The risk pullback we were looking for this past week proved exceptionally short-lived, with an opening dip at the start of the week giving way to yet another rebound by the end of the week. Stock markets stabilized after an early scare out of China and the S&P 500 managed to make minor new highs for the year, along with oil prices. Not all inter-market signals were in agreement as the broader NASDAQ nearly stalled below its highs, the USD (US dollar index) staged a decent bounce from above its lows for the year, and JPY-crosses were nowhere near their recent highs. This lack of confirmation from other markets keeps the FX outlook tentative to say the least, but the risk bounce did have some decent fundamental underpinnings, though it remains heavily driven by sentiment. Eurozone ZEW sentiment, Eurozone PMI's, the Empire and Philadelphia Fed indexes, and US existing home sales all surprised substantially to the upside. Upbeat observations from Fed Chair Bernanke sealed the deal and sent risk assets even higher. Bernanke was not unequivocal in his optimism, citing a likely slow recovery and only a gradual improvement in unemployment. ECB Pres. Trichet was blunter, expressing irritation at talk of green shoots and adding that a lot of work is still left.
With the caveats that we're still in a relatively thin August market and that sentiment remains exceptionally fickle, we think there is some more room to run higher next week in risky assets as a series of confidence gauges are likely to show further improvement and provide a fresh impetus for risk assets to move higher. Out of the Eurozone we'll see IFO business sentiment and GfK consumer confidence surveys, as well as the UK GfK survey. From the US, we'll see the Conference Board's August survey to start the week and final Univ. of Michigan sentiment at the end of the week. Perhaps most importantly, the OECD is expected to raise its economic outlook in coming days, according to comments from OECD Sec. Gen. Gurria at the Jackson Hole Fed conference. Gurria in particular noted that countries employing significant stimulus efforts (esp. the US) were likely to lead the way out of the global downturn.
Higher JPY-crosses likely on improved outlooks
If the stream of incoming news stays positive, we would look for risk assets in general to stage further gains. In Forex markets, it looks like the JPY-crosses (long carry trades, like AUD/JPY, EUR/JPY, NZD/JPY and CAD/JPY) are the most likely candidates to appreciate, while the USD has a more mixed outlook. This past week saw many of the JPY-crosses testing the top of the Ichimoku cloud from above, which ultimately held, suggesting greater potential for a further rebound. For the greenback, higher US Treasury yields on improving sentiment will likely lend support to the USD and may prevent it from weakening significantly against other currencies excluding the JPY. Another round of massive US Treasury debt issuance is also likely to support yields, as supply floods in and Treasury investors seek additional premium. We think the year's highs in EUR/USD, AUD/USD, and NZD/USD/ lows in USD/CAD may be tested, but will not give up without a fight, while Cable may lag to some degree. In USD/JPY, the course higher is more straightforward on the back of higher yields, stronger stock markets and risk appetites. As well, USD/JPY is currently trading below its Ichimoku cloud, but may break up through it on strength above 95.50/75, which would provide a more technically bullish scenario. On balance, we prefer to buy USD/JPY between 93.50/94.20 and hold looking for 96.50/97.00. We also look to buy EUR/USD while it holds above 1.4200, AUD/USD while above 0.8200, and to sell USD/CAD while it holds below 1.1000.
Improvement in US housing and employment crucial for confidence
Existing home sales have now risen four months in a row to an annual rate of 5.24 million units. It is obvious that much of the increase in sales is due to the capitulation on prices from the selling community. Indeed, the median existing home price is still running at a dismal -15.1% from one year ago. It is however encouraging to see that homes are clearing the market at current price levels and this suggests home prices will likely not fall much further from here. The inventory situation has also improved and in the single-family home space, months' supply has ground all the way down to 8.6 from a cycle high 11.0 months hit in June of last year. A normal supply overhang is about 7 months and we are now within striking distance of that level.
To be sure, the multi-family sector continues to be plagued with problems. While sales rose 12.5% in July, this came on the back of massive price concessions and median prices are now running -18.9% from last year. Unlike the single-family sector, the inventory problem in the condos/co-ops space has worsened with the months' supply now sitting at 15.1 from 13.1 the prior month. This is hardly an improvement from the cycle high 16.4 printed in November of last year. That said, consumer confidence in the months ahead will likely be more a function of the health in the single-family space. On this front, the recent evidence is encouraging and the bottom of the cycle looks to be behind us.
Employment is the other major factor that will guide consumer confidence and in turn the strength of the US economy in coming quarters and indicators on this front are also more optimistic. While the initial jobless claims numbers for August have disappointed to the upside, averaging 569K for the first two weeks, seasonal adjustment problems with July suggest the numbers are not as bad. In order to correct for the statistical mess that was created by earlier than anticipated auto plant shutdowns - which skewed the July claims numbers way down - we would have expected August reads of well above 600K in initial jobless claims. That we have not printed with a 6-handle since the month of June should be a welcome sign that the worst of the employment situation is behind us. The employment numbers are likely to improve further as the bulk of the stimulus package rolls out as well.
Recent reports suggest that a mere $1 billion (from the mammoth $787 billion package) has been spent on highway and energy projects thus far. Implementation of these programs should provide a nice crutch to the employment situation as we head into the final months of 2009 and early 2010. How many jobs will be added remains to be seen, but with the economy already having reduced monthly nonfarm payroll losses to -247K in July from a cycle higher -741K in January, it remains extremely likely that we get a positive print in NFP before the year is out. This is not to say that job growth will be robust going forward, but the bottoming out in employment will mark the official end of the US recession and this will help confidence at least move back to normal. What that normal will look like in terms of economic growth rates remains to be seen, however.
Key data and events to watch next week
The US data calendar has a plethora of top tier events lined up and kicks off with the Chicago Fed National Activity Index on Monday. Case-Shiller home prices and consumer confidence are up on Tuesday while Wednesday brings durable goods, new home sales and the weekly oil inventory numbers. Thursday is key with the usual jobless claims data along with the second cut of 2Q GDP. Friday rounds out the week with personal income/spending, core PCE prices and the University of Michigan consumer sentiment index.
The eurozone has a lighter than usual week and it starts with industrial new orders on Monday. German GDP is on deck Tuesday while Wednesday brings the German IFO business indicators. German consumer prices and the German GfK consumer confidence survey are up Thursday. Friday wraps things up with the eurozone business climate indicator and consumer confidence.
It is also just modestly busy in the UK. Data on loans for home purchases get the ball rolling on Tuesday. Business investment, GfK consumer confidence and the CBI Quarterly Distributive Trades report make for a busy Thursday. GDP and the index of services close things out on Friday.
Japan has a characteristically light one ahead. The trade balance is due on Tuesday while Wednesday brings small business confidence. Thursday is the highlight of the week with employment and consumer prices on deck.
The Canadian calendar is likewise not very busy. Retail sales kick off the action on Monday while the current account and industrial product prices close out the week on Friday.
No major blockbusters down under either. Australian new motor vehicle sales start the week off on Monday while Wednesday has the New Zealand trade balance on tap. Australian leading indicators, Australian capital expenditures and New Zealand building permits round things out on Thursday.