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08 Jun 2016
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07 Jun 2016
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06 Jun 2016
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PM Bulletin: A dismal Non-Farm Payroll number
03 Jun 2016
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Week Ahead: Monday 13th – Friday 17th June
 
Economic Outlook
 
  

This week was set to be a real humdinger for the financial markets.  Over the next few days the US Federal Reserve, the Bank of Japan (BOJ), Bank of England (BOE) and Swiss National Bank (SNB) all hold rate setting meetings. In addition, June is an important month when the Fed updates its economic projections. Of course, of all these rate decisions the Fed’s was seen as the most important. Until recently the US central bank was expected to hike interest rates for only the second time since June 2006.

When the Fed raised rates by 25 basis points in December last year, it also released its quarterly Summary of Economic Projections. Back then it threw markets in a tizzy by predicting that its fed funds rate would increase by a further 100 basis points over the course of this year. That implied a 0.25% hike each and every quarter (including one either side of the Presidential Election in November). Investors took fright, dumped equities and the Fed was forced to backpedal sharply from that projection. By March they were down to predicting hikes of 50 basis points before year-end.

But the markets were cheeky enough to call the central bankers’ bluff. The fed funds futures market (where investors put their money where their mouths are) assigned very little probability to any hike this year, let alone this summer. So then we had a plethora of Fed members spring up like startled meerkats to say that the markets had completely underestimated the likelihood of future rate hikes. They insisted that the US economy was looking good and that global risks had subsided. Their comments led to a sharp rally in the dollar and a plunge in precious metals.

But all that changed ten days ago following the release of US Non-Farm Payrolls. Just to recap, the headline number showed a payroll increase of just 38,000 – far below the 160,000 expected. Suddenly all that blather from the Fed was irrelevant. Investors realised that something was wrong and rushed to dump the dollar.

Then at the beginning of last week Fed Chairman Janet Yellen delivered a speech in Philadelphia. This was the last comment from the Fed before its members went into purdah ahead of this week’s meeting. Mrs Yellen called the jobs data disappointing but insisted that overall the labour situation remained quite positive. But there was a subtle change in emphasis concerning the timing of a rate hike. She said that rates probably needed to rise gradually “over time,” whereas the week before she said "in the coming months.”

As far as investors were concerned that pretty much took the probability of a June rate hike down to zero. It also reduced the likelihood of the Fed hiking in July, although it increased the possibility of a September rise. The latter point is worth noting: a rate rise in September would be controversial coming so soon before the US Presidential Election.

So for now it looks as if there’s little prospect of the Fed hiking rates in the face of a deterioration in the economic outlook. Last week’s payroll number could end up being revised higher. However, that doesn’t look particularly likely as we’ve recently seen a number of downward revisions to past releases. In addition, Mrs Yellen’s favourite employment indicator, the Labour Market Conditions Index (LMCI), fell 4.8 last month. Not only was this its largest month-on-month fall since 2009, but it was also its fifth consecutive decline.

Of course there’s always a chance that the Fed will surprise everyone and hike on Wednesday. A move now would suggest confidence in an ongoing recovery (however misguided); holding off suggests doubts. But a rise this week seems very unlikely. After all, it would blow the Fed’s credibility (such as it is) completely. It would also cause market chaos.

I think June and July are both off the cards. I can’t see the US central bank wanting to tighten monetary policy until they see a dramatic improvement in payrolls and the LMCI. They will also want to see Core CPI print over 2% for a few months running. So that could move things out to December, after the election. But that’s not a message the Fed will want to send out. So once this week’s meeting is done and dusted, expect those meerkats to start popping up again. 


This week’s major economic releases include:
  
Monday - AUD Bank Holiday; GBP CB Leading Index

Tuesday - AUD NAB Business Confidence; JPY Revised Industrial Production; CHF PPI; GBP CPI and RPI; EUR Industrial Production; USD Retail Sales, Import Prices, Business Inventories

Wednesday - GBP Claimant Count Change, Unemployment Rate, Average Earnings Index; CAD Manufacturing Sales; USD PPI, Empire State Manufacturing Index, Capacity Utilization Rate, Industrial Production, Crude Oil Inventories, FOMC Statement, FOMC Economic Projections, FOMC Press Conference

Thursday - AUD Employment Change, Unemployment Rate; JPY Monetary Policy Statement, BOJ Press Conference; CHF SNB Monetary Policy Assessment, SNB Press Conference; EUR ECB Economic Bulletin, CPI, Eurogroup Meetings; GBP Monetary Policy Summary, Official Bank Rate; USD CPI, Philly Fed Manufacturing Index, Unemployment Claims, Current Account

Friday - CHF SNB Financial Stability Report; EUR Current Account, ECOFIN Meetings; GBP BOE Quarterly Bulletin; CAD CPI; USD Building Permits, Housing Starts

  
Equities Outlook 
 

Last week the S&P500 came within 0.6% of its all-time high from May last year. On Wednesday the index briefly topped 2,120, just 11 points below the 2,131 close on 21st May 2015. The S&P is the main barometer of the US stock market, and, as far as many people are concerned, the best measure of US economic health.

Just to recap, this current strong appetite for US stocks comes despite another disappointing earnings season. First quarter revenues for the S&P500 were down 2.3% on the same period last year while earnings fell 8.5%. This represents the fourth consecutive quarter of year-on-year declines in earnings (the first time this has happened since 2008/2009) and the fifth successive decline in revenues. On top of this there has been a noticeable drop off in corporate buy-backs this year. As buy-backs have previously been a major factor in lifting stocks, any reduction should remove a significant pillar of support.

No doubt many investors believe that the worst is over for US corporate earnings. But it’s highly unlikely that we’ll see a significant turnaround (in other words, earnings and revenues stop declining) until next year when we get fourth quarter results. Quite simply, this is because the year-on-year comparisons are so tough. This time last year most sectors were doing well (if you exclude energy and industrials), but this year they’re not. Does that matter if investors know all this and have priced in low expectations? Not in the short-term, but ultimately there comes a time when equity valuations become overstretched for too long and have to snap back.

For now US equities are seen as being in a “sweet spot.” This is because Janet Yellen has effectively ruled out a summer rate hike from the Federal Reserve while insisting that the outlook for the US economy is pretty rosy. This is despite the appalling Non-Farm Payroll miss earlier this month. With the Unemployment Rate regularly coming in around 5% or below, the employment numbers have consistently been touted as evidence of US economic recovery. However, the Labour Market Conditions Index (Mrs Yellen’s favourite jobs indicator) has just recorded its fifth consecutive decline and its biggest month-on-month fall since 2009. On top of this government bond yields continue to fall. At the end of last week the yield on 10-year US Treasury hit its lowest level in four months, while the yield on 10-year German bunds was close to zero. While investors are no doubt buying government debt as a safe haven ahead of the UK referendum, they are also increasingly concerned about the global economic outlook. Investors fear a low growth, deflationary environment. The promise of even more monetary stimulus may offer some support, but ultimately that’s not a healthy environment for corporations to operate in. At some stage the diminishing returns of such loose monetary policies become obvious. After all, we’re talking about a global economy which has been on life support for over seven years now and still can’t breathe on its own. That’s not a good environment for equities. 

  

Commodity/ FX Outlook

Oil 

It took Brent seven months and WTI the best part of a year, but last week saw both contracts start to bed in above $50 per barrel. This level has acted as technical support and resistance for both crude contracts, although it is also a significant psychological barrier as well.

But crude prices slipped back at the end of last week. This was probably a mixture of profit-taking along with a general loss of risk appetite. On the demand side there are probably some concerns over the outlook for global growth. Last week the World Bank slashed its 2016 global growth forecast to 2.4% from the 2.9% estimated in January. The institution blamed stubbornly low commodity prices, sluggish demand in advanced economies, weak trade and diminishing capital flows. On top of this, the ongoing slide in government bond yields is also a concern. Investors continue to load up on US Treasuries, Japanese bonds, German bunds and UK Gilts. While this could be a temporary shift in asset allocation ahead of the UK’s referendum on EU membership, it could also signal that investors expect a deflationary/low growth economic environment for years to come. If that’s the case, then crude demand growth would slow.

Yet so far the pull-back in oil prices has been modest. The supply disruption due to the wildfires that swept through the Canadian oil sands is now over. However, the militant action in Nigeria continues. On Friday Niger Delta Avengers blew up an Eni pipeline run by the company's Agip subsidiary. Nigerian output is now at its lowest level in over a year.

   

Gold/silver
 

Gold and silver prices have come storming back in June after being thoroughly battered the month before. In early May gold was pushing above $1,300 per ounce while silver briefly poked its head over the $18 mark. The last time the two metals hit these levels was back in February last year. But then both turned sharply lower. Gold fell 7% over the course of May while silver ended the month down 12%.

The US dollar was the main catalyst for the sell-off in precious metals. The greenback made strong gains last month as members of the Federal Reserve talked up the chances of a summer rate hike. However, the dollar slumped while gold and silver soared in the immediate aftermath of the US Non-Farm Payroll release earlier this month. The dismal jobs number was followed up with a cautiously-worded speech from Janet Yellen last week. Putting the two together, the prospects of a rate hike this week, or even next month, have dimmed sharply. Consequently, the dollar is now in retreat while gold and silver have already made back a significant proportion of last months’ losses. The two precious metals look likely to consolidate or even build on these gains for as long as the greenback remains out of favour.

While members of the Federal Reserve are still desperate to convince investors that a July rate hike is a possibility, they’re battling against the headwind of poor economic data. Any improvement in the numbers is bound to reignite talk of monetary tightening and this will weigh on precious metals.  But we really need to see a vast improvement in the US data over the next month or so for the Fed to tighten in July, and that seems unlikely. The most likely scenario is that the Fed pulls out all the stops to keep investors guessing about each and every meeting between now and the year-end. So, no hike this month, then July is live. If there’s no hike in July then look to September. If the market sees though this then expect the dollar to weaken and precious metals to make further gains. 

       
Forex 
 

The US dollar managed to stabilise last week following its dramatic post-Non-Farm Payroll sell-off. Prior to this the greenback had rallied sharply throughout May as members of the Federal Reserve popped up to convince investors that a summer rate hike was a possibility. However, a disastrous jobs number earlier this month knocked for six any expectation of a rise in June. The dollar sold off accordingly. But after a shaky start, it crept higher at the end of last week. Perhaps traders felt it was oversold, although there was probably some safe-haven buying following the tumble in government bond yields. What’s difficult to know is whether it is currently pricing in any chance of a surprise rate hike ahead of this week’s FOMC meeting.

But the real volatility in currencies was seen in the British pound. Sterling fell sharply for the second successive week as investors priced in the possibility of the UK voting to leave the European Union. This followed the release of a number of polls which showed the “Leave” campaign pulling ahead.

The GBPUSD has been falling since last summer. But the sell-off gathered pace in December as Brexit fears began to get priced in. The sell-off culminated in the GBPUSD breaking below 1.4000 in February. Cable has dropped below 1.4000 on only a few occasions in the last twenty years: June 2001, January 2009, March 2009 and then over the last week of February this year. On each occasion it snapped back relatively quickly. However, that’s not to suggest it will do so if it drops back below there this time round. At the end of last week it was hovering around 1.4330 which has acted as modest support over the last six weeks.

The Japanese yen and Swiss franc both strengthened last week. The USDJPY hit its lowest level since it broke below 106.00 at the beginning of May, while the EURJPY dipped to a three year low. The EURCHF fell back to a two-month low. Both currencies rallied on “safe-haven” demand. That may continue this week if government bond yields fall further, although it’s worth remembering that the Bank of Japan and Swiss National Bank hold meetings this week. 

 
 
Disclaimer:
​    

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Category: Weekly Bulletin


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