Monday, September 27, 2010

Headwinds of Change

Unpredictable Market Forces at Work

After a positive week for U.S. equities, market action lacks directional impetus. What will drive equity markets higher? It is clear to us window dressing season is in full effect. Many fund managers and Institutional Investors continue to pile into crowded, growth-oriented, and alpha-seeking equity trades. In addition, many prominent investment bankers sitting in the position of 'Head of Global Equities', at their respective shops, continue to preach 1300 on the SPX by year end. Is this feasible? Sure, but it is not likely.

Much of the current rally in the SPX from August lows of 1015 has been due to a weaker USD across the board. One can argue the impact of illustrious economic data releases on price swings until blue in the face. Yet, since the fear of debt contagion in the Euro-zone abated panic and worry shifted back on the country with the world's largest Gross Domestic Product. Since then, the EUR, CHF, JPY, and AUD have all made substantial advances against the 'Greendback'.

Down Under

Australia continues to benefit from their trade relationships with Asia in that exports of commodities have led to sustainable growth down under. The economy picked up last month creating 29,000 new jobs predominantly in construction and industrial sectors. As long as Chinese demand for iron ore, copper, and aluminum remains consistent, thE AUD Will continue to appreciate against all major pairs.


The 'Swissy' benefits predominantly from the risk-on/risk-off trade. The linguistically diverse country maintains a current account surplus of 8.9% of GDP, inflation hovers around 1% while unemployment is below a comfortable 4%, and 2011 GDP growth forecasts 2% growth. If one wants safety what is not to like? In addition FX traders seem poised to test the patience of the SNB again. Recall when the SNB stepped in with 'unilateral intervention' and sold Swiss Francs to keep the rate above 1.30 EUR/CHF. Will they sell Francs and buy Dollars? No, the Japanese already failed in this endeavor.


The Japanese economy, like the U.S., is struggling to maintain growth. Deflation wanes in the balance and export demand is tailing off in large due to a strong currency and shrinking profit margins at the likes of Sony, Toyota, Bridgestone, and Kobe Steel. With a dire economic situation the MOF stubbornly talks up the JPY and the need for intervention. Though, by 'unilaterally intervening' in the FX markets already traders know the MOF has a gun. The question is how many bullets are in the gun, and does the Ministry possess the courage required to fire a full clip? Time will tell on the latter. I doubt we have seen the last of 'unilateral intervention'. Speculators who place bets in JPY strength will not learn until the MOF reverts back to 2004 tactics and dilutes the market with over $1 Trillion of Yen. Whether or not Kan's $55 B stimulus package helps weaken the JPY remains to be seen.

Lastly, I would like to touch on the political issues underpinning the currency. Since Ichiro Ozowa was ousted in his most recent attempt to gain power, Naoto Kan appeased the former's supporters with currency intervention. I trust the exporters mentioned above took note of this and will put pressure on Kan's administration to intervene again. Many have made it resolutely clear; 'we want USD/JPY rate at 95'. If Kan wants to keep his job longer than his predecessors he will intervene again and again until the Yen stops strengthening.

The Little King of Everything

Alas we have but one more pair to discuss, you guessed it, EUR/USD. As mentioned by Dennis Gartman this morning, 'This was the level from which the EUR plunged earlier this year... it marks almost perfectly the 50% retraetment of the EUR's collapse from the highs of 1.5200 last December to the lows of 1.1900 this spring.' 1.3500 will serve as a hard line of resistance over the next trading session. This morning around 10:00 the pair jumped above this level on a large candle to the upside. However, the pair rocketed back down to the 1.3450 levels within the next hour.

Also, ECB buying of sovereign debt is slowing. Last week the ECB bought only 134 M EUR of bonds in comparison to 323 M EUR the week prior. Maybe the ECB feels confident the liquidity in the sovereign debt market is here to stay, only until it dries up again. Another important point to note; many Germans are becoming unhappy with the 'Christian-liberal Coalition', noted in the latest edition of the economist. Any political instability surrounding the Euro-zone's growth engine may cause uncertainty in the single currency. However, I should note that this is pure speculation on my part.

Undoubtedly, the EUR/USD pair is driven by none other than the U.S. FED action. Various traders, analysts, and media alike expect a second round of 'Quantitative Easing' in which the FED once again opens up its balance sheet to buy U.S. Government Debt. Rumors suggest debt purchases of $1-2 Trillion of longer-term U.S. Treasuries. This is nonsense. If the FED wanted to create artificial inflation they already would have done as much. Especially considering the mid-term elections put a choke-hold on any further monetary policy action. I suspect, as a rumor from the WSJ this afternoon put it, 'Rather than announcing massive bond purchases with a finite end, Fed officials are weighing a more open-ended, smaller-scale program that they could adjust as the recovery unfolds.' Cheers. This ought to give the Bond market rally a bit more time run and allow equities to cool after a monster September.

Impetus for Change

Now let us examine a few possible harbinger's for a trend reversal in Dollar weakness. On Friday October first Global PMI data will release staring with CHina and ending with U.S. ISM. Last month trader's took China's moderate August reading of 51.7, up .5% from the month prior, as a reason to buy equities. The SPX rallied nearly 3% and closed up more than 30 points on the session. What would have happened if Chinese PMI came in around say 48 or 47? Equities would be in for a sharp and painful sell-off methinks. Hence, the fear of a global slowdown in consumption/demand would shift to the far east and away from the U.S. Perhaps poor EU PMI might just do the trick if the Chinese index posts 'robust' gains. Either way, I expect this data release to be a harbinger of asset allocation in the coming month.


We are gearing up for a switch in sentiment with a 'Strong Dollar Story' leading the charge. Specifically we like the the dollar against the CHF, CAD, and JPY. In addition, we see energy as the place to be in the coming months as seasonality changes. Be cautious though, this type of trading environment is dangerous.

Patrick M. Ambrus

Sources: The Economist, The Gartman Letter, Financial Times, FT Alphaville,,

1 comment:

  1. Really enjoyed the trend analysis, great work here lots of insides on all sides.


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