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Sentiment towards the U.S. Dollar
The US dollar is still the global reserve currency, so in economic uncertainties people rush to dollars in a large degree considering it a safe-heaven. The dollar can also act as a funding currency- when times were good people would sell (borrow in) dollars and invest in higher yielding assets, but when global economy starts to fall apart those dollar short positions are unwounded, and the dollar rallies.
A strong currency increases the appeal of a country's bonds and stocks for foreigners. For an American investor, a weak dollar increases the appeal of foreign bonds and stocks. Currency markets play an important role in the intermarket picture because all asset prices have to be seen in relative terms not only in absolute terms.
When placed against the international backdrop of rising inflation, economic growth, and pressure on central banks to tighten monetary policy in the Eurozone and UK, for example, any hesitancy by the Fed in extending its own rate hikes could compound the pressure on the dollar.
The market thinks there is a 74% chance the next round tightening will be in September and only a 50% chance that it will happen in June. We believe those odds should be lower as the complicated tax agenda could take even longer to overhaul.
The US Treasury Q1 cash deluge has significantly eased USD liquidity in the USD money market. It has contributed to an around USD500bn increase in the US monetary base, which is a significant rise in USD liquidity. It is more than double the amount of USD the Federal Reserve added to the market on a quarterly basis during its recent stint of quantitative easing. One area where this is likely to have made an impact is on the EUR/USD XCCY basis swap. It has narrowed significantly since the start of the year, as USD has become cheaper due to increased supply of USD. This effect has mitigated the increase in interest rates on the back of the Federal Reserve preparing the market for a rate hike tomorrow. Consequently, carry in EUR/USD FX forwards is about unchanged. Hence, while the Federal Reserve has tightened monetary conditions in Q1, the US Treasury has eased monetary conditions.
So-called experts had predicted a 20% surge in the dollar based on the “border adjustment tax” in the GOP House tax plan. Except that surge hasn’t happened. Maybe the plan is dead. Maybe the plan’s market impact will be different. Our take is: if you introduce barriers to trade, we believe currencies of countries with current account deficits tend to suffer. The greenback qualifies, and the recent decline coincides with more protectionist talk coming from the Trump administration.
...with inflation in the Eurozone hitting 2% in February, which could be translated into a possible shift in monetary direction from the ECB and other central banks. So rather than focusing on the U.S. alone, I will be watching spreads in the fixed income universe. For the Dollar’s Index to break above recent highs we need to have wider yield spreads between U.S. treasuries and government bonds elsewhere, otherwise any potential gain to the U.S. dollar is likely to be limited.
So is there reason to believe the U.S. may no longer be serving as the world's bank? At first blush, the answer would be no, as the U.S. has deep and mature financial markets. However, there are developments of concern: The first has already happened. [...] Due to regulatory changes in U.S. money market, it may now be no longer advantageous to issue debt in U.S. dollars, eliminating the downstream effects, including the holding of Treasuries as a reserve asset. A second change is under consideration: the House GOP tax proposal would eliminate the deductibility of net interest expense. If passed, it could have profound implications on how issuers around the globe get their funding...
The recent weakness in the buck could be attributed to a variety of factors – a deceleration of US economic data, a rocky start of the Trump administration that has created fears of instability amongst investors and the still rather cautious tone from the Fed. But perhaps the biggest reason for the correction in the dollar has been the stall in US interest rates. With fixed income markets no longer exuberant about the prospect of US growth the dollar has lost its primary catalyst for appreciation. Until rates perk up, the greenback is likely to remain subdued.
...there is a mistaken belief that a strong country and a strong dollar go hand in hand. Globalization has driven countries to desire a weaker currency wherever possible although there was some reason for a strong dollar in the past given America’s energy imports and domestic consumption. It seems the strong dollar policy, overt or covert, is now about to be ditched as Trump starts ruffling a few more feathers.
On balance, many of the comments from Trump officials have expressed concern about the strength of the dollar or, as Navarro, complained about other currencies being undervalued. The OECD confirms. Its models see the euro at nearly 25% undervalued, sterling almost 16.5% undervalued and the yen 11% under-valued. The Mexican peso, whose marked depreciation has been exacerbated by comments by Trump, is undervalued, according to the OECD, by 147%.
Sustained expansion should expedite the termination of the current reinvestment policy. The Fed will have to choose between a gradual reduction in reinvestment or a complete termination. There are benefits to shrinking the balance sheet instead of raising the policy rate. Such an action might tend to weaken the dollar, which could spur exports and boost factory activity. In the global context, a depreciation of the dollar would reduce pressures on countries with fixed exchange rates and external debt.
So why the dollar is not strengthening? The problem that the greenback is having right now is two fold - first Trump has been talking down the currency and second, his policies make foreign investors nervous. We would not be surprised if China fired back against his recent attacks with a threat to sell U.S. Treasuries. Until the market comes to terms with the risk / benefits of Trump policy, the dollar may have a tough time mimicking the one way moves in stocks and bonds.
The growing threat of Donald Trump’s proposed fiscal stimulus failing to keep up with market expectations may ensure Dollar weakness becomes a recurrent theme in the short term. While further Dollar selloffs may be expected as markets scale back on fiscal stimulus speculations, the prospects of higher US interest rates this year should limit losses in the medium to longer term.
2016 was a year of transition. The election of Donald Trump and the success of the Brexit movement in the UK were just the most visible manifestations
Eventually Trump’s focus could shift to the US dollar. If the greenback continues to strengthen then it could become a threat to US competitiveness, and the ability to sell off of the cars and other goods that will be produced on US soil during the Trump Presidency.
There may well be another factor contributing to the correction in the USD this year. In conjunction with a corrective fall in the USD so far this year, US Treasury yields have fallen significantly, Bitcoin has collapsed, CNY has been volatile, and commodity futures prices have jumped. All of these moves may relate to Chinese government efforts to clamp down on avenues for capital outflow.
Markets have high expectations about the changes in taxation, investment infrastructure and (de)regulation, but other issues like immigration and protectionism may be tackled too. Markets anticipated a much easier fiscal policy via lower taxation and higher infrastructure spending. Will Trump be able to satisfy the high expectations? If he fails to do so, there is room for some further USD correction.
The other China problem is a trade war started by Trump that leads to Chinese retaliation. This is almost certainly going to happen. Trump may practice on Mexico first but it's one of the few campaign promises we expect him to keep. The dollar is vulnerable to the very idea of a trade war and its prospects worsen as China starts talking about dumping Treasuries.
The dollar doesn't need capital flows from China to contribute to its rally. It does need the second larg-est dollar reserve holder to maintain its holdings. One of those big sticks is the threat of selling a big chunk of those dollar reserves. The announcement effect would trash the dollar fast, and probably hard.
And while monetary policy divergence has lost its charm as a headline, it's still the relevant theme and the basis for forecasts of euro parity. ING, among others, says it's only a matter of time. Citibank and Deutsche Bank concur, and Goldman calls the dollar one of the top trades for 2017. Ah, but we have been here before. Just when every shoeshine boy advises you to buy, it's the right time to sell
We expect further USD strength in the short term, as markets continue to reprice and put in more risk premium into the money-market curve. However, we maintain our call for a turn higher in EUR/USD later in 2017, as the majority of the strengthening USD move tends to be up to and at the beginning of a hiking cycle. At the same time, current account flows, valuation and positioning are supportive of the euro.
Since most times cycle balances themselves out, we could be poised for the next 3 year cycle to be a stretched 3 year cycle just as the dollar is ready to begin its 15 year super cycle decline.
When it is no longer attractive to borrow in U.S. dollar, the loan will be repaid, causing a dollar squeeze (higher). We think we have seen this dollar squeeze play out until the end of last year. The force may continue to play out, but other forces might be stronger. Some say that the dollar has to rise because U.S. rates may go up. In our analysis, real interest rates, i.e. those after inflation, may not go up as the Fed is at risk of falling further behind the curve; at the same time, interest rates in part of the rest of the world may have reached their lows. In this context, we see it is quite conceivable that the U.S. dollar could continue to weaken.
While I believe we could easily see this US Dollar selloff extend in the days ahead, I also believe the equity market will come off the rails and that alone will fuel an intense wave of US Dollar demand that will run over anything in it's path.
We have cautiously maintained our US dollar bias through the latest downtrend measured from the beginning of April this year labeled wave [b]. We have been suspecting/hoping (given our positioning) the dollar was correcting lower in what is a standard zig zag (A-B-C) correction lower completely Wave 4. But this move has been deep and many have jump aboard the top is in train of thought. As the dollar neared a key support level, which we have labeled a 50% retracement (98.40) of the last major Wave up—Wave 3—it did so with a slight divergence in momentum; i.e. lower prices but momentum oscillators turned higher. We think today's sharp rally in the dollar is the beginning of Wave 5 higher, which should carry to at least 106.
The dollar was at the center of Bretton Woods’ currency arrangement. It has also been the main reserve asset, one side of more than 90% of foreign exchange trades, and the currency that many commodities are priced and traded in the floating exchange rate era. There are two broad scenarios that can change this. The first is a clear, viable, and compelling alternative. It does not exist today. Some had thought the euro could be it. It is not. The euro is the second most important currency on various metrics, but in many, like use as reserve assets, or turnover in the foreign exchange market, the dollar is more than twice as large. Some talk as if the Chinese yuan can rival the dollar. Perhaps one day, but it is not just years but decades off. The second...
Why USD isn't higher against promises of Tax reduction is because the market doesn't trust the Republicans to come through and the market trusts Yellen and the Keynesians much less. [...] The longer Trump and the Republicans hold out and not pass Tax reduction then the more opposition will come and the opportunity for tax reduction will be lost. Without Tax reduction then the remainder of promises of investments, immigration, healthcare is meaningless. We see more of the same for the next 4 years and USD goes nowhere.
As per Citi, ultimately, the administration can say whatever it wants about a weaker Dollar, but if Trump goes ahead with sweeping tax reform and aggressive fiscal stimulus and if the Fed continues to move towards higher rates, while the rest of the developed economies stand still, nothing Trump says will do anything to stop the force of the US Dollar. These fundamentals can not be denied and the Dollar will not be able to ignore them if things move in this direction.
But in the EUR/JPY V JPY/EUR relationship, its the EUR side that remains top heavy. Most top heavy, neutral zone and market uncertainty is explained by EUR/USD Correlations to EUR/JPY at minus 90% and + 90 to USD/JPY. This means EUR/USD lost its ownership to EUR/JPY and EUR/JPY belongs to USD/JPY. Correlation informs overall, markets still trade and reside in risk off mode which is a USD positive environment.
While the situation with the Trump team is not an apples for apples comparison with the situation in 2010, it does suggest that verbal intervention by politicians into the currency market does not always go according to plan, and can even backfire.
The border tax adjustment is seen by many as automatically spurring a significant dollar appreciation. It is part of a destination-based corporate tax that is being touted. It would tax imports and exempt exports. Relying on theory, many economists expect that the dollar would rise to offset the tax. A 20% tax would produce a 25% appreciation of the dollar.
...we conclude that the currency impact of a repatriation holiday today could be of similar or perhaps greater significance than the effect of flows under the HIA in 2005. The absolute magnitude of any such support is difficult to quantify. However, to the extent that repatriation would be an overall supportive factor, however modest, for the U.S. dollar, it would only reinforce our core expectation of broad U.S. dollar strength in the coming quarters.
As a simple majority is sufficient in Congress to change the tax code, [...] And please disregard any analysis that focuses on the reduction in the number of tax brackets - the number of tax brackets are, in my view, completely irrelevant, as to the impact for investors. What is relevant is whether businesses will, as proposed, indeed be able to deduct 100% of their investments in the first year [...] What to look out for here is whether the U.S. tax system is shifting to a territorial one,[...] If so, it may remove the incentive for businesses to move their headquarters abroad. [...] whether any money that’s going to be repatriated will be used to create jobs, that discussion, in my humble opinion, misses the point: more important is whether artificial barriers to allocate capital are removed, allowing a more efficient allocation of capital.
In the larger picture, of the numerous factors that impact foreign exchange rates, the wish and desires of officials do not often seem to be particularly salient. Our long-term bullish outlook for the dollar is based on the divergence of monetary policy, the relative health of the financial system, the anticipated policy mix, and the uncertainty surrounding this year's elections in Europe.
Investors have been betting Trump will boost public spending and spur repatriation of overseas funds by U.S. companies, policies expected to bring higher inflation and induce the Federal Reserve to raise interest rates at a steady pace.
If Trump’s measures were passed and economic growth picked up, the Fed will have few options, either tightening monetary policy more aggressively, or to fall behind the curve and let the fixed income market lead the way, but three rate hikes in 2017 is my base case. Either way the dollar is likely to remain strong as divergence in monetary policies will continue to widen.
The dollar strengthens: Look for the greenback to rise to 120, likely by late 2017, while the euro falls to 0.85-0.88. In fact, the euro’s very existence could be threatened by default scares in Italy and the failure of Deutsche Bank.
Longer term bullish view since May remains in place as the upside pattern from the May 3rd low at 91.90 is still not "complete" (currently within wave 3), while long term technicals remain bullish (see buy mode on the weekly macd). As mentioned above, there is rising potential of a top for at least a month or 2, would likely be an extended period of sloppy ranging with good sized swings in both directions (wave 4) and with a resumption the longer term gains after
...capital outflows from the eurozone are the biggest so far this year than any other time in 14 years. The WSJ reports "Eurozone investors bought €497.5 billion ($516.5 billion) of financial assets, ...such as stocks and bonds, outside the bloc in that period. Global investors, meanwhile, sold or let mature €31.3 billion of eurozone assets during the year. Together, that adds up to a net outflow of €528.8 billion, the most since the single currency was introduced in 1999."
The world is USD dollar starved and there is a shortage of offshore dollar funding -the Eurodollar maket-, and if Trump starts protectionist policies, means less dollars flow into the global system because they are doing less trade with the US, and that means there are not enought dollars around for all those people who borrowed dollars. That in it self is an extremely positive outcome for the dollar.
The dollar is rising because there is a perceived lack of dollars in the outside system, and we have seen this in the LIBOR market rising with US interest rates also rising. But the other reason the LIBOR is rising is because money is being taken out of that offshore funding market and being put onshore in the US. About a trillion dollars moved out of the traditional markets -away from money market funds- into the fed funds market.
There is likely going to be some repatriation of corporate profits, and the idea is that corporations can bring back all those profits they holded offshore, bring it into the U.S. for a small tax penalty. If companies have holdings in foreign currencies and they sell them and buy dollars and bring them back that automaticaly pushes the dollar yet up again. But the more important factor are companies like Apple: they have hundreds of billions of dollars in US dollars cash but in the European banking system. They start to take it to the U.S. banking system and that again takes hudreds of billions of dollars out of the eurodollar market so there is more sucking out of that market and all of these borrowers will be scrambling to find funding. The Fed will have to extend swap lines all over the world to allow some dollar liquidity but rates are going higher for this.
With the FOMC seeming to be the only central bank on the path toward higher rates investors are starting to pour money back into the dollar. The new administrations plans for stimulating the US economy has provided even more fuel to the US dollar's fire which was sparked by the FOMC.
The dollar thus far appears to be doing exactly what I said it as it looks poised to break out of a two-year trading range above 101 and head up towards 120. Such a rise will only weaken gold, oil and commodities further.
While most economists are focusing on either the higher US interest rates and a likelihood of a somewhat more aggressive Fed tightening cycle, or the possibility of a dramatically more stimulative fiscal stance. We see the combination (the policy mix) as an exceptionally potent force that will continue to propel the dollar higher. Interest rate differentials provide an incentive structure for investors. Investors are paid to be long the dollar against most major currencies. This also means that for any given level of volatility, it is cheap to hedge European or Japanese exposure.
DXY is now on the verge of a massive breakout higher. More importantly to a higher DXY is the ability for currency prices to finally, after 8 years, normalize.
Sentiment in the Euro Market
Bearish for the Euro
Wave IV from there ended at 1.1640 (15 Nov 2005), the subsequent upmove to 1.6040 (July 15, 2008) is treated as wave V, the major selloff from the record high of 1.6040 to 1.2329 (October 27, 2008) signals a reversal has taken place with (I) leg ended at 1.2329 and once (II) ended at 1.5145, wave (III) itself is an extended move with I: 1.1876 and complex wave II ended at 1.4902, wave III has commenced with wave 1 and 2 ended at 1.2042 and 1.3993 respectively, wave 3 of III is now unfolding for weakness towards parity.
The Euro suffered increasing uncertainty overnight after Former French PM Allain Juppe stood aside and ruled out replacing scandal ravaged centre right candidate Francois Fillon...
We expect core inflation will have to exceed 1.0% for a number of months before the ECB will announce tapering of its QE purchases. [...] Our forecast for core inflation is it will be 0.9% on average this year and only go slightly above 1.0% at the very end of the year, implying the ECB, in our view, will not announce tapering of its purchases this year. We still believe the ECB will extend its QE purchases beyond December 2017.
With core inflation still being below target and the ECB expected to make no changes to their current monetary policy EUR/USD could start to feel the pressure.
ECB Lautensclaeger, a hawk, [...] recently said "I am thus optimistic that we can soon turn to the question of an exit from quantitative easing" She is a loner inside the dovish Executive Committee.
The Target2 system is designed to adjust accounts automatically between the branches of the ECB's family of central banks, self-correcting with each ebb and flow. In reality, it has become a cloak for chronic one-way capital outflows. Private investors sell their holdings of Italian or Portuguese sovereign debt to the ECB at a profit, and rotate the proceeds into mutual funds Germany or Luxembourg. "What it basically shows is that monetary union is slowly disintegrating despite the best efforts of Mario Draghi," said a former ECB governor.
It is well known than Marine Le Pen is no fan of the euro, and we won’t go into the detail of her policies in this note. But it is worth remembering this, rising support for Le Pen is likely to keep upward pressure on French bond yields, and this political risk premium could weigh further on the euro.
The series of pending elections in Europe which may spark uncertainty, coupled with the threat of Eurosceptic parties gaining ground and destabilising the unity of the Eurozone continues to pressure the Euro. Sentiment remains firmly bearish towards the EUR and recent reports of Greece's debt crisis returning with a vengeance could encourage bearish traders to attack the EURUSD incessantly. The International Monetary Fund has warned that Greece may not achieve the required target to qualify for a cash bailout with discussions already on the rise of a potential Grexit. This terrible cocktail of uncertainty and political risk could ensure the parity dream on the EURUSD becomes a reality in the longer term.
The IMF warned that Greece risks being forced to exit the Euro if things cannot be tied down and the German Finance Minister concurred. With the threat from Marine Le Pen seeking a French exit from the Euro – and perhaps the EU itself – this could be a growing threat to the Euro's very existence. Definitely a story to watch – and one that has the capacity to significantly weaken the Euro. Euro sellers beware.
Geert Wilders the populist candidate in the Dutch election was interviewed by the U.K’s Sky News on Monday. He stated his intention, if elected, to take the Dutch out of the EU. He said that democracy needs a nation state and what started as an economic union has turned into a political experiment. He believes that the EU is turning Europe into a “Federal State” which he feels harms the democratic rights of his countrymen. [...] The Dutch election is on 15th March precedes the French vote and a win or a good showing for Wilders will give a massive boost to Le Pen’s campaign.
My fundamental bearish bias for the euro has increased. This is due to the ECB extending its QE programme and presenting a dovish tone at their December meeting. I expect the euro to remain pressured for the foreseeable future. There are a few primary reasons for this. The first is that employment in the Eurozone has decreased to its lowest level in seven years. (9.8% for October 2016.) The second is the stability of the European Union following Brexit.
Professor Ted Malloch, Trump’s expected ambassador to the EU says “I am not certain there will be a European Union in which to have negotiations… The one thing I would do in 2017 is short the euro. I think it is a currency that is not only in demise, but has a real problem and could in fact collapse in the coming year or year and a half.”
There are two-way risks posed by the Brexit proceedings and the European elections. If you haven't reduced your [long] exposure, then look to do so below the 1.20 level. Then, you may wish to consider placing a protective stop below the 1.17 low that we saw in December.
Bullish for the Euro
A political triumph for Angela Merkel’s party in the Saarland state election and the popularity of Emmanuel Macron in France both suggest 2017 may not repeat the populist uprising of 2016. The perception of diminishing election risk in France and Germany coupled with dollar-weakness has come to the rescue of the euro.
we believe the euro has increasingly become a so-called funding currency. Amongst others because rates are so low, speculators are borrowing in euros to buy higher yielding assets. If we have a risk off event, e.g. a sharper decline in stocks, those speculators might have to reduce their bets and, as part of that, buy back the euro. Short covering may not lead to sustainable rallies in the euro, but it’s a piece of the puzzle worth watching.
The dollar started to surge at the first talk of tapering, even as the first actual rate hike was far, far, off. Similarly, the euro may well start appreciating well before rates will actually go up again in the Eurozone[...] Then the rumor came up that the ECB may hike rates before ending the purchases of securities; this rumor was given credence as the Austrian ECB member of the governing counsel suggested that there are many different rates and, yes, some could be raised before the bond purchases are done.`
Ignazio Visco, a member of the European Central Bank’s (ECB) Governing Coucil stated that the time between the end of Quantitative Easing (QE) and rate hike could be shorter, giving the euro bulls another reason to push higher.
While the cloud of political uncertainty weighs heavy on the Euro the impact in financial markets seems focussed on bonds rather than currencies at this point. Markets are still pricing in a win for Centrist favourite Emmanuel Macron ensuring reasonable support to the downside for the Euro.
Clearly the economic outlook for the US is better than the Eurozone – but is it so much better than Federal Reserve and ECB monetary policy should diverge so noticeably? We don’t think so, and that’s why we favour a recovery in the euro over the medium term.
...the ambassador to the European Union has been quoted saying that the Euro currency could collapse in the next 18 months.[...] Bearing in mind how viciously the Euro can appreciate on a round of investors unwinding on USD positions, the idea to "short the Euro" as the possible tipped ambassador has suggest could be questioned later on if President Trump himself once again makes comments on USD strength.
Last month, Draghi acknowledged that deflation forces were almost vanquished. He can extend this analysis a little, but it may not yet be time to change the balance of the outlook quite yet. Still, there may be scope for another type of concession to the more hawkish contingent: the reference that rates will remain low or lower can be modified to suggest less risk of a lower rates.
...eurozone data improving far more and far faster than we have come to expect from this region. It's a battle for the hearts and minds of traders between all the squishy stuff that goes into "sentiment" vs. the fundamentals.[...] the Eurozone is hardly sclerotic—it's getting the same boost the US got from QE. It's just getting it a few years later.[...] If we are looking for a hard reason to prefer the euro over the dollar, this is it.
I do expect the ECB to give more verbiage to the thought that bond buying will begin to be tapered starting in March, and while one would think that this would be welcome news to the euro, traders are a strange crew of thinkers, and if they think that the Eurozone economy isn't ready for a taper, then the euro will get whacked. If they think that a taper is due and needed, then the euro will benefit. It's all about sentiment these days, and not fundamentals, as I shake my head in disgust!
The fixed income trade may be overcrowded and positions overly extended, requiring a pullback, but the Big Picture is still in place. The question for us now is how strongly Draghi denies tapering intentions so that the differential can widen out decisively. Look at the 2-year differential vs. the euro/dollar. Notes were overbought/yields oversold. The correction has a way to go.
...the EUR seems to be enjoying a stint of increased popularity among traders. Typically, this would be indicative of some form of corrective wave taking hold of the pair which, in this case, will likely be the depicted ABCD wave. The primary reason that we expect to see such a wave take shape is due to just how well the forecasted retracements fit with some key support and resistance levels seen during the pair’s descent.
With the impending elections in Europe and expected volatility from EU political instability, it is important to reduce your [short] exposure. Momentum has turned lower, so consider reducing your exposure above the bottom of the recent trading range. Look to leave protective stops above the 1.20 Level.
In today's world, though, a European bank is no longer able to tap into U.S. dollar funding at the same favorable terms, as evidenced by the higher LIBOR rates. That means their clients won't have access to the same embellished terms, either. Such clients may well decide to no longer seek a U.S. dollar loan, but instead a euro-denominated loan, or a loan denominated in their home country's currency. This trend might be accelerated by the fact that interest rates in the Eurozone are lower than in the U.S. As much as we love to hate the euro, this trend may let the euro rise as a formidable competitor to the U.S. dollar as a reserve currency.
We expect further USD strength in the short term, as markets continue to reprice and put in more risk premium into the money-market curve. However, we maintain our call for a turn higher in EUR/USD later in 2017, as the majority of the strengthening USD move tends to be up to and at the beginning of a hiking cycle. At the same time, current account flows, valuation and positioning are supportive of the euro.
Sentiment in the GBP Markets
Bearish FOR GBP
What gets us really negative about the sterling, though, is their fiscal situation. Sure, there may well be a short squeeze at some point because others don’t like the currency but medium to long-term, we believe the Brits may well go down what we call the “Italian road.” That is, we believe they’ll finance substantial deficits with monetary policy that’s too loose, leading to a currency that will cascade lower over time. That’s because we don’t see how the Brits can finance their budgets
The pound has been treading water for a couple of weeks against its majors. While this price action indicates that GBP might have already reached its bottom, it’s still a matter of how Brexit negotiations plays out that’s going to move the currency forward. I still believe that GBPUSD will fall below 1.20 if the EU took a hard stance in the negotiations, and recent economic data shows softer service and manufacturing activities will speed up the declines. Another risk for the pound is going to play out if Scotland decides to go for a second independence referendum. Overall, I see the risks are still to the downside and any move higher will be seen as an opportunity to short GBP.
The fall in real yields in the UK is not a new story, however, it is important when determining whether these low levels of GBP offer a buying opportunity. Currently, the UK has the third lowest real yields and is bottom for average equity yields when compared with the rest of the G10. This is key for determining GBP’s direction over 2017 due to the likely slowdown in UK wage growth, inflation troubles and a cautious BOE.
The central bank now expects the U.K. economy to grow by 2% this year, up from its previous forecast of 1.4% in November. They also upgraded their 2018 and 2019 forecast by 0.1% each year and said they now believe the unemployment rate could fall to 4.5%, down from a previous estimate of 5% before it starts to push inflation higher. The upgraded forecasts were attributed to a weaker currency and an adjustment of their dire views of the economic damage that Brexit would have on the economy. Even with these upgraded forecasts, the BoE seemed in no rush to raise interest rates as they now expect inflation in 2 year's time (a key measure) to be slightly lower than previously estimated.
Sullying these figures are some uncomfortable truths about the state of UK growth, which is looking dangerously unbalanced propped up entirely by services. The large one-off decline in sterling that we saw last year has not helped to boost our trade position, or boost manufacturing production, which fell a hefty 1% at the end of last year. This is a big problem for the UK economy going forward, as the outlook for the consumer is set to darken later this year as rising inflation and Brexit uncertainty start to become a concern for the consumer.[...] the outlook for GBP is constructive, ahead of key resistance at 1.28, which could trigger a sharper sell off.
The year on year CPI was expected to rise by 1.4% but instead rose by 1.6%. I know 0.2% doesn't seem like much but this does in fact show that inflation in the UK is rising faster than expected, and it was already expected to be out of control. As we discussed in yesterday's update, the main tool that the BoE has to offset inflation is raising rates
...this political noise is not the only thing that pound watchers need to be aware of. From a volatility perspective politics is king, however the fundamentals for the pound are also eroding support for the currency.
Bullish for GBP
The lack of volatility on the Article 50 trigger shouldn't be a huge surprise. It was an event that was telegraphed for months and politicians on both sides avoid any inflammatory rhetoric. The next phase of GBP trading will be all about the details of negotiations but with EU leaders still getting their mandate organized, the next month may be quiet and that could send some GBP shorts to the exits.
While short options on the Pound are around record levels with the ongoing uncertainty expected with Brexit negotiations, traders need to be careful how they position themselves because further short squeezes on the USD can all of a sudden lead to additional bounces higher on the Pound.
UK PM Theresa May bumped into Parliament’s opposition on a bill regarding the EU citizens' right to continue living in the UK after the Brexit. The rejection revived hope that the Parliament’s implication would smoothen the EU exiting process and hinted at a softer Brexit.
The economy has been doing great, but the weak pound is causing inflation. In order to keep the inflation in check, the Bank of England may need to start raising interest rates relatively soon. Market expectations of a rate hike this year are rising. When we spoke about this 10 days ago the market expectations of a BoE hike in 2017 were just 28.4%, that number has now moved up to 48.7%.
... markets also took some solace from Ms. May’s promise that the Brexit deal would be put to a vote to both houses of Parliament, but post speech Cabinet official clarified that this is simply a vote to ratify the Brexit deal, rather than a vote on the issue of Brexit itself. Most legal expert agree that the court will most likely rule that a trigger of Article 50 which would be the official start of Brexit would indeed require a Parliamentary vote. [...] there is enough uncertainty surrounding the issue, that a trigger of Article 50 in March or April could be in doubt, which provided support for cable for the time being.
Britain will, in the PM’s view, continue as an outward looking trading nation, with a desire to do more business and not less; and to continue to be a good neighbour to Europe. The markets were happy with what they heard. Sterling rose by a cent against the Euro and two cents against the US Dollar as the Prime Minister was speaking; and the confirmation of parliamentary oversight of the final EU negotiations caused the greatest spike.
Sentiment towards the Japanese Yen
Bearish FOR THE YEN (USD/JPY up)
The dollar's performance against the yen seems to be driven more by US yields and equities than the news stream from Japan, which has been light. If US Treasuring can stabilize as we expect, then the dollar can begin recovering against the yen.
In the long run, not having a focus on anything but trade protectionism will hurt the dollar. However if we see an improvement in the US fiscal policy and additional FED hikes (I predict 2-3 in 2017), the USD might additionally strengthen vs JPY targeting 125.00 also because the Japanese investors want to buy rather than repatriate.
...a continued expectation of strong policy divergence between the Fed and the Bank of Japan which will drive interest rate differentials sharply in the US dollars favour. That's something both Fed chair Janet Yellen and BoJ governor Kuroda highlighted last week. Kuroda then again reiterated that he will keep the policy in Japan accommodative even though he has a more upbeat outlook on the economy and inflation in the year ahead.
Bullish FOR THE YEN (USD/JPY down)
In short, while markets remain placid and calm about the current chain of events, there is considerable risk that the Russia probe could uncover criminal activity in the White House which would trigger risk aversion flows back into yen, despite Governor Kuroda's best efforts to expand QE. For now, the assumption of the FX markets is that the primary driver of trade in USDJPY is economic growth.
The Bank of Japan meets. The rise in global interest rates is pulling up Japanese rates, requiring the central bank to defend its +/- 10 bp target range. The BOJ may upgrade its economic assessment after stronger than expected exports and industrial output. It may be too early to expect the BOJ to upgrade its inflation outlook, but even many private sector economists suspect the worst of deflation is passed.
...for now, the central bank’s QQE programme looks set to continue at an annual rate 80 trillion yen. Although fundamentally JPY is a bearish currency as inflation falls, it will continue to remain attractive as a safe-haven currency during 2017. It will, therefore, strengthen during times of uncertainty/risk-off sentiment.
Sentiment in the Commodities Market
A bull market in commodities normally corresponds with bull markets in other currencies than the US dollar because the dollar and commodities are expected to trend in opposite direction (note commodities are priced in USD). Nevertheless, there can be periods when the sentiment is very negative toward bonds, so that safe-heaven currencies like the USD and assets considered an hedge against political uncertainty, like gold, rise together.
Tradicionally, the sentiment towards commodities goes opposite to equities, except during late stage expansion and contraction in the business cycle.
The negative influence of rising commodities on stocks holds true during inflationary and disinflationary periods- but not necessarily during a deflation! In a deflation, rising commodity prices are generally positive for stocks.
Commodities usually trend in opposite direction of bond prices, that is, in the same direction as interest rates. when inflation is expected or experienced, sentiment in the commodity sphere becomes bullish. Positive sentiment in both markets, commodities and bonds, is also good but not for a prolonged time because it's considered inflationary.
Bearish FOR THE COMMODITIES
[...] the cartel members have set themselves up for almost certain failure. Whether production rises because they can’t stick to their agreement, the U.S. and others produce a lot more, or some combination of the two, the outcome will be OPEC’s inability to control the markets, sending prices lower.
Higher interest rates and a higher $ are bearish for gold over the longer-term. In addition, the decline from the September 2011 high has retraced a large proportion of the price rise from the 1933 low. Tony Plummer of London (Helmsman Economics) points out that the 2011-2015 decline retraced more than 38% of the rally from 1933 to 2011. The violation of the 38% level suggests that there has been a shift in the underlying fundamentals. I think that this price move is telling us that the ability of governments to boost the economy by having central banks inflate the currency is failing.
Those record bets on a rise in the price of oil haven’t paid off. As of Tuesday afternoon, oil was having its worst two-day drop in a month. CFTC data from Friday showing a net long position of 885m was a sentiment extreme. The result is the market has rolled over. Quite simply, almost everyone in the market has gone long already and it wasn’t sustainable. More nimble oil traders are taking short-term profits as the price turns lower.
We expect a pro-growth agenda under Donald Trump and a limited global impact from the UK’s Brexit plans to put gold back under pressure soon. However, if the UK opts for a hard Brexit and Donald Trump spends his first days in the Oval office adding trade tariffs rather than unleashing ‘animals spirits’, gold stands to gain further.
As I’ve said all along, the next major target in gold is its 2008 low of around $700. To get technical with Elliott Wave Theory, that would retest the 4th-wave correction before the largest 5th-wave bubble run into $1,934. I still see gold landing somewhere between $650 and $750 in the next year or so, likely by the end of 2017.
...the commodity complex, which has seen the WTI plummet due to an increase in US and Canadian drilling, offsetting the planned OPEC production taper. There was also little support for oil prices as API inventory data reported 1.5 million barrel inventory, slightly higher than the consensus of 0.9 million.
Gold falls: This is the year we’ll see gold sink to $650-$750 per ounce, likely by late 2017 or shortly there after. I still see it dropping to as low as $400 (if not lower) before this down 30-year commodity cycle is over between early 2020 and early 2023. Oil rises a bit more and then crashes again: Oil will likely rise to as high as $60 at first, and then fall back to $26 or lower by late 2017. Ultimately, I expect we’ll see oil prices between $8 and $18 a barrel by early 2020.
Oil falls to $15 per barrel: Iran and Saudi both renege on their plans to cut oil production in 2017, which in turn leads to the break down of the Opec consortium. Russia distances itself from its previous plan to cut production by 600,000 barrels, leading to a massive oil glut. President Trump steps in to protect the US’s oil and shale gas industry, as the US becomes the first oil producer to guarantee oil companies a minimum price for a barrel of oil, thus increasing the size of the US’s balance sheet even more.
A global push higher in yields, which began stateside following Trump's victory shows little signs of ending anytime soon and this makes non-yielding assets such as gold relatively less attractive.
Gold has done exactly what I said it would. It peaked shortly after my sell signal in late April 2011 and crashed after breaking major support at $1,525. It rallied to near $1,400, as I predicted it would, in late 2015 and has recently fallen $200 towards my target of $700 in the next year or so.
With further strength in equity markets and the dollar, along with continued expectations of higher interest rates, gold could have substantially further to retreat.
Back in early 2013, silver topped after [...] Moving above its 10-week moving average [...] Correcting a bit more than half of the preceding short-term downswing [...] The RSI moved a bit above the 50 level. This time, we have already seen these signals and consequently, silver appears to be ready for the next part of the pattern – a huge decline.
The gold and the stock markets have different drivers. The stock market tends to rise year after year due to population growth, technological developments, and currency inflation. The commodity markets do not benefit from all three. Thus, the stock market tends to rally and then retrace part of its prior advance such as 38% or 50% of the previous bull market. Due to the lack of support from the same drivers, commodity markets can retrace 100% of their prior advance.
Bullish FOR THE COMMODITIES
... why this correlation [gold - USD] can be most ephemeral over the short- and intermediate-term time frames is the fact both the US dollar and gold can act as safe havens at the same time. We saw this during the credit crunch. We will likely see it again at some point in this cycle.
After the election, we believe the price of gold came down as the market priced in higher real interest rates in anticipation of lower regulations. We indicated that this euphoria will cede to realism, meaning that regulations might not be cut quite as much. We also suggested that any fiscal stimulus on the backdrop of low employment may be inflationary. That is, expectations of higher real rates might be replaced with expectations of higher nominal rates; net, bonds might not change all that much, but the price of gold may well rise in that environment.
Gold does not necessarily rise and fall with interest rates, jewelry demand in India, or any other widely believed nonsense. Rather, gold has moved in conjunction with perceptions as to whether or not the Fed and central banks have everything under control. If you think everything is under control, and do not want insurance against a currency crisis or another debt crisis, then dump your gold. If you believe as I do, that everything is not under control, or if you want some insurance, then take a position in gold. the ab
Gold could drop on massive tax cuts and fiscal spending program in the US, however, the dip could prove to be short lived as rising inflation expectations are likely to pull up the yellow metal in the long run. Furthermore, record rally in stock markets could also force investors to allocate a small portion of their money to gold (hedge demand).
Here's a politics-driven forecast—inflation is a good enough excuse for gold bugs, but Trump's "mistakes" are even better. David Roche, a long-time market observer, told Bloomberg gold will rise about 6% this year to $1300 on a safe-haven flight from the political risk being created by Trump. We will probably get a trade war with China, for example. Gold is already up 6.8% so far this year from the 13% slump in Q4. And it's up today by 0.5% to $1,226.19 an ounce by 11:45 a.m. in London. The Fed can go ahead and raise rates three times. So what? Political risk will outweigh and "lure investors to gold."
One reason why I am optimistic on gold is that I haven’t seen any proposal to get long term entitlement spending under control which is, in my view, key to long-term fiscal sustainability. The link to gold is that a lack of long-term fiscal sustainability may lead to negative long-term real rates which, in turn, would be a positive for gold which has a cost of holding and doesn’t pay interest.
Gold prices are on the rise, supported by a weaker dollar and safe haven buying on uncertainties over U.S. policy. The yellow metals continues to shrug off better-than-expected U.S data that reinforces the view that the U.S. economy is sufficiently robust to warrant Fed rate hikes.
...the widely expected higher inflation would increase nominal interest rates, but not real interest rates, which are crucial for the gold market. [...] The stock market rally after Trump's victory led to the belief that we are entering into period of higher economic growth, real interest rates, and great rotation from bonds to stocks, which would be negative for the shiny metal. [...] we do not call for a bull market in gold, but simply point out that investors may overestimate the potential for reflation under the Trump's presidency and the bearish perspective for gold.
...the key drivers of gold and gold miners are the value of the US Dollar and the level of real interest rates. The sharp drops in both of these variables over the last couple of weeks have driven GLD and GDX skyward. Based on the risk-off moves we're seeing today and President-Elect Trump's concerns about the value of the US dollar, the big rally in GDX could easily extend toward 26.00 or 28.00 in the coming weeks.
gold achieved above average returns during those calendar years, +14.8% in Presidential transition years vs an overall average of +8.4%. Perhaps equally important is that those have been years when the S&P 500 greatly underperformed its average over that same time period, -0.9% in Presidential transition years vs an overall average of +9.0%.
As the US Fed normalise rates this year, it is likely to steer Investors away from speculative investments like Gold to Fixed Income as it offers a yield. I expect further weakness in Gold in the coming year, however, should we experience unexpected rapid inflation, then I can see Investors flocking to Gold in such an environment.
...Gold can't go broke because it has no counterparties or liabilities against it. Gold can't go broke because gold is pure wealth. Sure gold can go down in price in terms of a currency, but gold CANNOT GO BROKE. This is the crucial fact that the "dollar-bugs" fail to comprehend. This is the reason why sophisticated wealthy people own large quantities of gold. Gold represents eternal unquestioned wealth.
...if you take a look at the spike in the short two-year government bond, which most currencies trade off of, you see an extra 80 bases points – an unexpected rally in that yield. And that would have basically on a debt rollover take the debt servicing up to 3.5% of GDP. So, I think that that would be fragile to say the least. I think the other things where investors need to recognize is that if Trump does go with his tariffs and doing all this stuff, some of these thoughts are out there, this will trigger inflation and we're going to see gold participate in a big rally
2017 will present obstacles such as compliance and oversupply, at least in the first half but as the year rolls on should get better. Demand should exceed supply as we get into the second half of the year, this will encourage adherence to quotas as monthly cheques get fatter.
The rise in Bitcoin is attributed to several factors. The recent currency policy by India’s Modi and Venezuela’s Maduro are credited as one of the factors, as the leader of these two countries tried to replace the old currency notes. Although there are valid reasons for the policies, it creates obvious side effects with public confidence in the national currencies taking a hit. Another driver for Bitcoin is the strict capital controls in some countries like China which may drive capital into bitcoin to circumvent the control, as well as the steady devaluation of Chinese Yuan. Most bitcoin trading takes place in China so financial conditions in the country can have a huge impact on Bitcoin’s price.
Looking back to this time last year, the outlook for a US normalization was optimistic and as the Fed failed to deliver, it triggered one of the greatest first halves in 40 years. [...] the scarcity of gold is not as close as the yearly gold output accounts for less than 2% of the gold that has been ever produced which in reality implies that there is definitely room for metals to get back into the market.
Yes, we could get commodity infla-tion and slow growth at the same time. But what is the relationship to low-but-rising bond yields? We might better look to demand (and supply) of bonds themselves. Just saying.
... something that could be a real game changer for the price of Gold (and I'm sure Silver too, but as always Gold gets all the attention!), and that is the proposed change to Sharia standards (which are what many Islamic financial institutions follow in whole or in part) to allow Gold to be traded like a commodity and held as an investment.
Sentiment in the Equity Markets
The appetite for stocks is believed to manifest the people's expectations about the economy. But they can also be perceived as a good investment in a deteriorated economic environment.
Here at FXStreet, we are more concerned about the relative return of stocks, which can be positive even in a declining market in absolute terms. That is why a strong currency also increases the appeal of a country's stocks (and also bonds) to foreigners, because the relative return, when translated back to their home currencies is greater than the absolute nominal return.
The opposite is also true when a currency falls, its stock market becomes less attractive to foreigners.
In the same way, if the stock market in one country starts performing better than the stock market in another country, you should be aware that this could lead to a rise in value of the currency for the country with the stronger stock market, while the value of the currency could depreciate for the country with the weaker stock market.
Bearish FOR THE STOCK MARKETS
If we are going to see a Flash Crash we should see a major swing High about 2 ½ months before we see a sharp 18% decline into the June-July Flash Crash Lows. That means we should top out in April or even as early as today’s 3/30-31 cycle High. You won’t want to miss the upcoming decline. Be forewarned and be prepared.
[...] a little-known valuation indicator invented by Norman Fosback – which has called major market tops and bottoms – is the average price of the 25 cheapest stocks in the S&P 500. When stock prices were completed decimated like they were in 2002 and 2009, this indicator was flashing major buy signals. Now, it’s as high as it was during the Internet Bubble and much higher than the Housing Bubble.
Another way to look at the reckless speculation in stocks is the bull to bear ratio. The chart below has a red line through the S&P 500 when the bull to bear ratio is above 3.0. The optimism is much greater than the beginning of the last bull market in 2003 as there are more red lines.
When looking at S&P 500 Shiller’s cyclically adjusted price-to-earnings ratio (CAPE) which is currently trading at 29.5 x earnings.This takes us back to April 2002;from April to October 2002, S&P 500 dropped from a high of 1,174 to a low of 768, a total of 34.5%.Since then, the Shiller’s CAPE never re-visited these levels until just this week.
We are about to enter a stressful period of time. [...] This could potentially cause significant problems in the stock market and other areas of life (i.e. earthquakes, violent weather, conflict) . [...] February looks rough but March and the first half of April look worse. The next estimated Primary cycle ( aka nominal 18 week cycle) low is estimated to be March 6th +- 3 weeks with a range of February 13th, 2017 to March 19, 2017. It could also be the week of March 19, 2017 +- 3 weeks. [...] Early April is another possibility. The March 6, 2017 forecast was first mentioned in our blog post of November 14, 2016. I mention this again as early March is looking more and more like a low and we are getting close to a change in trend which will be down. On the evening of February 6th Jupiter will turn retrograde. The Jupiter retrograde is often found at highs and lows. I'm looking for a turn down by February 6th +- 5 tds.
...most of the heavy lifting that powered the Dow to its magic barrier was done by relatively few market segments, mainly financials. Banks have been among the best performers since the election on 8th November, but Goldman Sachs alone accounts for some 170 points of the market’s 42-session surge above 19,000, the largest contribution by one stock. Together with rival JPMorgan, GS contributed 20% of the rise.
Trump is at a massive historical disadvantage when it comes to stock market returns, because equities today are deemed expensive. The P/E ratio of US stocks when Regan took office was 9, this compares to nearly more than 30 today, on a cyclically adjusted basis.
There is clearly a lot of uncertainty surrounding a Trump presidency. From the rhetoric surrounding deregulation to the proposed infrastructure improv
Topping cycles are suggesting that the uptrend is living on borrowed time. [...] If we are to make a high next week, the current cyclical configuration calls for a decline into April-May. If this materializes, it would bring more than just a minor correction.
Here are some cautionary sentiment developments: The amount of money in inverse index funds has fallen by 75%, one of the lowest levels in 20 years. [...] The average strategist expects the S&P to end 2017 at 2356, a gain of about 4%. That would be their least-bullish outlook since 2003 [...] The latest survey of active money managers from NAAIM shows bullish sentiment with low standard deviation [...]
financial markets tend to price in events before they occur, but this time I believe investors have priced in most of the good news, and it requires very strong corporate profit growth to keep this bull market alive. Predicting the end of the bull market is a tough call, but the downside risk in 2017 is likely to be larger than the upside potential.
Tax cuts won’t get companies to expand substantially any more than did free money that largely only led to stock buybacks and mergers and acquisitions – financial engineering – not real growth. Besides, infrastructure investments take forever to get drawn up, approved and shovel ready. While the Trump rally seems to have legs, it’s not based on anything substantial or real, except perhaps some cuts in regulations. I think it’s not likely to make it into the summer of 2017. In fact, it’s just another sign of how much the stock market is in an irrational bubble!
I see stocks going as high as 22,000 on the Dow and 2,500 on the S&P 500 by mid-July or so… maybe even a bit later. After that, I expect the Russell 2000 (small caps) will lead us into the trenches. A growing divergence between large and small caps will be an important sign of such a top. Small caps have grown the most irrationally since the Trump win after lagging and could disappoint increasingly in the continued rally from here.
...many more of these tweets against America’s biggest businesses and markets could start to question whether Trump has a pro-business agenda. Mr Trump’s tweet attacking GM comes after earlier claiming he prevented rival Ford from moving its Lincoln plant to Mexico. If the hope that trade policy wouldn’t play as big of a role as Trump’s business-friendly plans for tax and deregulation is misplaced, Dow 20k may not last long.
we mentioned that if cycles have anything to say about the direction of the market for the next few months, the decline which is starting now could last until April-May. But cycles are not reliable enough as a forecasting tool and they must be confirmed through other technical means. The weekly trend may be in the process of topping. If SPX drops to the low 2200s, the weekly indicators will shift to a sell mode and this will be one of the requirements needed to suggest that we have started an intermediate correction.
Considering the fact that the mkt has had such an explosive move since the election - pricing in perfection on so many levels - this indicator is only telling us that the mkt is currently overvalued and the risk of a correction is high vs. not. It is sending a warning signal about what could come in the new year.....and with the FED suggesting multiple rate hikes in 2017, 2018 & 2019.....it does make some sense that a 're-pricing' is in the cards if 'perfection' is not achieved...
Essentially a rising dollar and rising US Treasury yields are also bad news for US stocks, but the market is not concentrating on that right now.
The momentum oscillators are in an uptrend, but the A/D has been trending down for the past two days against a strong price move. This is negative divergence in market breadth at the daily level -- another warning that a top is in the offing.
Sectors in U.S. equity markets diverged substantially. Financials and industrials continued to lead, sending the Dow Jones to a new record high while the technology sector was left behind weighing on heavy tech Nasdaq index. If the divergence continues within these major sectors it could send a warning signs to investors that the rally is not sustainable, especially sincelong term fixed income maturities have started to lookattractive.
...after Trump won, we started to see aggressive US Dollar buying accompanied by a rally in stocks. I have said I thought the rally in stocks made little sense given the fact that the prospect for a more hawkish Fed was a disincentive to be long risk.
Coeure said the ECB was far from having to contemplate buying stocks and had never discussed such option, which has been adopted by the Bank of Japan.
Everyone is so focused on interest rates. Too focused. The thing is, they’re focused on the wrong interest rate. While the federal funds rate has seen little movement and may not budge much for the rest of the year, three-month LIBOR is at multi-year highs! [...] The problem is, as interest rates creep up and more portfolios have been used as collateral to finance asset purchases, it could create a huge storm if stocks and bonds take even a minor dip.
Bullish FOR THE STOCK MARKETS
This is going to be an interesting next four months, in which I believe financial markets (especially equity markets) will reflect what is going in the life of USA President Donald Trump. Therefore, the risk to financial markets will continue to be political in nature. The economy on its own is fine, with Jupiter and Saturn in sextile through most of 2017. The political realm is not, for it reflects the transits to the charts of our world leaders, and in the case of Mr. Trump, the transits are anything but stable. The financial markets are apt to give increasingly more weight to the political instability and the risk that it poses.
At the risk of highlighting another overly simple narrative to explain the strong recent performance in US stocks, the fundamental pillars of support for US stocks (earnings) are as strong as they've been in years.
The BAI cycles projected a flat 8 years that is now ending and the cycles are rising in 2017. The cycles were picking up the election of a business-friendly administration as well as the cycles did when they were flat, preceding the election of a business-unfriendly administration. This event has led to a rise in optimism which will bring investment in new business. This has overwritten all other considerations. And, tax cuts are bullish. We have not had cuts in so long that I think that most have forgotten the beneficial effect.
I have attempted to highlight various analyses that show market sell-offs are quite hard to come by, and rallies are slow to fade. Recent analysis from Bloomberg suggests that when the S&P 500’s RSI – Relative Strength Index – moves into overbought territory it can be a bullish signal. Since 1929 the S&P 500 managed a 7% gain over the following 6 months after the RSI topped 75, compared with a 3.3% gain in other 6-month periods. JP Morgan also sent a note to investors this week, which told them to stick with stocks in the short-term. In my humble opinion stocks still have some way to go, after all rates are rising from an historically low base, prospects for growth in the US are extremely high, and global economic data is strong, the Citi Economic Surprise index for major economies is close to its highest level since 2010. This all fills me with confidence that the fundamentals will win the day, rather than the naysayers worried about valuation metrics.
...there’s no doubt it’s becoming a serious alternative investment to consider in a portfolio. Much of the moves recently were supported by tighter currency restrictions in emerging economies, and if this remains the case in addition to political instability, we may see even further gains in the bitcoin.
What’s even more interesting is markets now consider a tighter monetary policy a sign of confidence in economic growth and thus a reason to continue purchasing stocks, when for years post 2008 crisis it had been considered the most significant motive to dump stocks.
Since the financial crisis any prospect of higher rates has typically spooked equity markets. However, the situation is quite different these days. Equities are soaring as a rate rise now comes for all the right reasons. The US economy is improving, the Fed is seen as getting ahead of the curve (at least where inflation is concerned) and investors can now look forward to fiscal stimulus and a business-friendly Trump administration. What could possibly go wrong?
The changes to Dodd Frank are likely to be small to begin with but Trump is shifting the direction of travel from more regulation to less regulation. That’s a good thing for the financial sector, and less red tape is good for corporate America as a whole. Trump turning his attention to deregulation could be just the boost Wall Street needs to send the Dow back above the 20,000 mark.
Technically speaking - Despite another surge we continue to have breadth indicators that diverge greatly from index prices.......During January the percentage of issues that continue to trend above their 50-day moving averages has drifted from way overbought (near 100%) to near 65% at the end of last week. The other indicator that continues to show weak breadth is the McClellan Oscillator for the Nasdaq indexes. Since late December this Nasdaq indicator has barely moved into the positive breadth area - In fact, it continues to remain weaker suggesting that only a handful of issues is carrying the load....The enduring sideways correction will have to break out or break down at some point.....depending on what you think will dictate your next move....now while I am bullish - I also acknowledge that risk remains elevated. I do not expect the mkt to meltdown at all, but I would not be surprised to see the mkt pull back as Congress and the President start the debate....But like so many pullbacks - My sense is that those pullbacks will provide a longer term opportunity for investors.
What is the VIX telling us? 10.66 - which is very complacent...it implies that the stock mkt has an implied volatility of 10.6% on the S&P - which then means that investors think that the index has a 68% chance (one standard deviation) of trading within a 10.6% range of its current level over the NEXT year. [...] So at 10.6 - investors are saying - "I'm ok with this".
With regards to stocks, we don’t have a crystal ball, but are concerned about high valuations. Without giving a specific investment recommendation, we would not be surprised if small caps (as expressed in the Russell 2000) outperform large caps (as expressed in the Nasdaq). The reasons include:...
For the timeframes we trade, the % of stocks above the 50-day MA is most relevant. Taking a step back, the fact that nearly 80% of S&P 500 stocks are trading in an "uptrend" (above their 50-day MA) is still a bullish signal.
Earnings are expected to grow at 11% in the 1st qtr, 11% in the 2nd qtr, 9% in the 3rd qtr and 14% in the 4th qtr! And that my friends is where the rubber hits the road....[...] this EXPECTATION is what is now driving stock prices [...] if earnings can grow at this exponential rate in 2017 - then maybe stocks are not as expensive as they appear...........we know that Trump will not get 100% of what he wants - but the mkt does expect that he gets 50 - 60% of what he campaigned on...and if that is the case then it's all good....
After the inauguration, what will be the nature of the next year? Disruption. Sometimes markets like disruption when it takes the form of change that benefits the bot-tom line. Most folks think rising US inflation—from a skilled labor shortage, oil or Trumpian fiscal boosts—will drive the Fed to faster hikes, if not more hikes. At some point equities won't like it, but that's for later in the year.
The macro forces we identified, reflation and nationalism that were expressed most clearly in the US election, but were evident before too, is spurring a dramatic shift in asset preferences. The dollar, core equities, and financials are broadly in favor. Bonds, emerging markets, gold, have broadly fallen out of favor.
I am still confident that equities will remain buoyant at least for the time being and from here US equities will likely consolidate around all-time highs. Underpinning my view in the equity space is the belief that if the US economy performs the way Yellen intends then the underlying fundamentals warrant a continued move higher, but if the worst materialises and populist movements continue to gain traction, Brexit negotiations break down, China has a hard landing etc… I think that the central banks will simply turn on the taps and do “whatever it takes” to counteract any impending downturn.
...as long as banks continue to outperform, and REITs continue to underperform, the overall stock market, the path of least resistance for interest rates will remain higher.
The magnitude of the US stimulus the investors seem to be assuming will pass a Republican-controlled Congress has spurred a shift out of bonds, emerging markets, and gold.
Three of my [...] research studies show that the recent uptick in volatility is a GOOD thing for stock prices. The statistics suggest we should see outsized stock gains in the months ahead [...] Following a one-day sell-off worse than 2.5% [...] Following a VIX spike of 50% or more [...] More than 80% of stocks are below their 10-day moving average [...] For now, the dominant trend in a majority of stocks is bullish… and so that’s where our bias remains.
Sentiment in the Bond Markets
It is important to note that bond yields and bond prices go opposite. Furthermore, bonds have several maturities ranging from very short-term 1 week up to 30 years or even more. These two opposite ends of the yield curve may see different supply-demand imbalances, but general sentiment towards government bonds will provide the trader or investor with a general sense for the appetite for that particular asset class. Bonds are the focal point of the intermarket chain and the deepest market compared to equities and commodities.
Any capital flows out of the bond market, is prone to create a sharp move in other asset classes. Market participants are therefore sensitive to changing inter-market relationships involving bonds. Bonds are traditionally considered risk-free investments but demand for government bonds from the public can dry up if other assets are perceived as carrying lesser risk of default. Also central banks can reduce or increase their holdings of domestic or foreign bonds.
Bearish for the Bond Markets
Despite the belief voiced by many commentators the Trump reflation trade was, or is, over, we maintained confidence in our Wave view for long yields, as seen below. At least a modicum of confidence here is critical to maintaining a dollar bullish view. That's because over time interest rates, or more importantly, relative yield spread (e.g. United States yield versus Eurozone yield) is probably the most important indicator of the intermediateterm direction of currency value (the major exception to this rule is the Japanese yen).
With the market coming off its best quarter since 2015 (that included a DJIA winning streak not seen since 1987 – of all years) and stocks now up eight years in-a-row (tying records set from the 80’s and 90’s), the Fed is naturally up against increasingly lofty valuations, with record highs seen in the CAPE (Cyclically Adjusted P/E) Ratio, Price/Sales, Median P/E, and Total Market Cap/GDP, even as GDP growth decelerates below 1% behind the scenes. With these record valuations coming largely as a result of the entire economy having been subsidized by 100 straight months of ZIRP (Zero Interest Rate Policy), and inflation now picking up (up +2.5% YoY and past the Fed’s 2% inflation target), the Fed also has no choice but to raise
This difference in real yields is particularly striking in Germany. An inflation rate of 2% isn't just a target...it's a reality. The 10-Year Bund currently yields 0.43%, and the February year-overyear rate of Consumer Price Inflation (CPI) is 2.2%. Therefore, real interest rates are currently a negative 1.77%. If the ECB were to seriously commit to ending its QE program, fixed income investors and speculators would panic to get ahead of the removal of Draghi's bids; and Bund yields could surge well above the rate of inflation in a very short period of time. Therefore, it is a very credible assumption that the free market will rush to front run the offers from Draghi and Kuroda, and cause chaos in global bond markets.
Confirmation of a large build in US oil inventories by the Department of Energy saw the low recorded, but then prices recovered. Higher oil prices may remove one source of pressure on US yields.
...if Trump does deliver on his economic promises at next week’s State of the Union address on 28th Feb, then we could see bond and Tip yields start to rise, which may trigger a stronger dollar, higher levels of volatility, and also a stock market sell-off.
Longer term, we hold our negative views on both German Bund and US Note future on the back of accelerating growth and inflation. US investors still have to adapt to the Fed's 2017 rate hike scenario (3 hikes) while European investors might face another "recalibration" of the ECB's APP-programme in H2 2017.
Bonds should prove interesting in 2017. My personal opinion is that we saw historic lows in 2016. However, if stocks were to tumble, wouldn’t bonds rally? Possibly. What I’m concerned about is that bonds will fall for different reasons than in 2016: in late 2016, more real growth was priced in; I happen to believe that some of those higher real growth expectations will be replaced with higher inflation expectations. If that happens, bonds can lose money even if stocks fall.
we note that the US breakevens (the difference between the conventional bond and TIPS yields) are rising. The 10-year breakeven is elevated at 2.07%. The peak since September 2014, was recorded a week ago at 2.09%. However, yesterday was the first time since 2014 that the five-year breakeven also poked through 2.0%. We hear more clients talking about this and the possibility that the Fed may be slipping behind the curve. Bloomberg calculations suggest a little more than a one-in-three chance of a hike in March has been discounted by the Fed funds futures. The CME's calculation sees a one-in-four chance is discounted.
There is still more reason for bond yields to be rising rather than falling. [...] Market-based measures of inflation expectations have been rising globally, consistent with stronger global growth indicators and stronger commodity prices in recent months. These factors are likely to reassert upward pressure on global bond yields, and rising relative real interest rates in the USA, where rate hikes are more likely to be implemented, supporting the USD.
Bill Gross grabbed headlines Tuesday by casting aside all other markets and economic indicators and saying the future of global markets hinges on one chart – the 10-year yield. The T-note yield has been trending down for 30 years but is testing the upper limit of that channel. Gross says a break above 2.60% would signal a new paradigm of growth and inflation that would be the start of a bear market in bonds. He didn't predict it was coming but said it would have to come with 3% real growth. Gross' rival for the bond crown – Jeff Gundlach had a similar take but with 10-year yields at 2.37%, he allows for more leeway before declaring a new paradigm. He said it won't be a bear market in bonds until 3% yields.
The rise in US yields since the election is not so much an increase inflation expectations but real yields. An increase in real yields could be a reflection of an increase in the demand for capital (which could come from the private and/or public sector). It could reflect anticipated changes to supply-side factors (tax cuts and regulation) that boost profitability.
Medium term, we expect US markets to further align with the Fed’s scenario of 3 rate hikes this year. We hold our negative bias for US Treasuries with entry levels around 125-09 (tested after payrolls).
The global reflation theme continues to be the driving force of markets, pushing up equity markets and bond yields. Over the past few weeks, global stocks have broken out of the muddling through state and broken on the upside not least due to a jump higher in European stocks, while US 10-year yields edged higher again leading to a cumulative increase of 100bp over the past three months. We continue to see this theme playing out over the coming months and look for further upside in equities and bond yields.
China is the second-largest holder of Treasuries after Japan but at the moment someone is clearly selling. Perhaps it's one of the Asian powers? We won't find out for months but Treasury-holdings data in the months ahead is must-watch economic news.
... regulations combined with reductions in the trading desks at the banks have greatly reduced the volume of bonds that can be liquidated quickly and easily. The entrance was large but the exit has been shrunk. Thus, the bond market appears very risky from a longer-term perspective.
Despite significant purchases by the ECB and the BOJ, bond yields appear to have bottomed. Deflationary forces in most countries have been arrested. Bond yields have been falling since the early-1980s. This trend may be over. That is what is at stake. We may have entered a new paradigm.
The end of the 35-year-old bond bull market is upon us. Trump’s trade policies, along with his avowed love of debt, is putting significant upward pressure on borrowing costs. The Donald will now try to convince Janet Yellen to reverse her incipient tightening policy and bring rates back to zero—and eventually even to launch QE IV. [...] what Yellen and Trump don’t understand is that our nation is both debt-disabled and asset-bubble addicted, which requires interest rates to be near zero percent or the whole ersatz economy will implode. The devastating bond bubble’s collapse will bring Trump to that reality very soon.
... demand for government bonds from the public and foreign central banks dries up while the government’s borrowing needs grow ever larger.
Nicole Elliott, Private Investor and Technical Analys says the yields on the Treasury bills are far lower than the Fed funds rate, while the interbank lending rates are at least 50 bps above the Fed funds rate. She calls this as the failure of the Fed policy. Elliott then goes on to detail the dynamics of overnight offshore Yuan lending rates.
Bullish for the Bond Markets
Ask how many times the implied probability calculators used by many failed over X amount of meetings. I see the Fed's desire to raise by placing Fed Funds above the Natural Rate but Fed Funds is not ready to rise and actually has a long way to go before a raise should be considered.
If inflation remains at a more moderate pace than some are currently projecting–perhaps reflecting continued seller competition, dollar appreciation, and/or more modest energy price increases–then the FOMC will not need to be as aggressive in raising the funds rate. Moreover, estimates of the neutral fed funds rate indicate that the rate remains below its historical average of prior cycles. The recent policy proposals aimed at increasing the repatriation of capital held abroad, which would boost the cash position of domestic firms as a source of funds and thus reduce business loan demand, may also support the case for lower interest rates going forward than otherwise might be the case.
10-Year Treasurys could rise to near 3.0% before reversing down on falling inflation and slowing economic trends again. Once they’ve started to fall, they could go as low as 1.0%, or lower, and then stay near there for years, creating the fixed income opportunity of the decade for buying 30-year Treasurys and 20-year AAA corporate bonds.
The rally in yields has been breathtaking in its ferocity and with the end of the year approaching, some of the shorts may begin taking their profits. Therefore it is not unreasonable for the 10 year yield to slide back towards the 2.50% level which was former resistance and will now become support. That in turn means that USD/JPY could see a correction as well towards the 115.00 figure over the next several days.
The reason for the wild jump in yields is the expectation of more fiscal stimulus and rising inflation in the US that will bleed over to other countries. It is a classic case of "Sell on the rumor." [...] For European yields to rise because the US elect-ed Trump is more than silly. It's unsustainable and dangerous. Yields are supposed to respond to hard domestic economic data, right? Like actual inflation.
..my sense is that a counter-trend rally in TBT (upmove in YIELD) is nearing exhaustion [and] that the U.S. economy is increasingly vulnerable to a recession, and/or a flight to safety into, and immediately after, the election...
Global core bonds profited from deteriorating risk sentiment on European stock markets, declining oil prices, and central banks’ “lower for longer” attitude...
Sentiment in Emerging Markets
Emerging markets reflect foreign currency exposure, which could explain correlations between EMs and Dollar Index. It's also important to know that many EM countries depend on commodity exports. For example, a side effect of a rising dollar and thereby weakening commodity prices, is that EM currencies such as the Brazilian Real and Russian Rubble suffer. That's important because weaker EM currencies have a negative impact on EM stocks making these look less attractive for global investors.
Also rising Treasury yields (often associated with a stronger dollar) also reduce the appeal of higher yielding (and riskier) EM assets.
Inversely, they do better when yields are dropping along with the dollar. Look above to the sentiment in the US dollar as it is is part of the reason for money flows into and out emerging assets.
When considering a particular asset class or financial market, instead of versus analyzing the subject in isolation, intermarket analysis includes all related asset classes. It is important to remember that these relationships are dynamic which makes trading applications even more difficult. This page's contents try to go beyond traditional historical intermarket relationships, and to be representative of the current relationships.
Bearish FOR EMERGING MARKETS
Our view on both EURTRY and USDTRY has been consistently positive [negative for TRY] since last July’s bullish triggers in spot and RSI. USDTRY rose more than 30% to last month’s high and EURTRY 25%. These gains have been supported by the 13 and 21 week mvg avgs and, for the most part, have tracked the upper band of positively trending weekly Keltner channels. Setbacks have been temporary and limited.
Hot money inflows intensified as higher Czech inflation brings CNB‘s exit closer. The Czech central bank has to intervene heavily to defend the EUR/CZK 27.0 floor, while liquidity in the Czech banking system (sitting in the CNB accounts) has spiked in 2017.
The 6-month EUR/CZK forward is pricing in a 256 point drop, one of the largest declines since the financial crisis. This suggests that the market believes that there is a very real possibility that the Czech authorities will disband with the peg in the first half of this year.
...we expect the market to win out, and the [Turkish] central bank to embark on more forceful measures such as a large one off interest rate rise, which could cause a sharp reversal in Turkey’s fortunes in the short-term. The risk of a rate hike is growing, especially if we see a series of consecutive sell offs in the TRY this week. Back in 2013 and 2014, Russia’s currency also came under pressure and the central bank embarked on a series of unscheduled rate hikes, eventually pushing interest rates up to more than 14%.
... we expect China to continue tightening capital controls gradually because if the PBoC continues to dissipate its FX reserves, this may enhance downside pressure on the yuan.
Longer-term outlooks will not change due to the short squeeze [in the Yuan]. More powerful fundamental drivers include the broader trajectory of the dollar and interest rate differentials. Still, capital controls and the willingness of officials to facilitate such a powerful squeeze demonstrates their resolve and ability to manage the challenges.
a change in the calculating factors for the Yuan. As we reported last week the calculation continues to move away from the expensive US Dollar and will now be measured against an increased basket of currencies. This move has the potential to make Chinese exports cheaper and imports more expensive. However, the obvious impact will weaken the currency core and therefore be supportive for the Shanghai index which will be helpful as money leaves the country seeking a safe-haven
A wide range of analysts follow the gloomy forecast for the Mexican economy at large, with a correspondingly grim set of expectations for the Peso's future value.SocieteGenerale expect the Peso to sink further, to a level of 23 to the Dollar, U.S. rate rises in 2017 are expected to bring further bad news, and James Barrineau, co-head of emergent market debt at Schroders, notes of his company: 'we don't own any Pesos.' Further to this, a Nomura Securities survey suggests that the USDMXN rate will hit 26 Pesos to the Dollar by the end of 2017, on the assumption of capital flight, and competitive devaluations. Less alarmist, but still bad news if you have a position on the Peso, is longforecast.com's prediction of an near the end of 2017 exchange rate of between 21.42 and 22.40 Pesos to the Dollar.
Of course, supporting the rotating carousel of real estate, commodity, and stock bubbles, while also trying to stem bond defaults, comes at a cost. All of that debt and money creation usually results in a decimated currency. However, China uses its currency reserves (held mostly in dollar denominated Treasuries) to keep the value of the yuan from falling too quickly. But what had once been China’s get out of financial crisis free card--their immense foreign exchange reserves--is dwindling at an alarming rate.
... the Chinese authorities have not made much of an attempt to halt the post-election decline in the YUAN, as if to say to Trump that his ascendancy has triggered a natural reaction in the currency markets, a far different situation than orchestrated currency management.
My view is that China’s US bond dump is about demand for US Dollars, which highlights growing concerns about financial stability in the mainland, amidst inflating asset bubbles and burdening bad loan provision.
Right now, the decline in the renminbi is also a reflection of a strong dollar. Since we still see the dollar as the dominant force in the FX world in the coming months, this pair may climb further into record territory. The world may have to get used to a weaker renminbi,...
...onshore to offshore flows do not appear be causing severe liquidity problems for Chinese capital markets or wider global risk aversion, but they do point to underlying weakness in Chinese economic confidence and may be contributing to strength in the USD against other currencies.
Bullish FOR EMERGING MARKETS
If USA economic reports appear to show a plateauing and US equities stall, the Fed may revert to a wait and see stance through the middle of the year. A sense of stable Fed policy may further encourage capital flows to other countries exhibiting stronger growth trends.
If Trump struggles to implement tax reform, including a border tax, it may mean a more moderate growth path for the USA, less reason for Fed rate hikes, and less disruption to international trade and less upheaval in the US economy. It may be consistent with a more modest but also more stable outlook for the US economy. A benign outlook that sees capital move towards assets outside of the USA.
Measures of US investor bullishness are running close to their highest levels in more than two years. Emerging market equities and US small cap stocks seem to be particular in vogue at the moment. Investors seem to be expecting stronger global growth and inflation this year and rising interest rates. I would agree with the economic diagnosis.
The first trading day after inauguration has the “mighty” buck seeing red due to Trump’s greater focus on protectionism than on economic stimulus. [...] Emerging market currencies are finding support.
I am actually short the US Dollar against the Turkish Lira, looking for this market to reverse course after racing to record highs, going parabolic and tracking in violently overbought territory across the daily, weekly and monthly timeframes. I can remember in January 2015 when USDRUB made a similar move before pulling back, and I can remember in January 2016 when USDZAR and USDCAD did the same. My hope is that this pattern plays out yet again with USDTRY in January 2017.
The relatively high interest rates offered in Russia have attracted investors, and firmer oil prices have helped to stabilize the Russian economy. Now speculators have really started to move into the rouble as they make bets on the possibility of the end of sanctions.
Taper Tantrum, these yield curve dynamics remain negative for EM bonds and EM FX. EM equities are a different matter, supported in part by the continued post-election rally in DM equity markets. Higher commodity should also help insulate some EM countries from the selling pressure.
Once the Yuan stabilises against the U.S. currency, there is an argument for a measured investment, banking on the longer-term strength of the Chinese currency. [...] Will we see a true level of support for the currency, or will the Chinese Central Bank step in to prop up its currency [...]?[...] Should the Chinese step in to support the currency before markets feel its price has been fully corrected, a mid-term rally is unlikely to be in the offing. Market sentiment may, however, be influenced by this and the PBOC may find that its intervention point mirrors expected base-levels of support.
Sentiment concerning Volatility
Bearish FOR VOLATILITY
...what is an exchange rate, what is DXY and EUR/USD. Both are interest rates transformed to an exchange rate. Exchange rate and interest rate are synonomous terms. Fed Funds rates are contained therefore DXY is restricted from movements. Fed Funds is not only the supreme USD interest and overnight rate but regulate Fed Funds is to stifle all USD interest rate movements. To understand this concept is to conquer perfect market knowledge, become a currency trader rather than a person who trades currencies and realization the amount of pablum written is astounding.
Bullish FOR VOLATILITY
The markets will ultimately reflect the President. [...] That kind of personality can only add to volatility in the four years ahead and risk assets prefer less-stormy seas. [...] his volatility personality won't change.
...at least another few months of these wide swings [in Oil] are favored (as wedges break down into 5 legs) before finally rolling over, and "fits" of the nearer term view of an important topping.
...there is a very real possibility that the Czech authorities will disband with the peg in the first half of this year. Due to this, if you trade EUR/CZK, watch out for heightened levels of volatility in the coming days and weeks.
With the inaugurationof Donald Trump as President of the United States just over 2 weeks away, we may see some volatility in the gold price on the back of some of his remarks and election promises, and if he will in fact, follow through on them.
This year is going to be the biggest year for geopolitical surprises since the Iraq war, and even that could be seen from far off. [...] the stock market is way ahead of itself and making too big a bet on reflation (and against Congressional gridlock). In practice, uncertainty (and volatility) will be high next year.
Market sentiment is defined as the net amount of any group of market player's optimism or pessimism reflected in any asset or market price at a particular time, a kind of collective emotion. The goal of understanding sentiment is to discern when a trend has reached an extreme point and is prone to reverse its direction.
Among sentiment indicators there is the VIX, the CoT Report, Put-Call Ratios, the Ted Spread, Mutual Funds statistics, Margin Balances and Investor Polls- such as FXStreet's weekly FX Forecast Poll.
The Forex Forecast Poll
The Forex Forecast is a currency sentiment tool that highlights our selected experts' near and medium term mood and calculates trends according to Friday's 15:00 GMT price. The #FXpoll is not to be taken as signal or as final target, but as an exchange rates heat map of where sentiment and expectations are going.
The CoT Report
The COT provides up-to-date information about the trend and the strength of the commitment traders have towards that trend by detailing the positioning of speculative and commercial traders in the various futures markets. The Commodity Futures Trading Commission (CFTC) releases a new COT report each Friday.