Posted on: 07 Jul, 2019
The US Dollar attracted sufficient demand to end Friday at the most expensive levels of the week against most of its peers after a stellar US payrolls number that exceeded the most optimistic calls.
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Well, it turns out that May’s 75k US NFP reading was a mere blip as the June number blew it out of the park with an impressive 224k headlined. To put this number into perspective, it exceeded by well over 20k the most optimistic call by Bloomberg forecasters.
Even if the US NFP proved again that wage pressure is nowhere to be found (+0.2% actual vs +0.3% expected), the standout headline number has now some pundits calling into question, even if the market is far from buying into it, whether or not the US economy may need an increased stimulus from the Fed after all.
The latest data will certainly make Fed’s Chair Powell testimony before Congress this week an interesting one to decode. Will Powell backtrack on the well-telegraphed insurance rate cut? If we observe the latest probabilities of an FOMC rate move with the CME FedWatch Tool, looks like, despite the appreciation in the US Dollar across the board, the market remains undeterred that a 25bp rate cut is baked in the cake with the odds at 95%, which is considerably higher than pre-FOMC.
This variation in the minimal Fed easing expected tells us that US depressed wage inflation, coupled with the dicey trade war environment, is still the key determining factor that will move the needle for the Fed to cut to most likely reduce interest rates. That said, if you were to put me in a time machine back 10y and someone told me the Fed will be cutting rates on the back of a 224k jobs number, I’d clearly be thinking that it defies any logic any way you slice it.
But these are the mad times we must contend with. If the market dictates that a rate cut is a done deal by the end of the month as the Fedwatch implies, it tells us the US NFP was never on the driving seat as a factor for the market in the first place, which has been my main case.
In a nutshell, as I posted last Friday: “Even if there is a turnaround from the poor May’s print, market participants will still view the Fed cut as still highly likely. It's all about understanding what makes the Fed tick at every juncture, and it's hard to believe that the US NFP print when juxtaposed next to a dragging trade war, can overrule and play that great of a role to deviate Fed's Powell from its intention to backtrack on a rate cut.”
Still, as our prop currency index shows, the US Dollar attracted sufficient demand to end Friday at the most expensive levels of the week against most of its peers. The aggregated tick volume saw a spike even if it still falls short of its moving average. To me, the strength in the US Dollar reflects the view of a market overstretched and now coming to terms that a 50bp cut is out of the table. That said, the structure in the daily chart still remains bearish while below the purple trendline.
Proof of that is that no matter if the Fed may now fully discard an aggressive easing of 50bp in July, the absorption candle in the S&P 500 by NY close is a clear testament that buyers are lurking near loaded. Equities remain as hot as ever after the index closed at its highest weekly level ever. The data release of strong payrolls and low wage gains was always going to find risk buyers anyway as it flags to investors that the US economy is not yet teetering on the brink of a true late-cycle stage.
Back to the twisted rationale of markets and the mad times at play. With the total amount of negative-yielding global bonds over US$13 trillion, it makes the search for higher-yielding assets such as equities as one of the few options available to aim for higher alpha. The irony of it is that the unorthodox central bank policies and renewed cues of further easing only stresses the negative correlation dynamics between the performance of economic and sizzling financial assets.
What the world needs to correct the current imbalances is clearly a lower USD that can promote an increase in nominal growth in the global economy. That’s why the renewal of a fresh easing cycle by the Fed is so reminiscence of 2016 and so needed for risky assets to be sustained. It’s all about liquidity in the system, in other words, the oxygen that has been promised to be administered to the ailing patient (global economy). It’s a fine line to walk indeed as any miscalculations by the Fed in its easing preparations can shake the grounds in financial markets with investors cutting their risk exposure in earnest.
And if I am going to introduce the word ‘hot’ for equities, a special mention must be made to the darling of the forex market for the last 2 weeks. I refer to none other than the Canadian Dollar, even if as a new week gets underway, a caveat must be outlined. We’ve had a stellar 2-week run with our prop CAD equally-weighted index hitting a macro projected move target where I’d expect gains to be much harder to come by. In the chart below, I’ve highlighted, based on the concept I always dwell on about a 100% projection target from a key breakout point, the red targets in 2019. Can’t make this stuff up!
Bottom line, while the adage the trend must be your friend should hold true, if you have been a stubborn bull looking to hold onto the very rare trend the CAD has put on in recent weeks amid such low vol regime, it’s time to seriously consider taking some chips off the table if evidence starts to build on a reversal to the mean play. The double whammy misses in the Canadian jobs and PMI data last Friday adds to the case to stay cautious.
On the opposite side of the spectrum to the CAD, we find a suppressed GBP as the process to nominate a new Conservative leader is underway before the summer recess and BoE Carney shifts the semantics towards a potential easing by the CB if the softer economic activity persists.
Interestingly, technicals suggest it’s time to be on high alert as the GBP index tests major macro support. By reading the volume the selloff carried into this major area of liquidity, the prospects of running into exhaustion as volume taper for an ultimate rebound off of it are well and alive.
Another chart I want to bring to the readers’ attention is the current lay of the land in the offshore Chinese Yuan as a barometer of the market’s view on the trade war. Here it’s important to make an important point, now fully confirmed via price action. Even if a vaguely-trusted trade truce is the official juncture the two powerhouses find themselves in, the recovery into a key resistance in USD/CNH, as an inverted US30y bond yield makes higher highs, is a clear indication that the market is not anticipating major headways by either China or the US anytime soon. This is my personal central scenario why I believe, as the market does, that the Fed is, therefore, more concerned about the trade war-induced economic weakness to come as the dispute drags on for months on end.
Any AUD trader should be monitoring the chart above like a hawk, as any clean breakout of the resistance level above in USD/CNH could unleash a fresh wave of selling interest in the AUD as the favorite proxy to play China. Even if I must state that fundamentally speaking, the AUD looks firmer after the national bank’s regulator confirmed the re-establishment of easier mortgage rules, essentially allowing home buyers to higher borrowing capacity as stress tests’ buffer levels decrease. This positive development adds to the fiscal and monetary policy stimulus recently enacted.
Back to China, if the latest comments from Trump serve as an indication of the level of progress made so far after he tweeted “China broke the talks, we will see what happens”, then such narrative is congruent with the resumption of supply imbalances in the USD/CNH market. From the Chinese side, it’s not looking any rosier either, as China’s state media reports that the country won’t buy further US agricultural products until Americans ‘flip-flop’ in trade talks by lifting restrictions on Huawei.
US Economic advisor Larry Kudlow, in a Bloomberg TV interview last Friday, said US-China face-to-face meetings are coming this coming week, which along with Powell’s interventions, is going to keep first algorithm activity and potentially real money next on the lookout to hunt key headlines. As the week progresses, is going to be a big one again as the Fed minutes, BoC meeting, UK growth data, EU and US inflation, central bankers speaking, will keep us busy.
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