Dollar pause, but when?

Since the beginning of July, the US Dollar has entered into a bull momentum and nothing seems to stop its trend. The USD index surged by almost 9% in the past three months and is now trading at a four year high at 85.65 (June 2010 levels to be precise). With the Fed about to finish tapering at the next meeting in October ($15bn cut) and policymakers acting much more confident (compare to H1) due to stronger macro indicators and an equity market still ‘rallying’, the market didn’t hesitate to position itself back into US Dollars.

If we have a look at the last Fed’s dot plot below, Fed Officials raised their median estimate for the FF rates at the end of 2015 to 1.375% (vs 1.125% in June). Moreover, by the end of 2017, the majority of the committee expects the FF rate to rise to 3.75%.

imagedotplots

(Source: Federal Reserve)

With the unemployment rate sitting at 6.1% (below the once-used-to-be 6.5% threshold), growth revised higher in Q2 at annualized 4.6% (vs. 4.2% in previous estimate) and most of the fundamentals being stronger (except August NFP and dismal durable goods that came in at -18.2% MoM), the market is looking at an earlier-than-expected rate hike in the US. I heard and read Q2 seems likely. In my opinion, US policymakers are making a mistake as they should have let the market ‘swallow’ a period without QE before starting to be more explicit concerning their ST monetary policy (see article Could we survive without QE?). I agree the Fed’s recent ‘move’ has probably made the joy of most of the central banks as all the currencies have been trending lower against the US Dollar. However, it looks to me that the recent talks we’ve heard have been premature [a bit] and in case of disappointing fundamentals, the Fed could easily switch to another mute period (aka BoE lately).

Based on my last discussions with the strategy team, we agreed there are several factors that could continue to hold back a significant growth acceleration in the near term. For instance, mortgage applications (MBA Purchase Index: orange line) in the US stands at a 14-year low even though the 30-year fixed mortgage rate (black line) is still trading at ‘decent’ low levels (4.39%, vs. an average of 6% between 2002 and 2008) as credit conditions are much tighter now.

HousingMarck(1)

(Source: Reuters)

Moreover, wage growth continues to increase only at a modest pace (except for skilled workers in areas such as health care) and will continue to weigh on personal consumption expenditures, which represents roughly 70% of the US economy.

US data this week:

 – Important figure to watch this week will be September Non-Farm Payrolls on Friday, which is supposed to print above the 200K (215K according to pools).

 – September Average Earnings and Workweek Hours (Friday) are expected to print at 0.2% MoM and 34.5h.

 – ISM Manufacturing PMI should remain strong at 58.5 on Wednesday.

Chart on STIRs: As I mentioned it in some of my previous research, the implied rates on the FF December 2015 and December 2016 futures contracts suggest that the Fed’s target rate will the end the year at 75bps in 2015 and 112bps in 2016 respectively.

ImpliedFFRates(1)

(Source: Bloomberg)

It is all about CBs…

Before the FX trading week starts, I just wanted to share a little chart (See source below the chart) with you that shows the evolution of the top 4 central banks’ balance sheet since GFC. More than 10 trillion of USD were injected into the system in the past six years, which tells us that it is all about CBs. You can see the latest development from Bank of Japan (Abenomics) and its consequences on the Yen (It closed the week at 109.04 against the USD). Next ‘big player’ will be the ECB (purple line); Draghi announced that Officials were looking to expand the size of the balance sheet by 1 trillion Euros (in order to come back to June 2012 levels) over the next couple of years. Hold short: EUR/USD will continue its BEAR momentum in the following months… My ST target is set at 1.2800 (greedy will play the 1.2750 retracement), my MT target is set at 1.2000.

Central

Euro and UK Updates

In short, inflation came in slightly above expectations at 0.4% YoY (vs. 0.3% expected), however it didn’t have much of an impact on the Euro. EUR/USD has been pretty rangy for the past couple of weeks, oscillating between 1.2875 and 1.3000. We see sellers at 1.2975-80, 1.3000 and 1.3025.

I believe that any bounce back above 1.3050 could be considered as a new opportunity to short the pair. Next target remains at 1.2800, greedy traders will target the 1.2750 retracement (9 July 2013).

EURUSD(1)

(Source: Reuters)

We went short EUR/GBP at 0.8030 last week as we believe the pound will ‘recover’ slightly from its losses. Earlier this morning, the ONS figures showed that the number of people claiming Jobseeker’s Allowance in August fell by 37.2K (vs 30K expected), and the unemployment rate fell to 6.2% (vs 6.3% expected), its lowest level since October 2008. In addition, average earnings (ex bonus), the BoE’s new focus, edged up 0.1% to 0.7% in July and still stands much lower than the rate of inflation (CPI came in at 1.5% YoY in August).

The BoE minutes [of MPC Sep 3-4 meeting] showed once again that two policymakers – Ian McCafferty and Martin Wheale – voted to raise interest rates [by 0.25%] this month, leaving the central bank divided (7-2) for the second consecutive time. The implied rate of March15 Short Sterling futures contract (white line) is trading 8bps higher from last week’s low, bringing the value of the British pound with him (see Cable in green line).

On the top of that, the pound benefitted from 3 opinion polls suggesting that 52% of Scots will vote ‘No’ to independence…

Stirsandcable

(Source: Bloomberg)

Standard Bank on T-LTROs: The market expects the first TLTRO tomorrow to generate around EUR175bn of demand from euro zone banks.

Update on Kiwi, RNNZ on hold as expected…

The Kiwi has remained under pressure against the greenback since the middle of July when it flirted with its 3-year resistance at 0.8840. Since then, we saw a lower than expected CPI that printed at 1.6% in Q2 on July 15 (vs 1.8% expected) followed by a dovish stance from RBNZ policymakers on July 24th. Despite the central bank raised its OCR by 25bps for the fourth time this year to 3.5% (in line with investors’ expectations), Governor Wheeler indicated that the central bank was considering a pause in the following meeting after the 1% shift.

Therefore, investors lost interest in the currency (probably some take profits above 0.8800) and the negative trend started. I have remained bearish on the currency since the central bank’s last statement, and I anticipated the NZD to depreciate even more against the USD ahead of the RBNZ meeting (September 10th). As expected, the central bank left rates unchanged yesterday and added that ‘softer inflation might limit the extent of rate hikes’, pushing NZD/USD below the 0.8200 level (trading at 0.8175 as you can see on the chart below).

I set my target at 0.8050, which corresponds to February 2nd (2014) low.

KiwiDol(1)

(Source: Reuters)

Buy the dips on NZD/JPY?

It looks to me that the 14-day SMA (orange line) has been acting as a ‘strong’ support on NZD/JPY for the past couple of weeks. Despite my bearish sentiment on the Kiwi, I also turned bearish on the Yen and I believe that bearish Yen is preferable to bearish Kiwi. Therefore, I will try to buy some at around 87.30, stop loss below 86.90 with a target at 88.00.

NZD-11-Sep(1)

(Source: Reuters)

Japan, the Yen and the Aussie

Three days ago, we saw that Japanese GDP contraction in the second quarter was revised to an annualized 7.1% QoQ (vs. 6.8% previously), shrinking at its fastest pace in more than five years, due to a deeper decline in consumer spending and a bigger fall in capital expenditure (money used to purchase, upgrade, improve or extend the life of LT assets). In addition, the Ministry of Finance reported that the country showed market a current account surplus of 416.7bn Yen in July (slightly less that 444bn expected and 30% down compare to July last year) as the income from foreign investments (up 2.8% to 1.853tr Yen) outweighed the trade deficit (964bn deficit Yen in July, August one to be released on Sep 17th).

While the unemployment has fallen quite sharply since Abe’s election (4.5% in Dec 2012) to 3.8% in August, real wages have constantly been declining over the past few years (they fell by 3.8% YoY in May, the sharpest decline in years). One explanation of the fall in real wages I read lately (The Economist, Feeling the pinch) was that Japan’s labour market is divided between two sorts of employees, regular ones who are usually highly paid and protected [against being fired] and the non-regular [low-paid] ones. If you have a look at the figures, non-regular workers accounted for 36.8% of all jobs in June, a high number compare to historical standards and therefore confirming that most jobs created since Abe took office were non-regular workers.

This definitely explains weakening figures in household spending. We saw that July Household Spending fell 5.9% YoY, twice what economists expected, printing in the negative territory for the fourth time in a row. As a reminder, Japan is a consumer-driven economy (61% as a percentage of GDP in 2012 according to the World Bank); therefore the BoJ will watch closely those figures in order to avoid another dismal quarter.

However, according to the Bank of Japan Deputy Governor Kikuo Iwata, the economy is ‘gradually recovering’ and it is all about the sales tax increase effect. Moreover, with the BoJ now monetizing debt at negative rates (T-Bill 12/08/2014 has been trading in the negative territory for the past few days as you can see it in the chart below), Iwata added that he didn’t see ‘any difficulties in money market operations’.

sg2014091052862(1)

(Source: Bloomberg)

Quick review on USD/JPY

The recent surge in the stock market (Nikkei up 1,000 pts over the past month, closing at 15,788.78 earlier this morning) mainly coming from ‘more QE coming soon’ speculation combined with demand for international securities (Bonds, Stock) from Japanese funds have both played in favour of the depreciation of the Yen lately since it broke out of its 101 – 103 range on August 20. In addition, with US yields starting to ‘surge’ (10-year yield up 20bps over the past two weeks and now trading at 2.53%), USDJPY was sent up to 106.85 during today’s trading session, breaking its resistance of 105.44 (Jan 2nd high) and trading to levels seen back in September 2008. If the depreciation continues, the next MT target on the pair stands at 110.

Aussie updates…

AUDJPY (black bar) eased a bit from last week’s [16-month] high of 98.65, down more than a 100 pips (carry trade unwinds combined with AUD selling from corporate and macro names), taking the equity market (red line) with ‘him’ (S&P closed below the 2,000 level at 1,988).

AUDJPY-10-Sep(1)

(Source: Reuters)

The AU benchmark (S&P/ASX) index came back to a 3-1/2 week low after Westpac’s index of consumer sentiment reported a 4.6% decline in September, bringing the Aussie below the 0.9200 support against the greenback.

AUDUSD is also trading below its 200-day MA (0.9180) for the first time in five months. Market has turned bearish on the pair as the failure to hold the 0.9180 – 0.9200 support area has opened up further retracements levels: 0.9075 (61.8% Fibo retracement of 0.8658 – 0.9756), followed by 0.9030. Australia will report employment figures overnight (2.30 am), which traders expect to be disappointing, therefore sending the Aussie to lower levels.

AUD-10-Sep(1)

(Source: Reuters)

Could we survive without QE?

As we are approaching the end of QE (the Fed will probably announce a $10bn / $10bn and then 5bn cut in the next three meetings), I thought it is a good time to have a quick recap of the US QE history since the Great Financial Crisis and its impact on the equity market.

QE1 (December 2008 – March 2010): On November 2008, roughly two-and-a-half months after the Lehman Brothers collapse, the FOMC announced that it will purchase up to $600bn in agency MBS and agency debt and on March 18, 2009, Bernanke and its doves announced that the program would be expanded by a further $750bn in purchases of MBS and agency debt and $300bn in T-bonds. At that time, the Fed had approximately $750bn of Treasuries ad MBS on its balance sheet.

QE2 (November 2010 – June 2011): After 9 months of stagnation in the stock market, the FOMC decided to go for another round of quantitative easing on November 2010 and announced that it will purchase $600 bn of LT Treasuries, at a pace of $75bn per month. Stock market started to rallied once again (S&P was up approximately 10%) as by applying this un-conventional monetary policy, the Fed brought interest down to the floor and ‘forced’ investors to move to the stock market in order to receive a more interesting real rate.

Operation Twist (September 2011 – December 2012): While the stock market was plummeting (S&P was down 300 pts to hit 1,075 a few months after the end of QE2), it didn’t too long for the Fed to react and on September 21st 2011, the FOMC announced Operation Twist. In this program, the Committee intended to purchase, by the end of June 2012, $400bn of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. The main goal was to lower long-term rates in order to stimulate consumer spending and corporate borrowing as growth was judged sluggish by US policymakers at that time. In the middle of 2012, the FOMC downgraded its growth expectations from 3.5% (a year earlier) to 1.9% – 2.4%.

By the end of June 2012, the Fed extended the monetary twist program and said it would purchase another $267bn LT Treasuries by the end of the year, bringing the program up to $667bn.

QE3 (September 2012 – December 2012): With inflation in the US plummeting from 3.9% in September 2011 to 1.4% in July 2012 and credit continuing to contract and still disappointing unemployment figures, the FOMC decided at the September 2012’s meeting (13th) to initiate additional open-ended purchases of residential MBS for an outstanding amount of $40bn every month. Combined with the (approx.) S45bn monthly purchase of US LT Treasuries, the FOMC will increase the central banks’ holdings of LT securities by about $85bn each month, which should ‘put downward pressure on the LT interest rates, support mortgage markets and help to make broader financial conditions more accommodative’ according to the Fed’s statement.

QE4 (December 2012 – December 2013): With Operation Twist coming to an end and US policymakers still judging the recovery as ‘fragile’, the Fed decided to continue to purchase $45bn worth of US LT Treasuries, raising the amount of QE to $85bn on a monthly basis. Its goal at that time was to drive economic activity so that unemployment rate drops to 6.5% (it was standing at 7.7% at that time), as long as inflation remains below 2.5%.

And it went on, that year the Fed increased its balance sheet by a trillion+ dollars, bringing it to a record high of $4trn in December 2013 and which could totally explain the 30% increase in the stock market and the 10% appreciation in the housing sector (Reminder: for the 2013 fiscal year ended Sep. 30th 2013, the US Congressional Budget Office – CBO – announced that the deficit fell drastically to $680bn from $1.087tr in 2012).

QE Taper (December 2013 – ): As the unemployment rate was falling faster than expected in 2013 (down 1% to 6.7% in December 2013), the Fed officials decided to start its QE Taper, announcing that it would scale back its monthly purchases by S10bn each meeting (Auto-pilot strategy). After almost two years of extended QE and with the Fed’s balance sheet up 1.5tr USD (according to FARBAST index), we are now three meetings ahead of the QE exit (last cut expected to be on December’s meeting). The real question now is: would the ZIRP policy on its own be enough to support the equity market (and the housing sector)?

We saw some turbulence back in January this year when the market corrected 5.5 – 6 percent (between mid-Jan and February 3rd) and also in end-July/August where we saw another 4.5-percent correction in the middle of high geopolitical tensions (11.7% of the World is at war according to a DB analysis, see chart at the end). However, it seems that the market has perceived those ‘corrections’ as new buying opportunities and the S&P 500 has been flirting with the 2,000 level for the past week (closed four days out of five above 2,000 over the past week). The index is already up 8.3% since December 31st 2013 close (1,848.36) and I am asking my self, how far could this go? Especially now that the Fed is now giving us some updates concerning its ST monetary policy, and is potentially considering raising rates (currently at 0 – 0.25%) sometime next year (Q3 seems to be the market’s view). I am going to steal Stanley Drunckenmiller’s sentence: ‘Where does the Fed’s confidence come from?’

Aren’t policymakers supposed to wait a little bit after Taper ends in order to start focusing on its ST interest rate policy?

Even though the rate hike is priced for Q3 next year based on the market’s expectations, I don’t see the point of starting talking about an ‘eventual rate hike’, and especially after the only excuse you had to explain a 2.9% contraction in the first quarter (because there has to be always an explanation) is to blame the weather. In my opinion, US policymakers’ plan sounds a bit ambitious.

Chart: S&P 500 index and QE history

S&PQE(1)

(Source: Reuters)

Another popular chart that I like to look at is the equity market (S&P500 index) overlaid with the Fed’s balance sheet (FARBAST index). As you can see it, it is clear that the Fed’s balance sheet expansion have played in favour of the equity market. Liquidity drives asset price higher and I believe that we are about to hit the high of the asset price inflation we have seen for the past six years…

FEDSP(1)

(Source: Bloomberg)

Appendix

20140725_war2(1)

ECB shakes the market

In addition to an ‘interest rates corridor cut’ (refi rate down to 5bps, deposit rate to -0.20% and marginal lending rate to 0.30%), the ECB surprised the market today after Draghi announced that the central bank will start buying securitised loans (portfolios of transparent ABS which will include loans to the real economy and real estate assets) and euro-denominated covered bonds in order to boost lending to small and mid-size companies (further details next meeting on Oct. 2nd).

 It was clear that ECB aims to get the total assets of its balance sheet back to the levels seen in  2012, which is to say a 1 trillion-Euro expansion. The ECB balance sheet (total assets) is now standing at 2.038tr Euros according to the EBBSTOTA index from Bloomberg, 34% lower than June 2012 high of 3.1tr Euros. This would bring back the Fed-to-ECB balance sheet ratio (one of the pair’s strong drivers) to 1.22 within the next few years, down from 1.67 where it stands at the moment, therefore adding pressure to the single currency.

 EURUSD started the day quite flat, trading at around 1.3150, before it was sent to 1.3000 at first during Draghi’s conference and even lower below 1.2940 as core European bonds yields turned negative to 2Y as you can see it below. French 2-year yield is now trading at -2.8bps, Austrian 2-year yield at -0.6%. German yields are now negative up to 4 years.

CoreYields(Source. Reuters)

In addition, the Governing Council reduced its growth and annual inflation to 0.9% and 0.6% for 2014, down from 1% and 0.7% respectively.

If you have a look at the picture chart below, which represents the full ‘ECB bailout scheme’ in order to sustain the European economy, you just start to think ‘what else could they do more?’

MRO, LTRO, ZIRP, SMP, OMT… and now T-LTROs, ABS and covered bonds. There are talks that Europe is heading towards a long period of stagnation / deflation period, where QE will be the only [pretended] option to get out of the negative spiral (have a look at Japan since Abe took office in December 2012 and see if QE is the solution).

ECB-bailing-out-Europe (Source: Bawerk.net)

If we have a look at EUR/CHF, it ‘only’ went down 20 pips (bottomed at 1.2044) after the ECB’s action; therefore I think that the SNB has already started buying some Euros in order to protect its floor at 1.2000.

USDCHF broke through the 0.9300 level to trade at 0.9330 earlier this afternoon, slightly below its 50-percent Fibo retracement of 0.8700 – 0.9980. The next resistance on the topside stands at 0.9450, followed by the psychological 0.9500.

CHFSNB(Source: Reuters)