Market Outlook 8/10/11

By Mike Conlon, ForexNews.com on Aug 10, 2011 01:14:22 GMT

 

Did Bernanke kill the Dollar?  Yesterday’s FOMC meeting produced major market volatility, the type that we have not seen since the “Flash Crash” occurred.  Changes to the FOMC statement from keeping rates “exceptionally low for an extended period” to an actual target date 2 years away “mid-2013” left the market wondering what to do.

The initial reaction, as it usually is, was to sell first and ask questions later.  And that’s what the market did.  Bernanke acknowledged the declining economy as the reasoning for the policy change.  There were 3 dissenters on the FOMC board for the first time since it happened to Greenspan in 1992.  Nevertheless, Bernanke went ahead with the change.

So the initial reaction that things are getting progressively worse was correct, however it was trumped by the notion that there will be “free money” for the next 2 years.  This takes away some of the fears of potential rising interest rates, but also now limits what the Fed can do.  At this point, I think Bernanke is scrambling to do whatever he can as he is fully aware that there isn’t much left he can to for the economy with monetary policy, and that economic growth needs to come from fiscal policy.

So how do we encourage economic growth?  I’m going to go into a remedial economics lesson here because I think it’s important.  GDP is how we measure economic growth and it is simply a formula that aggregates inputs.

The formula is:  GDP=  C+I+G+X, where C= household consumption, I= business investments, G= government spending, X= net exports (trade balance).

Now if we address each component of the equation, we can see rather easily why GDP is declining. 

C is declining because of unemployment in the US which is officially reported at 9.2% but in reality is north of 15% when you include the underemployed and those who have dropped out of the workforce.  C makes up roughly 70% of GDP as consumer spending is the largest driver of the economy. 

I is declining because of uncertainty in the markets due to policies of the government.  Increased regulation, the fear of higher taxes, and the unknown of Obamacare have left companies no choice but to hold back on major expenditures, as well as hiring despite the fact that corporate balance sheets have never looked better!

G is declining because of the public outrage at wasteful spending of politicians as they attempt to buy people’s votes to keep themselves in power.  The recent debate over the debt ceiling was a charade intended to make people believe that politicians will reduce our debt.  Not likely!

X is declining (technically the formula is X-M exports minus imports but I’m just using the net figure) because the number has always been negative!  We run a trade deficit here in the US, not a surplus despite a declining Dollar.  Why?  Because China despite being the world’s second largest economy pegs the value of their currency to the Dollar, thereby negating the effects of a weaker Dollar on our exports!  China just reported a larger than expected trade surplus despite their currency “appreciation” which has gone up the most in 18 years.  The problem is that it is still less than the daily gains we saw in the Aussie just yesterday!

So we are clearly in a bad situation and politician are making worse by continuing to do more of the same!  So how do we fix this?  We are definitely in a chicken vs. egg cycle where politicians are quick to point out the obvious, but address the root cause.

Ask any politician why we have high unemployment, and they will tell you it is because of a lack of consumer demand.  While this is very true, it is not the cause but rather the effect!  Businesses will not take a chance on increasing expenditures, if they think that higher taxes or Obamacare will ruin their profitability. 

If you roll-back or throw out everything that has been “accomplished” in the last 2 years, then this economy can get moving again.  Otherwise, S&P is going to look very prescient with their downgrade as it is only going to get worse.  

 

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Canadian Dollar Lower on Recession Fears

As fears grow that the U.S. economy could be headed for a weak period, or even another recession, the Canadian dollar has seen its value decline. The U.S. buys 75 percent of Canada’s exports and the prospects of lower demand for these goods has investors leaving the loonie for other currencies.

The Canadian dollar depreciated 0.9 percent to 98.61 cents per U.S. dollar at 8:23 a.m. in Toronto, from 97.72 cents yesterday, when it jumped 1.7 percent, the most since May 2010. One Canadian dollar buys $1.0141.

“While the Fed did make a conditional commitment and indicated it’s going to do more, it also left the impression that the near-term outlook for the U.S. economy has become exceptionally choppy,” said David Watt, senior currency strategist at Royal Bank of Canada’s RBC Capital Markets, by phone from Toronto. “They’re going to be on hold for the next two years. It’s not exactly the greatest vote of confidence in the potential for the U.S. economy to stage a sharp rebound.”

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Loonie and Aussie Share Downward Bond

In yesterday’s post (Tide is Turning for the Aussie), I explained how a prevailing sense of uncertainty in the markets has manifested itself in the form of a declining Australian Dollar. With today’s post, I’d like to carry that argument forward to the Canadian Dollar.

As it turns out, the forex markets are currently treating the Loonie and the Aussie as inseparable. According to Mataf.net, the AUD/USD and CAD/USD are trading with a 92.5% correlation, the second highest in forex (behind only the CHFUSD and AUDUSD). The fact that the two have been numerically correlated (see chart below) for the better part of 2011 can also be discerned with a cursory glance at the charts above.

Why is this the case? As it turns out, there are a handful of reasons. First of all, both have earned the dubious characterization of “commodity currency,” which basically means that a rise in commodity prices is matched by a proportionate appreciation in the Aussie and Loonie, relative to the US dollar. You can see from the chart above that the year-long commodities boom and sudden drop corresponded with similar movement in commodity currencies. Likewise, yesterday’s rally coincided with the biggest one-day rise in the Canadian Dollar in the year-to-date.

Beyond this, both currencies are seen as attractive proxies for risk. Even though the chaos in the eurozone has very little actual connection to the Loonie and Aussie (which are fiscally sound, geographically distinct, and economically insulated from the crisis), the two currencies have recently taken their cues from political developments in Greece, of all things. Given the heightened sensitivity to risk that has arisen both from the sovereign debt crisis and global economic slowdown, it’s no surprise that investors have responded cautiously by unwinding bets on the Canadian dollar.

Finally, the Bank of Canada is in a very similar position to the Reserve Bank of Australia (RBA). Both central banks embarked on a cycle of monetary tightening in 2010, only to suspend rate hikes in 2011, due to uncertainty over near-term growth prospects. While GDP growth has indeed moderated in both countries, price inflation has not. In fact, the most recent reading of Canadian CPI was 3.7%, which is well above the BOC’s comfort zone. Further complicating the picture is the fact that the Loonie is near a record high, and the BOC remains wary of further stoking the fires of appreciation by making it more attractive to carry traders.

In the near-term, then, the prospects for further appreciation are not good. The currency’s rise was so solid in 2009-2010 that it now seems the forex markets may have gotten ahead of themselves. A pullback towards parity â€" and beyond â€" seems like the only realistic possibility. If/when the global economy stabilizes, central banks resume heightening, and risk appetite increases, you can be sure that the Loonie (and the Aussie) will pick up where they left off.

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Forex Outlook 8/9/11

« Market Outlook 8/8/11 | Home

By Mike Conlon | August 9, 2011

The markets appear to be “stabilizing” for the time being after yesterday’s massive sell-off, the 6th largest down move for stocks in the history of the markets.  Oil has pulled back as well, though gold is sky-rocketing to new daily highs, reaching just under $1780.

There is obvious fear in the marketplace, and what started out as debt concerns both here in the US has become global economic growth concerns.  So right now, the market is unsure who poses the bigger the risk, the US or the Euro zone.  This is reflected in the currency values, as EUR/USD has been trading a range with no clear direction. 

This is in stark contrast to the commodity currencies, which have sold-off greatly lead by the Aussie which is down close to 10% for the week!  On the flip side, the safe havens have received these money flows, with the Swiss franc making new all-time highs vs. Euro and USD.  The Japanese yen is also strengthening despite the attempt to weaken the currency through intervention last week.

The British pound is also trading a range as their economic data weakens and also dealing with the “protests” taking place in London right now.  I’m not sure that the media is giving this the proper attention it deserves, but looting and rioting are taking place as a single incident has ignited the anger over austerity measures.

One of the last bastions of growth in the global economy has been China, and overnight their CPI data came in higher than expected showing inflation of 6.5% which means that they may make further efforts to slow down their economy.  Talk of the global “double-dip” is starting to heat up, as it appears that the soft patch we were dismissing the data as may become a harsh reality.

So it’s the Fed or nothing today, as all eyes are on the FOMC meeting taking place today.  What, if anything, can the Fed do at this point?  Bernanke will clearly attempt to calm fears in the market but at this point it may be difficult to provide the magic pill that everyone so desires.  Instead, the medicine we may be forced to take is a much tougher pill to swallow.

The global banking system while not in great shape is clearly better than in 2008, though European bank exposure to sovereign debt and US bank exposure to a still-declining housing market may make it difficult to bring confidence back.  Money pours into US Treasuries, as it is not certain where to go.

So how do we get out of this mess?  It all comes back to economic growth.  Without it we are doomed and those who think the government can pick up the slack are delusional.  Without job creation form private business, demand will continue to weaken.

So while stocks may be higher to start the morning, do not be fooled into believing a bottom is in.  This saga is far from over, and thankfully politicians are on vacation for the rest of the month so I don’t have to listen to the blame game take place. 

Be cautious and judicious in your trading and use strict risk management principles.  Volatility can be your friend, though it can also be your greatest enemy!

 

 

 

 

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Fed Statement Expected to Include Stimulus Plans

Federal Reserve members are meeting in Washington today and Chairman Ben Bernanke is scheduled to issue a statement later today. It is expected the announcement will contain an outline on how the Fed plans to boost stimulus to support the badly sagging economy.

“The odds of more dramatic action are higher,” said Vincent Reinhart, a former chief monetary policy strategist at the Fed. “However, they might not want to be seen as responding so directly to equity prices,” Reinhart added.

More detail is expected when Bernanke speaks at a Federal Reserve conference at Jackson Hole, Wyoming on August 26th.

Source: Bloomberg

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Loonie and Aussie Share Downward Bond

In yesterday’s post (Tide is Turning for the Aussie), I explained how a prevailing sense of uncertainty in the markets has manifested itself in the form of a declining Australian Dollar. With today’s post, I’d like to carry that argument forward to the Canadian Dollar.

As it turns out, the forex markets are currently treating the Loonie and the Aussie as inseparable. According to Mataf.net, the AUD/USD and CAD/USD are trading with a 92.5% correlation, the second highest in forex (behind only the CHFUSD and AUDUSD). The fact that the two have been numerically correlated (see chart below) for the better part of 2011 can also be discerned with a cursory glance at the charts above.

Why is this the case? As it turns out, there are a handful of reasons. First of all, both have earned the dubious characterization of “commodity currency,” which basically means that a rise in commodity prices is matched by a proportionate appreciation in the Aussie and Loonie, relative to the US dollar. You can see from the chart above that the year-long commodities boom and sudden drop corresponded with similar movement in commodity currencies. Likewise, yesterday’s rally coincided with the biggest one-day rise in the Canadian Dollar in the year-to-date.

Beyond this, both currencies are seen as attractive proxies for risk. Even though the chaos in the eurozone has very little actual connection to the Loonie and Aussie (which are fiscally sound, geographically distinct, and economically insulated from the crisis), the two currencies have recently taken their cues from political developments in Greece, of all things. Given the heightened sensitivity to risk that has arisen both from the sovereign debt crisis and global economic slowdown, it’s no surprise that investors have responded cautiously by unwinding bets on the Canadian dollar.

Finally, the Bank of Canada is in a very similar position to the Reserve Bank of Australia (RBA). Both central banks embarked on a cycle of monetary tightening in 2010, only to suspend rate hikes in 2011, due to uncertainty over near-term growth prospects. While GDP growth has indeed moderated in both countries, price inflation has not. In fact, the most recent reading of Canadian CPI was 3.7%, which is well above the BOC’s comfort zone. Further complicating the picture is the fact that the Loonie is near a record high, and the BOC remains wary of further stoking the fires of appreciation by making it more attractive to carry traders.

In the near-term, then, the prospects for further appreciation are not good. The currency’s rise was so solid in 2009-2010 that it now seems the forex markets may have gotten ahead of themselves. A pullback towards parity â€" and beyond â€" seems like the only realistic possibility. If/when the global economy stabilizes, central banks resume heightening, and risk appetite increases, you can be sure that the Loonie (and the Aussie) will pick up where they left off.

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S&P Downgrades US To AA+, Outlook Negative

The U.S. had its AAA credit rating downgraded for the first time by Standard & Poor’s on concern spending cuts agreed on by lawmakers to raise the nation’s borrowing limit won’t be enough to reduce record deficits.

S&P dropped the ranking one level to AA+, after warning on July 14 that it would reduce the rating in the absence of a “credible” plan to lower deficits even if the nation’s $14.3 trillion debt limit was lifted. The U.S. was awarded the top credit ranking by New York-based S&P in 1941. It kept the outlook at “negative.”

‘The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” S&P said in a statement today.

Bloomberg

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