- Risk assets are levitating a la Wile E. Coyote
- G20 and Eurozone Fin. Min.'s may lend USD verbal support
- Bank of England set to revise up near-term inflation forecasts
- QE could be phased out by February
- Somber US employment report makes for ominous outlook
- Key data and events to watch next week
News that the US unemployment rate rose to a 26-year high of 10.2% failed to dent risk appetites as seen in stocks, at least in the immediate aftermath on Friday (more on the data below). Commodities, however, did register the pain of rising unemployment and the implicit hit to demand, with the CRB index dropping to its lowest level this month, and now down about 5% from the Oct 21 high. JPY-crosses also responded appropriately to the downbeat labor market news, erasing most of the week's gains. The USD, however, failed to see much strength overall. In a sense, that's to be expected after the Fed reaffirmed its commitment to maintain exceptionally low rates for an extended period of time, a decision which was reinforced by the soft jobs news. But there's also the 'risk on/risk off' correlation, and while stocks managed to rebound, the USD remained under pressure.
In a scene reminiscent of the Wile E. Coyote/ Roadrunner cartoons, stocks seem to have run off a cliff, but are hanging in mid-air until they stop, take a look down and then plunge into the canyon. We view this past week's rebound in stocks and accompanying set-back in the USD as a correction after the larger reversal seen in the last week of Oct. The S&P 500 is holding below the broken trend line that guided the move higher since March, currently at 1070/71, along with the 21-day sma. A re-test of a technical break point is normal and we think that's the case with this past week's price action. EUR/USD followed shares higher after basing out above key trend line support, basically the equivalent of the S&P trend line, at 1.4600/20. The euro effectively retraced 61.8% of the decline from the 1.5060 high to 1.4620 low, another very normal corrective movement. We think a combination of excessive USD-short positioning, increasing risk aversion in light of the weak US data, and possibly some verbal support are likely to return to weigh on risk assets and support the USD.
G20 and Eurozone Fin. Min.'s may lend USD verbal support vs. the EUR in the approach to Nov MPC
The G20 is gathering in St. Andrew's Scotland on Friday and Saturday and a communique is expected to be released before noon EST on Saturday. The main topic of the meeting is to orchestrate so-called exit strategies, with the main message likely to be a slower withdrawal of stimulus. On FX, the Chinese will be pressed to allow the Yuan to strengthen, but comments from PBOC head Zhou on Friday suggest the pleas will fall on deaf ears. The Europeans are also expected to press the US Treasury to step up its defense of the USD, and there is minor potential for a revision to the wording of the US strong dollar mantra. In terms of the communique, we think the standard language on currency volatility being undesirable for global growth will be retained. Any bolder comments on USD weakness, EUR strength, or currency volatility are most likely to come from individual participants. On Monday, Eurozone finance ministers will gather for a regular monthly meeting, which will continue on Tuesday, and comments on FX could be heard beginning Monday evening European time. The Europeans are the most concerned about USD weakness/EUR strength as it may undermine their export competitiveness, which is the key to their nascent recovery.
Bank of England set to revise up near-term inflation forecasts
The Bank of England has already warned that "inflation is likely to rise sharply to above the 2% target in the near term, reflecting higher petrol price inflation and the reversal of last year's reduction in VAT". The revision to BoE inflation forecasts can be expected in the Bank's Quarterly Inflation Report due on November 11 but crucially upward revisions to inflation are unlikely to have any significant impact on expectation for BoE interest rate policy. Over the past couple of months the BoE have taken every opportunity to warn of the forthcoming rise in near-term inflation forecasts. At the same time the Bank has continued to stress that excess capacity will continue to bear down on price pressures over the medium-term. Despite signs of improvement in the UK economy, GDP failed to turn positive in Q3 suggesting the recovery in the UK economy is lagging that of most other G10 nations. While this year's rise in oil prices has shown up in the 2.6% m/m rise in Oct PPI input, the lagging impact of last year fall in oil is still having an impact; PPI y/y remains subdued. Even if the weaker pound vs the EUR and higher oil prices push input costs higher, the weakness of the consumer sector suggests that producers/retailers have little pricing power. UK interest rates are likely to remain at their 0.5% low at least until the latter half of 2010.
QE could be phased out by February
Low expectations for medium term inflation in the UK combined with disappointing growth in money supply meant that many proponents of quantitative easing were disappointed that the BoE opted for a relatively conservative allocation of GBP25 bln in November. While QE has no doubt played an important part in helping the financial system move away from crisis, the lack of response in either money supply or inflation indices could be illustrating that it is a policy unable to lend significant support to the real economy. By opting for GBP25 bln this month rather than GBP 50 bln, the BoE was probably hedging its bets but it seems likely this will be the last extension of the plan meaning that QE could be phased out by February.
While the change in the BoE's inflation forecasts this week is unlikely to bring forward rate hikes, the news could lead some short-term support and encourage cable back towards the USD1.6680 recent high. Significant upside in cable could be difficult, however, failing a break by EUR/GBP below 0.8900. The 0.8920/00 area is likely to continue providing solid support for EUR/GBP.
Somber US employment report makes for ominous outlook
US nonfarm payrolls slipped a touch more than expected in October, falling -190K on the month. The real shock was the jump in the unemployment rate to an eye-popping 10.2% from a prior 9.8%. This will make for some bold headlines over the weekend and should weigh on consumer confidence further in the short-term. The details of the report also suggest that the labor market has still not bottomed and we retain our cautious view with regards to risk assets and short-term constructive view on the USD and JPY specifically.
The surprise in the unemployment rate will without a doubt lead to a ratcheting up in forecasts for where that number will peak. Indeed, that we will eventually surpass the 11% mark sometime next year now looks like a foregone conclusion. The leading indicators of the employment market (mainly jobless claims and hours) have yet to show any marked improvement. For all the talk of the downturn in the trend of initial jobless claims, continuing claims remains near all-time highs. Indeed, those folks in state and federal programs still total around 9 million and this metric has merely moved sideways in recent weeks.
The monthly drop in aggregate hours worked is also ominous. Historically, the annual rate of hours has bottomed and bounced sharply as the recession comes to an end. This data point remains well in negative terrain on an annual basis and has shown little improvement on a sequential basis to boot. We know much has been made about the increase in temp employment but this is only a good leading indicator of employment activity if the pace of job declines in other sectors slows significantly - something that has yet to happen.
Fundamentally weak labor markets in the US suggest a market that will trade in choppy fashion into year-end at best, and much lower at worst. Keeping in mind recent inter-market correlations that are unlikely to break over the next couple of months, a major stock market correction would still favor USD and JPY the most. This also makes for a sideways USD/JPY market so selling other yen crosses on rallies makes more sense.
Key data and events to watch next week
The United States calendar is on the light side in the week ahead. The NFIB business optimism index and the IBD/TIPP consumer sentiment indicator kick things off on Tuesday. The usual initial jobless claims, oil inventory numbers and monthly budget statement are on deck Thursday while Friday rounds out the week with the trade balance and the University of Michigan sentiment index.
It is not terribly busy in the Eurozone either. Monday starts the action with French business confidence, German trade and German industrial production. The German ZEW economic sentiment survey, French industrial production, German consumer prices, and the Eurozone ZEW survey are all up on Tuesday. Friday closes out the week with Eurozone GDP reports. Look for the Eurozone Finance Ministers meeting starting Monday evening CET and continuing on Tuesday - remarks on currencies are always possible.
The economic calendar in the UK is heavily weighted to early in the week. Tuesday has the BRC retail sales monitor and the trade balance on tap while Wednesday brings the employment report and the Bank of England's quarterly inflation report.
Japan has a characteristically light week. The trade balance will be important to watch on Monday while machine tool orders are the highlight Tuesday. Friday rounds out the week with industrial production and consumer confidence.
Canada also has a limited amount of events lined up. Housing starts are due on Monday while new home prices are up on Thursday. International trade and new motor vehicle sales close things out on Friday.
It is pretty busy down under. In Australia we'll see home loans on Monday, business conditions and consumer confidence on Tuesday, and inflation expectations and the employment report on Thursday. New Zealand has credit card spending on Monday and retail sales on Wednesday.
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