Lessons For The Coming Week: Focus On Policy – Risks And Opportunities
by Cliff Wachtel, TheSensibleGuideToForex.com
Continued uninspiring global growth data is keeping markets focused on government policy moves as the main source of salvation. Data mattered, but mostly only to the extent that it hinted at new central bank or other government policy.
We see some opportunities developing in the USD and a few other asset types, as discussed below.
Speculation On Official Economic Policy Overriding Data
Virtually all globally traded asset markets continued to move with speculation about official policy. Fed tapering, its likelihood, timing, and extent, remains the biggest market focus, as shown by the halt or reversal of most trends, be they in stock indexes, currencies, interest rates, etc., ever since rumors of QE tapering began leaking out in early May. The increase in volatility on May 22nd, when Bernanke and the FOMC meeting minutes confirmed this rumor, confirmed the primacy of sentiment on QE tapering for the week ahead and beyond.
News that reduces tapering fears is bullish, while anything that increases that anxiety sends markets lower. That’s the dominant market driver right now.
[Here are a few examples...]
Fed Official’s Pro-Tapering Comments Smack Markets Wednesday
For example, European and US stock indexes closed sharply lower (mostly down 1% to 2% range) after Fed official Esther George said on Wednesday she supported slowing the pace of bond purchases to help wean financial markets off the Fed’s massive liquidity.
Bad News Becomes Good News For US Because It Reduces Chances of QE Taper
We continue to see examples of poor US economic data boosting risk appetite because it reduces tapering fears. For example, on Monday US stocks moved decisively higher as markets concluded that disappointing manufacturing data suggested that the Fed would defer and curtail its QE tapering plans. On Tuesday the Nikkei bounced 2.05% on the same news and conclusions.
US Jobs Report: “Just Right”
Market reaction to the monthly official US jobs reports was the climactic example of how QE tapering speculation is the prime market driver. It was a mix of contradictory indicators, but the overall theme of the data was that US employment continues to improve, but at too slow a pace to suggest the recovery is anywhere near self-sustaining. For example:
- Job creation was 175k for May, beating the 163k expected, but downward revisions to prior months meant a net loss of 12k jobs. The US is adding more jobs than the roughly 150k believed needed to keep up with new entrants to the workforce, but is still far from consistently adding the over 200k plus new jobs needed to suggest a sustainable recovery that meaningfully reduces unemployment and increases wages.
- Unemployment rose for 7.5% to 7.6% and wage growth stagnated, but the U-6 unemployment rate, the number economists follow more closely than the official rate, actually fell in May.
In sum, it provided enough good news to show the US continues a slow recovery, and enough bad news to calm fears of imminent QE tapering.
Official policy moves in Europe and Japan also proved market moving last week. For example:
- On Wednesday Japan’s Nikkei share average sagged 3.8% to a two-month low after a speech by Prime Minister Shinzo Abe on his growth strategy to revive the world’s third-largest economy failed to enthuse investors.
- On Thursday the ECB’s monthly rate statement and press conference sent European indexes lower after it said the economic outlook remained weak and it failed to satisfy hopes for new stimulus policies.
Given the lighter economic calendar this week, official actions should continue to weigh particularly heavy on markets.
GLOBAL SLOWDOWN CONTINUES
The focus on government help for markets is logical given that there is little in the actual economic data to justify asset global stock markets at their current 5-10 year highs. For example:
Continued Evidence of China Slowdown
Continued weak Chinese manufacturing and services PMIs pressured Asian markets Monday and Wednesday, adding to fears of Chinese economic weakness. On Saturday Bloomberg reported that China’s export growth plunged to a 10-month low in May and imports unexpectedly fell as a crackdown on fake trade invoices exposed weakness in global demand.
Europe Remains In Recession
On Monday we saw that Eurozone PMI improved markedly but recession still on. Eurozone manufacturing PMI rose to a 15-month high of 48.3 in May from 46.7 in April, still well below the 50+ readings that indicate expansion, and price deflationary pressures remained. Extending the euro-zone’s recession into a seventh quarter, the overall euro-zone data, according to Markit,
“still suggest that GDP is likely to have fallen 0.2%” in Q2.
The IMF cuts its 2013 GDP growth forecast for Germany to 0.3% from 0.6%, mostly due to overall EU weakness.
As we noted in our 2013 forecast back in January, QE is the pillar holding up stocks and other risk assets. When markets fear that pillar could be weakened, we get a selloff. This past Friday’s jobs data and market reaction to it suggests that the taper fear has receded, and that the pullback has stabilized. Long term upward momentum remains intact for long term traders and investors.
Risks And Opportunities
The past weeks’ have shown what assets are particularly sensitive to the ongoing QE tapering speculation. A few I’ve been watching include:
Dividend Stocks: Stocks bought primarily for their income stream have been hit hard on the assumption that rising rates will both hurt demand and, for those that depend on cheap credit like REITs, MLPs, bottom line performance. Many in this group are down 10% or more. There remains little evidence to suggest that there will be a material increase in rates, so we view the current dip as a buying opportunity. Sure, underlying economic fundamentals remain poor relative to stock prices, so markets remain vulnerable to normal correction. However that’s been the case for all of 2013. If you believe rates will remain low and markets will continue to move with QE speculation, the pullback in this area could represent a buying opportunity once it stabilizes.
The USD: While the long term trend remains intact as long as the Fed continues to look relatively hawkish compared to its counterparts in Japan, Europe, the UK, Australia, and elsewhere, it’s come down in the past weeks. Reasons for the pullback include:
- Technical positioning: The long USD trade has gotten crowded and thus vulnerable to corrections.
- QE tapering related speculation: QE increases the supply of dollars and thus weakens it. The USD index had been rallying since early May, when the tapering hints started to flow, and peaked around May 22nd. Part of the reason was a short term “sell the news” reaction, so was USDJPY selling as that long USDJPY trade was overextended.
- ECB Hold Steady: The ECB’s reluctance to add new stimulus Thursday strengthened the EUR, and that weakens its chief trading counterpart, the USD.
It’s unclear how much room the USD decline has yet to run. If in fact the Fed tightening expectations are overdone, then the pair EURUSD could move back up to its January 1.37 area highs. You can play that directly or via ETF like the UUP, UDN, FXE, etc.
See our EURUSD weekly Outlook for further details.
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