reversed strongly after attempts at new highs for the cycle. That EURUSD high level overnight at 1.2500 was awfully symbolic.
USDCAD also posted a reversal on the day after new lows since mid-May. The Bank of Canada was out with extremely cautious rhetoric today on the implications of that should give the CAD bulls more pause than we have seen thus fa r(of course, some of the risks to Canada are from household indebtedness being the worst in the OECD - one of the reasons the market is looking for the BoC to hike - but is a known future catastrophe bullish for a country's currency because you think that the BoC will have to hike in order to ensure that the crash will come sooner rather than later?). At the same time, we have endless articles out praising the virtues of Canada at the moment. This is a contrarian's dream. Next step for USDCAD is the 55-day moving average up at around 1.0280 now that we have a bullish candle reversal, but to get a much better structural reversal and sign that USDCAD is turning back around, a move and close above the 200-day is worth a wait for more conviction. The swoon in gold prices should also be seen as CAD bearish.

Other technical action of note: EURGBP found resistance at the ideal 0.8400 level, and it makes sense to see GBP firming a bit today as risk aversion returned (and UK rates look less pathetic as rates fall elsewhere). Still, GBPUSD turned tail today after trying and failing above the 55-day moving average. Lets' see if this is the top for now there. Oddly, the yuan news is still seeing the AUD significantly stronger in places, even if AUDUSD and AUDJPY corrected fairly sharply from the highs. AUDNOK burst to a new 13-year high and EURAUD trying close to the recent all-time low. If equities follow up to the downside in the days to come, we would expect the market to realize that it has played the AUD wrong and that risk appetite still dominates for that currency.

Looking ahead:
As we promised this morning, here is a look at the rest of this week's economic calendar highlights:

Tuesday

• Sweden May Unemployment Rate. This is Sweden's Unemployment Rate according to Statistics Sweden. It has been rising again - back towards the high of the cycle. Meanwhile, alternative surveys show the employment picture improving. Confusing, to say the least. SEK has moved back toward the stronger side of the range vs. the EUR on the recent risk appetite moves, and that key EURSEK pair will likely continue to track risk appetite from here, now that EURSEK just today broke to the lowest levels since pre-Lehman.
• Germany Jun. IFO Business Climate. If this survey doesn't disappoint after almost managing to maintain a near 2-year high in April, then we're not sure what can dent the optimism, which must be focusing on the benefits of the weak Euro for German exports rather than the growth implications of a political and banking crisis all across the EuroZone.
• Canada May Consumer Price Index - no inflation scares in Canada, where the government is looking more at the housing situation and overall growth in judging the need to raise rates. Still, the rhetoric from the BoC has turned extremely cautious of late.
• US May Existing Home Sales - is the consensus seriously looking for an increase from April when the home-buying incentive expired April 30? Apparently so, the question is why? The NAHB survey and building permits and housing starts fell off a cliff last month.
• US Weekly Consumer Confidence - we'll make note of this weekly survey when it breaks above -40 and holds there for more than two weeks. The last time it was above that level? April 2008. Prior to that month, it hadn't registered a sub minus 40 reading since the early 1990's, when Ross Perot was making political hay despite erratic behavior and hopeless political ineptitude. This will be an interesting mid-term election in November - just over four months from now.

Wednesday

• Germany/EuroZone Preliminary Jun. Services and Manufacturing PMI - These have yet to show any real slowing of momentum, but we have to imagine that this is the case soon with European banking at a standstill, as Meredith Whitney recently said.
• UK Bank of England Meeting Minutes - the bank clearly wants to keep rates low and will look through short term inflation figures
• UK CBI Distributive Trades - saw an ugly drop in May, which was at odds with BRC and official data. CBI data probably the best, however, so stay tuned.
• Norway Norges Bank Rate Decision - Norges Bank is on hold, considering the NOK's relatively strong levels vs. the Euro and very poor growth data out of Norway. The Norges Bank's only concern with low rates is likely the overheated housing market, which is a further risk going forward.
• Canada Apr. Retail Sales - looking for signs of a slowing consumer - especially after recent torrid increases in consumption in a country sporting the OECD's highest private debt level...
• US May New Homes Sales - see above on Existing Home Sales. Likely to come in very weak after tax incentive expiry at the end of April.
• US FOMC Rate Decision - expect something along the lines of "low rates forever unless conditions warrant otherwise". The Fed may actually need to focus more on downside risks this time around than it has in the past, though a minority of FOMC members is clamoring for rate increases despite near record low inflation and troubling new signs of a slowdown. Still, the May Fed Beige Book noted improved economic activity in all 12 Federal Reserve districts, though it said improvement was modest.

Thursday

• New Zealand GDP - the RBNZ recently hiked for the first time for the cycle, but confidence is beginning to slow and there are signs of a tired consumer.
• US May Durable Goods Orders - notably volatile data series, fell last time, but only after March's largest rise since 2005 ex Autos.
• US Weekly Jobless Claims - talk that Gulf oil spill will is beginning to have an effect here, so optimists will try to look through that.

Friday

• New Zealand Trade Balance - not seasonally adjusted data - usually falls from this point until the late fall period. Still, the surplus has been impressive this spring.
• UK Bank of England Financial Stability Report - stable as long as the bond vigilantes are on the defensive!
• Japan May CPI - deflation, anyone? Remember the paradox of the carry trade - the spot rate of a currency in a country with deflation should be rising versus higher inflation countries.
• US Final Jun. University of Michigan Confidence - is the improvement in confidence behind us? According to the weekly survey, the improvement never got started...

This is what deflation could do to gold

From Pragmatic Capitalism:

Despite being a highly misunderstood asset (in my opinion) regular readers know I have no hatred of the yellow metal. In fact, I love any asset that has potential for appreciation regardless of its tangible “value”.

Like a good view, this precious metal carries a certain intangible value. Of course, as a form of currency, I think investors are...

Read full article...

FX Closing Note: USDJPY tests 200-day moving average

This market remains a head-shaker, with an odd combination of resilience in risk and a weakish dollar, while bonds and JPY have snapped to attention a bit on ugly data from the US. The initial claims data was ugly once again as we enter the summer period when jobless claims traditionally rise until early to mid July. (This seasonality is adjusted out of the data releases that everyone follows, but still interesting to note that the claims are still rather high during this period.) The Philly Fed survey fell drastically short of expectations, at 8 vs. the 20 expected and 21.4 in May. That was the largest drop since June of last year. The internals showed that much of the drop was due to a very large drop in the prices paid and received components, which is  bit of a relief, though it was more than discouraging that the Number of Employees component fell to -1.5, the first negative reading since last November. Optimists will note that New Orders rose for the month to a solid 9.

Looking at our risk indicators, we note a dramatic bifurcation in the market, with emerging market spreads, junk spreads and central bank forward expectations continuing to show high risk aversion in the market. Junk bond spreads have ratcheted higher almost every day of late and are close to touching a new 10-month high. Meanwhile, equity volatility, FX volatility and to a lesser extent corporate CDS indices continue to improve at a rapid pace, with the first two of those now all the way back to the neutral threshold, an amazing divergence.

Below we have a look at a couple of our risk indicators vs. equities and at equities vs. AUDUSD, which has been one of the currency pairs most consistently correlated with risk.

Chart: Junk Bond Spreads and Equities
We worry about junk bond spreads because they often serve as a leading indicator on the status of risk appetite elsewhere, especially at big market turning points. Here, we can see that junk spreads have continued to head wider (this is an inverted spread on the chart below, so wider spreads equals lower levels on the chart for the blue line indicating these spreads), while risk in the form of equities has squeezed higher.

Chart: Equities and AUDUSD
This chart shows how the FX carry trades like AUDUSD tend to more or less follow the equity market. These two markets are likely to continue moving in synch with one another. AUDUSD got a bit overexcited back in late 2009 on the hawkish outlook from the RBA. Since then, the market has pulled back sharply on its forward.

Chart: Rate expectations and AUDUSD
Here we chart interest rate expectations as expressed by the 2-year swap spread (two years out being about the farthest that a central bank can influence rates). This shows us that if the risk appetite move continues higher, an AUDUSD view of 0.90+ would be warranted - especially as the rate outlook is often a part of the risk outlook. We would be surprised for this move to continue for that long. The next key resistance levels for AUDUSD are the 55-day moving average, currently at 0.8850, and the 200-day moving average currently at 0.8980.

Chart: USDJPY
USDJPY traversed the 200-day moving average today, but at the New York close doesn't look like it wants to close firmly below this level. It seems this rally in risk is hitting the greenback harder than the JPY.

Looking ahead
This market makes little sense as we outline above. We'd be happier to allow for more leeway on a solid bullish rally here if the indicators and fresh economic data warranted such, but they don't. Nonetheless, this market can go anywhere as it has already shown and the squeeze could yet continue higher in the short-term as it seems so willing to ignore important developments and normal fundamental tethers. This may be about positioning and possibly option expiration tomorrow, so let's see how we close the day tomorrow and open the week on Monday as a test of the short squeezers' moxie. Divergence in risk conditions tells us we shouldn't believe in the move, but don't tell us how ugly the divergence may yet become.

So stay careful out there as always.

Crude/Stock Correlation Slips

Risk appetite remains robust in European session. Although the euro, equities and commodities were down modestly amid concerns over Spanish banking systems, prices recovered as the central bank of Spain said it might publish results of the stress test to the public. Currently trading at 77.3, the front-month WTI contract is down -0.35% from yesterday's close. Price slid to as low as 76.78 earlier in the day.

Latest development regarding Gulf of Mexico (GOM) oil spill is that BP and the US government reached a preliminary agreement that the oil company will set aside $20B to cover the economic damages of the GOM oil spill. BP has also started a new containment cap system to increase overall collection capacity to 28K bpd from around 15K bpd. BP shares, however, rebounded almost +10%, the biggest increase since November, yesterday after the agreement and the company decided to halt dividend and sell assets to meet the liability. Jump in BP shares also boosted stock markets.

Read full article here

Wake-up Call

Bearish News Flooding In Today's Markets

Spain’s central bank announced that it will release results from a stress test of banks while BP announced that it won’t pay a dividend and will also resort to asset sales to fund the Oil-spill fund.

What's going on?

Theme Comment

·         News overnight was mostly bearish. Spain’s central bank announced that it will release results from a stress test of banks while BP announced that it won’t pay a dividend and will also resort to asset sales to fund the Oil-spill fund demanded by President Obama. Of course, the large decline in US housing starts didn’t help matters much despite a solid display from the manufacturing sector with industrial production up 1.2% MoM.

·         Spain will test the market today with EUR 3.5bn in 10y and 30y bond auctions, and if recent Spanish auction are any indication then spreads will once again widen relative to the prior auction (in the spring).

·         It’s another busy day for economic releases led by US CPI, Jobless Claims, and Leading Indicators. The latter is expected is improving despite an 8% drop in S&P500 in May, which is one of the leading indicators.

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Calendar

Economic Data Releases
Country	Time (GMT)	Name	Saxo	Consensus	Prior
UK	08:30	Retail Sales MoM (MAY)	0.0%	0.1%	0.1%
US	12:30	CPI / Core CPI MoM (MAY)	0.0% / 0.1%	-0.2% / 0.1%	-0.1% / 0.0%
US	14:00	Leading Indicators MoM (MAY)		0.4%	-0.1%

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FX

FX	Daily stance	Comment
EURUSD	0/+	Buy break abv 1.2350, or dip to 1.22, for tgt 1.2420. Stop below 1.23, 1.2165 resp.
USDJPY	0/-	Resistance edging down to 91.40. 90.85 next suppt. Expect to trade a range
EURJPY	0/-	Break below 111.90 risks 111.50 before any suppt. Ranging 111.50-112.50 with slight –ve bias
GBPUSD	0	See n/term suppt at 1.4680. Below risks fall to 1.4615 else trade a 1.4680-1.4750 range
AUDUSD	0	0.8575 next suppt level. Below sees 0.8510 first or a 0.8575-0.8665 range
USDCAD	0	Seems to be building n/t base at 1.0225. Ranging 1.0225-1.03 again

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FX Options

FX-Options	Comment
EURUSD	Market still well bid for EUR puts. Market still very nervous despite  yesterday’s
	relatively narrow ranges in spot, with a vol curve remaining well bid throughout the sessions  still remains bid Banks aggressively paying up for EUR puts now and would not be surprised to see
	session. Definitely see potential for further downtrend in spot.

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Equities

Equities	Daily stance	Comment
DAX	0/-	Sell on rallies towards 6190 targeting 6156. S/L above 6207.
FTSE	0/-	Sell on rallies towards 5240 targeting 5208. S/L above 5257.
S&P500	0/-	Sell on rallies towards 1118 targeting 1112. S/L above 1119.
NASDAQ100	0/-
DJIA	0/-

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Futures

Commodities	Daily Stance	Comment
Gold	0/	Buy on dips towards 1228 and target 1236. Stop below 1226.
Silver	0/+	Buy at the break of 18.68 and target 18.96. Stop below 18.50.
Oil (CLQ0)	0/+	Sell on rallies towards 79.80 and target 78. Stop above 80.50.

FX Update: Ugly US Housing Data no big deal?

FX Update: Ugly US Housing Data no big deal?

The zany action in risk markets continued, with yesterday's big rally in risk on no real catalyst yielding to a sell-off in risk on no new catalyst before the US opened strongly despite ugly housing data. This leads us to believe that short term movements are paying little attention to fundamentals, which continue to tell a rather depressing story. The question, as we cover in our latest FX Monthly is whether the complacency we have seen in recent days is something that can support markets for another month or even throughout the summer, or whether we are simply seeing a short term bump in a new downtrend in the risk appetite. Stay tuned.

Elsewhere, one of the more interesting data releases was the UK Nationwide confidence number, which plummeted all the way to 65, a full 7 points worse than expected and a level that takes us back to nearly a year ago. The weekly ABC US confidence level also disappointed once again and seems terminally stuck in a low range until the job market improves.

EuroZone woes: focus on Spain
The general EuroZone fears are fading somewhat as the main focus now is the situation in Spain, where banks are unable to get funding in the interbank market. Spanish 2-year notes are now yielding almost 3.30%, about 280 bps above German 2-year notes. Spain is currently denying rumors that the US, IMF and EUR are planning to extend a large credit line to the Spanish government.

In contrast with the situation in Spain, the risk premium on holding Italian debt, for example, actually continues to fall (though Italy has a very high public debt figure, it features much less private debt than elsewhere, a reasonable savings rate, and a far smaller budget deficit than even France, for example, so the short term funding needs are not particularly pressing).

Russian Central Bank to add AUD and CAD

An almost sure sign that it is about time to sell the AUD and CAD as the Russian Central Bank says it is planning to add the two currencies to its international reserves. The bank announced some time ago that it had "added" the Canadian dollar to its reserves, though it apparently hadn't yet "begun operations", meaning apparently that it had approved the addition without actually going to market. While the bank's potential purchases could represent a significant new support for the currencies on a day to day basis because of their relatively thin liquidity compared with the supermajor G3 currencies, central banks are notoriously bad timers of the market and Russia's exasperation with the Euro should be used as a contrarian signal on the likes of EURCAD and EURAUD in the coming weeks and months. One also wonders how much the central bank will add as a percentage of reserves when the British Pound makes up only 10% of reserves and the Japanese Yen only makes up 2%. Russia's FX and Gold reserves stand at some USD 460 billion, so 1% is a fairly hefty USD 4.6 billion, certainly enough to move markets day to day, but hardly enough to alter the landscape for the commodity currencies.

US Data
US data was a slightly mixed bag, with a marginally higher PPI than expected - pulling the rug out slightly from the deflationists, especially considering the rising dollar during late April and throughout May and plunging oil prices for most of May, though the effect of that sharp fall may not work its way into price until the June figure (and oil has rallied strongly from the May low...)

Much more attention was focused on the very ugly US Housing Starts and Building Permits numbers for May, the first full month of such data since the home buying incentives expired in late April. Housing starts were well below expectations and the lowest since December (when the first round of home buying tax incentives was expected to expire) and the Building Permits were also well below expectations and at the lowest level in 12 months. In our book, it is a bit hard to understand why this numbers are a surprise, but the building permits drop is perhaps more alarming since this is the first phase of the housing construction life cycle and suggests that builders don't expect demand to pick up a again in the near future. The takeaway from the data is that housing demand is understandably lower with the expiration of the incentives, but another month of data this low or lower should raise the level of concern as it would suggest that housing demand is actually weakening from already very low levels - especially considering the drop in mortgage rates in recent months. With the lack of any real improvement in the job market, it is hard to see housing bouncing back anytime soon, anyway.

The Industrial Production data, on the other hand, came in rather strong, though the cynics can attribute this to the later phases of the inventory rebuilding cycle.

Chart: US Industrial Production
The May Industrial Production release saw one of the steepest increases in recent history. The chart below shows where production is currently versus the last twenty years. We have just now recovered back to a level that was reached about 10 years ago for the first time.

Looking ahead
The action this morning suggests that the worst case scenario for both bulls and bears is playing out - a choppy market that makes it look like something directionally interesting is getting started, only to see an immediate direction change at the last moment. The risk rally yesterday took the bears to the maximum pain level yesterday and just beyond through key resistance, only to see that apparent "break" faded in today's trading -though we haven't yet full reversed back into the old trading range as oft his writing. Elsewhere, bond markets have snapped higher this morning from yesterday's low and suggest that equity markets and the perhaps even more emotional FX market (especially AUD and CAD crosses) have seen the pendulum swing too far in the direction of optimism. If bonds were to crumble more convincingly, then we would be more happy to jump on board for the shorter term risk rally - until then, we remain wary of this latest rally.

Later today, we have the ECB's Bini Smaghi speaking in the US, and the BoE's King is also out speaking. Bernanke is set to give a speech about financial regulation. In Asia, there is little of interest Thursday, while Europe see the SNB's Libor-target announcement (and perhaps the latest on its intervention thoughts) and the US will release the latest CPI, Weekly Jobless Claims, and Philly Fed data.

Recall that this is triple witching week for equity markets - with expiration of options, futures, and options on futures. This could be yet another reason for the treacherous back and forth trading this week in equities and the highly correlated FX risk trades.

Economic Data Highlights

• US Weekly ABC Consumer Confidence fell to -45 vs. -43 expected and -43 last week
• New Zealand Q2 Westpac Consumer Confidence rose to 119.3 vs. 114.7 in Q1
• UK May Nationwide Consumer Confidence fell to 65 vs. 72 expected and vs. 75 in Apr.
• Australia Apr. Leading Index fell to 0.0% vs. 1.0% in Mar.
• Australia Q1 Dwelling Starts rose 4.3% QoQ vs. +7.0% expected
• UK May Jobless Claims Change fell -30.9k vs. -20k expected
• UK Apr. Average Weekly Earnings ex Bonus rose 1.9% YoY vs. 2.0% expected and 2.0% in Mar.
• Switzerland Jun. ZEW Survey out at 17.5 vs. 40.5 in May
• EuroZone May CPI rose +0.1% MoM as expected
  US May Producer Price Index fell -0.3% MoM and rose +5.3% YoY vs. -0.5%/+4.9% expected, respectively
• US May Producer Price Index ex Food and Energy rose +0.2% MoM and +1.3% YoY vs. +0.1%/+1.1% expected, respectively
• US May Housing Starts out at 593k vs. 648k expected and 659k in Apr.
• US May Building Permits out at 574k vs. 625k expected and 610k in Apr.
• US May Industrial Production rose +1.2% MoM vs. +0.9% expected
• US May Capacity Utilization rose to 74.7% vs. 74.5% expected and 73.7% in Apr.

Upcoming Economic Calendar Highlights

• US Weekly DOE Crude Oil and Product Inventories (1430)
• EuroZone ECB's Bini Smaghi to Speak (1715)
• US Fed's Plosser to Speak (1815)
• UK BoE's King to Speak (1945)
• US Fed's Bernanke to Speak on Financial Regulation (2145)
• New Zealand Jun. ANZ Consumer Confidence (0300)