Dollar weakness looks to be a chance to buy this week

Macro Outlook

Although Friday’s Non-farm Payrolls report underwhelmed, the report contained an important, steady, theme. The latest data shows that the US added 214,000 jobs in October which was lower than the market had been anticipating (231,000 had been expected) and the market reacted in a fairly luke-warm manner with the S&P 500 and FTSE 100 slightly higher (DAX and CAC closed lower), whilst the dollar corrected some of its recent gains. However this is likely to be a near term reaction as once the dust settles, the market will see that the report was solid, if unspectacular. A key factor is that revisions for prior months data have meant that the originally disappointing 142,000 in August, has been revised higher to 203,000. This means that the US has now added over 200,000 jobs for 9 months in succession, significantly, this is also something that has not been seen since the 1990s. The recovery is steady but slow in the US. Wages growth is still a key factor in how the Fed will gauge its outlook for tightening, adding 0.1% on the month taking it to around 1.9% for the year (above the 1.7% inflation meaning there is slight real wage growth). Furthermore, the participation rate remains solid at around 62.8%. The US economic recovery is on track and this should help to support the dollar and equities.

Must watch for: Bank of England Quarterly Inflation Report

Impact: In recent weeks pressure on the Bank of England to hike interest rates has eased. Global markets volatility, and deteriorating UK economic data (falling inflation and PMI data especially) has pushed back market expectation of a first interest rate increase until summer 2015 and after the UK General Election in May. The quarterly inflation report gives the Bank of England’s forecasts and expectations for growth and inflation in the coming months and is likely to be the final nail in the coffin for those expecting an early rate hike. Expect sterling to be especially volatile.

Foreign Exchange

The US dollar strength has been incredible and with some key levels breached on major pairs, once markets have fully digested the Non-farm Payrolls minor correction, there should be further gains for the greenback in the coming days. The Euro remains under pressure and after $1.2500 support was breached; whilst we recently saw Cable at a new 12 month low, the Aussie dollar at a new 4 year low and Dollar/Yen at a 7 year high. The Dollar Index dipped slightly on Friday, but is close to testing some key levels with little to suggest it will not subsequently continue higher. The June 2010 high at 88.7 is within striking distance, whilst the March 2009 high at 89.6 also close. Strong US economic data has certainly been a driver, combined with the dovish stances of the ECB and the BoJ. However, this week with a dearth of US data, the attention is on the Bank of England as the only other major central bank that could rival the Fed in the hawkish stakes. A surprisingly upbeat BoE Quarterly Inflation report could induce some dollar profit taking and some respite for the majors.

WATCH FOR: With a lack of US announcements we look elsewhere for the drivers. Chinese CPI and industrial production will impact on risk sentiment with the commodity currencies (Aussie, Kiwi) especially reactive. The Bank of England Quarterly Inflation Report will be crucial for sterling, whilst the flash GDP figures for the Eurozone will be a huge focus for the euro.

Indices

Equity markets could be in for further gains in the coming months if statistics on the reaction to the mid-term elections in the US are anything to go by. In the 17 mid-terms since the end of the Second World War the markets have rallied almost 90% of the time in the next year. With political uncertainty removed for at least a year (the Presidential election is not until 2016) the theory is that markets are free of the politicking that can hold them back. With Republican control of both Houses of Congress the expectation is that there will be more “market-friendly” legislation (or should that be less regulation). The impact on the Federal Reserve is less clear, as Republicans are historically more hawkish in their preference of monetary policy, however markets will not welcome any early rate hikes at the Fed. A fine balancing act may be needed one might think. Q3 earnings season in the US has been strong for equities and has been a key reason behind the push on Wall Street to new all time highs, whilst the corporate outlooks have also not been too much of a concern as some had been worried. As we move towards the end of the year, markets are traditionally positive, are we set up for a nice “Santa rally” once again?

WATCH FOR: With a lack of key US data in the early week (especially with Veterans Day on Tuesday) investors will be focused on Chinese inflation and industrial production to gauge the appetite for risk. The crucial Eurozone flash GDP and final CPI data could also be a key driver of European sentiment on Friday.

Other Assets: Commodities & Bonds

Precious metals are being hammered by the strength of the dollar which has been accentuated by the decision of the Bank of Japan to expand its QQE programme. Multi year lows are being posted on gold and silver and both metals continue to look weak. Furthermore, a lack of demand is failing to hold up prices of gold. The China Gold Association recently announced that for the first three quarters of 2014 the demand from China was 21% lower like for like versus 2013. With oil it is more of a supply story with the price war that Saudi Arabia appears to be playing at then moment in an attempt to gain market share. OPEC chief EL-Badri has bemoaned that oil prices have fallen too far, but the first real opportunity for OPEC to rectify the supply issues is not until the next meeting on 27th November.

There is still an interesting dichotomy between the sovereign yields of the UK and UK versus those of the Eurozone, with Treasury and Gilt yields drifting higher, whilst Eurozone yields remain fairly well anchored. A dovish ECB will maintain this. The Bank of England’s Quarterly Inflation report could be a drag on Gilt yields if growth and inflation targets are cut.

WATCH FOR: Commodity prices will react to the Chinese inflation data and also industrial production this week. Eurozone sovereign yields will be volatile on Friday with Eurozone GDP and CPI both released.