Risk Rally Continues, but Remains Suspect
04/06/2009 11:50 am EST
After briefly sputtering at the start of this past week, risk sentiment has continued to improve as evidenced by gains in stocks and JPY crosses (carry trades) and declines in the USD, gold, and Treasuries. My outlook for a return to risk aversion failed to materialize, but I am still suspicious of the staying power of the current rally. However, one of the hallmarks of major market bottoms is that gains develop despite incoming negative data and gloomy outlooks, with investors essentially looking beyond the immediate environment in anticipation of better days ahead. That certainly seems to be the case at the moment, but major risks lie ahead.
Much of the improvement in sentiment is based on the perception that the rate of deterioration in some recent data has slowed, which I would agree with in most cases. But the follow-on proposition—that the data and outlooks will subsequently begin to improve—seems excessively optimistic at the moment. To use an analogy, it's like an airplane crash landing on a runway with the wheels up. No, it didn't crash nose first and yes, it did make it on to a runway, but it's still going to be a while before that plane gets off the ground again. While I do remain optimistic that we'll see an improvement in overall activity later this year, the weeks ahead are rife with potential obstacles that could derail this sentiment-driven rally in short order. Among these are 1Q earnings reports, results of the Treasury's stress tests of major financial firms (which won't be explicitly announced except in the form of the amount of capital firms need to raise), success of the Treasury public-private scheme to sell toxic bank assets, and funding commitments for the G20's proposed contribution to the IMF and World Bank, on top of incoming data. I may be discounting the biggest rally of the year, but I'm not getting married to this move and I'm alert to the significant potential for a reversal at any time.
Critical Turning Points May Be at Hand
Various markets and indicators have reached critical turning points, where the current risk rally will either stall and potentially reverse, or break through and see gains extend. Chief among these is the VIX index, which has dropped to the 38/40 level, which has been the floor for the stock market's so-called fear index since the end of September. A drop below that area will likely signal further gains in shares. The S&P 500 closed above the top of the daily Ichimoku cloud and the 100-day moving average for the first time since June 2008. Those levels need to be sustained for further gains to unfold. Gold has closed below its Ichimoku cloud bottom at 904.44, but still needs to take out key lows between 875/885, and a drop through there would also suggest further improvement in risk appetites. The USD index is still inside the cloud, but a bearish crossover suggests a drop through the cloud base and further USD weakness may lie ahead. EUR/USD looks similar, but in reverse, and a daily close above 1.3438 on Monday may open up further gains that would likely exceed last week's highs at 1.3740. USD/JPY closed above its 200-day moving average at 99.16 and is currently above its cloud, as are all the JPY crosses, but the crosses are still below their own 200-day moving averages. Clearly some significant technical hurdles have been cleared, but the question is will they be sustained?
RBA, BOJ, and BOE Rate Meetings on Deck This Week
The Reserve Bank of Australia is set to decide on rates on Tuesday at 4:30 GMT. The market forecast is quite contentious, with multiple economists/strategists looking for no change, -25bps, or -50bps from the current 3.25% rate. Given that rates have already reached the bottom of the RBA's comfort zone and that the Australian economy continues to perform better than other economies on a relative basis, no change in rates is indeed a good possibility. Indeed, Australia's 2.1 billion-dollar trade surplus is being touted as one of the potential reasons the bank could decide to stand pat this week. The Australian dollar should benefit from no cut, as this will seemingly be a vote of confidence for the economy there. A rate cut of -25bps would likely elicit some modest weakness in the currency, while a -50bps slash likely sees AUD/USD dip back below the 0.70 level.
The Bank of Japan is up at 4:00 GMT on Monday, while the Bank of England is scheduled to release their decision at 11:00 GMT on Thursday. Both events are likely to elicit little price action as these central banks look to be done cutting. The BOJ rate is expected to remain steady at 0.10%, while the BOE is forecast to stand pat at 0.50%. In terms of the risks to consensus, they are clearly on the BOE event. Though at an already very low level, the BOE could decide to take rates even lower, potentially borrowing a page from the Fed playbook and going with a 0.00% to 0.25% target range. Ultimately, this would probably be quite negative for GBP as the unexpected cut would likely be viewed as a panic move. In other words, if the BOE does decide to cut, we would not be surprised to see Cable spill back below 1.45 in relatively quick fashion.
MORE: March Non-Farm Payroll Report Points to More Pain Ahead |pagebreak|
While the market was busy celebrating—albeit briefly—what was an as-expected result in both the NFP headline at -663K and the unemployment rate at 8.5%, a look at the details of the report suggest an employment cycle that has yet to hit rock bottom. The two best leading indicators—hours and temp help—put in fresh cycle low annual rates of decline. Hours collapsed to -6.1% from -5.3% and was the worst rate of decline since 1975, to boot. Meanwhile, temporary help employment sank at an annual rate of -26.9% from -25.0% and the worst since records began back in 1991. These are the things employers tend to cut first, and the fact that the bleeding here has not decelerated is an ominous sign for the job market in the months ahead.
Another metric flashing no end yet in sight is the recently available Employment Trend Index from the Conference Board. The index is composed of eight indicators that have historically led employment cycles. This metric sank to an annual rate of -21.8% in February from -20.8% in January and tends to signal the bottom in the employment cycle with a five-month lead. This means the earliest we can expect to put in a bottom in terms of the job declines is July of this year. Employment is ultimately a lagging indicator, but the bottom of an employment cycle is not. This must be reached before any significant pickup in economic activity can ensue. So while today's report may seem cheery on the face of it, the reality is indeed bleak.
Key Data and Events to Watch This Week
The US economic calendar is on the light side with little in the way of top-tier data. Tuesday kicks off the week with the IBD/TIPP economic optimism index and consumer credit. Wednesday sees the usual weekly oil inventory numbers along with wholesale inventories. The trade balance, import prices, and initial jobless claims are up on Thursday, while Friday rounds out the week with the monthly budget statement. Look for the Fed meeting minutes on Wednesday as well.
It is modestly busy in the euro zone, and Monday starts the week off with euro zone producer prices and retail sales. Euro zone GDP is on deck for Tuesday, while French trade, German trade, and German factory orders are up Wednesday. German consumer prices and industrial production are the Thursday highlights, and Friday has French consumer prices and industrial production.
The UK action starts on Tuesday with industrial production, consumer confidence, and the NIESR GDP estimate. Producer prices and the trade balance are up on Thursday along with the Bank of England rate decision (see above for more on this).
Japan has a few important releases on tap this week. Monday sees the leading economic index, while Tuesday has the current account and trade balance due up. Machine tool orders on Thursday are the highlight for the week. Look for the Bank of Japan rate decision on Tuesday and the BOJ monthly report, which follows on Wednesday as well.
Canada is characteristically light, but features top-tier data nonetheless. Building permits and the all-important Ivey purchasing managers index are on tap Monday. Housing starts are on Wednesday, while Thursday rounds out the week with employment, trade, and new home prices. It points to a good week in terms of CAD price action.
It is on the light side down under. The RBA rate decision on Tuesday is the highlight for the week here (more above). Before that, we get New Zealand business confidence on Monday. Wednesday is busy with Australian consumer confidence, Australian home loans, and New Zealand home prices. Last but not least, Australian employment closes things out on Thursday.