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)