- Bloodbath on Wall Street
- USD set to benefit as EUR shows cracks
- Commodities in the process of peaking
- RBNZ, BOJ and BOC rate decisions due
Stocks fell into the abyss this week as fears of a US recession mounted, even as US policymakers sought to assure markets they were intent on delivering both monetary and fiscal stimulus. To give you some historical context on the extent of declines, the S&P 500 is off to its worst annual startâ€”ever. But equity market losses were hardly confined to the US, as all major global stock markets are now down between 8-12% YTD. In the midst of the rout in equity markets, the USD managed to hold up extremely well and is even poised to potentially break out to the upside in coming weeks, which is extraordinarily counter-intuitive to say the least. I think traders need to consider that we are currently dealing with a market that is responding much more to psychology than to fundamentals, and that always makes for difficult trading conditions.
Several weeks ago, I wrote that investors were increasingly uncertain and risk averse and were on the verge of turning outright defensive. I think itâ€™s safe to say that investors are now clearly defensive and that means we are dealing with a liquidating market. In short, existing positions are being exited across the board en masse, with slumping equities the most obvious indication of that. In currency markets, the JPY continues to be sought as carry trades are exited (JPY-cross selling) and Japanese investors repatriate foreign investments as the global investment environment deteriorates. However, the largest open positions are short-USD bets and I believe this is the why the USD is holding up relatively well, even as the economic outlook and interest rate expectations continue to move lower. Itâ€™s always a dangerous prospect to try to pick the bottom of a liquidating market, and my own sense is that weâ€™re probably closer to the beginning than the end, and this keeps me alert for a potential USD breakout to the upside.
Other major markets, in particular gold and oil among the commodities, are on the cusp of turning lower in the weeks ahead. Likely market declines in commodities are supported by lower global growth outlooks as well as by speculative long positions being exited. In gold, this past week was highlighted by a candlestick pattern known as a Tweezer Top, which formed after two successive days of gains to $914/oz could not be sustained. Subsequent declines saw an important Ichimoku support level at 885.70 (Tenkan line) fail and later contain price rebounds on a daily close basis. The drop below the Tenkan line suggests a likely fall to the Kijun line just below $850/oz, and if that level should fail on a daily close basis, the chart suggests a further drop to the top of the cloud, which will be at about $803.50 for next week. Oil prices have already retreated into the cloud, and the Tenkan line has crossed down through the Kijun line, signaling a medium strength sell signal. A daily close below the bottom of the cloud, which will be at $88.82 next week, suggests likely further declines and an overall trend reversal. Given the massive amount of speculative positioning in these two markets (everyone on board for $1000 gold and $100 oil), a reversal could turn into a rout in short order.
Iâ€™m highlighting those two markets because of the high degree of correlation they have recently displayed with the USD and especially with the EUR/USD pair. The run-up in commodity prices has occurred hand-in-hand with the rundown in the USD and the run-up in EUR/USD. The fundamental justification for higher commodity prices has been strong global growth resulting in demand outstripping supply. But as major economies confront weaker growth scenarios, it stands to reason that global growth will suffer.
And Iâ€™m not just referring to the weaker US outlook. The second largest national economy in the world, Japan, is in near-recession. The third largest national economy, Germany, is in the process of lowering its 2008 growth forecast from 2.2% to around 1.7%, and that may turn out to be optimistic. The fourth largest national economy, China, is intensifying efforts to slow its rapid growth through a combination of higher interest rates, faster Yuan appreciation, and tighter bank lending rules. Last week, China reported another decline in its trade surplus, suggesting the governmentâ€™s measures are taking hold. Perhaps most telling in terms of psychology, economic leaders in countries facing declining growth outlooks are now routinely pointing to emerging market economies as â€˜theâ€™ source of continued global growth. When the big guys start pointing to the little guys as a source of support, you should be hearing alarm bells ringing. Emerging markets have been extraordinaryly resilient to date given their historical vulnerabilities, but I think this is due to excessive euphoria over their emergence and a lack of investment growth alternatives elsewhere. However, when reality hits, emerging markets are in line for the traditional capital exodus, and this why I think we are still closer to the beginning than the end of market liquidations.
Turning back to the EUR, ECB council member Yves Mersch this past week exposed a raw nerve in the marketâ€™s anti-USD/pro-EUR complacency. Mersch suggested that the ECB needed to be more flexible in the conduct of its monetary policy, pointing to increasing signs of slowing and uncertainty in the outlook. He was forced to step back from those comments just a day later, but the damage had been doneâ€”markets were now reckoning with a slower Eurozone outlook and the prospect of no further rate hikes and even the potential for a cut later in the year. EUR fell back sharply, even against the beleaguered GBP, and is finishing the week closer to its lows. EUR/USD and the broader USD index are both trading inside their clouds, setting the stage for a potential trend reversal. The failure of EUR/USD to extend gains early in the week have generated a bearish engulfing line on the weekly candlesticks, and the long shadow above suggests a break lower is the greatest risk. (See the Weekly Strategy for more detailed analysis of EUR/USD.)
Next week, there are several central bank rate decisions expected. First up is the Bank of Japan (BOJ), which will hold rates steady when they announce on Tuesday afternoon Tokyo time. Next is the Bank of Canada (BOC) which is expected to cut rates by Â¼% to 4.00% when they announce on Tuesday morning ET. Weakness in recent data and the slowdown south of the border in the US make a rate cut a done deal. Next is the Reserve Bank of New Zealand (RBNZ) which is expected to hold rates steady when they announce Wed. evening NY time/Thursday morning in Wellington. Higher 4Q inflation and still strong retail sales suggest the risks are for a rate hike, but in the current global environment this does not seem likely.
Turning to the US, a national holiday on Monday will see stock and bond markets idled, but FX will continue, though with lower participation and liquidity, which is always a recipe for volatility. Data on the whole is light, starting with the Richmond Fed index on Tuesday. Weekly mortgage application data is all there is on Wednesday. Thursday sees weekly jobless claims followed by Dec. existing home sales, which are expected to weaken further. There are no Fed speakers due to the blackout period prior to the Jan 29-30 FOMC meeting.
Eurozone finance ministers will be meeting beginning on Monday evening through Tuesday; comments on currencies are a regular feature of these get-togethers. Eurozone data includes a number of key sentiment gauges that could prove pivotal to the direction of the EUR. Monday begins with German Dec. producer prices. Wednesday sees Eurozone January purchasing manager indexes for manufacturing, services and the composite, and expectations are for declines in sentiment. Thursday sees the German Jan. IFO gauge of corporate sentiment and expectations, which is also expected to register declines. Friday sees German Dec. import prices and the Feb GfK consumer sentiment survey, which is expected to decline slightly.
Japanese data begins on Monday afternoon Tokyo-time with the final Nov. leading economic index and Dec. convenience store sales. Tuesday sees the BOJ rate decision in the afternoon followed by the BOJâ€™s monthly report. Thursday morning in Tokyo sees the Dec. trade balance and the Nov. All-Industry activity index. Friday sees Jan. Tokyo CPI, Dec. national CPI, and the release of the BOJ MPC minutes from their Dec. meeting.
UK data kicks off with Jan. Rightmove house prices at midnight GMT Monday, followed by money supply and bank lending data in the London morning. Tuesday sees only the Jan. CBI quarterly industrial trends report. Wednesday morning sees the release of the BOEâ€™s minutes along with advance 4Q GDP estimates. Thursday sees only British Bankers Association home lending statistics. BOE Gov. King will deliver a speech in Bristol on Tuesday evening.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.