Advice From Your Central Banker

The key things to watch this week, and an important message from your local central bank chief regarding your local currency…

FUNDAMENTAL MARKET DRIVERS

1-7. Prior Week’s Mix Of Bullish And Bearish Market Movers Likely To Remain In Force This Week: Bullish

As we noted in our recent post here on last week’s lessons for this week, the following bullish factors look set to continue to override the following bearish ones (barring some unforeseen risk-off event) because

• The bearish factors listed below have been around for weeks or months and have not prevented  the current rally
• Leading global indexes like the S&P 500 are so close to all time highs that markets will be tempted to test them

The array of bullish and bearish forces we cited in that article was (quoted)

The Bullish

1. 1.       Focus on Japan stimulus
2. 2.       EU calm continues as markets focus on good news like German economic reports, and  ignore French and other negative data,
3. 3.       US defers debt ceiling and austerity debate until May
4. 4.       Earnings falling but beat reduced forecasts and market interprets that as positive
5. 5.       Prevailing belief greed for yield will outweigh fear of loss from buying at market peak (more on this in our article on coming week market movers)

Bearish

1. 1.       Most Economic Data
2. 2.       Technical resistance as risk markets hit decade highs

8. US Monthly BLS And Related “Preview” Jobs Reports Set To Resume Importance: Neutral

Earnings seasons typically lose their power to influence markets after their third week because by then the tone has already been set.

In recent months, the US monthly jobs reports have not been influential, which is unusual. They were drowned out by more pressing stories related to assorted stimulus/deleveraging uncertainties in the US, Japan, and EU.

However this month, the monthly US BLS jobs reports could resume their market moving prominence as one of the top market moving events of the month.  The above mentioned uncertainties that drowned them out are no longer present.

There is no longer any big deleveraging or stimulus related uncertainty story this week. In particular:

• No US Debt Ceiling Uncertainty: Even the opponents of raising the debt ceiling, the Republicans, have agreed to suspend debt ceiling limits until May.
• The highly anticipated BOJ stimulus plan has been announced. Initial disappointment that the announced measures would be delayed has been broken by assorted official comments assuring markets that stimulus is coming.
• The Fed is not expected to make any changes to its current QE 3 stimulus at this week’s FOMC meeting (see below).
• EU anxiety remains minimal despite overall deterioration or stagnation in most of the EU. There is a potentially important IMF report out on Spain due this Friday. However if the past is any indication, given the potential for renewed anxiety about Spain to spark another bout of EU solvency fears, expect officials to downplay the negatives, despite Spain’s unrelenting deterioration and ‘overoptimistic’ accounting methods.

Therefore expect markets to turn cautious in the days before the Friday release, and to respond to positive or negative surprises from the ‘leading indicator’ reports earlier in the week that hint at the official results Friday results (the ADP NFP report, the jobs components of the manufacturing and services PMIs, jobless claims, etc)

9. IMF Report On Spain Friday: Watch Both The Report And Spain Bond Yields After Its Release: Neutral

This week the IMF will visit Spain and complete its second report on Spain’s banking sector reform; the report should be released this Friday. This report could be significant because it will include some of Spain’s most troubled small domestic banks that are still on ECB-liquidity life support. If these banks are not recovering, then anxiety about Spain’s sovereign debt could re-surface once more.

While Spain bond yields have been falling, market sentiment can change quickly. As we’ve noted earlier here, it has no OMT deal set up, such a deal would likely not come quickly given Spain’s resistance to submitting to the politically unpopular conditions that would come with the aid. Thus Spain is vulnerable to a sudden spike in yields given its considerable bond inventory in needs to sell this year.

10. FOMC Meeting: Neutral/Bearish

This will be the first meeting of 2013 and thus the first chance to see if the rotation in of new voting members effects Fed policy. We don’t anticipate any major shifts, because the new composition of the FOMC is about as dovish as the old one, and the economic picture hasn’t changed since the last meeting. However any surprises could be market moving, if not for stocks then for the USD and hence currency markets in general.

If it has any influence, it’s more likely to be to the downside as the Fed repeats its dissatisfaction with the economy. With markets at decade highs that should make them vulnerable to any kind of negative news, although they’ve been resilient as of late.

11-19. Top Calendar Events

This week is more rooted in the end of January than the start of February, so while it’s busy, it’s a bit lighter than the usual first week of the month. It’s heavy on US data, with a bit of Asia at the end of the week. It’s light on major European events. Both the IMF report on Spain and Italian bond sale are too important for the EU not to do all it can to ensure these don’t rattle markets, and so they probably won’t. Of course, that means that if these do come out negative, that could really shake markets lower.

In addition to those mentioned above, here are the top events to monitor.

Monday

US durable goods and pending home sales

Tuesday

US CB consumer confidence

Wednesday

• EU: Italian 10 year bond sale

• US ADP NFP employment change, advanced GDP, FOMC statement

Thursday – none

Friday

• Australia: PPI- low inflation will support speculation on a rate cut that would send the AUD lower
• China:  Official manufacturing PMI
• UK: manufacturing PMI – a poor reading increases expectations for new BOE stimulus that could boost stocks, and lower the already falling GBP
• US: Monthly jobs reports, both the NFP and unemployment rate. There is also the ISM manufacturing report, which is still important as a read of the US economy however with the US jobs report already out its value as a predictor of that report is gone

20. TECHNICAL MARKET DRIVERS: SIREN CALL OF NEW HIGHS LURING TRADERS

Although daily or longer time frame charts generally reflect fundamentals, market move based on perceptions rather than reality, and there are times when the technical picture creates perceptions and hence its own reality. This week we may well have that kind of situation.

For example the bellwether S&P 500 can remain above the key 1500 level, that alone will tempt markets to test and break above decade highs about 3% higher around 1550. Given the strong entrenched momentum, as discussed last week, even a 10-15% pullback would not break the current intermediate term uptrend. Given that entrenched uptrend in risk assets, and markets’ continued ignoring of the deteriorating fundamentals in the global economy, the current technical picture supports a bit more upside, at best a break to new highs, and at worst a normal 10-15% correction that is likely to end quickly as markets see dips into the 1250-1350 area as no more than a normal test lower to be used as a buying opportunity.

Conclusions And Lessons For The Coming Week

We already discussed most of these in our recent post here.  We’d just add a few additional points.

Currency Markets Diverging From Stocks: Temporary Aberration Or Sign Of Change?

If we ignore currency specific situations like:

• The rising EUR, which is moving higher due to calming about EU solvency risk.
• The falling Yen, which is due mostly to BOJ’s open attempts to drive it lower
• The GBP’s weakness after BOE Governor King admitted more GBP-debasing stimulus is being actively considered
• The CAD being undermined a bit by unexpectedly dovish comments from the BOC

Then the overall trend in currency markets is in favor of the safe haven USD (despite ongoing Fed stimulus) suggests that currency markets are less bullish than their equities counterparts. As a rule currency markets tend lead stocks, so the divergence between more risk averse currency markets as shown by a stronger safe haven USD, and rising stock markets, suggests one of these trends needs to reverse. Given the poor global fundamentals and high stock markets with limited justification for their high prices, we suspect the USD’s near term strength is the more trustworthy trend that suggests some kind of halt to the stock market rally.

Admittedly, currency markets have enough currency-specific events to limit the significance of this divergence and accept that the past week was simply an aberration due to the above currency specific events

Watch What Your Central Bank Does, Not What It Says

They probably know more about where markets are going. They certainly know whether their currencies are likely to move up or down. They’re offering some very important advice.

The Chinese, and any other export nation with a sovereign wealth fund is heeding that advice. So should you.

They rarely state it explicitly, but their actions scream it. So I’ll translate what these mean. For the ‘greater good,’ (boost exports, facilitate reducing their debt levels, etc) they want to cut the value of your local currency and everything denominated in it.

The Fed, BOJ, and ECB are all actively pursuing policies that should reduce the value of the USD, JPY, and EUR. The BOE is openly thinking of doing the same. If most of your assets are linked to or denominated in one of these currencies, then you need to cut your exposure to them and increase your holdings of currencies and assets that will better hold their value. See here for the most up-to-date collection of simpler, safer solutions for hedging that currency risk than generally found in guides to forex or overseas investing.