WEEKLY KEY MARKET DRIVERS AND IMPLICATIONS:STOCKS, COMMODITIES, FOREX
How The FOMC Rocked All Markets, And Coming Week's Market Drivers
It isn't often that we see one distinct event that forces a reevaluation of ongoing trends, but the FOMC statement this past Tuesday could prove to be one of them. By issuing a statement that markets interpreted to be a clear indication of a new round of stimulus in the coming months, the Fed has altered the picture in every major asset market for the near term at minimum. Key effects include:
Global Equities: Further rally appears likely as the US has put a floor under markets, which in turn anticipate another liquidity-fed rally like that of 2009 that may continue despite stagnant fundamentals as cash seeking a home flows in to equities.
Commodities: The implied further debasement of the USD feeds the demand for hard assets, particularly traditional currency hedges like gold and silver. Crude oil also broke through multi-week resistance despite the highest ever recorded US inventories. Such was the effect of the FOMC's implication of new QE in the coming months.
Forex: This same implied future devaluation of the USD, which is part of over 80% of all forex trading volume, drove the USD index to its lowest level in months, with predictable results.
–The USD was the week's weakest currency
–The EUR was the strongest, despite news of deteriorating PIIGS bond prices and EU growth which together at other times could have put the EUR at the bottom of the weekly forex pile.
–The move virtually wiped out the nascent downtrend in the USDJPY that the Bank of Japan has been trying so hard to engineer.
PRIOR WEEK
The Biggest Market Mover: The USS QE II Now Boarding – Or Is It?
After Monday's rally on hawkish RBA comments and the US NBER's declaration that the recession ended in June 2009, the really significant market moves were related to the FOMC statement.
-Stocks drop as the move is seen as no confidence vote in US recovery
-USD crashes on the implied future devaluation, boosting the EUR, and JPY
-Markets drifted lower
-Then CNBC interview Friday focuses traders on QE's bright side – stocks can rally on QE cash regardless of fundamentals. A push past multi-month resistance is now far more likely barring all but the worst deterioration in fundamentals. Indeed, if stock markets see new stimulus as the best hope for a rally, then bad news which is seen as moving stimulus closer may even lift stocks.
-BoJ Yen intervention is thwarted by falling USD
Contradictory News Pulls At FX Markets
-RBA Hawkishness
-US, Japan, central bank official dovish remarks
-BoE issues both dovish, hawkish comments
-Relatively successful Irish, Greek, Spanish bond sales combined with USD weakness boost the EUR despite…
-Spiking Irish, Portuguese bond yield, CDS rates – surprisingly had little real impact this week
As we discuss below, just as assumed immanent new QE was the primary market driver last week, disappointed expectations may be key for markets in the coming week.
COMING WEEK
A typically light end of month economic calendar suggests a quieter week between last week's FOMC fireworks and the US monthly job reports and start of Q3 earnings season 2 weeks from now. Coming week likely market drivers include:
Reversal Of Last Week's Expectations For Imminent New US QE
Markets clearly interpreted the FOMC statement to mean QE is coming soon.
Is QE really coming? Forex.com's Brian Dolan argues that QE is far from assured, and even if it comes may not be coming as soon as markets believe. His key points include:
The US economy would need to decline further, and recent data suggests at least some near term stabilization
The Fed is unlikely to act before the next meeting on November 3rd, so markets reacted too fast, as suggested by the 10 year note recovering half its losses by week's end
It's far from clear that additional QE will help the US economy, as marginally lower interest rates are unlikely to stimulate borrowing, hiring, and spending while US consumers' wages and net worth (mostly in their homes) remains stagnant.
I would add:
It's been argued (by Andy Xie of Caixin, among others) that US stimulus cash is more likely to wind up fueling emerging market growth as US companies deploy the cheap cash to markets with lower labor costs and faster consumer spending growth rates.
While it's questionable whether the Fed can truly prevent future inflation by sopping up excess liquidity at just the right time, it certainly risks further loss of confidence in the USD and thus America's ability to continue selling bonds at such low rates. That would be a greater problem, given America's dependence on its bond sales to fund its own operations. With debt levels already at 93% of GDP, even a small increase in borrowing costs could become a crippling burden.
Currency Hedge Rally Supported By USD, EUR Weaknesses
While the EUR was the week's strongest currency last week, most of that was a result of USD weakness rather than any fundamental improvements. In fact the week's news was mostly negative for the EUR with rising PIIGS bond/CDS rates, Irish banking trouble, lackluster manufacturing and services PMIs. Thus as long as the two most widely held currencies fundamentally weakening, anything seen as a currency hedge with decent fundamentals like precious metals or grains is benefitting.
EUR Weakness Ahead
There is plenty of potential for a reversal lower with the EUR.
- As noted above, most of the EUR gains are from USD weakness, which was likely overdone last week.
- PIIGS bond sales went off but were at high rates and even those ‘successes' may turn out to be from ECB purchases.
- Spain will try to pass new austerity measures in the coming week. The last one passed by only one vote.
- Recent data suggest EU growth may be slowing. If the EU growth advantage is seen as fading, so will the EURUSD.
Further Evidence of UK Weakness Could Pressure GBP
Recent UK data has been weak and MPC minutes suggest openness to more QE, even as a BoE economist stated that if inflation becomes a problem an aggressive rate hike may be forthcoming. We believe the UK, like most democracies, will risk inflation over another recession.
Scheduled Events
It's a typical light end of month economic
US: Thursday-Chicago PMI, Friday – ISM manufacturing PMI, CB Consumer Confidence. Note: These are likely to drop after August increase, but market reaction is unclear. If in fact markets want more US stimulus for a short term rally, then we may more rallies on bad news that markets hope will bring the desired new liquidity-fed rally. Note that despite the new month US jobs reports do not appear until next Friday.
EU: Monday-ECB Pres. Trichet speaks, Thursday-German retail sales, Friday- German jobs and retail, EZ final September mfg PMIs and August unemployment.
UK: Tuesday-GBP Current account, Friday-September mfg PMI, Nationwide HPI m/m
Japan: Wednesday-Tankan Index
Switzerland: Wednesday- KOF index, Friday – retail sales
Australia: Thursday-Building approvals
New Zealand: NBNZ business confidence
China: Friday: Mfg PMI
Wildcards: Not Scheduled But Market Moving If They Appear
EU Sovereign Debt/Banking Crisis: Unlikely to spark more than short term drops as long as ECB can continue to ‘manage' PIIGS bond auctions so that they succeed, and the focus remains on weak US data rather than on weak EU data.
The big question is, how long can the ECB continue to buy PIIGS bonds to keep auctions successful without its own new QE, and concomitant hit to the EUR?
Again, ratification of new Spanish austerity measures could be the next EU crisis eruption, as it could raise questions about long term commitments to austerity elsewhere in the EU as well as in Spain.
US Treasury Bonds, Stocks, And Gold Resume Normal Relationship
Both gold and US treasury bonds have been in simultaneous up trends since May 2010. As David Roda points out in Gold vs. Treasuries: Something's Gotta Give, this doesn't make sense.
Gold is a currency hedge priced in US dollars and thus its rise suggests fear of loss of value of the USD.
US Treasury bonds are a safe-haven asset and partial bet on the USD as a store of value, and hedge against riskier assets like stocks.
The two move in opposite directions. Either the USD is in trouble and gold should be higher, or Treasuries are the right bet and gold should be lower. Over time, one of these trends must reverse.
I point out another relationship that should correct soon.
The S&P 500 and most other major global stock indices are up since July 2010. US bonds and stocks move in opposite directions as a rule, because bonds are a safe haven asset and stocks are a risk asset. One of these markets is due for a reversal.
DISCLOSURE & DISCLAIMER: NO POSITIONS, THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY AND NOT TO BE CONSTRUED AS SPECIFIC TRADING ADVICE. RESPONSIBILITY FOR TRADE DECISIONS IS SOLELY WITH THE READER
Cliff Wachtel, Chief Analyst, AVAFX
Originally posted here.
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