18 / 10 / 2017 | Market News

Fundamental Analysis 18.10.2017 - Market Outlook

There are several big speakers taking the stage today at an ECB conference on structural reforms in the euro area. ECB President Draghi gives the opening speech, while ECB Chief Economist Praet chairs a panel discussion on the political economy of reforms and Executive Board Member Coeure chairs a panel on reforms and governance. I don’t expect anything market moving to come out of these panels.

Aside from that, the European morning will be focused again on Britain as the UK labor market data is released. The figures show the same split between employment and wages  that many countries are puzzling over.

The unemployment rate is expected to remain unchanged at 4.3%, the lowest it’s been since 1975, while the number of new jobs is forecast to increase substantially – not as many as last month, but still well above trend. 

However, there’s no sign of an acceleration in wages – average earnings total is expected to rise at the same year-on-year rate as in the previous month, while growth in base wages excluding bonuses is forecast to slow a bit.

Nonetheless, I expect the figures would be modestly beneficial for sterling, because many people still expect that as the labor market remains tight, eventually wages will have to go up and drag prices up with them.

US housing starts and building permits for September 2017 were expected to be down slightly from the previous month. That stands to reason, given that there were massive hurricanes in Texas and Florida that would interrupt building. However, any decline should be only temporary – there’s likely to be a surge in Q4 as people start rebuilding their destroyed homes (although the labor shortage in the building industry will mean only a limited increase). That’s why I don’t think anyone will care about a decline now.

Canadian manufacturing sales are forecast to be down for the third consecutive month, which could be a negative for CAD. However, the pace of decline has slowed notably, so it might not have that big an impact.

The Fed releases the “Summary of Commentary on Current Economic Conditions”, also known as the Beige Book, as always two weeks before the next FOMC meeting. The book doesn’t have any number attached to it, but many research firms do calculate a “Beige Book index” by counting how many times various words appear, such as “uncertain.” In any case, the book is largely anecdotal so you’ll just have to watch the headlines as they come out.

This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.


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17 / 10 / 2017 | Market News

Fundamental Analysis 17.10.2017 - Market Outlook

USD gained on two main factors: 

1) an incredible surge in the Empire State manufacturing index, and

2) Trump meeting with and being impressed by John Taylor, inventor of the eponymious Taylor Rule for calculating an appropriate level for a central bank’s main rate.

Taylor is probably the most hawkish of all the candidates for Fed chair. If his rule were applied nowadays, the Fed funds rate would be about 250 bps higher than it currently is, and indeed even higher than most of the FOMC members think is the appropriate “long term” rate where Fed funds should settle once things are back to normal (3%). Taylor thinks that long-term level should be closer to 4%, which is higher than anyone currently on the FOMC thinks (the highest estimate is 3.5%). He did say last week though that he did not think "rules should be used as a way to tie central bankers' hands,” even though that’s exactly what a lot of Republican members of Congress would like to see. 

Trump is expected to interview current Fed Chair Yellen on Thursday 19th October 2017.

On the other hand, CAD was the weakest G10 currency. Over the weekend, Bank of Canada Gov. Poloz said that Canada’s economy may be entering a point in the business cycle where growth can accelerate without triggering inflation. He said investment could fuel growth while expanding production capacity at the same time, thereby preventing inflation. This view, coupled with a disappointing result from the BoC’s survey of managers Monday, pushed the odds of a rate hike this year down to 45.8% from 53.4% on Friday 13th October 2017 and caused CAD to weaken.

I think there could be further reconsideration of the Canadian interest rate story ahead of next week’s BoC meeting, which could push CAD lower still. Watch for Friday 20th October 2017’s Canadian inflation numbers, which could change the story again.

EUR was only vaguely affected by the rising tensions in Spain, while GBP was only mildly affected by further headlines about looming disaster in the Brexit talks.

Today’s market

The focus during the European day will be squarely on the UK as Bank of England Gov. Carney and two of his colleagues from the Monetary Policy Committee (MPC), Silvana Tenreyro and David Ramsden, appear before the UK Parliament’s Treasury Committee. This is the first time since the June election that Carney has spoken here. Tenreyro and Ramsden are the newest members of the MPC and this is their first appearance.

Carney appeared on CNBC on Friday 13th October 2017 and repeated his view that the BoE is “running out’ of spare capacity and it therefore may be “appropriate” to raise rates “in coming months.” He declined to say when more specifically or to be drawn on whether this would be a one-off hike or the start of a tightening cycle. 

The graph below shows how the market has interpreted the MPC’s changing views. The green line shows the market’s estimate of the likelihood of a rise in rates at or before the November 2017 MPC meeting. Note how those odds fell after the August 2017 meeting, when Carney warned about the uncertainties caused by Brexit, and then soared after the last MPC meeting in September 2017, when the statement added the fateful words that “some withdrawal of monetary stimulus is likely to be appropriate over the coming months.” 

At the same time as those three are elucidating their positions to the Right Honorable Members of Parliament, the UK CPI will be announced. It’s expected to show a further acceleration in inflation, which would probably seal the deal on a rate hike in November 2017. It could also propel GBP higher, at least temporarily – assuming no bad news on Brexit during the day. 

Germany’s ZEW survey is expected to move ever higher. This is a survey of analysts and investors, not people who really do something, and so is more of an indicator of sentiment than of activity. Given that Germany’s DAX stock market index is at a record high, I’d say investor sentiment is pretty good, which suggests that expectations of a further rise in the index are reasonable. The current situation index is forecast to hit 88.5, not far off the record high of 91.5 set in May 2011. EUR-positive.

Then we wait until the US day begins.

The US indicators start with import prices, a second-tier index that is somewhat important for its theoretical implications for the CPI. But imported goods are only part of total goods, and in any event some 40% of the CPI is comprised of housing costs, which aren’t influenced at all by imports. Nonetheless, the index does seem to have a significant impact on EUR/USD over the 1-hour horizon. The forecast is for a modest acceleration in price increases, so it may be positive for the dollar.

However notice how much more slowly import prices excluding petroleum (the green line) are rising – only 1% yoy, vs the forecast 2.6% for overall import prices. Moreover, based on the consensus forecast for the mom change in that index, it’s expected to stay at +1.0% yoy this month, showing no acceleration. Given that the Fed targets core inflation, not headline inflation, that should be negative for the dollar. But it probably won’t be, because people don’t look that hard at this one. 

US industrial production is probably more important for the market. The figure is forecast to show a month-on-month rise slightly higher than the six-month moving average, which would be excellent considering that it includes the effects of the two hurricanes during the month. I think a positive figure would show the resilience of the US economy and be positive for the dollar. 


The National Association of Home Builders (NAHB) housing market index is expected to be unchanged. The index peaked in March 2017 at almost a 12-year high, so the fact that it’s stuck at a slightly lower level now is nothing to be alarmed at. USD-neutral

Overnight in Australia we get the Westpac-Melbourne Institute leading index. No forecast is available, but it does seem to affect AUD significantly in the hour following the release. The index seems to be on a downward trend; a further decline could be expected to be negative for AUD.

The main event overnight though will be President Xi’s opening speech to the 19th Conference of the Communist Party of China (CPC). These congresses take place every five years to elect the people and approve the policies for the next five years. This congress marks the start of Xi’s second and presumably final term. China experts say Xi is likely to use the event to further solidify his position. As for what he’s likely to do when he’s even more solidly in charge…well, we’ll have to wait to hear what he has to say. My guess is that he’s likely to promise wonderful things, which could give AUD and NZD a temporary boost.  

This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.


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16 / 10 / 2017 | Market News

Fundamental Analysis 16.10.2017 - Market Outlook

EUR was the biggest loser since last Friday 13th October 2017, although the movement wasn’t that great. The drop could be just a reaction to USD strength after Fed Chair Janet Yellen on Sunday 15th October 2017 reiterated her long-standing view that inflation will eventually accelerate and the Fed intends to keep raising rates gradually. (Just FYI, ECB’s Draghi and Bank of England’s Carney agreed with her on inflation.) Why anyone would think she would say anything different is beyond me; perhaps they were worried that Friday 13th October 2017’s slightly lower-than-expected US CPI might have changed her view.

I wonder though if the EUR weakness also reflects the return of political concerns to Europe. There were two significant elections in Europe on Sunday 15th October 2017, and both didn’t go the way the markets would have preferred.

The Austrian center-right People’s Party came in first in the election for the Austrian National Council, with the far-right Freedom Party coming in second. The ruling Social Democrats came in third. The two right-wing parties will now form a government. Austria is now likely to align itself more with the eastern European countries that have clashed with Brussels over some EU policies, notably migration. Secondly, in Germany, PM Merkel’s CDU party posted its worst result in the state of Lower Saxony since 1959. The result may weaken Merkel’s hand in talks that begin on Wednesday 18th October to form a national coalition.

Political uncertainty has faded recently in Europe, especially since the CDU won the national ballot three weeks ago, but these elections together with the tensions in Spain (see below) may bring back a political risk premium to the euro.

Speaking of political risk premium, NZD was the biggest gainer even though the politicians failed to achieve a breakthrough over the weekend. Acting PM English said it could take until the end of the week to confirm the country’s next government. Nonetheless NZD and AUD both held onto much of their gains from Friday 13th October, when the disappointing US CPI came out.

Today’s market

The main indicators for the day are over already – China’s CPI came out as expected at 1.6% yoy (down from 1.8%), while PPI rose more than expected to 6.9% yoy from 6.3%. The PPI is what’s important for global inflation, since China exports so much. The jump in Chinese PPI inflation does make it marginally more likely that Western countries will hit their inflation targets.   

We’re now waiting to see how Catalonia clarifies its declaration of suspended independence from last week – when Catalan President Puigdemont said the vote gave the region the right to be “an independent state,” but that the state had been “suspended” for a few weeks pending talks.

Spanish PM Rajoy has given Puigdemont until 10 AM local time today to state whether they actually declared independence. If he says they didn’t, then fine. If he says they did, then he will have three days to reconsider, after which Rajoy will seek official approval to defenestrate the Catalan government and govern the region from Madrid. That would be almost sure to involve huge demonstrations, which could rebound against the euro.

The developments in Catalan haven’t had that much of an impact on the Euro yet, as the EU authorities have stayed totally out of the picture. The graph shows that as the spread of 10yr Spanish bonds widened out relative to German bonds, the green line, EUR/USD, the purple line, was pretty steady. That may be because the EU and other regional authorities have been careful to stay out of the crisis. But if the situation worsens, I think we can expect some contagion and a knock-on effect on the euro.


In the US, the Empire State manufacturing index is expected to fall slightly, as is the Philadelphia index, which will be released on Thursday. The decline in the Empire State index is nothing to be concerned about, seeing as it was recently at the highest level in three years anyway (and second highest since 2010). It stands to reason given the diminishing prospects for tax reform or any kind of fiscal stimulus. USD-neutral.

While it’s not usually given on most FX calendars, the sub-index for new orders is closely watched by economists as a leading index of manufacturing strength. In September it hit the highest level since Oct. 2009. Even if the headline number falls more than expected, we could see USD gain if the new orders figure rises further. 

After that, it’s all quiet until Tuesday morning in New Zealand, when the Q3 CPI will be released. The market expects it to hit 1.9% yoy, above the Reserve Bank of New Zealand’s forecast for the quarter and close to their 2% target.

Faster NZ inflation could be positive for NZD and see AUD/NZD fall further. Right now there’s slightly less tightening priced into NZD (the green line below) than AUD (the purple line). An acceleration in NZ inflation could narrow that gap and push AUD/NZD down.

The minutes of the 3 October meeting of the Reserve Bank of Australia (RBA) will be released. We should get more clarity on their views about such key issues as housing, consumers and the labor market. However, the statement and the decision didn’t have a lasting impact when they were released – AUD/USD fell 30 pips immediately following the announcement, but had regained it all four hours later and was higher by the end of the (European) day. Thus it’s unlikely that the minutes will reveal anything to dramatically change people’s view of the RBA, particularly since the twice-yearly Financial Stability Review was recently published. AUD-neutral.

This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.


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13 / 10 / 2017 | Market News

Fundamental Analysis 13.10.2017 - Market Outlook

The EU’s chief Brexit negotiator, Michel Barnier, sent GBP plunging and then soaring. He said there was a “deadlock” in the talks over the question of how much the UK would pay the EU to leave. But later, the German newspaper Handelsblatt cited him as saying that the EU could offer Britain a two-year transition period during which Britain would stay in the EU’s single market if Britain agreed to settle its financial obligations with the EU. That would mean additional time to hammer out the details of the separation and reduce the odds of a “hard Brexit,” where Britain just crashes out of the EU without any agreement.

Reports that the ECB is considering cutting its monthly bond purchases in half from January while keeping it going for at least nine months didn’t have much impact when they first surfaced, but since then EUR has weakened further. Since the ECB has said it won’t start raising rates until it has ended the bond purchases, the long delay until then means rates will remain lower for longer, which is negative for EUR.

NZD rose as the market anticipated that New Zealand First Party would complete talks on a coalition government over the weekend. It also benefited from some pressure on AUD/NZD from the Reserve Bank of Australia (RBA) Financial Stability Report, which said regulatory measures are constraining some borrowers, meaning there’s less need for interest rates to rise to control borrowing.
CAD on the other hand fell as the US proposed a “sunset clause” for NAFTA deal, meaning NAFTA would expire every five years unless all three parties agreed to keep it going. This would be a disaster for anyone considering an investment that needs NAFTA to continue. Lower oil prices and a fall in new house prices didn’t help the currency, either.

Today’s market
Once again, nothing major during the European day. The final German CPI will be coming out, but it usually isn’t any different than the preliminary version.

The US CPI on the other hand is a big, big deal. It’s expected to accelerate both at the headline level and the core level. Energy prices will play a big role in pushing prices up as gasoline prices rose in the wake of Hurricane Harvey in Texas, whereas the seasonal adjustment assumes prices fall during this period.

Although this isn’t the inflation measure that the Fed officially targets, it seems that people pay more attention to this one than to the official target (which is the core personal consumption expenditure deflator). With the headline figure leaping over 2% and core inflation accelerating as well, it would seem to confirm all the prognostications from various Fed officials that inflation is likely to hit their target level.

At the same time, US retail sales are expected to soar, at least at the headline level. The figure there is temporarily inflated by soaring gasoline prices (and therefore gasoline sales) as a result of the hurricanes. Auto sales also rose as people started to replace some of the 300k autos damaged in the Houston flooding. And even after excluding autos and gasoline, they’re forecast to rise at an above-trend rate owing to sales of building materials. The increase in retail sales should also prove positive for the dollar.

Consumer confidence is expected to be more or less unchanged. In combination with the other solid reports from the US, it would probably confirm to the market the resilience of the US economy and would therefore be dollar positive. 

There are a number of speakers in the US afternoon. ECB Governing Council Vice President Vitor Constancio will participate in a panel discussion on “The European Spring?”.

Two of the FOMC’s doves – both voters -- speak today, but since both have spoken recently anyway, I don’t expect their comments to be market-moving. Chicago Fed President Charles Evans discusses current economic conditions and monetary policy in Wisconsin. He spoke on Wednesday and said, “I’m thinking it’s going to take a little bit longer to get up to 2% than many people. We might need a continued accommodative stance…”  Dallas Fed President Robert Kaplan will appear in a moderated Q&A session in Boston. He was at a similar event on Tuesday, when he said he wanted to see more signs that inflation was accelerating before raising rates.

Fed Governor Jerome Powell was scheduled to be the keynote speaker at the Boston Fed’s annual economic conference, but cancelled a few days before. Fed spokesmen said that the cancellation is routine, but there’s bound to be some speculation, because Powell is thought to be one of the front runners for head of the Fed when Janet Yellen’s term finishes next February.

On Sunday, the Group of 30 holds two high-powered events in Washington. Unlike the G7, G10, or G20, the G30 is a public and private-sector organization that brings together central bankers, the heads of various financial institutions, and some academics to discuss financial and systemic issues. First there’s a panel discussion on “The Global Economy: Prospects for Broad-Based Growth,” featuring Fed Chair Yellen, PBOC Gov.  Zhou, BoJ Gov. Kuroda, and ECB VP Constâncio, After that there’s a panel discussion on “Financial Regulation and Economic Policies to Avoid the Next Crisis,” featuring US NEC Director Cohn, RBI Gov. Patel, and Bundesbank President Weidmann, and Banco de Mexico Gov. Carstens.

This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.

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12 / 10 / 2017 | Market News

Fundamental Analysis 12.10.2017 - Market Outlook

Another day of dollar decline. The currency basically declined for most of the day. It tried to stage a rally several times, but each time when the move failed to recover the earlier high, it just collapsed further. The currency may be suffering from doubts about whether the Republicans can pass a tax reform bill, which seems increasingly unlikely.

EUR may have gained – and the dollar suffered – from the developments in Catalonia. Spanish PM Rajoy threatened to arrest Catalan President Puigdemont and suspend Catalonia’s autonomy if they declare independence. The market seems to believe the threat will work:  the spread of 10-year Spanish bonds over Bunds came in by 8 bps and is now back to were it was before last week. EUR may continue to gain for some time, but I’m on the edge of my chair waiting to see what happens.

The FOMC minutes described in more detail what we already know from listening to the Committee members and from looking at the dots: that the FOMC members fall broadly into two camps.“Many” participants still believe in the Phillips curve, which relates inflation to the level of unemployment, and expect the tight labor markets to lead to higher inflation. They therefore think another rate hike later this year is warranted. But there is another group of “many” participants who are concerned that the low inflation this year might reflect unknown factors “that could prove more persistant.” And “a few” of those members thought there shouldn’t be another rate hike this year. This is consistent with the four dots on the dot plot that are unchanged from current levels.

The difference here between “many” and “a few” is significant. It implies that some members are skeptical about whether the low level of inflation is really just temporary, but are still willing to go along with rate hikes. The risk for the dollar is that if inflation doesn’t turn up soon, these people may change their minds and decide further rate hikes aren’t warranted until they can better understand the forces that are keeping inflation low. This increases the already high significance for tomorrow’s US CPI data.

As for the Fed’s plans to shrink its balance sheet, the minutes said that "participants generally expected that any reaction in financial markets… would likely be limited" because it’s been well publicized in advance and will be gradual. The minutes didn’t change the market’s estimate of the likelihood of a rate hike in December 2017.

CAD was the best performing currency. Part of it may be generally higher commodity prices (although oil was down slightly), part may be momentum from last week’s impressive wage data, and part may be just USD weakness. Part may also be optimism about the NAFTA negotiations, and that’s where I’m concerned. Canadian PM Trudeau was optimistic after his meeting with Trump to discuss NAFTA and said it was “very possible to get a win” for all sides. However, today’s New York Times, which has a headline: “Trump’s Talk of Scrapping Nafta Could Soon Become Reality.” contradicts this. If the Nafta talks to go badly, at least in the beginning, CAD could weaken as a result. One risk here: a lot depends on how oil reacts to Trump’s Iran speech today.

Today’s market

As usual recently, there’s not much going on during the European day. The EU industrial production figures may be interesting, but they’re not particularly market-affecting.

During the US day, Trump is going to make a speech about US policy towards Iran. Administration officials have said he will decertify the international deal to curb Iran's nuclear program, just a few days ahead of the 15 Oct. 2017 deadline. He may also announce a more confrontational policy towards Iran, including designating Iran’s Revolutionary Guard a terrorist group. Decertification is not the end of the deal. Technically speaking, the agreement is neither a formal treaty nor an executive agreement but rather a “non-binding political commitment.” Decertifying it only means that the administration is no longer committed to it, but it does not invalidate the agreement. On the other hand, it does signal to Congress that it can reimpose sanctions on Iran when next the sanction wavers expire next January. 
It’s unlikely that the move would cause the 2015 accord between Iran and the US, EU, Russia and China to unravel entirely, because the other signatories have said that they stand by the pact. Nonetheless, tighter sanctions on Iran might make it more difficult for the country to produce and export oil. In addition, increased tensions in the Middle East can send oil prices higher.

Higher oil prices tend to be beneficial for RUB, CAD, NOK and MXN.
Brent, the European benchmark, is more sensitive to problems in the Middle East than WTI, the US benchmark is. So when there are problems in the Middle East, Brent usually increases in price relative to WTI. 

The rate of increase in the US producer price index (PPI) is forecast to accelerate significantly at the headline level owing to higher petroleum prices. The year-on-year rate for the core PPI on the other hand is expected to remain unchanged as the strengthening of the dollar last year gradually feeds through. With the employment situation unclear in the wake of the hurricanes, the various inflation gauges have become more important than ever as a way of determining what the Fed is likely to do. A higher PPI is likely to be positive for the dollar.

There are a number of big wigs speaking in Washington at events scheduled around the annual meeting of the IMF and World Bank. ECB President Mario Draghi and Fed Governor Lael Brainard take part in a panel discussion of a paper on monetary policy presented by former Fed Chair Ben Bernanke at the Peterson Institute for International Economics. There are no details available for the paper, but the title of the conference is “Rethinking Macroeconomic Policy.” A host of other economic luminaries will be there and talking during the day, including former US Treasury Secretary Lawrence Summers and Bank of England Chief Economist Andy Haldane.

About the same time, Fed Governor Jerome Powell will speak on “prospect for emerging market economies in a normalizing global economy” elsewhere in Washington. And ECB Chief Economist Peter Praet will speak at a JPMorgan investment seminar there, too (no indication of what he’ll be talking about). Later in the day, Bank of Canada Senior Deputy Gov. Carolyn Wilkins will participate in a panel discussion on “Cashing Out: The End of Paper Currency?” which may be of interest to traders who follow cryptocurrencies.

Oil markets were dealt a blow after the American Petroleum Institute announced that inventories had risen 3.1mn barrels in the latest week. This is a sharp contrast with the forecast for today’s US Dept. of Energy figure is for a drawdown of 2.4mn barrels. If the DoE figures do come out as forecast, I would expect to see oil prices rebound. 

Overnight, China announces its trade figures. The country’s trade surplus is expected to decline, but there are “good” declines and “bad” declines. This is a “good” decline in that it’s expected to be caused by an accelerating pace of import growth rather than decelerating pace of export growth. On the contrary, exports are forecast to have risen at quite a healthy pace. The figures should increase confidence in the Chinese economy and those countries that supply China, meaning it may boost AUD and NZD particularly.

This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.


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11 / 10 / 2017 | Market News

Fundamental Analysis 11.10.2017 - Market Outlook

Catalan President Carles Puigdemont declared independence, as he had threatened, but immediately suspended the declaration to allow time for talks with the central government through an international mediator. The national government rejected the request as they say the referendum was illegal and therefore invalid.

In any event, the speech had little impact on the markets; EUR/USD had risen gradually during the day ahead of the speech, and aside from a small spike at the opening in Asia, it’s now trading at about the same levels as during the speech. Spanish 10-year yield spreads also barely moved during and after the speech.

The corollary to a higher EUR was of course a lower USD.

Elsewhere, market movements were subdued. AUD fell further even though the Westpac consumer confidence index was up sharply (no forecast available). My guess is that people outside the region thought the move in AUD/NZD was overdone and shorted the pair, which moved lower after the Asian day finished. The move accelerated when trading started in Asia today, suggesting locals were taking what profits were left. As I said yesterday, I think with the steel market in China cooling, Australian coal prices are likely to fall and AUD fall with it.

Oil soared as the OPEC Secretary General reiterated his claim that the market is rapidly rebalancing and predicted strong demand for oil next year. There are also reports that Saudi Arabia will reduce its output, but I question how important that is – they often increase output in the summer and then decrease it in the fall. In any event, I don’t believe the rebalancing story and think oil is likely to head back below $50 in the not-too-distant future. 

Today’s market

Another relatively quiet day in terms of indicators. There’s nothing of particular interest during the European morning.

There could be some volatility as the annual IMF and World Bank meetings get under way in Washington and reporters talk to the assembled dignitaries.

There could also be news headlines as the fourth of the seven rounds of NAFTA talks begin. Nearly 700 officials are gathered to discuss overhauling the free-trade agreement between the United States, Mexico and Canada. This could be the decisive week as the US negotiating team is expected to finally reveal its position on the most contentious issues, such as “rules of origin;” how to settle disputes involving foreign investors; Mexican labor standards; and Trump’s goal of narrowing the US trade deficits.

If this round of talks also ends in failure, it will be difficult to reach an agreement in the time that’s left. But this may be exactly what Trump intends. Some analysts think he will deliberately make proposals that Mexico, which holds a presidential election next July, can’t possibly agree to. Then the talks would collapse and the US could leave the agreement. CAD and MXN will be very sensitive to these talks.

Chicago Fed President Charles Evans takes part in a moderated discussion on the economy and monetary policy. Evans, a voting member, is skeptical about whether the low inflation is transitory and said on 25 September 2017 that “we need to see clear signs of building wage and price pressures before taking the next step…” If he still thinks this way, which seems likely to me, it could be hard for Fed Chair Yellen to get enough votes to raise rates in December 2017. That would be USD-negative.

The Job Openings and Labor Turnover Survey (JOLTS) report is expected to show that job openings remained near the record-high level of the previous month. That would be good news for the US economy, because of course payrolls can increase only if there are jobs out there. Plus, a continuing high demand for labor should mean in theory that eventually employers will have to start bidding up wages in order to get employees – although there are many people around the globe wondering why this hasn’t happened yet in their country. USD-positive.

The minutes of the 20 September 2017 FOMC meeting will be closely scrutinized to get further clarification on the inflation debate. Some members (Yellen and Dudley, for example) argue that low inflation doesn’t mean there’s too much slack in the economy, and therefore the Fed should stick with its plans for gradual tightening. Other members (Brainard and Evans) want to wait to see more concrete signs that inflation is nearing their target before they hike further.

Several members have spoken on this topic since the meeting however so there might not be too much confusion left to clear up. The risk is perhaps that one or two members made dovish comments that stand out in the minutes and give an unbalanced impression of the discussions. In any event, the market sees a 77% likelihood of a hike in December 2017, so the minutes can’t do that much to increase the odds.

The minutes may also give us some insight into the surprising revisions to the FOMC’s forecasts that were made at the meeting. They were revised to show stronger growth this year, a deeper fall in the unemployment rate, and yet lower inflation this year and next and therefore a longer time to achieve the Fed’s inflation goal – seemingly contradictory developments. We may also get some insight into how the Committee members expect the hurricanes to affect the economy.

Finally, the FOMC announced at this meeting plans to begin shrinking their balance sheet starting in October 2017. That move will no doubt impact overall financial conditions regardless of what happens to rates. How do they see the impact of the balance sheet move vs rates?

Next up is ECB Chief Economist Peter Praet, who will be speaking at a conference in New York on “European Exit Strategies.” This is a tantalizing topic, because of course everyone is wondering what the ECB’s strategy for exiting its extraordinary stimulus program will be. The ECB has made it clear that it’s going to end its bond purchases long before it considers raising rates. Now the question is, do they sharply cut the amount they buy each month but continue the program a long time, or do they reduce the amount they buy by less, but end the program sooner? Volume vs duration. Praet may give us some hint as to which way he’s leaning.

If they choose the former path, it would mean rates would stay lower for longer and therefore be negative for the euro, whereas ending the program sooner means they can raise rates sooner, which would be positive for the euro. Currently, the market expects ECB rates to remain below zero for some four more years. 

Overnight, Japan announces its producer price index (PPI). In theory this should be a leading index of inflation, in which case the further rise in this index should be JPY-positive. In fact as you can see from the graph CPI inflation in Japan seems to be going nowhere, but we are discussion how the market is likely to react, not how the real economy is likely to react.

Finally, Australian home loans are seen growing at a slightly above-trend pace, even after the strong gains in the previous month. Note that this indicator measures loans to owner-occupiers. The amount of these kinds of loans may have been boosted by the macro-prudential measures put in place in March to cool demand for housing loans for investment purposes, which may have shifted demand into these kinds of loans. In any event the figures suggest that demand for housing is still robust despite those measures, and so it’s less likely the Reserve Bank of Australia will cut rates further = AUD-positive. 

This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.

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10 / 10 / 2017 | Market News

Fundamental Analysis 10.10.2017 - UK & German Trade Data

Market Recap
GBP was the surprise leader overnight, after the UK statistics office revised up its estimate for labor costs in 2Q. That suggests inflationary pressures may be more than people had thought. Also, there’s talk of a Cabinet shuffle in Britain to strengthen PM May’s position. The government is faced with an almost impossible task:  to produce an exit plan that can win the agreement of MPs on both the Leave and Remain side and at the same time is acceptable to EU negotiators.

EUR gained as yesterday’s German industrial production wildly beat estimates -- +2.6% mom vs +0.9% expected, the best month in six years.

I was surprised to see AUD higher even as iron ore futures fell back into the $50/ton range (down 2.3% in Singapore, 1.8% in China). It may simply be a reaction to the fall in NZD, which is suffering from political concerns as the parties there continue to negotiate. People who are looking to sell NZD often do it against AUD. In any event, I think AUD could be ready for a fall again.

CHF was the main loser – I don’t see any reason on the Swiss side for this move. A lower JPY as well suggests that this is part of a risk-on move, although I note that silver and gold were both higher. It may have been the way some traders expressed their enthusiasm for EUR in the wake of the better-than-expected German output figures.

I’m bearish on CHF as well. I think as EUR monetary policy starts to normalize, the extraordinarily loose Swiss monetary policy will start to weigh more heavily on the currency. 

Today’s market
The big event in Europe today is the meeting of the Catalan regional parliament to consider a declaration of independence. Catalan President Puigdemont will speak in Parliament at 1600 GMT.

As for the indicators, the European day gets off to an early start with the German trade data. The country’s trade surplus, which has become politically sensitive now with the Trump administration, is expected to remain stable. That may be bad news for the euro, in that it suggests continued trade tensions with the US, although no change in the country’s overall trade surplus doesn’t necessarily mean no change in its surplus with the US.

Next it’s “short-term indicators day” for Britain, when the government announces the trade data and industrial production. The trade deficit is expected to narrow slightly. In theory that should be good news for the pound.

But while industrial production is forecast to accelerate a bit, manufacturing production is actually forecast to slow. That suggests any improvement in the trade balance isn’t doing much for the country’s economy. Moreover, the minutes of the September 2017 Bank of England meeting indicated that the Monetary Policy Committee expects Q3 growth to be stronger than the +0.3% qoq rate that was predicted in the August 2017 Inflation Report. A figure like this might bring that assumption into doubt and would therefore be negative for the pound.

In the US, the National Federation of Independent Businesses (NFIB) small business optimism index isn’t the most closely watched indicator in town. Moreover, its important sub-index about hiring plans comes out a few days earlier and so is already known. Nonetheless, given all that’s going on in US politics, including the threats of nuclear war, there’s a lot of questions about whether business optimism will hold up. In this case, if the index does come in around as estimated – little changed from the previous month, which represents an improvement over several months ago  – and with hiring plans continuing at their relatively high level, that would probably be positive for the dollar.

Canadian housing starts and building permits are expected to show a slowdown in the Canadian housing market.

Housing starts for September are expected to show a sudden lurch lower. This is after three months of rising starts. In fact starts have generally been trending higher since December last year, so a decline like this is somewhat worrisome. I would rate this negative for CAD.

The building permits figure is quite erratic. Even the six-month moving average jumps around a lot. So if it does register a second consecutive negative month, as the consensus forecast suggests, that might be significant but it might not be either, especially since it’s not expected to be a very big decline. I would call this neutral, although the small dip does corroborate the decline in starts in September.

Note that these two indicators are for different months, and often they do not come out on the same day.

Later in the day, Bank of Canada Senior Deputy Gov. Carolyn Wilkins will participate in a panel discussion at the IMF on “Systemic Risk and Macroprudential Stress Testing.” This doesn’t sound like it will have any immediate relevance for the market, but you never know what comments might slip in.

Also, at some point in the day Canadian PM Justin Trudeau will meet with Trump to discuss the NAFTA negotiations that begin tomorrow. Trudeau will then fly to Mexico to update Mexican President Enrique Peña Nieto.

Before then, Minneapolis Fed President Neel Kashkari delivers the opening remarks at a conference hosted by his bank. He is a well-known dove who speaks often, so it’s unlikely that his comments will be particularly market-affecting.

Overnight there are several indicators coming out.

The Westpac consumer confidence index isn’t forecast, but it does seem to have an impact on AUD sometimes. The market may be wondering if last month’s rise was the beginning of a new trend or just a temporary bounce.

Japan’s machinery orders are one of the worst economic indicators I know. There is no way to forecast them, really, so economists are basically guessing. Furthermore, the figure is incredibly erratic, as you can see from the graph. Even the year-on-year rate of change jumps around. Some economists prefer to look at the three-month moving average, which last month finally emerged from negative territory. If the figure comes in as expected, the three-month moving average will continue its uptrend. That would probably be positive for the yen.

This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.

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09 / 10 / 2017 | Market News

Fundamental Analysis 09.10.2017 - German Industrial Production

There’s not much on the schedule today, and with the US market thinned out for the Colombus Day holiday, activity is likely to be particularly slow. 

The Scottish National Party Conference began yesterday. Normally this wouldn’t be a market-worthy event, but with Catalonia erupting in a drive for independence and the Brexit talks faltering, it’s natural to question how Scotland is going to react to all this. Will they resume their demand for independence?

The only major indicator out during the European or US day today is the German industrial production (IP). It’s expected to show a rebound in activity on a month-on-month basis, but for the year-on-year rate of growth to decelerate somewhat. Nonetheless, the manufacturing PMI for August was sharply higher at an extremely high level (59.3, up from 58.1) and rose even higher (60.1) in September. The Ifo index for current assessment also rose in August. While this does illustrate the often-discussed gap between the “hard” data, such as the IP figures, and the “soft” data from surveys such as the PMI and Ifo, I think the unusually high level of the surveys, plus the general optimism towards the European economy, will allow markets to ignore a slight slowdown in the year-on-year data. EUR-neutral. 

After that, nothing on the schedule until Japan announces its current account balance. For some reason the market seems to pay more attention to the not seasonally adjusted data than to the seasonally adjusted data. In this case however both are expected to be little changed, so I don’t think the figure will have a big effect on the yen. 

The campaign for the 22 Oct 2017 Lower House election in Japan also gets under way today. 

National Australia Bank (NAB) announces its business conditions and business confidence indices. No forecasts are available. The figure is occasionally market-moving, though. I would expect that if the divergence between the two indices continues, that would tend to be negative for AUD, while if it starts to reverse, that would be positive.  

Finally, early in the European day Tuesday 10 October 2017, Germany announces its trade data. The country’s trade surplus, which has become politically sensitive now with the Trump administration, is expected to decline. That may be good news for the euro, although a fall in the country’s overall trade surplus doesn’t necessarily mean a fall in its surplus with the US.

This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.

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06 / 10 / 2017 | Market News

Fundamental Analysis 06.10.2017 - Market Outlook

USD had an up day as US yields moved modestly higher and risk-on sentiment improved. The Spanish situation calmed down somewhat after Spain's Constitutional Court ordered Catalonia’s Parliament to suspend its planned session on independence. US factory orders beat estimates, while durable goods orders were revised higher.

Hawkish comments from both SF Fed President Williams and Philadelphia Fed President Harker also helped the dollar. The market doesn’t believe the FOMC’s forecasts for rates as set out in their quarterly “dot plot,” but the Committee members seem to be sticking to them – indicating to me that at some point the market will have to readjust its views and push the dollar higher.

That won’t necessarily happen today, though. The outlook for the dollar today will of course depend on the payroll data, particularly the average earnings, in my view. I think the risk is that average earnings fail to impress and USD weakens (see below).

EUR by contrast was hit by some dovish remarks in the minutes of the ECB’s latest meeting. The ECB Council agreed that “(a)ny reassessment of the monetary policy stance should proceed in a very gradual and cautious manner, while maintaining sufficient flexibility.” The members also expressed “discomfort” about how much longer they expected inflation to remain below their target levels. The debate within the Council seems to be more about the pace at which they taper down their bond purchases rather than the date by which they terminate the purchases completely. That would suggest rates are likely to remain lower for longer than many people had expected and is therefore negative for EUR. 

GBP was the big mover. It continued to fall as PM Theresa May’s future, never that certain, became even less certain. Her disastrous performance Wednesday at the Tory Party Conference has increased the likelihood that she has to step down at some point, throwing the confused UK political situation into even more chaos even as the Brexit deadline approaches inexorably. I remain steadfastly negative on GBP.

AUD was also lower on press reports that RBA board member Ian Harper said a rate cut was possible if consumption continues to slow. AUD too seems likely to depreciate further as the economy there searches for new supports, in my view.

The European day starts early with German factory orders.  They’re expected to have bounced back in August, but not enough to keep the year-on-year rate of increase stable. This is a reminder of the recent contrast between the “hard” data, such as this figure, and the “soft” data, such as surveys like the Ifo business survey and purchasing managers’ index (PMI). The Ifo indicated a rise in manufacturing order books during the month, while the PMI also rose substantially. If it becomes clear that those surveys may be exaggerating the strength of Germany’s economy, it could be negative for the euro.

Britain’s Halifax Building Society’s index of house prices is expected to be unchanged from the previous month, but higher on a year-on-year basis. This may be because the year-on-year rate of change is actually a three-month moving average, and the 0.9% mom decline in June is now dropping out. Also as often happens there are different sets of data:  there are seven estimates for the mom rate of change and nine for the yoy. I would tend to think that no increase in prices from the previous month would be a negative sign, especially after the Nationwide Building Society showed a +0.2% mom rise, and would therefore be negative for the pound. 

After that, the market will probably settle down and wait for the US nonfarm payrolls. The official “consensus” forecast is 80k, but as I mentioned earlier in the week, there’s fantastic uncertainty about this – the standard deviation of the estimates is 40k, with people guessing anywhere from -45k to +153k. By comparison, the standard deviation was only 16k and 15k in the previous two months.  

Despite the uncertainty, Wednesday’s ADP report hit estimates exactly at 135k. This has made some people think the figure won’t be as bad as they might have thought, and the “whisper” number – a Bloomberg survey of whoever has a Bloomberg terminal and wants to submit their view – is 120k. This indicates that the market thinks the risk is a figure higher than economists expect, probably because the NFPs have been fairly steady at close to 180k for many months now. 

Given the distortions, the market may instead choose to put less emphasis on the NFP number and instead focus more on other parts of the report. The unemployment rate is expected to hold steady at 4.4%, which is below what the Fed thinks is a non-inflationary rate. That would be bullish for the dollar. The average workweek is also expected to be unchanged, which would be neutral. 

The focus outside the NFP number itself is likely to be the average hourly earnings. Earlier in the week the consensus was for earnings growth to accelerate, which would’ve been quite positive for the dollar, but now the median forecast is for the year-on-year rate of growth to remain unchanged for the sixth month in a row.  `

The average earnings figure is quite significant, because the Fed desperately wants to see the tighter labor market feeding through to higher wages. But if it turns out that there’s still no change, and indeed the month-on-month rate of growth is continuing at a weak pace, then the dollar could come under some selling pressure, in my view.  

At the same time as the US employment data is coming out, the Canadian employment data will also be released. The figures are expected to be mixed: the unemployment rate remaining at the lowest since the financial crisis of 2008, which is good, but only a modest increase in employment during the month, which is not so good. I think the figures are likely to be neutral for the CAD. The currency implications could be tipped one way or the other by the figure for wage growth, which is not forecast. If wage growth accelerates, that could prove encouraging for the Bank of Canada, just as it would for the Fed.  

Late in the day there are a number of Fed speakers. The most important one is clearly New York Fed President William Dudley, who will speak on “The Monetary Policy Outlook and the Important of Higher Education for Economic Mobility.” Of course it’s the first half of that title that the markets will be interested in. Dudley is on the dovish side, but he’s been arguing in favor of gradual tightening for some time. He said recently that the Fed “will likely continue to remove monetary policy accommodation gradually.” In other words, he’s still OK with a rate hike in December. But that was before the core personal consumption expenditure deflator (PCE) for August was announced, showing that the Fed’s targeted inflation gauge is actually slowing. Does he still expect to hit the Fed’s 2% inflation target “over the medium term”? Stay tuned! 

This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.

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29 / 09 / 2017 | Market News

Fundamental Analysis 2017.09.29 – Trump’s New Tax Reform

Market Recap
USD slipped as the market re-evaluated the likely impact of the Trump tax breaks, or perhaps more accurately, the likelihood of them getting enacted as is. Furthermore, many bond investors rolled out their positions slightly as the end of the month approached in order to keep in line with bond indices, which also had the effect of bringing US interest rates down. Lower US rates put downward pressure on USD. 

It was notable that the market ignored several indicators that should have been positive for USD:  an unexpected upward revision to Q2 GDP (albeit a small one), a much narrower-than-expected US trade deficit, a much higher-than-expected rise in wholesale inventories, and an unexpected rise in the Kansas City Fed manufacturing activity index. This just shows me how the focus in the US is largely on politics and Fed policy and how the underlying sentiment towards USD is so negative.

CAD was the best-performing G10 currency as the USD weakened and some of the pessimism caused by Bank of Canada Gov. Poloz’ recent speech faded. Investors may buying ahead of today’s Canada GDP and industrial product prices, although I expect only the latter to be a reason to push CAD higher (see below). CAD’s rallyl was all the more impressive given that oil prices fell on the day.

Today’s market
Following yesterday’s German CPI figures, the focus for the indicators today remains on inflation, with the EU-wide inflation figures and the US personal consumption expenditure (PCE) deflators coming out.
There’s a lot happening over the weekend, too. If Catalonia goes ahead with its referendum on independence, that could hurt EUR. And Japan announces the results of its quarterly Tankan report, the most important Japanese economic indicator, at the start of its business day on Monday.

UK indicators will dominate during the European morning.

The European day starts with British house prices from the UK Nationwide Building Society. While the year-on-year rate of growth is expected to slow, on a month-on-month basis, prices are expected to rise slightly, compared to the slight fall in the previous month. That could be interpreted as supportive for the pound, even though it does appear that the downward trend is still in place. 

German unemployment can sometimes affect EUR, but usually it’s just a minor impact.

The Bank of England data on mortgage approvals is expected to show a 2% month-on-month decline. This would be in contrast to the 0.4% mom increase in the British Bankers’ Association. While not impossible, the two indicators have moved in the same direction 85% of the time since 1999 (88% since 2010), so such divergence would be a relatively rare occurrence. I see a good possibility of an upward surprise in this indicator, which could also be positive for the pound (if it happens). 

The third and final revision of UK Q2 GDP is expected to be unchanged from the 2nd revision and therefore unlikely to have much impact. 

EU CPI is the crucial indicator for the Eurozone nowadays as the ECB mulls withdrawing some of its extraordinary stimulus by slowing down and eventually stopping its monthly bond purchases. Today’s CPI data is the last one before the ECB’s October meeting (26 October) and hence will set the background for the discussion then.

While the headline figure is expected to creep up a notch, core CPI (which excludes energy prices) is expected to rise at the same pace as in the previous month, well below the Bank’s target of “below, but close to, 2%”.

Nonetheless, this result is already incorporated in the ECB’s outlook and shouldn’t give the Board pause. At the Bank’s last meeting on 7 Sep, ECB President Draghi noted that core inflation has “yet to show convincing signs of a sustained upward trend.” Nonetheless, he said it “is expected to rise gradually over the medium term, supported by our monetary policy measures, the continuing economic expansion, the corresponding gradual absorption of economic slack and rising wages.” Thus so long as inflation doesn’t slow further, the report should be positive for the euro.

Yesterday’s German HICP inflation rate was unchanged from the previous month, contrary to expectations that it would accelerate slightly.  

The US day starts off with US personal income and spending. Both are expected to be up from the previous month, but growth is expected to drop by 20 bps from the previous month’s month-on-month rate of growth. Both are expected to rise at a below-trend pace. Growth in incomes is expected to continue to outpace growth in spending (not in my family, unfortunately), which is healthier over the longer term but may result in some negative reaction in the dollar.

An examination of the impact of these two indicators on EUR/USD suggests that the market largely ignores the income figure and focuses on spending, at least with regards to the surprise vs expectations. 

The US PCE deflators are expected to show much the same story as the EU CPI data:  headline inflation accelerating slightly but core inflation remaining stubbornly below target. This is important for the US, because the core PCE deflator is the Fed’s preferred gauge of inflation. Nonetheless, again as in Europe, this prospect seems to be incorporated already in the FOMC’s thinking, as embodied in Fed Chair Janet Yellen’s recent comment that “it would be imprudent to keep monetary policy on hold until inflation is back to 2 percent.” Accordingly, so long as the PCE deflators don’t slow, I would expect this report to be positive for the dollar and to outweigh the impact of slowing incomes & spending. 

An examination of all four of these four indicators – personal income, personal spending, PCE deflator and core PCE deflator – shows that the market’s reaction seems to follow the headline PCE deflator most strongly, at least in the first 30 minutes. That’s what I would expect the market to focus on if there’s any contradiction among the indicators. 
Canada will also be in focus as the country announces its monthly GDP figure as well as industrial product prices, the equivalent of producer prices. These two series, which are released simultaneously, are forecast to have opposite impacts on the currency, which suggests considerable volatility following the reports as investors weigh the relative importance of each.
Canada’s GDP growth is forecast to have slowed somewhat in July. This should come as no surprise to the Bank of Canada; Gov. Poloz said in his speech on Wednesday that the 4.5% pace of growth in Q2 “is unlikely to be sustained, and recent data point clearly to a moderation in the second half of the year.” Still, in the context of his observation that monetary policy “will be particularly data dependent”, plus the market’s newfound skepticism about the pace of rate hikes in the country, the news could be negative for CAD.

On the other hand, the nation’s industrial product prices are forecast to rise sharply after two months of steep declines. This could bring the prospect of higher inflation back into the conversation and reverse some of CAD’s recent softness. 

Which indicator is likely to win out? Watch for any divergence from the forecast. My guess is that since industrial product prices are most closely associated with inflation, the result here should be the key to CAD, but of course the market is not always so rational. It also depends on the size of any miss.

There will be a major hurdle for EUR over the weekend:  a possible referendum on independence for the Spanish region of Catalonia. The regional government there has pledged to go ahead with the referendum, which Spain’s Constitutional Court has outlawed. If the referendum goes ahead – not certain at the time of writing – and if the vote is for independence – also not certain – it could plunge Spain into a constitutional crisis. Following the recent better-than-expected showing by the AfD in Germany, such a result could resurrect political concerns about the Eurozone, resulting in downward pressure on EUR.

Catalonia held a symbolic poll in 2014. The vote was overwhelmingly in favor of complete succession (80%), but only 32% of the electorate took part, meaning only 26% of possible voters voted in favor of succession. Thus even if the vote goes ahead on Sunday, it’s impossible to say how it will go, and even if it goes in favor of succession, it’s impossible to say what impact it will have, since the central government has already ruled it’s illegal. Nevertheless, uncertainty is bad for a currency, and such a result could be expected to be negative for the euro.

Finally, right as the market opens for business Monday morning Asian time, Japan announces the Bank of Japan’s short-term survey of economic conditions, aka Tankan, for Q3. This is the most important Japanese economic indicator. While there are almost limitless data points from this survey of 10,799 non-financial and 196 financial companies, the most important ones are probably the diffusion index (DI) for large manufacturers, plus the larger manufacturers’ forecasts for what their DI is likely to be in Q4. That gives an indication of whether they see things headed. Both are expected to improve by one point. Oddly enough, that could be negative for the yen, because the tankan often has a strong impact on the stock market, and when the stock market rallies, JPY often weakens. 



This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.
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