Highlights

  • Risk looks set for a correction lower
  • Greece edges closer to calling in the IMF
  • UK election nears; better economic data are GBP supportive
  • Key data and events to watch next week

Risk looks set for a correction lower

This past week has all the hallmarks of a market set to stall and undergo a correction lower for a few weeks at least. Before outlining those hallmarks, it's worth mentioning the main source of hesitation with this view, namely the proximate catalyst to Friday's sell-off: the US bank being charged with fraud by the SEC. (Oh, and also that it happened on a Friday.) While it makes sense that their own shares should be hammered, it's less than clear why oil, gold, JPY-crosses, not to mention the broader stock market, should collapse in tandem. After all, they're only one bank, and they'll be able to pay off any fine if found guilty, and then resume making billions again. But perhaps we're getting too caught up in the headlines of the moment.

Taking a step back, there are plenty of other fundamental reasons why the rally in risky assets may take a breather for a while. China's President Hu indicated in a speech in Brazil on Thursday that China plans on reverting to a managed float of the Yuan, though the timing of that move is still open. China also raised mortgage lending requirements to take some air out of the growing real estate bubble, adding to earlier steps to rein in bank lending. Taken together, markets fear those moves will crimp Chinese growth and undermine the global recovery, hence the commodity and stock market sell-off. In terms of allowing the Yuan to potentially appreciate, we would argue that it would eventually be a positive for the global recovery outlook, after the initial knee-jerk risk averse reaction, which should last only a few days or weeks. If China allows the Yuan to strengthen, it will improve the export competitiveness of key export-driven economies like Japan and Germany, to name just two, supporting the recovery in developed nations, which still account for 2/3 of global GDP. Imports to China would also become less expensive, potentially stimulating Chinese domestic demand, which would also add to global growth prospects. Then there is Greece (more below), which is ultimately a sideshow to the growing sense that the EUR has been fundamentally wounded. Lastly, high and prolonged unemployment continue to restrain recoveries in the most developed economies, effectively limiting the upside for risky assets in the process.

Turning back to the hallmarks of a stall and potential downside correction in risky assets, we would first note the continued high correlation between various asset classes--the symmetry is truly amazing. In FX, in the JPY-crosses double tops (or close facsimiles) are evident in EUR/JPY, GBP/JPY, AUD/JPY, and CAD/JPY and prices have since fallen back into the middle of the recent ranges, ultimately exposing potential back to the range lows. In commodities, gold and WTI crude oil also posted double tops at $1160/70/oz and $86/87/bbl, respectively. In stocks, the case is even more compelling: Bullish sentiment at extreme levels of 92%; lowest CBOE put volume since the rally started in March 2009; and asset managers reporting the lowest level of cash holdings in years. Then there is the 61.8% retracement of the 2007-2009 decline in the S&P 500, which comes in at the 1225/1230 area, a natural point to trigger a correction, and which was effectively seen with a high around 1214. (Also worth mentioning, there appears to be a potential 'abandoned baby top' pattern in the S&P, but gaps are not present, so it's not perfect. But it's a rare pattern and quite significant when it appears.) Lastly, there is the dog that didn't bark. All of this past week's price action took place in a week with arguably better than expected data and positive corporate earnings reports, meaning risky assets should be finishing the week out on the highs. Instead, after trying the upside most of the week, risky assets are closing out at the lows, suggesting a potentially significant failure and downside correction ahead. Finally, we would note that most markets have simply fallen back within recent ranges and we will continue to use key range levels as entry/exit points, but our bias is now for lower risk ahead (lower JPY-crosses, stocks and commodities/higher USD, except against JPY).

Greece edges closer to calling in the IMF

Yields on Greek 10 yr bond crept back to the 7.37% area ahead of the weekend as the markets await details on the next step in the country's funding crisis. Members of the IMF, the EU and the ECB are expected to travel to Athens in the coming days to discuss how Greece can meet its EUR 32 bln funding requirement for the rest of the year. Despite this month's announcement that the EU will make EUR 30 bln available to Greece at 5% in the form of a 3 year loan, the timing and even the possibility of such a transaction is presently being questioned. Talk that Germany may have to pass a parliamentary act to allow a loan to Greece and news that a German academic may launch a Constitutional Court petition aimed at preventing aid to Greece have undermined the credibility of the agreement. In May Greece has a funding requirement of EUR11.6 bln. Since it cannot afford to issue debt at current market rates and still hope to reduce its budget deficit to 8.7% of GDP this year (from 12.9% of GDP last year), it seems that the country is edging ever closer to calling in the IMF.

On the upside there have been signs that Greece is making progress on attacking its budget deficit. Parliament has approved a bill targeting tax evasion and the press has reported that the retirement age will be raised to 65 years (it is 67 in Germany and 66 in the UK). The Finance Ministry has announced that the budget deficit in the first quarter of 2010 stood at EUR5.7 bln, down from EUR6.4 in Q1 2009 (although the timing of Easter will have had an influence). IMF involvement will almost certainly require a step up in austerity measures going forward. Of more concern to the markets, however, will be whether a debt restructuring is demanded. While IMF participation is likely to ensure that Greece will eventually pull out of its deficit quagmire, it also focuses attention on the EU's inability to sort out its own problems. Most specifically its highlights the inadequacy of EMU's stability pact and raises the question of whether monetary union is sustainable without greater fiscal controls. Also, Germany's May 9 regional elections could be used as a platform for the electorate to protest against their position as the EU's major creditor. In short the EUR faces further tests ahead.

UK election nears; better economic data are GBP supportive

With just weeks to go before the May 6 general election only a minority of opinion polls have suggested that the 'market friendly' Tory party is likely to win an outright majority. That said, the bookies are more confident; the odds have shortened to 1/8. Sterling softened as the Tories failed to take the lead in the televised debate between the leaders of the three main political parties. The winner of this debate was seen to be the Liberal Democrat party. However, since the odds of this party winning a majority in the election are still at 50/1, this is only of relevance insofar as the LibDems may have increased influence if Labour attempt to form a coalition after the election. Overall sterling has gained in recent sessions vs both the USD and the EUR with better export, retail activity and production data all contributing to an improved economic backdrop. Although the budget deficit and election continue to blight the outlook for the pound, continued improvement in growth data would make it easier for any government to improve the budget deficit/GDP ratio. On a Tory victory on May 6 sterling could be squeezed sharply higher suggesting it may be prudent to cover some shorts.

Key data and events to watch next week

US data kicks off on Monday with March leading indicators, but then there's little until Thursday when we get PPI, jobless claims, home price index and existing home sales. Friday finishes up with March durable goods orders and new home sales.

Eurozone data see EZ Feb. Construction output on Monday, followed on Tuesday by German PPI and German and EZ ZEW investor surveys. Thursday sees preliminary April PMI's for manufacturing/services and EZ consumer confidence. Friday ends with French consumer spending, German IFO index, and EZ industrial new orders.

Japan will report March consumer confidence on Monday afternoon. Tuesday morning sees the Tertiary Industry Index followed by machine tool orders in the afternoon. Thursday morning sees the March adjusted trade balance, and Friday ends with the Feb. All-Industry Activity index for Feb.

In the UK, its busy all week starting from Tuesday when CPI/RPI for March are released. Wednesday sees the release of the Bank of England minutes followed by March employment data. Thursday sees March retail sales, money supply, government borrowing, and the CBI quarterly industrial trends survey. Friday wraps up with 1Q advance GDP estimates.

In Canada, Monday starts with Feb. International securities transactions, but the big day is Tuesday when the Bank of Canada meets to decide on rates. No change is expected now, but the market will be listening for any indication from Gov. Carney as to the timing of the BOC's move to tighten interest rates. Wednesday sees Feb. Wholesale sales; Thursday leading indicators; and Friday March CPI and Feb. Retail sales.