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June, 2009 Monthly Forecast
The ABC’s of Recovery
by TradetheNews Staff
With the doomsday scenario apparently off the table, prospects for
recovery have helped fuel the resurgence in stocks and in some
commodity prices. The first wave of the Treasury's unprecedented debt
sales have been absorbed relatively smoothly, though the US dollar has
weakened substantially on concerns about the mounting government debt
burden. Still, there are growing hopes that the economic rescue
measures implemented by global central banks and governments are
beginning to take hold and provide a lush foundation of ‘green shoots’
underfoot that can be nurtured into a blossoming global economic
recovery by late 2009 or into 2010. The data in May seemed to have
confirmed that things have stopped getting worse but do not suggest a
timeframe for when the economic environment will actually improve.
Debate is now centering on what the “shape” of the economic recovery
will be, with sentiments represented by letters from "V" to "U" to "W,"
and of course, the dreaded "L". A number of economic and political
events in June could help influence the outcome of this economic
alphabet soup.
Triple-A, For Now
Peering
into June, trading in US Treasuries will likely remain a focal point
for financial markets around the world. The action in these markets
will hint at the possible shape and timing of any economic recovery. A
sustained uptick in rates could severely hinder any rebound in US
housing, but also stoke fears the United State’s AAA sovereign debt
rating could be jeopardized by driving up the cost of issuing and
servicing future debt. US credit markets participants will also
continue assess Fed policy with specific attention on the effectiveness
of its quantitative easing program.
The benchmark US 10-year
yield gained roughly 40 basis points in May to test the psychological
level of 3.5%, including a spike towards 3.75% late in the month. The
relative ease with which rates were testing their highest levels in
months caused some justifiable fears that a subsequent move up in
mortgage rates could extinguish any recovery in the housing market. The
widening spread between mortgage backed securities and comparable
Treasuries over the final two weeks of May only fanned those concerns.
The month’s final two trading sessions saw rates retreat as experts and
government officials, including some at the Fed, signaled the current
environment of rising rates is likely a harbinger of economic
improvement down the road. As long as rates stay within a context that
is historically viewed as low, and the incoming data continues to
decline at a slower rate, a bottoming process for the economy can find
traction. Under that scenario the allocation from the relative safety
of government backed bonds to riskier assets can continue.
Ultimately
rates likely moved higher in May on concerns surrounding rapidly
expanding deficits and the ever increasing future Treasury supply
needed to fund it. Though the month’s auctions of new supply went off
pretty much as well as can be expected, anxiety remains high ahead of
the 10 and 30-year paper sales set for the second week of June. Demand
has definitely been more fickle at the long end of the curve as
evidenced by the US benchmark spread widening out to its highest level
on record in the final week of May. A certain level of trepidation has
seeped into markets surrounding the US Treasury’s ability to
successfully find demand for the oncoming supply.
Treasury
demand concerns were initially highlighted through a mid-May coupon
purchase by the NY Fed. It garnered special attention after the amount
submitted for sale was the largest since the inception of the
quantitative easing program, but in response the Fed was unwilling to
increase its purchases. This gave the markets a noticeable jolt of
disappointment in light of the fact just the day before, the FOMC
minutes hinted that the Fed was mulling an increase of its asset
purchases going forward. US yields continued to trek higher into
month’s end as traders and prognosticators alike suggested the markets
were testing the Fed’s resolve. Criticisms abound regarding the size of
the Fed’s asset purchasing operation and the ultimate effectiveness of
the quantitative easing methodology, with many critics urging the Fed
to immediately announce that it will boost its current operations to
buy back Treasury and mortgage backed securities, which currently have
about $170B and $750B remaining, respectively. Reports suggest that Fed
members are studying the recent rise in yields but are still hesitant
to make any dramatic changes at this time. With the FOMC not scheduled
to meet until June 23rd, it will be interesting to see if rates can
continue rise without the Fed stepping up in a more aggressive manner.
The
mid-month the move higher in US yields was exacerbated by S&P’s
decision to downgrade its outlook for the UK’s AAA sovereign debt
rating. Concerns quickly found their way to the US as many speculated a
similar action on Uncle Sam’s debt was in the offing. Though both
Moody’s and S&P would ultimately come out and affirm their AAA
ratings and outlooks, comments from widely followed experts like
PIMCO’s Bill Gross and Mohamed El Erian kept the notion in the
forefronts of traders' minds. Both pointed to the conflict of interests
between the government’s aggressive short term actions to stimulate
growth and the long term imperative to significantly cut the deficit
and future borrowing needs.
All the "T" in China
These
sovereign debt rating whispers were intensified by an environment of a
declining US dollar and rising prices for hard assets. Speculation is
growing that foreign nations are looking to diversify away from dollar
denominated assets, and the mid-June meeting of BRIC nations in Moscow
promises to see ministers discussing the dollar. Also of note, on June
1st and 2nd Treasury Secretary Geithner will travel to China to meet
with his counterparts there. Geithner, whose first political gaffe came
during his confirmation hearings when he seemed to suggest China was a
currency manipulator, will likely tread very carefully as he meets the
USA's biggest creditor. Any policy missteps at this critical juncture
could cause the dollar to slide and Treasury yields to rise further.
China's
PM Wen recently cautioned about "blind optimism" for economic recovery,
warning governments should not underestimate the possible duration of
the crisis. Abundant caution is warranted as unemployment and
bankruptcies continue to mount, and the housing market continues to
seek a bottom. In light of this, EUR/USD enters June just above the
1.40 level with the USD clearly on the defensive, despite US officials
assuring that a strong dollar policy remains intact. The direction the
US dollar will take in coming months will be largely determined by the
“shape” of things to come, both in terms of the shape of the economic
recovery and the shape of the global yield curve.
Major central
banks may be caught in a US dollar trap as large holders of US
Treasuries (particularly China) have little choice but to keep pouring
the bulk of their growing reserves into the U.S. debt instruments.
China has expressed its discontent with the Fed freely printing money
under for its quantitative easing activities, but the Treasury remains
the only market big enough and liquid enough to absorb China’s huge
purchases.
Should the USD continue to exhibit weakness, the
question of currency intervention could become one of the key buzzwords
in June. Last year, prior to the global economic slowdown taking hold,
the German Export association called the 1.50 level in the EUR/USD a
‘line in the sand.' Should the greenback reach this boundary, economic
headwinds and the need for US to keep confidence in the dollar might
provoke a rare central bank coordinated effort to hold that line.
Preparing for an “L”-Shaped Future?
June
4th will see the ECB policy meeting, which is expected to hold interest
rates at 1.00%. The meeting will generate intense interest as the ECB
is expected to provide the technical details of its €60B covered bond
purchase plan. At the ECB's press conference, the media may raise the
question of whether the program can be expanded beyond €60B, which is
less than half the size of the equivalent Fed asset purchasing
operation. Market participants will also look for more hints on whether
the ECB has definitively decided if interest rates are at their lowest
possible level. The BOE meet the same day and is expected to remain
hold its base rate at the historically low 0.50%.
The FOMC's
rate announcement comes on June 24 as speculating grows that the Fed
will up the ante on quantitative easing. To their credit, the Fed and
other central banks have started jawboning about the eventual
withdrawal of the extraordinary stimulus they have been providing. But
this summer central bank speakers may start feeling pressure to be more
forthcoming about the details of what will clearly be a very tricky
disengagement process to forestall murmurs that and exit strategy might
not exist. This even as the Fed may judge it needs to go even bigger on
its asset buying plans.
In its latest economic forecast, the Fed
revised its outlook to reflect a deeper recession in 2009 and slower
recovery in 2010. Several data points this month will help inform the
central bank's evolving economic assessment. Unemployment, though
deemed a lagging indicator, is particularly sensitive in this time of
the government essentially nationalizing auto makers and financial
firms and forcing massive layoffs as part of restructuring efforts. The
US May Nonfarm Payrolls and Unemployment data will be released on June
5, and are expectations are the jobless rate will continuing to
stampede toward 10%, while over half a million jobs will be lost for
the 7th month in a row. Inflation data represented by the PPI (6/16)
and CPI (6/17) will also be increasingly eyed as commodity prices
continue to press higher.
“A” is for Ana
Commodities
had a remarkable rally in May, with the CRB commodities index posting
its biggest monthly percentage gain since 1974, on bets that the world
economy is starting to stabilize. Crude oil led the way, rebounding
significantly off of recent lows thanks in part to strong compliance by
OPEC members and a weakening US dollar. In fact, crude had its biggest
one month move in about 10 years, rising over 30% in May. Notably,
$66/barrel oil has not been followed by natural gas, which continues to
linger near multi-year lows, a sign that the crude rebound could be
based more on speculation of economic recovery than on any
fundamentals. Ironically, the bets on an economic rebound that have
helped drive commodities higher could put a damper on recovery as
higher material and energy prices could restrain the still fragile
economy.
Hurricane season officially starts June 1, and weather
experts at NOAA are forecasting a moderately active season with 9 to 14
named storms expected of which 1 to 3 are expected to be major storms.
The first named storm will be called Ana, and she and her brethren
could throw some new volatility into the energy market after three
relatively quiet storm seasons following the upheaval Katrina caused in
2005. A rough hurricane season in the Gulf of Mexico and persistent
dollar weakness could boost the entire energy complex and send crude
toward OPEC’s nominal $75 target. On the other side of the ledger, as
the price of oil rises OPEC members have an increasing incentive to
cheat on quotas, though they have shown unprecedented discipline to
date.
U-Turn Ahead?
As the pace of decline has
slowed, investor appetite has turned back in the direction of China,
where expectations of hard commodity demand has helped copper reach
7-month highs. Recently Vale, the biggest miner of iron ore and nickel,
announced it was not planning any more output cuts due to recovery of
demand from China. That sentiment was then echoed by other large miners
Rio Tinto and Fortescue Metals, who saw China demand improving amid the
bottoming process in spot metal prices. The timing of the bullish
outlook is particularly significant for another reason—Chinese
steelmakers are still embroiled with miners on securing this year's
pricing commitment and face the prospects of buying iron ore at the
steadily rising spot levels, while their Korean and Japanese
competitors have already secured a 33% price cut.
Other voices are
less optimistic. The CEO of mining giant BHP recently expressed
concerns that Chinese buying is not an evidence of real demand but
rather an inventory buildup at bargain prices in preparation for the
stimulus. Also, according to the Financial Times, implementation of
that stimulus is in question because state officials and private
sector— responsible for CNY2.8T of the CNY4T package—are having trouble
financing their share of the burden. Likewise, a World Bank official
suggested that expectations of recovery in China is premature and needs
to be validated by improving domestic consumption. The coming weeks
should clarify some of this uncertainty over the true economic state of
the region, however if the balance does shift back in favor of the
skeptics, given the extent of the recent run-up, the perception of the
V-shaped bounce is likely to take an abrupt U-Turn.
Spelling it Out
The
global economy is still in a fragile state, and despite signs of
stabilization and glimmers of recovery the timing of these improvements
remains uncertain. Keep in mind that there are plenty of factors that
could complicate things, not the least of which is the US Treasury’s
plans to borrow $1.8T this year. The Treasury’s ambitious plans can
only deepen the coming glut of sovereign debt and might threaten the US
and other nation’s sovereign ratings, while ensuing interest rate
problems could further weaken the world's reserve currency. And nobody
should count on a return to spending by newly cautious consumers, who
have been tempered by withering home prices and shrinking 401Ks.
Spending will not be roaring back to pre-crisis levels, making it clear
that while the worst may be over the road to recovery will be B-U-M-P-Y.
Calendar of Significant Events
June 1-2: Geithner in China
June 4: ECB and BOE rate decisions
June 5: May US Nonfarm Payrolls and Unemployment
June 10: Treasury’s 10-year auction
June 11: Treasury’s 30-year auction
June 24: FOMC rate decision
http://www.tradethenews.com/monthly-forecast.asp
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| Category: Forecast | Added by: forex-market (2009-05-31)
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