Rates Down Under

The AUD/USD pair corrosively sold off the moment the rate decision became apparent at 11:30 EST. The pair rallied more than 150 pips since the initial sell-off and now trades higher around 0.972o. Unfortunately, I was on the wrong side of this trade. Lesson learned.

Interest rate day came and went.  The RBA decided not to raise rates by the sure-fire economist/analyst prediction of 25 basis points.  Instead, rates stayed in check at 4.50%.  Central Bank Governor Glenn Stevens explained:

“Financial markets are still characterized by a degree of uncertainty, and are responding both to differences in growth outlooks between regions and evident strains on public finances and banking systems in several smaller countries in Europe. Most commodity prices have changed little over recent months, and those most important to Australia remain very high.”

The tacit implication here is that while commodity prices continue to rise, notably Copper, the substantial appreciation of the “Aussie” supplants any real threats of inflation in the near-term.  I surmise the central bank employed this policy to assist in job creation through private sector reinvestment, which in turn may help reignite housing demand and retail sales.  In the minutes the RBA suggested higher rates over a mid-term period.  The central bank did note cooling domestic demand and global economic uncertainty as concerns:

“Several measures of inflation expectations had eased a little over recent months to be around average levels. Similarly, business surveys reported that the share of businesses planning to increase their prices over coming months was around average…While policy had to be alert to these risks, members considered that if the central scenario came to pass it was likely that higher interest rates would be required, at some point, to ensure that inflation remained consistent with the medium-term target. For the immediate decision, there had been no significant change in the overall outlook, with conditions looking a little stronger domestically than they had at the previous meeting, but looking a little weaker internationally.”

In addition, I found the IMF’s recent comments in their annual Article IV moderately firmer than those found in the most recent RBA minutes:

“Should the recovery unfold as expected, monetary policy will need to tighten further to contain inflation pressures generated by the mining boom… from a medium-term perspective, our assessment is that the exchange rate is mildly overvalued… This overvaluation is likely to be temporary and may dissipate with the eventual normalization of interest rates in the United States and other advanced economies.”

Here, The IMF argues interest rate policy (tightening) as the correct tool to cool inflation.  Conversely, the RBA seemed content to let the ‘Aussie” appreciate and reap the benefits of cheaper cost of capital and simultaneously increase prices of exported commodities.  Note, as the CNY remains weak against the USD, imports from Australia become more expensive for the People's Republic of China. Either way, inflation will cool. 

What caused economists and analysts to maintain such conviction of an interest rate hike?  The empirical reason may never be discerned.  I maintain a theory though. Many rumors sloshed between investors, traders, and media pundits that the Central Bank Governor openly desired hirer rates. However, Mr. Stevens did not lay his cards on the table in between the release of RBA minutes on September 7^th and the rate decision on October 5^th.  Thus, many of ‘us’ were fooled.  Next time 'we 'ought to err on the side of caution when attempting to forecast a Central Banker’s policy decision.

--Patrick M. Ambrus

Sources: http://www.rba.gov.au/, bloomberg.com, imf.org

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.


Efficiency



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.


Tradition



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.


Trade

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
Contact: analyzecapital@gmail.com


Sources: The Economist, The Gartman Letter, Financial Times, FT Alphaville, WSJ.com, bloomberg.com

Japan GDP Growth

The Gross Domestic Product (GDP) in Japan expanded at an annual rate of 5.00 percent in the last quarter. Japan Gross Domestic Product is worth 5068 billion dollars or 8.17% of the world economy, according to the World Bank. Japan's industrialized, free market economy is the second-largest in the world. Its economy is highly efficient and competitive in areas linked to international trade, but productivity is far lower in protected areas such as agriculture, distribution, and services. Japan's reservoir of industrial leadership and technicians, well-educated and industrious work force, high savings and investment rates, and intensive promotion of industrial development and foreign trade produced a mature industrial economy. Japan has few natural resources, and trade helps it earn the foreign exchange needed to purchase raw materials for its economy. This page includes: Japan GDP Growth Rate chart, historical data and news.

tradingeconomics.com

Export oriented growth remains resilient. However, The world's second largest economy faces a grave test of fiscal fat camp. The island's budget deficit as a percent of GDP staggers at -7.5%. Also, political reform/turnover transcends any progress made from previous fiscal reform.

Alas not all hope is lost. Deflation fears begin to subside while unemployment holds around 5%. Additionally, Industrial production surged 17.0% from June 2009. Now, Japan's leadership needs to make lemonade. Naoto Kan a former finance minister and current PM, may be the correct leader to tame the ravenous debt beast as well as exploit the island's strengths.


Patrick M. Ambrus
Analyze Capital LLC
Twitter: Analyze Capital

The Golden State- Part 1

There are many reasons to compare the State of California with the small European nation of Greece besides their warm Mediterranean climates. Like Greece, the Golden State has become a symbol of fiscal irresponsibility, in effect spending what it cannot pay for through taxes. And, although there is no serious need to worry about the state defaulting on its debt; rating agencies consider that risk in California to be greater than all the other 49 states.

Even after a decade of passing measures to cut spending, the state is once again considering a new budget, proportionally smaller to what is was a decade ago after taking into account population growth and inflation. And, even then the state still faces a $17.9 budget hole in the current and coming fiscal years. To produce more cash, without raising taxes, California will be forced to cut whole programs including welfare-to-work, subsidized child care, and the cash assistance to poor families with children. Reducing overgenerous state employee pensions costing the state over $6 billion a year remains a priority, as well as initiating an alternative budgetary system proposed by bi-partisan leadership last year that introduces a new value-added tax, simplifies income taxes, and scraps more from corporate and sales taxes. Part of the state’s problematic tax issues revolves around the ineffective proposition 13 of 1978 which fails to raise enough money from property taxes for local municipalities. On top of that, Proposition 98 of 1988 was meant to find new ways of generating funds, but it’s horrendously complex mathematical systems and funding formulas have never produced positive results.

California faces a more general problem as the political structure ensures spending will always outpace revenues. While simple majorities in Sacramento are required to lower taxes, super majorities must agree to increase them. The recent primary elections for the governor’s seat in California have highlighted new ideas on spending reductions in various sectors of the government, however statistics in 2008 indicated that California had 108 state employees for every 10,000 residents, a ratio which remains one of the lowest in the United States, only Florida and Illinois have fewer. Where the incumbent governor can realistically cut jobs remains unclear. Recently, Governor Schwarzenegger has initiated measures to cut the state’s employee pay to minimum wage. Although this may help ease the state’s economic problems it seems rather controversial that a few must suffer the irresponsibility’s of an entire society. There will come a time when the taxes will have to be increased, and presently it seems we are once again prolonging the inevitable for immediate political safety.

Tom Rodelli
Research Analyst
Analyze Capital LLC
trrodelli@gmail.com

Canadian CPI- 06.22.2010

Consumer prices rose 1.4% in the 12 months to May, following a 1.8% increase in April.

Overall, energy prices rose 6.2% between May 2009 and May 2010, following a 9.8% increase during the 12-month period to April. Excluding energy, the Consumer Price Index (CPI) rose 1.0% in May, after increasing 1.1% in April.

www.statcan.gc.ca

Patrick M. Ambrus
Managing Partner
Analyze Capital LLC
Twitter: AnalyzeCapital

Chinese Inflation & Industrial Production

Consumer price inflation rose to 3.1 per cent in May from 2.8 per cent the month before, while factory gate inflation was also higher at 7.1 per cent, up from 6.8 per cent. However, industrial production dropped to a year-on-year increase of 16.5 per cent in May, against a 17.8 per cent increase the month before.

Falling growth and rising prices places the government in a policy quandary,” said Tom Orlik, economist at Stone & McCarthy in Beijing. “Falling growth argues for policy continuity. Rising inflation suggests accelerating the tightening schedule.”

FT.com



China may be headed for a prolonged period of stagflation in the future.


Patrick M. Ambrus
Managing Partner
Analyze Capital LLC
Twitter: AnalyzeCapital

Consumer Price Index A.K.A. Inflation

Temporarily soft energy costs pulled down the headline CPI for February while weak shelter costs kept core inflation very sluggish. Overall CPI inflation for February eased to no change from 0.2 percent the month before. The latest came in just below the market forecast for a 0.1 percent uptick. Core CPI inflation rebounded a modest 0.1 percent, following a 0.1 percent dip in January and matching consensus expectations. A number of weak components point to the fact that inflation pressures, indeed, are subdued. Shelter costs were flat in the latest month while declines also were seen in apparel and recreation.

Looking at detail, the energy component of the CPI declined 0.5 percent in February after jumping 2.8 percent the month before. Gasoline temporarily eased 1.4 percent, following a 4.4 percent jump in January. Food inflation slowed in February to 0.1 percent from 0.2 percent in January.

Year-on-year, overall CPI inflation fell to 2.2 percent (seasonally adjusted) from 2.7 percent in January. The core rate was slipped in February to 1.3 percent from 1.5 percent the month before. On an unadjusted year-ago basis, the headline number was up 2.1 percent in February while the core was up 1.3 percent.

Today's report leaves a lot of room for the Fed to keep rates low for some time. On the news, Treasury yields edged down and equity futures rose slightly. At the same time, initial jobless claims came in very close to expectations.


My only take from this report is that the economy is not inflating. Meaning QE will likely remain in some form until the Fed raises rates.

It is a beautiful day in New York. Take some time away from the terminal and get some spring air. I am likely heading up to Newport, RI later tonight. Enjoy the rest of the trading week.