Economists vs. Traders

Carnage on global stock and commodity markets last week had traders reaching for Alka-Seltzer to calm their nervous stomachs. And without a forthcoming cut in interest rates or reserve requirements by China on the weekend that had been speculated, it will be more of the same for the week ahead. The USD severely underperformed against the majors only managing to outpace the CAD and AUD. The risk aversion trade benefited the CHF with safe haven flows.

The other top performers were the EUR, NZD, and JPY. The NZD escaped the carnage of the other commodity currencies because it received a boost after a nearly 15% rise in last week’s GlobalDairyTrade auction. The EUR and JPY were up strongly for entirely different reason – short covering. With the negative interest rates of the ECB and zero rates with the BOJ, the EUR and JPY have been used as funding currencies to make bets in various investment arenas. With the downturn in global stock and commodity markets last week, traders have been selling their investment and paying back their loans causing them to have to purchase the EUR and JPY.

The USD may have been down against the majors but it was up against the emerging market currencies. Analysts at Deutsche Bank noted that 17 EM countries have seen their currencies depreciate by over 3% since China devalued CNY last Monday. Also weighing on the EM currencies is the possibility of the Fed raising interest rates at their September policy meeting. This would cause the debt servicing costs to rise for all of the EM. However, the release of the FOMC minutes last Wednesday paints a decisively different picture. The minutes highlighted concerns from Fed members with both the U.S. economy and the global economy, with particular focus on China. The comments from the Fed minutes on China are of particular interest because the meeting of the central bank actually took place back in July, before the China’s devaluation of CNY.

On the surface it appears that a September rate hike is viewed as less likely by market participants compared to prior to the minutes release. In other words, traders have responded and traded down to this perceived outcome. Fed funds futures, used by investors and traders to place bets on central bank policy, showed Friday that investors and traders see a 28% likelihood of a rate increase at the September 2015 meeting, according to data from the CME Group. It wasn’t that long ago that the odds were near 50%. Furthermore, noted currency analyst, Ashraf Laidi, points out that the 2-year breakeven inflation measures have tumbled to 7-month lows of 0.22% and the 5-year BE rates at 1.1%, is the lowest since August 2010. BE measure the difference between traders' expectations of the difference between nominal bonds and inflation-protected bonds. These measures are telling us that the collapse in oil prices is going to spur deflation across the globe.

The trader’s conclusion is that the Fed will not hike rates in September, which is at odds with what the economists are predicting. According to the latest Wall Street Journal survey of 60 business and academic economists, 82% of economists expect the first rate increase since 2006 at the September FOMC meeting. What should you believe – the survey of economist or the market based measures created by trader’s actions? Like a veteran market participant once told me – when’s the last time an economist made you money?

To Catch a Falling Knife

If you were surprised that the Yuan devaluation(s) didn’t give the USD a bit of a kick upward, you weren’t the only one. Economists will tell you that the devaluation should make the dollar at least

marginally more attractive given the implicit widening of policy divergence between the U.S. and the rest of the world. Instead, what you’re seeing is that the market is changing its perception of the policy divergence. As we’ve stated in weeks past, there is lack of hard evidence of the Fed's readiness to start rate normalization, and this has further greased the skids for the USD. The market has expressed its disillusionment by pushing the odds of a first rate hike out of the realm of September to December.

The dust hasn’t entirely settled after Friday’s massive sell-off in equities in part because the odds of a September rate hike fell from 45% to 24%. The odds of a hike in October fell from 50% to 32%. The likelihood of a December rate hike? That’s just one fragile catalyst away from pushing the first rate hike into 2016. And if the odds go into 2016, you may as well assume no imminent rate hikes as the U.S. Presidential election soap opera season kicks into high gear (without commentary from Jon Stewart, unfortunately).

The flavors of the day as traders run from the USD are (so far) the EUR and JPY. One could argue that the GBP should be included in the short list, but its move hasn’t been quite as significant. The rush into the EUR looks a bit overextended as the EUR trades close to its highest since the QE era began.

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Keep Calm and Have a Fortune Cookie

The last week we saw the Chinese government force the devaluation of their currency by 4.4% in an effort to inject life into their economy after their recent market crash. This started a frenzy of protest on Main St. and Wall St. alike. Both sides of the political aisle in the U.S. claimed this currency manipulation by the Chinese will further weaken U.S. exports. Although it's relieving to see bipartisan action, we would like to highlight this event and others that our readers and clients should also focus on in world markets.

Chinese devaluing their currency, effectively making their products more affordable to the rest of the world, was a foregone conclusion with the recent strength of the US dollar. In March, the Euro hit an all-time high against the Yuan at 0.15274 due to the Yuan's peg to the strong US Dollar. The Eurozone is virtually the same in importance to Chinese exports as the U.S. market. The PBoC devaluation in China to protect their exports has a similar effect to low interest rates and the bond buy-back (quantitative easing) in major markets.

The declining economies in Europe and Japan have caused both central banks to print money and embark on massive bond buying programs. This helped jump start both economies and also devalued their respective currencies. Japan saw over 3% GDP growth but also saw some of the lowest levels in their currency since 2007, closing at less than 124 JPY per US dollar Friday, August 14. This made Japanese exports even more attractive, and lucky enough for Japan, global commodities are so low their cheap currency didn’t hamper growth. Look for Japanese intervention to increase the value of their currency if commodity prices rebound. Virtually the same can be said for the Eurozone.

Funny enough, the move in the Chinese currency caused such speculation that it would hurt U.S. exports, the top performing major currency last week was the EUR, gaining 1.34% over the USD hitting over 1.1150. This month-long high for the Euro and increase in strength for the GBP and CHF was likely aided by the multi-billion dollar deal approved by the Greek parliament to finalize their bailout. Even though the EU only grew 0.3% this quarter (projected 0.4%), the perceived stabilization of the region was enough to convince the market of its relative strength.

With a pending rate decision in the U.S. in September, low commodity prices and shaky global markets, be on the lookout for more government intervention by regions globally. Closer to home, take a look at the article below for some signals coming this week of what might happen in September.

Hints of a Fed Rate Hike Could Come This Week

Today’s release offers one of the early estimates of the macro trend in August. Although the data is focused on the New York Fed’s region within the U.S., the report is the first of several regional updates on manufacturing activity from the Fed banks. As usual, this data will set the tone for expectations for the monthly figures that will follow in the weeks ahead.

In addition, today’s report will be widely read as the first clue of the week for assessing the potential that Yellen & Co. will begin raising interest rates in September for the first time since 2006. The odds that tighter policy is set to begin with next months’ Federal Open Market Committee meeting draw fresh support in last week’s optimistic news on retail sales and industrial output for July. More of the same is expected for the initial peek at August’s profile.

According to consensus forecast from www.econoday.com, the NY Fed Index is on track for a modest rise to 4.75 for this month. If the calculation holds, the benchmark will tick up to its highest level since March. In turn, the news will offer the throng of analysts another reason to think that we'll see a rate hike next month.

Last week’s key economic updates – industrial production and retail sales – delivered positive news. In both cases, strong gains for July marked a turnaround from disappointing comparisons through most of the first half of the year. Are the encouraging numbers a sign that the macro trend is poised to deliver stronger growth in the second half of the year? Those of you in manufacturing know the answer just by looking at your order pipeline.

The view from the perspective of home builders is certainly optimistic these days. In the July update, the mood was clearly resilient. The National Association of Home Builders/Wells Fargo Housing Market Index (HMI) remained unchanged at 60 in July, sticking to the highest reading in nearly a decade. “The fact that builder confidence has returned to levels not seen since 2005 shows that housing continues to improve at a steady pace,” NAHB’s chairman Tom Woods said last month. “As we head into the second half of 2015, we should expect a continued recovery of the housing market.”

The bullish narrative is projected to remain intact in today’s release for August. At www.briefing.com, the consensus estimate sees HMI rising fractionally to 61, which would mark another multi-year high. In that case, we’ll have another clue for expecting upbeat news in tomorrow’s report on residential housing construction.

It's Official: Canada is in Recession

It’s Official: Canada is in Recession

From Business Insider:

Canadian gross domestic product unexpectedly fell 0.2% in May. This was worse than the 0.0% expected by economists.

"The economy has contracted in six out of the last seven months," BNP's Derek Lindsay noted. The resource-rich economy has felt the crushing pain of falling commodity prices as global demand for raw materials has decelerated. And relief doesn't seem to be coming anytime soon.
"We continue to see falling commodities prices weighing heavily on the economy, with mining, utilities, and manufacturing presenting biggest drags on the goods side," Lindsay said. And this probably means more easy monetary policy.

"The Bank of Canada is likely to read this report as supportive of their move to cut rates at their last policy meeting earlier this month," Lindsay added. "We expect further easing ahead, as investment and exports remain in contractionary territory and the economy remains vulnerable to a correction in housing and a pullback in spending due to high levels of household debt."

Here are the specific details from Stancan:

Manufacturing output contracts

Manufacturing output contracted 1.7% in May, following no growth in April.
Durable-goods manufacturing fell 2.4% in May, as almost all major groups lost ground. Notable declines were recorded in machinery, computer and electronic products, fabricated metal products and miscellaneous manufacturing. Non-metallic mineral products manufacturing was up.
Non-durable goods manufacturing was down 0.7% in May, primarily because of declines in the manufacturing of food as well as beverage and tobacco. Decreases were also posted in textile, clothing and leather manufacturing, chemical manufacturing as well as printing and related support activities. The manufacturing of petroleum and coal products and of plastic and rubber products advanced.

Mining, quarrying, and oil and gas extraction falls again

Mining, quarrying, and oil and gas extraction fell 0.7% in May, down for a seventh consecutive month.
Oil and gas extraction fell 1.0% in May, after decreasing 3.4% in April, mainly as a result of a decline in conventional oil and natural gas extraction. Non-conventional oil extraction was also down.
Mining and quarrying (excluding oil and gas extraction) was down 0.8% in May. A decline in metallic mineral mining outweighed a gain in coal mining. Non-metallic mineral mining (which includes potash mines) was unchanged in May.
Support activities for mining and oil and gas extraction increased 2.8% in May, after rising 9.6% in April, as both drilling and rigging services advanced again. The gains in April and May followed double-digit declines in the first three months of the year.

Wholesale trade falls while retail trade rises

Following a 1.6% gain in April, wholesale trade fell 1.0% in May. Declines were notable in wholesaling of machinery, equipment and supplies, miscellaneous wholesaling (which includes agricultural supplies) as well as motor vehicle and parts wholesaling. On the other hand, food, beverage and tobacco wholesaling and farm products wholesaling were up.
Retail trade rose 0.5% in May after a 0.3% decline in April, led by increases in the activities of building material and garden equipment and supplies dealers as well as electronics and appliance stores.

Construction grows

Construction grew 1.0% in May, as engineering and repair construction as well as residential and non-residential building construction advanced.
The output of real estate agents and brokers rose 2.1% in May, up for a fourth consecutive month.
Finance and insurance sector declines
The finance and insurance sector declined 0.3% in May. A decrease in banking services outweighed increases in financial investment and insurance services.

Other industries

Utilities declined 1.4% in May, down for a third consecutive month. Electricity generation, transmission and distribution as well as natural gas distribution were both down in May. Unseasonably warm weather was recorded in some parts of the country in May.
The public sector (education, health and public administration combined) edged down 0.1% in May. Declines in educational and health care services more than offset an increase in public administration.
Accommodation and food services were up 0.9% in May, in parallel with an increase in the number of overnight travelers to Canada.

Need even more evidence?

Here are Five stages of death of the Canadian dollar according to the Globe and Mail which include Denial, Anger, Bargaining, Depression and finally Acceptance...

From BMO deputy chief economist Michael Gregory and senior economist Benjamin Reitzes:

"With a view to final trimester Fed tightening this year, unmatched by the BoC, we look for the currency to continue to depreciate, averaging C$1.33 in October [meaning about 75 cents]. Political uncertainty heading into the Oct. 19 federal election and continued global oil price volatility (but along sideways trend) should reinforce the weakening trend. Presuming the absence of post-election policy uncertainty and more oil prices, we look for the Loonie to average a cent or so stronger by 2015-end."

Other news...

The top performing currency last week was the Pound Sterling (GBP) but the excitement builds this week as we may see further gains in anticipation of the three PMI’s; Construction, Manufacturing and Services. In addition, it will be the first time the Bank of England will simultaneously release its policy decision, the meeting minutes, the votes and their new macroeconomic forecasts. Early last month BoE Governor, Mark Carney, had stated that, “the British economy's strong momentum meant the decision on when to raise rates would come into sharper focus around the end of this year.” Therefore, there is a strong possibility that there will be at least one vote for an interest rate hike.

The worst performer last week was the Swiss Franc (CHF). The SNB, Switzerland's central bank, reported a loss of 50.1 billion CHF on Friday due to a policy change. Per Business Insider, the bank's foreign currency reserves underwent a major devaluation when it decided to abandon a policy to cap the value of the franc against the euro earlier this year. Since the SNB had been buying Euros to maintain an exchange of 1.20 Swiss Francs to the Euro, it pushed up the value of the Franc, devaluing the recently bought Euros.

If you’re wondering why the US Federal announcement had little impact on the on the market last week, it might be because “staff projections prepared before the June 16-17 policy meeting were inadvertently included in a computer file that was posted to the Fed’s website on June 29.”
How’s that for a spoiler! The projections saw the federal-funds rate averaging 0.35% in Q4 of 2015, then rising to 1.26% in Q4 of 2016 and finally 2.12% in the fourth quarter of 2017. That’s one hike this year and potentially four next year. The actual statement however was quite lack luster, as the central bank only made small changes to its monetary policy, being very careful not to suggest when exactly they will raise interest rates this year; September or December. A September hike is the heavy favorite among banks, analysts and traders alike, but they may have missed something…