By
Marc Chandler
:
The week ahead kicks off what we expect to be a period of
intense event risk. The combination of positioning, judging from
the futures market and anecdotal reports, and the low implied
volatility in currencies and equity markets warn of heightened
risk in the period ahead.
The week begins off slowly with a long holiday weekend in the
US. It is here that continued position adjusting may dominate. Of
the central bank meetings, the Reserve Bank of Australia is first
(September 4) and is the least likely to surprise the market. While
most participants expect that the easing cycle is not over, most
look for a resumption of it later in Q4. That said, a rate cut
would likely push some of the Aussie bulls to the sidelines, even
though Australia will continue to offer among the highest interest
rates of the major industrialized countries.
The Bank of England meetsSeptember 6. An extension of its gilt
buying program was discussed last month and evidence points to
continued deterioration of the economy. Extending the current gilt
purchases, which run through early November, would likely have
little market impact. A rate cut would likely be seen as somewhat
more negative for sterling.
The ECB meeting, also on September 6, is one of the two
critical events of the week
,
the other being the US employment report onSeptember
7.
Let us just sketch our views quickly here, with a fuller analysis
to be provided in the coming days. First, without a deposit rate
cut below zero, a 25 bp cut in the main refi rate will have little
market significance. Second, Draghi has promised to change in the
overall collateral framework, which will likely be in one
direction: making it easier to access the ECB's facility and making
some collateral more effective by reducing the haircuts applied.
Third, it seems unreasonable to expect a discussion of the precise
size and/or conditions (yield or spread targets/shields) of a new
sovereign bond purchase program.
Fourth, there may be some discussion of the ECB's seniority as a
creditor. It is ironic, in some respects, that this is being
discussed now, two weeks after Greece had to jump through fresh
hoops to ensure the repayment in full of a Greek debt the ECB had
purchased (apparently redeemed at face value) and a coupon
(suggesting the ECB just booked profits on some of its Greek
bonds). In any event, participating in the very short-end of the
market, bills for example, might be a way to square the circle for
the ECB. The problem with this, of course, is that it would force
countries to issue more short-term debt.
Fifth, there is also some talk that the ECB may buy Portuguese
bonds to demonstrate its new approach (modalities). While we
advocated this a
few weeks ago
, there are some shortcomings that the new advocates may not fully
appreciate. Portugal is getting international assistance now. It is
not tapping the capital markets to fund its deficit. If the ECB
were to drive down yields in Portugal, this would not help the
Portuguese government as much the current holders of short-term
Portuguese bonds, like local banks. Whether it would trickle down
to lower consumer and business rates is a completely different
story. As we have seen elsewhere, lower interest rates in a
weakening economy with rising unemployment is not sufficient to
rekindle the animal spirits or the demand for capital.
Last but not least, the US jobs data, on which the outcome of
the following week's FOMC meeting appears to rest. We understand
the recent string of US economic data to show that the economy is
improving modestly in Q3. The bar of "significant and sustainable"
that the Fed has cited is a question of judgment.
The Fed places emphasis on the full employment as the other two
(yes, two), price stability and long-term interest rate stability,
have been largely achieved. The monthly non-farm payroll report is
among the most difficult of the high frequency data to forecast. It
is a net figure, as the world's largest economy creates and
destroys hundreds of thousands of jobs a month. It is impacted by
seasonal adjustment and complicated adjustments for the creation
and destruction of small businesses.
On balance, we expect that on a net basis, the private sector
generated around the same number of jobs in August as it did in
July (~172k) and that this, or something reasonably close to this,
will keep the Fed adjusting its future guidance rather than a new
asset purchase program. Such an outcome, we suspect, will be
understood as dollar bullish.
Euro:
Short covering in the week through August 28 saw the net short
cover position fall 22k contracts to 102k, which is the smallest in
about four months. The gross shorts fell 22.4k, but at 147.5k are
almost as large as the other gross short futures positions
combined. The gross longs fell less than 60 contracts to dip below
46k.
While we continue to look for technical evidence that the euro's
corrective advance is over, there is frankly little to hang one's
hat on presently. The single currency continues to hold above the
uptrend line described here last week off the July 24, August 2,
and August 16 lows. It comes in near $1.2465 at the next week
(September 7). On the upside, the $1.2600 has been flirted with
intra-day basis, but has not been maintained on a close basis. If
this is achieved, we see potential to $1.2700 and possibly
$1.2740.
We have understood the price action in recent weeks as a spring
coiling. The short covering in the euro corresponded to lower
volatility. Last week, the three month implied volatility rose
every day last week, but reversed at the end of the week. We note
that the correlation between percentage change in the euro and in
three-month implied volatility is inverse by nearly the most it has
been since the advent of the euro. The inverse correlation is about
-0.63; rarely has it been beyond -0.60.
As the euro rose in recent days, the premium the market was
willing to pay for euro puts over calls, equidistant from the
forward (risk-reversals) actually increased marginally. Even for
participants who are not involved in the options market, important
insight maybe be gleaned.
Yen:
The net long position nearly doubled to 21.6k contracts from 11.2k
in the prior reporting report. This was largely a reflection of 10k
new longs that brought the gross figure to 56.3k. The gross shorts
were by trimmed by less than 400 contracts.
The yen remains uninspiring. With a handful of relatively brief
exception the dollar has been confined to a JPY78 handle. The long
speculative position does not reflect optimism about Japanese
politics or economics, both of which are deteriorating. Rather the
long position seems to be more of low cost insurance policy for
heightened capital market tensions. Although some participants may
see this as n opportunity to play the yen on a cross rate basis,
given the lack of dollar-yen movement, it may not be much different
than a dollar trade against the other currency. Three-month implied
yen volatility is near five year lows. The combination of the
direct price action, low volatility and the absence of much of a
skew in the risk-reversals suggest there is not a compelling case
for intervention, though the rhetoric may increase.
Sterling:
The gross long position fell to almost 2k contracts from 7.8k. This
was a function of a liquidation of longs (3.6k) and small growth in
shorts (2.3k) to stands at 42.4k and 40.4k contracts,
respectively.
Sterling recorded new highs for the week last Friday at about
$1.5896, just shy of the previous week high of $1.5912, which
itself was a three-month high. While a retracement objective of
sterling's dime fall from late April through early June comes in
near $1.5910, the momentum readings and MACD are not yet flashing
the signal (including divergence) that would normally be associated
with an imminent top.
Nevertheless, our fundamental understanding of the UK political
economy is not supportive for sterling. The economy appears to be
stagnating at best or the contraction is becoming chronic at worst.
Despite the government's austerity, government spending is
contributing more to GDP than in the US, where federal spending has
still not offset in full the cut backs by state and local
governments. Talk of a cabinet reshuffle appears to be increasing
and it may result in some measures that may blunt some of the
austerity (infrastructure investment?).
There is still scope for additional efforts from the Bank of
England. More gilt purchases and even a rate cut (where the costs
and benefits should be understood dynamically, depending a number
of other factors, like real borrowing rates in light of the funding
for lending scheme).
Swiss franc:
The franc continue to draw the least speculative attention of all
the currency futures as what was intended to be a cap is acting
like a peg. The new short position was reduced to 11.5k contracts
from 5.7 in the previous reporting week. This is the smallest in
about 2 months. The gross longs nearly doubled to 10.7k contracts.
The gross shorts edged 562 contracts higher to 22.1 contracts.
The only reason at the present it makes sense to look at the
Swiss franc chart is that although its practically pegged to the
euro, the idiosyncratic price action may offer unique insight. This
week, if anything, it confirms as we saw in the euro and that is
simply the absence of the technical kind of evidence that would
encourage us to aggressive express out fundamental euro bearish
views. That said, we would share two observations. First, the
downtrend line for the dollar comes in near CHF0.9625 at the end of
next week. Second, a break of the CHF0.9485 area could spur another
centime move (~CHF0.9375).
Canadian dollar:
The market had shown a clear preference in recent weeks to extend
long speculative positions in the Canadian and Australian dollars
and Mexican peso. In the latest reporting period, the Canadian
dollar was the only one to stay in such favor. The next long
position rose 20% to 60.9k contracts, the largest in three months.
The gross longs tagged on another 10.6k contracts to 86.6k, which
itself is a two year high. The gross shorts inched higher. The new
562 contracts raised the gross short position to 25.7k.
The Canadian dollar had looked to be carving out a high.
We had cited
a potential double bottom for the dollar near CAD0.9843, but with
last Friday's sharp drop, this area is again being challenged, but
would set up a test on the CAD0.9800 support area.
If the event risk that we still envision in the coming weeks
materializes, we continue to warn of the Canadian dollar's
vulnerability. Over the past 30 and 60 days, the Canadian dollar is
has the highest correlation with the US S&P 500 (on a percent
change basis). at 0.77 and 0.84 respectively.
Australian dollar:
We noted last week
the divergence between the new longs still be established and the
lack of satisfactory price action. That was resolved in the recent
reporting week by the a lower Australian dollar and a reduction of
gross longs and a increase in gross shorts. The net long position
fell by about 10% to 78.1k contract, which is the smallest in more
than two months. The gross longs were pared by 3.4k contracts to
stand at 124.1k. This is the largest gross long of all the currency
futures. The gross shorts rose 5.4k contracts and at a little more
than 46k contracts, the gross short is the second largest behind
the euro.
The Australian dollar traded heavily against the dollar last
week and extended the losses since the early August high above
$1.06. These latest losses stopped shy of the 38.2% retracement of
rally off the early June low just below $0.96.
We detect a shift in sentiment toward the Australian dollar.
Increased press reports of a potential end o of a secular advance
in commodity prices, and a more immediately, the decline in iron
ore and steel prices are hitting a market with extended long
positions in the Australian dollar. Some of the Aussie bulls may
have been encouraged by talk of some central banks, including the
Germany Bundesbank and the Swiss National Bank, embracing it as a
reserve asset.
News on September 1 that the official Chinese manufacturing PMI
fell below 50 (49.2 from 50.1) for the first time in nine months
will not do the Aussie any favors, nor has the Australian dollar
consistently benefited when China provides additional monetary
support.
Mexican peso:
The net long position slipped 3.4k contracts to stand at 94.6k,
which means the largest net long position in the currency futures
universe. The gross longs fell 2.9k contracts to 104.2k, second
behind the Australian dollar. The gross shorts increased by about
450 contacts to 9.6k, which is easily the smallest in the futures
markets.
The Mexican peso sold off in first two sessions following the
end of the CFTC reporting period. The dollar rose to MXN13.44 on
August 30 only to recover in full before the weekend to almost
MXN13.18. A strong bid for pesos appears to continue to be coming
from international fixed income managers. Foreign investors are
purchasing a record amount of peso-denominated government bonds
this year. Mexico pays about 175 bp more than the US on 10-year
borrowing. Mexico's dollar-denominated world bond yields about 108
bp more than the US-10-year Treasury. The central bank meets next
week and there is little doubt that the rates that the key
overnight rate will be left unchanged at 4.5%.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
See also
Will The Ever-Elusive Crash Ever Materialize?
on seekingalpha.com