Equities having a new February like drop
Although I have offered zero warnings about equities drop, I count 5 out of 5 correct forecasts, at my last week’s report. (1) Keeping short EURJPY positions, (2) entering short USDCAD at 1.3014, (3)being long AUDUSD, (4)exiting the short USD trades as the currency was expected to have a corrective move, (5)entering short EURUSD at 1.1597 and (5+1) noting that no further rising of sovereign debt yields was expected. All of the above played well.
Major last week’s events:
- USA-China: On Tuesday, it became official. Mike Pompeo, US secretary of state, described the context of trade tensions with China. It is a move against China’s quest for Global domination (not a matter of trade deficit that needs to be shrunk). On the other hand, USA did not name China as being a currency manipulator.
- Equities sell off: On Wednesday,US equities fell bellow the February’s peak level and went all the way down to the 200 Day Moving Average (-3.7% move in one day). Thursday’s reaction happened at the same time as USDCNY retraced from 6.94 to 6.86 (now the pair trades back at 6.90). Market fear was not wide, as there was not significant inflows to safe-haven assets.
- IMF: Estimates for GDP growth were revised downwards. -0.2% revision for USA and China 2018 growth, -1.0% revision for USA, -1.6% for China and -1.0% for the World in 2019
- Turkey: The Pastor was released. One could have felt the changing mode of US-Turkey relations since Monday (and short USDTRY) when USA turned the heat on Saudis, following the murder accusation of Turkish. Saudis are accused of murdering a Saudi journalist at their embassy in Turkey.
- Japan-Australia:The foreign and defense ministers are edging closer to a military alliance in the Indo-Pacific
- Cryptos: Total market cap at $201bn, -8.6% w/w, -75% from January’s $821bn peak, +8% from the $186bn September’s low.
Major next week’s events:
Monday is the deadline for the Italian Budget to be submitted to EU.
Thursday’s EU summit. There is a possibility of a Brexit deal happening.
Weekend’s Australian by-elections for the seat of the former Prime Minister
I would close my short EURJPY positions at Sunday’s opening, taking advantage of the expected weak week’s start of EUR, following the Bavarian Elections.
Snapshot unchanged – Arguments unchanged:
- Core CPI (=BOJ’s compass) at 0.9% (vs 2.0% target and BOJ’s members’ expectation of 1.2~1.3% within 2018), BOJ rate at -0.1%
- GDP at 1.00% annual, 0.7% q/q, 10Y Government bonds yield at 0.15% (-1bps w/w) vs BOJ’s target of 0.00±0.20% level
- Unemployment at 2.4%
Strengths of JPY:
- Abe’s win at the Liberal Party elections provides stability.
- QQE will stay, up until core CPI reads 2.0% in a stable manner. The scheduled VAT hike in Oct’19, rules out any possible monetary policy change, before 2020.
improving macro readings: GDP reading, inflation, unemployment, bank lending, retail sales, housing spending, housing market, capital spending and sentiment readings
Weaknesses of JPY:
I do not expect a continuation of the recent equity sell-off, that could further boost JPY
deteriorating macro readings: Manufacturing PMI,Services PMI, monetary base, M2, trade balance (new reading is expected) and current account
Tuesday’s Trade balance and Friday’s national core CPI.
Next Monetary Meeting on 31 October
I am re- entering short USD/CAD at 1.3088 and 1.3154 targeting 1.2690
- Inflation at 2.8% (vs 2.5% target, BOC expects 2.0% within 1Q19), BOC rate at 1.50% (4 hikes so far, neutral rate according to BOC within 2.5%~3.5% range).
- GDP at 1.9% (vs. BOC expectations of 2.0% in 2018 and long term potential of 1.8%), GDP m/m increased to 0.2%, 10Y Government bonds yield at 2.50(-9bps w/w).
- Unemployment at 5.9%
Strengths of CAD:
- next monetary meeting on the 24th of October may include a rate hike
- at the latest OPEC+ meeting, no oil production increase agreed.Apart from the lower supply due to Iran sanctions, I am expecting a demand shock when marine-time industry would start asking for refined oil to be used at all ships traveling in European ports.
- improving macro readings: GDP, foreign securities purchases(new reading expected this week)
Weakness of CAD:
- OPEC’s October report included a decrease of world’s demand growth, coupled with increasing supply and increasing inventory levels. The OECD inventory increase(14Mb increase of inventory over a month) is very small but enough to halt the increasing oil price scenario. Some inventory building up, is also found at the US numbers that are released every Wednesday.
- Demand shock driven by marine-time industry may happen on 2020 or even later
- deteriorating macro readings: unemployment, housing market, wholesale sales, and retail sales
Tuesday’s Foreign securities purchases, Friday’s inflation readings
Next Monetary Meeting on 24 October
I keep my long AUDUSD position and could re-enter at 0.7095. I could also go long AUDCAD at 0.9193 and 0.9178
- Inflation at 2.1% (expected at 1.75% later in 2018 and then higher in 2019), RBA ‘s rate at 1.50% (no hike so far)
- GDP at 3.4% (RBA expects more than 3.0% within 2018 and 2019), 10y Bond yields at 2.74% (+3bps w/w)
- Unemployment at 5.3% (expected to reach 5.0% by 2020)
- AUD demonstrated a persuasive behavior during the latest equity sell off. Wednesday’s risk off environment only resulted in a brief retest of the week’s lows AUDUSD. The pair is already trading 70pips higher than that and is heading north.
- Weekend’s by-election for the former PM’s seat: It seems almost inconceivable the liberal party could lose it. They are 17% ahead at the polls and are running their best funded campaign.
I expect Australian Household consumption to increase
China reported increasing (+13.6% m/m/) trade balance and services PMI
- improving macro readings: GDP, employment change, household consumption recovered in 3Q18, retail sales, trade balance, consumer sentiment
- market participants expect the RBA’s rate to remain unchanged and not follow the rate hike schedule of other Central Banks
- deteriorating macro readings: current account,company operating profits, decreasing capital expenditure, building approvals, home sales and home loans
Monday’s Chinese M2 supply and New Loans. Increasing numbers are also helping Australian economy and AUD.
Thursday’s Unemployment reading and Business Confidence
Next Monetary Policy meeting on November 5
I am expecting a continuation of the USD slide.
- Core PCE (=FED’s inflation compass) at 2.0%, CPI at 2.7%, FED ‘s rate increased to 2.25% (IOER) and expected to reach 3.1% within the cycle. FED’s view of long run rate at 2.9%
- GDP at 2.9%y/y, 4.2% q/q, 10y Bond yields at 3.17% (-3 bps w/w)
- Unemployment at 3.7%
Points to be considered
- Equities: Starting from last Friday (04 Oct), they fell significantly. The 04 October’s headlines included the Chinese spy-chip story on Bloomberg (that was argued as wrong claims by Apple) and the hard wording of Mike Pence on the South China Sea incident between the Chinese and US war ships. Equities fell to the February’s peak on the Tuesday’s close and dropped another 3.7% on Wednesday, reaching the 200 Day Moving Average on the Wednesday’s close.
The sell-off was not accompanied by significant inflows to safe-havens. On top, as shown in the chart from JP Morgan, when yields are bellow 5%, rising rates have historically been associated with rising stock prices. I do not expect a continued downtrend.
- inflation is not worrying. Latest releases showed decreasing numbers, labor cost data decreased & Trump canceled a 2.1% wage raise for federal employees. Yet inflation expectations are +0.1% higher than a month ago.
- wholesale inventories increased further. If retail sales (new reading in expected on Monday) fail to increase, US equities will be, once again, in danger.
- three new narratives capable of boosting US markets for another semester are in the making (a) indexing inflation so that long term capital gains are taxed lower (b) publishing earnings every 6 months instead of every 3 months can bring creative accounting. (c) 3Q earnings are once again expected higher than 20%. The week includes the earnings call of Bank of America (Monday), Goldman Sachs, Morgan Stanley & Netflix (Tuesday) Alcoa (Wednesday)
GDP, Manufacturing PMI, Non-manufacturing PMI, durable goods orders are all recording big numbers.
- risk-on news like a EU-UK negotiations concluding, consensus with China, may simultaneously hit the headlines sending USD lower. I believe that the worse outcome of both topics is already priced.
- Monday’s Retail Sales and Business Inventories
Tuesday’s Treasury currency report and Wednesday’s Minutes of latest FOMC meeting
Next Monetary meeting on November 8, following the Midterm Elections.
Bavarian elections could result in a Sunday’s gap. I would take my profits from past short trades and enter long, targeting to the close of the gap.
- Annual CPI at 2.1%, core CPI (=ECB’s compass) at 0.9%, ECB ‘s rate at 0.00%
- GDP at 2.1% growth (OPEC reduced expectations to 2.0%), 10y Bond yields of EFSF at -0.45% (-13bps w/w), 10y German Bond yields at 0.49% (-7bps w/w), 10y Italian Bond yield at 3.60% (+19bps w/w, +76bps in 3 weeks), 10y Greek Bonds yields at 4.40% (-11bps w/w)
- Unemployment at 8.1%
Strengths of EUR/USD:
Last week I was arguing that markets are overpricing the Italian political risk and I was expecting Italian yields, and consequently European yields, to decrease. I was wrong with Italy. Markets punish Italy for the wording used by the Italian goverment, but at the same time are willing to accept lower yields for the rest of European bonds, sending EUR higher.
EUR was unexpectedly strong during last week’s equity sell-off.
excluding Italy, fiscal policies will not be as neutral as previously expected.
- improving macro readings: wage growth, decreasing unemployment, private loans,German factory orders, industrial production
Weaknesses of EURUSD:
Italian bond yields are increasing. Italian budget will be sent to EU on Monday. On October 26, S&P credit agency will rate Italian debt and there is a chance of a downgrade
the different stages of monetary policy between EU and US, can only be simulated with another dip of EUR/USD in mid December. (the expected dip on late September has already happened, as I had noted at previous reports)
- deteriorating macro readings: current account, M3, retail sales, investor confidence
Tuesday’s Trade Balance & Economic Sentiment, Wednesday’s Inflation readings,Friday’s Current Account
Thursday’s EU summit when there is always a small possibility of a Brexit deal
Next Monetary Meeting on 25 October.
I would avoid offering a view on GBP as we are approaching the 17th of October EU summit and the possible Novembers extra summit.
On Wednesday, Michel Barnier (Brexit negotiator from EU) commented on 80-85% of Brexit treaty agreed and on Friday, Prime Minister May, was reported telling to her cabinet that a deal is on the making. A temporal remain in EU’s custom regime is within the range of outcomes.
Snapshot deteriorated – Arguments unchanged:
- Inflation at 2.7% (vs 2.0% target), BOE ‘s rate at 0.75%
- GDP at 1.2% growth (vs 1.75% BOE’s expectations and 1.3% decreased OPEC’s expectations), 10y Bond yields at 1.62% (-7bps w/w)
- Unemployment at 4.0%
positive macro releases: Services PMI and Manufacturing PMI, consumer’s inflation expectations increased
- inflation is peaking up again while BOE has only signaled 3 hikes for the next 3 years. It will be a very hard task to fight inflation and GBP weakening at the same time
- a no deal with EU is possible. In this case UK would be able to be competitive to EU regulatory wise, but would loose tax revenues from the decrease of financial activity in the City.
- the no deal scenario has already been characterized as bad outcome by Mark Corney (Governor of BOE) and has been quantified to be equal to a £80bn in public finance by Philip Hammond (Head of Treasury)
Negative macro releases:GDP m/m, Manufacturing production, construction output, consumer’s confidence, current account, average earnings, industrial order expectations,
UK politics and negotiation process. On Thursday there is an EU summit. Either we will be announced the terms of the Brexit deal, or we will learn that an extra November summit is scheduled, or we will head to UK leaving EU with no deal.
Tuesday’s average earnings and unemployment reading and Wednesday’s Inflation readings
- Next Monetary Meeting on 1st of November.
Issued by Labis Michalopoulos, CFA
To help speed reading green is used for numbers that have a risk on effect, red is used for numbrtd with risk off effect, blue is used for new arguments, forecasts are underlined and found at the beginning of each page.
Readers checking the returns at www.forexfactory.com/dxmix will notice a leveraged trade on AUDUSD opened on 24 August that ruined the hard earned statistics of 0.5 montly Sharpe Ratio, for over 45 months. I mistakenly ordered to open a position 10 times bigger than I am used to, and my reaction to the mistake was a series of new wrong actions.
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