The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
Risk Aversion Reigns for Currency Markets
03/09/2009 10:37 am EST
If it weren't for bad news, there would be no news at all these days, it seems. Friday's NFP report suggests the US labor market continues to deteriorate with no end in sight. ECB staff slashed euro zone 2009 growth forecasts by -2%, with an intensified contraction now expected in the second half of the year. Canadian financial minister Flaherty said on Friday he expects that 2009 economic data will be "persistently poor." Bank of Japan deputy governor Yamaguchi expects the Japanese economy to remain in a "severe condition" into the new fiscal year beginning in April and noted "The speed and the magnitude of the deterioration is something we haven't experienced for decades." And that observation comes from an official in the country of "the lost decade." As such, it's little wonder that investor pessimism has reached such epic proportions. At the same time, a good argument can be made that pessimism and risk aversion have reached extreme levels and are due for a correction. Note, though, that nothing on the fundamental horizon is expected to improve any time soon. Indeed, further deterioration in incoming data should be expected.
Instead, I'm referring to investor sentiment, which can change very quickly. The most recent example came in the middle of this past week when global stock markets rallied on word that China "might" announce another fiscal stimulus package. Chinese premier Wen Jiabao subsequently dashed such hopes and sentiment turned south yet again. Even in the aftermath of the terrible February NFP report on Friday, risk-averse trades rebounded sharply (stocks jumped and JPY crosses rebounded) when a worst-case jobs decline failed to materialize. Such sudden rebounds in risk appetites should serve as a warning to traders to remain flexible and to not become overly complacent that pessimism will persist indefinitely.
In the weeks ahead, a number of major initiatives have the potential to resurrect sentiment, perhaps as a significant prelude to the anticipated stabilization in the US in the second half of 2009. The Bank of England is expected to commence large-scale asset purchases in coming weeks as part of their quantitative easing efforts to restore consumer credit. Similarly, the US Treasury will implement the TALF (Term Asset-Backed Securities Lending Facility) on March 25, which is intended to kick start consumer lending in areas such as credit cards and auto loans. As well, the US fiscal stimulus package will begin entering circulation in greater force over the next few weeks and months. Lastly, the US Treasury's plan for 'stress tests" of major banks may provide some sense of relief on a system-wide basis, though individual banks may be severely hurt if capital levels require further government infusion.
To be sure, there is no lack of negatives weighing on sentiment at the moment, and stock markets continue to serve as the best barometer of risk aversion. When shares are weak, the USD will likely remain strong, and the JPY crosses will likely stay under pressure. If shares rebound, the USD will likely suffer against all but the JPY, while JPY crosses would tend to benefit strongly. Also, I think the risks are asymmetric at this point, meaning that fresh bad news may see only minor further declines in risky assets, while positive news may see a much larger upside recovery in risky assets. In other words, the USD likely has more to lose from improved sentiment than it stands to gain from greater pessimism.
With that in mind, I would be especially cautious on gold in the weeks ahead. Gold temporarily lost its correlation to risk earlier this week, collapsing alongside stocks, but seemed to have re-gained it by week's end. The recovery in gold so far has stalled below key Ichimoku resistance levels (Tenkan and Kijun lines are just below $948/oz and set for a bearish crossover) just below the psychologically important $950 level. The rebound in gold occurred from around the $900/oz level, but more significant trend line support highlights the $872/$882 area as critical to gold's trend higher. Below there and a deeper pullback is likely, perhaps consistent with a rebound in sentiment.
Frail US Consumer to Weigh Heavily on Global Growth
Economic data this week continued to paint a bleak picture for the US consumer going forward. The bad news started with the factory orders report, which showed a downward revision to non-defense capital goods ex aircraft to a -19% annual rate in January, down from -15% in December and -5% in November. This metric is a proxy for capital expenditures by firms that feeds directly into GDP and suggests 1Q growth in the US will be even weaker than the dismal result last quarter. Indeed, forecasts for a -7% quarterly decline in activity are becoming more mainstream.
Mortgage delinquency data followed and showed nearly 8% of all US mortgages currently in some form of default. This is well above the 6.1% delinquency rate we witnessed in the midst of arguably the worst post-war recession in the early 1980s. If recent indicators such as the increases in jobless claims are prescient, it looks as if this is only likely to get worse in the first half of 2009. As such, the bottom in US housing still remains elusive.
Then US non-farm payrolls were just plain ugly. The headline number came in as expected at -651K, but this was at the expense of severe downward revisions to the prior two months totaling -161K jobs. January was taken down to -655K from -598K, while December is now estimated at -681K from -577K previously. The unemployment rate also jumped at a much more rapid pace to 8.1% from 7.6%, and this was well above the market's assumption of a 7.9% print. That market forecast for the unemployment rate to be 8.4% at year's end now looks optimistic to say the least. Our base case for the year remains 9.2%.
The forward-looking components of the employment report look ominous to say the least. For one, temporary help employment dropped another -78K on the month, and this is on top of an -80K decline in January and -73K in December. Temporary employment is the first thing firms shed ahead of a downturn and the first thing to recover as well when things begin to improve. The trend thus far is clearly lower here. The other major leading indicator for employment is aggregate employee hours, and they plunged to a new cycle low -5.3% annual rate from -4.6% last month—the weakest run-rate since that 1980s recession. Hours lead bodies and this points to continued job shedding in 2Q.
If that wasn't enough, we got another indication of consumer frugality in the consumer credit numbers this week. Total credit outstanding rose a meager $1.8 billion in January, recovering very little of the -$7.5 billion contraction the prior month. Consumer credit outstanding (not including real estate) is now 23.7% of annual personal disposable income. This is down from 24.1% last month and the 25.5% peak back in the mania days of 2005. Prior to the secular credit expansion that started in the early 1990s, this ratio never got above 20%. We would need a -$400 billion contraction in debt to reach that ratio at current income levels. The consumer has come to the realization that current liability levels are unsustainable and we expect this deleveraging process to continue.
So the fact remains that US economic activity is plunging, the housing bottom is nowhere in sight, employment continues to worsen, and the US consumer has a lot of deleveraging still to do. The ramifications for global growth from a fragile US consumer in balance sheet repair mode are tremendously bleak. With the US consumer comprising nearly 20% of the global economic pie, further weakening in purchasing power and an outright unwillingness to pile on more debt to offset this are likely to be detrimental for global economies. Reality bites and we would look for the trend of lower stocks and higher USD to continue as risk appetite dissipates further on a global level.
Key Data and Events to Watch This Week|pagebreak|
(Please note: The US and Canada have shifted to daylight savings time. For those outside North America, US and Canadian data releases will come one hour earlier than usual.)
The economic calendar in the US is on the light side and kicks off with wholesale inventories on Tuesday. The monthly budget is up on Wednesday, and Thursday is busy with initial jobless claims, retail sales, and business inventories—all of which we expect will remain weak. The trade balance, import prices, and the University of Michigan consumer sentiment index round out the week on Friday. Look for a speech from Fed chairman Bernanke on Tuesday as well.
The euro zone is much busier. Monday starts off the week with the euro area finance ministers meeting and French business confidence. Tuesday is jam-packed with French industrial production, French trade, German consumer prices, German trade, and the German current account. Wednesday sees German producer prices and factory orders. On Thursday, we have euro zone producer prices, French employment, French consumer prices, and German industrial production. Friday ends it with euro zone retail sales and German wholesale prices.
Japan is busier than usual, and the current account, trade balance, and bank lending reports kick it off on Sunday. Monday we have bankruptcy data due up, and Tuesday sees the index of leading economic indicators and the all-important machine tool orders. On Wednesday, we'll see the revision to that horrid 4Q GDP number, and Friday has industrial production and consumer confidence on tap.
The UK calendar is not too busy, but important data loom nonetheless. Tuesday has the BRC retail sales monitor, home prices, and industrial production on deck. Wednesday has the trade balance, and Thursday closes out the week with the Bank of England quarterly inflation report.
Canada is characteristically on the light side. Housing starts kick things off on Monday, and Wednesday has new home prices on tap. Friday is the big day with the employment report and international trade, the highlights for the week.
It's a pretty busy week down under. New Zealand home prices get the action started on Sunday. On Monday, we'll see the NZIER business opinion survey, and this will be followed by New Zealand terms of trade, Australian business confidence, and Australian consumer confidence on Tuesday. Wednesday is important with the RBNZ rate decision looming. The market is looking for a -75 basis point cut to 2.75%, but if what the RBA did is prescient, we could be in store for a less aggressive reduction here. New Zealand business PMI and Australian home loans are also up on Wednesday. The week closes out with New Zealand retail sales, Australian inflation expectations, and Australian employment on Thursday.
By Brian Dolan of Forex.com
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