Incisive market commentary from David Morrison

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AM Bulletin: Markets rise for the second day ; back to pre-referendum levels, sterling still weak
30 Jun 2016
AM Bulletin: Confidence returns – but for how long?
29 Jun 2016
AM Bulletin: The onslaught continues – and we’re not just talking the football
28 Jun 2016
Weekly Bulletin: Investors rattled by Brexit vote
27 Jun 2016
PM Bulletin: Brexit - Referendum fallout
24 Jun 2016
AM Bulletin: We’re out! And so is Cameron
24 Jun 2016
Video Update: #AskSpreadCo - EU referendum
23 Jun 2016
AM Bulletin: Markets on tenterhooks ahead of UK vote
23 Jun 2016
Spread Betting Tips
22 Jun 2016
AM Bulletin: Risk assets waft higher
22 Jun 2016
PM Bulletin:Referendum and Market Reaction
21 Jun 2016
PM Bulletin: Gold and the referendum
21 Jun 2016
AM Bulletin: Yellen testimony in focus
21 Jun 2016
PM Bulletin: Janet Yellen’s testimony
20 Jun 2016
Weekly Bulletin: It’s all about the referendum
20 Jun 2016
Market Info Update: EU Referendum Margin Changes - CFDs
17 Jun 2016
Market Info Update: EU Referendum Margin Changes - Spread Betting
17 Jun 2016
PM Bulletin: Forecasting the referendum result
17 Jun 2016
AM Bulletin: Central banks leave rates unchanged
17 Jun 2016
PM Bulletin: FOMC post-mortem
16 Jun 2016
AM Bulletin: Yen, precious metals soar post FOMC/BOJ
16 Jun 2016
PM Bulletin: FOMC look-ahead
15 Jun 2016
AM Bulletin: FOMC meeting ahead
15 Jun 2016
PM Bulletin: European equities slide
14 Jun 2016
AM Bulletin: Stocks down on oil, growth fears and UK referendum
14 Jun 2016
Weekly Bulletin: FOMC and BOJ meetings in focus
13 Jun 2016
PM Bulletin: Markets rattled by slide in bond yields
10 Jun 2016
AM Bulletin: European stock indices drift lower
10 Jun 2016
PM Bulletin: WTI at $50 – thoughts on US production
09 Jun 2016
AM Bulletin: Precious metals soar
09 Jun 2016
PM Bulletin: S&P closes in on all-time high
08 Jun 2016
AM Bulletin: Investors in limbo ahead of Fed and UK vote
08 Jun 2016
PM Bulletin: Yellen and the jobs data
07 Jun 2016
PM Bulletin: Fresh polls send sterling lower
06 Jun 2016
Weekly Bulletin: Rate hike? What rate hike?
06 Jun 2016
PM Bulletin: A dismal Non-Farm Payroll number
03 Jun 2016
AM Bulletin: Non-Farm Payroll Friday
03 Jun 2016
PM Bulletin: Non-Farm Payrolls look-ahead
02 Jun 2016
AM Bulletin: OPEC, ECB, key data releases and central bank speakers
02 Jun 2016
PM Bulletin: OPEC and the oil price
01 Jun 2016
AM Bulletin: Manufacturing PMIs in focus
01 Jun 2016
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Week Ahead: Monday 6th – Friday 10th June
Economic Outlook

Last week was a big one in terms of economic events and data releases. We had a stack of manufacturing and services PMIs, an important press conference from Japanese Prime Minister Shinzo Abe, OPEC and ECB meetings, which were rounded off with Friday’s US Non-Farm Payrolls. All of this played into the outlook for monetary policy for the US and elsewhere. 
This time last month the markets weren’t predicting a summer rate hike from the Fed. We had just had a raft of poor US data releases including a weak first quarter GDP reading, a Manufacturing PMI which had dipped dangerously close back towards contractionary territory and a shocking Non-Farm Payroll number which undershot the consensus expectation by more than 40,000 jobs. Yet even back then a number of Fed members were anxious to keep the prospect of a June hike on the cards. Since then we’ve had the minutes of the FOMC’s April meeting together with a host of hawkish statements from Fed members, including Janet Yellen. Just over a week ago the Fed Chairman said that gradual and cautious rate increases could be “appropriate” in the coming months. Not only that, but some of the latest US data releases have shown improvement. First quarter GDP was revised up; the latest Manufacturing PMI came in higher than expected (although the Chicago PMI and Dallas Fed Manufacturing survey were both weak) and April Retail Sales showed their biggest jump in a year suggesting that consumers are spending again. But Friday’s Non-Farm Payrolls capped off everything coming in at a dismal 38,000. 
The payroll number was much worse than anyone predicted. The consensus expectation was for an increase of 160,000. The number was so bad that even with the Unemployment Rate dropping to 4.7% it now looks very unlikely that the Fed can justify a rate hike this month.  
Added to that, at the end of last week FOMC-voting member Charles Evans said that there was a “reasonable case” for deferring a rate hike until core inflation (excluding food and energy) hit the Fed’s 2% target rate. The Fed’s current forecast is that this won’t happen until 2018. Yet Mr Evans hedged himself beautifully saying he still favours two hikes in 2016. Core inflation is expected to be around 1.6% at year-end.
However, the FOMC doesn’t operate like the Bank of England’s MPC where the decision to raise (or lower) rates is taken by a majority vote. The FOMC is dominated by three people: Fed Chairman Janet Yellen, Vice-Chairman Stanley Fischer and FOMC Chairman Bill Dudley. What these three say really matters. Consequently, Janet Yellen’s speech tonight (Monday 6th June) is seen as being a “big deal.” Some analysts still believe that she may take this opportunity to prepare the markets for a move next week. The argument goes that by delaying now the central bank would send out the wrong message about the resilience of the US economy. A rate hike would express confidence in an ongoing recovery while backing off would suggest doubts. Not only that, but the central bank is understood to be anxious to move rates further away from the zero-bound to give themselves room for manoeuvre should a cut be needed in the future. Additionally, it is argued that any change to monetary policy becomes problematic as we get closer to the November Presidential Election – that effectively rules out a move in September. 
This all sounds very plausible. However, Friday’s appalling jobs numbers and the UK referendum on EU membership on 23rd June are a pair of fat bluebottles in the ointment. The Non-Farm Payroll disaster suggests that something serious has been missed in assessing the US employment situation. Additionally, whatever may happen over the medium and longer-term, the immediate effect of a UK vote to leave the EU would be uncertainty and a sharp rise in volatility. For this reason if Mrs Yellen still decides to leave the door open to a summer rate hike, the actual decision will almost certainly be delayed until July. It’s worth noting that her semi-annual Humphrey Hawkins testimony has been scheduled for 21st/22nd June – just before the referendum. This is surprising as the summer report is usually held a month later. I don’t know what we can infer from this, but it could be that Brexit fears, along with payrolls, will be excuses for the Fed to delay tightening monetary policy. 

This week’s major economic releases include:
Monday - EUR German Factory Orders, Retail PMI, Sentix Investor confidence; USD Labour Market Conditions, Fed Chair Yellen Speaks  

Tuesday - AUD RBA Rate Statement; EUR German Industrial Production, Revised GDP; USD Revised Nonfarm Productivity, IBD/TIPP Economic Optimism, Consumer Credit

Wednesday - JPY Current Account, Final GDP, Bank Lending, Final GDP Price Index; CNY Trade Balance; GBP Manufacturing Production, Industrial Production; CAD Housing Starts, Building Permits; USD JOLTS Job Openings, Crude Oil Inventories; NZD RBNZ Rate Statement

Thursday - NZD RBNZ Gov Wheeler Speaks; CNY CPI, PPI; EUR ECB President Draghi Speaks; GBP Goods Trade Balance; USD Unemployment Claims, Wholesale Inventories

Friday - JPY PPI; CNY Bank Holiday; EUR German Final CPI, WPI, German Buba President Weidmann Speaks, French Industrial Production, Italian Industrial Production; GBP Construction Output, Consumer Inflation Expectations; CAD Unemployment Rate; USD Consumer Sentiment, Inflation Expectations, Federal Budget Balance.

Equities Outlook 

While the major European stock indices are lagging somewhat (as is the tech-heavy Nasdaq100), the two major US benchmarks (the Dow and the S&P500) are back within a few percentage points of their all-time highs. The Dow Jones Industrial Average is trading less than 3% below the highs hit this time last year while the broader-based S&P500 only 1.5% below its own all-time high from May 2015.
These lofty levels have been achieved despite a couple of nasty sell-offs – one last summer and the second at the beginning of this year. In both cases, China was root cause of the equity market tumbles, although January’s decline was also catalysed by the Fed’s 25 basis-point rate hike the month before. Yet US equities surged back up on both occasions with the recovery in the two months from the mid-February lows being one of the sharpest in recent years. 
This renewed appetite for US stocks has come despite another disappointing corporate earnings season. For the S&P500, first quarter revenues 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. 
Nevertheless, US equities continue to be in favour with investors. No doubt many are convinced that revenues and earnings should begin to pick up now, particularly in banking and finance which (along with the energy and materials) is a sector that has been particularly badly hit. However, there are signs that the worst is not yet over. Last week a report from data analytics outfit Tricumen suggested that investment banks should brace themselves for further significant revenue declines of up to 40% in the second quarter. The problems stem from trading with revenues from fixed income, currency and commodity (FICC) taking a hit. FICC has historically been a big profit centre for investment banks.
The report suggests that trading conditions for all banks across all asset classes will remain tough although US banks are expected to fare better than their European counterparts. Deutsche Bank is expected to be the biggest underperformer, with overall revenues from market trading seen falling 35% in the second quarter compared to the same period last year. Along with other European investment banks Deutsche has been hit by new regulations forcing them to hold more capital, reduce risk-taking and scale back market-making activities. 

Data from industry analytics firm Coalition showed that revenue at the world's 12 largest investment banks fell 25% in the first quarter from a year ago as economic uncertainty and investor caution led to the slowest start since the financial crisis. 


Commodity/ FX Outlook

Last week crude oil repeatedly attempted to get a toe-hold above $50 only to be knocked back on every occasion. It didn’t matter if it was US inventory data, the US dollar, misleading headlines coming out of OPEC or US payroll numbers. Whatever happened crude just couldn’t get a grip on the psychologically-significant $50 per barrel level. 
There were a fair number of big oil-related stories last week but these were overshadowed to an extent by Friday’s shocking payroll data. May’s number came in at a paltry 38,000 against an expected reading of 160,000. The news led to a slump in the US dollar and a corresponding sharp rally in dollar-denominated commodities such as gold and silver. However, crude fell back on the news. The prime reason for this is that the poor jobs number suggests that the US economic recovery (such as it is) may be even weaker than previously considered. This is been taken as a sign that we may see a slackening off of future crude demand growth. As far as the markets are concerned, it appears to have kicked the prospect of a summer rate hike from the Fed into the long grass. 
In other news, Thursday’s OPEC meeting in Vienna was, as expected, a non-event. There had been an attempt by some OPEC members to boost interest in the meeting by suggesting that a fresh plan to freeze production may be agreed. However, the cartel later confirmed that it would not be changing its output policy and was not planning to reintroduce a production ceiling. But the resulting sell-off was limited as members of the cartel (including Saudi Arabia) said that they would not be flooding the market with extra crude. This may well be the case, but it seems more likely that OPEC and non-OPEC producers will want to take advantage of this year’s price rally to knock out as many barrels as possible while crude it at eight month highs. At the same time they won’t want to telegraph their intentions as this would drive prices lower. 


The common thread across all sections of this weekly commentary is the market reaction to Friday’s Non-Farm Payroll release. The number overshadowed every other bit of market-related news as it caused yet another sharp re-evaluation of the outlook for US interest rates. 
Gold and silver have had a torrid time of late. After surging to multi-month highs and being among the best performing assets over the first four months of the year, both got a kicking in May. The chief reason for this was the turnaround in the dollar’s fortunes. The greenback had been trending lower from early December, giving back some of its gains made since the summer of 2014. However, it began to rally in early May as the market began to price in the likelihood of a summer rate hike from the US Federal Reserve.
Back then it became apparent that the Fed was unhappy that the market was refusing to price in the prospect of a summer rate hike. The Fed wanted to keep alive the possibility of imminent monetary tightening. No doubt it didn’t like the idea of the market demonstrating that the Fed was out of options.  Consequently, numerous Fed members popped up over the last three weeks to declare that their conditions for monetary tightening were being met. Some were claiming that two, three or even four rate hikes were possible in 2016.This constant barrage of hawkishness pressed the markets to sharply cut the odds on a summer rate hike. This led to a rally in the dollar together with a nasty and protracted sell-off in precious metals. Much of that has now been reversed thanks to last week’s payroll release.


There’s no getting away from Friday’s Non-Farm Payroll (NFP) release as it appears to have blown the Fed’s entire summer rate hike prospects out of the water. 
The headline number showed an increase of just 38,000 jobs. This compares to the consensus expectation of 160,000 jobs being added in May. The miss was extraordinary – not only because it was totally unexpected, but also as this is the worst NFP reading since September 2010. Even the most bullish of commentators were wary of writing it off as a rogue release. Sure, it may get revised up in future. But April’s dismal number was a prime candidate for an upward revision. Unfortunately the revision went the other way. In fact, that has been the recent trend suggesting that there’s something rotten in the US jobs market. Even the news of a sharp drop in the Unemployment Rate to 4.7% from 5.0% last month is really a negative. This shows (when taken alongside the Participation Rate) that people are so discouraged from finding suitable work that they are dropping out of the jobs market. If they’re not actively looking for work then they aren’t counted as unemployed. 
The initial reaction was a plunge in the US dollar. This was most keenly noticed against the euro and the Japanese yen. Of course, it’s often the case that the market acts in a knee-jerk fashion to an unexpected data release only to reverse its initial move later in the session. That wasn’t evident on Friday. The problem was that the constant barrage of hawkish comments from Fed members over the last three weeks led to investors piling back into long-dollar positions. This is totally understandable as a number of Fed members explicitly commented that the market had got it wrong and had mispriced the odds of a summer rate hike. As things stand now, the market has gone back to pricing in zero chance of a June hike, and has slashed the probability of one in July. Unfortunately, Chairman Yellen is speaking on Monday evening (6th June) so there’s an opportunity for further market volatility.
Friday’s dollar move has done some real damage to the currency charts and we’ll just have to watch this week to see how this unravels. But two things are for sure: the Chinese will be cheering on the sell-off in the dollar as it helps keep the yuan competitive. But Japan will be in all kinds of trouble over the stronger yen. If the dollar continues to sell off then we can expect more talk of Japanese currency intervention – no matter what was agreed at G20. 

David: The Non-Farm Payroll disaster suggests that something serious has been missed in assessing the US employment situation.

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Posted by David Morrison

Category: Weekly Bulletin

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