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Pound Falls Towards January Lows Following Weak UK Manufacturing

THE TAKEAWAY: UK PMI manufacturing falls to an unexpected 45.9 -> Manufacturing sector sees first job losses in five month -> Cable nearing January low
UK manufacturing slowed at the fastest pace since March 2009. Scaled back production and low employment led to a drop in the UK Purchasing Manager’s Index for manufacturing to 45.9 during the month of May. The index contracted from last month’s revised 50.2, according to Markit Economics, and disappointed expectations for 49.7. A reading below 50 shows a slowdown in manufacturing.
Markit Economics reported that the weakness in manufacturing resulted from worsening economic conditions and a subdued domestic market. Manufacturing production would have been worse if not for a backlog of existing contracts that needed completing. New export orders also fell for the second month in a row and the industry also reported job losses for the first time in five months during May.
Earlier today, the British Chambers of Commerce lowered its projected growth for the UK economy from 0.6% to 0.1% for 2012, the BCC also sees a 1.9% growth in 2013. Both the BCC and IMF are calling for increased stimulus to try and fight the effects of the euro-area crisis and keep Britain’s AAA rating.

Cable continued today’s fall towards January lows at 1.5232 following the weak UK PMI. EUR/GBP rose on the better than expected Eurozone PMI’s and continued its rally after the UK data release.

European Investor Confidence Falls to 3-Year Low

THE TAKEAWAY: Sentix investor confidence hits 3-year low, still better than expected -> European leaders continue to disagree over crisis fighting measures -> Euro sees slight bounce before today’s trading
European investors’ optimism for the Eurozone has reached a 3-year low according to a Sentix survey. The Sentix investor confidence for June came in at -28.9, the lowest score since May 2009, but still better than analysts’ expectations for a -30.0 survey result. Back in March of this year, the survey reached a six month high at -8.2, before the survey results declined for the next four straight months.
The Sentix survey reported a 3.5 point dip in investor confidence for the current situation to -35.0, and expectations for the future also dropped over 5 points to -22.5.
Eurozone worries weighed on economic sentiment as European leaders continued to disagree before the weekend on how to solve the debt crisis. German Chancellor Angela Merkel said that she would not agree to joint debt issuance under any circumstances. US President Barak Obama joined the ECB, Italy, and France in pressuring Merkel to take further steps to control the crisis contagion.
EUR/USD didn’t move much following the better than expected investor optimism survey. After the close of a bearish month that saw a 7% decline for the euro against the dollar, the pair started June with a bounce back above 1.2400 from a fresh 2-year low below 1.2300 during Friday’s trading.

Eurozone Needs Healthy “Proponomics” Application to Survive Crisis

• Markets finding some bids following excessive risk liquidation
• Aussie growth data come in much better than expected
• We introduce “Proponomics” – the economics of artificially propping economies
• Eurozone must apply this strategy to prevent further collapse
• ECB policy decision due later today; no rate change expected

It’s excellent to be back on the desk after some time off to enjoy my new baby boy.
Meanwhile, markets have settled following a wave of volatility resulting in broad based strength in the safe haven US Dollar and Yen. While there is still no clear resolution in place to deal with the Eurozone crisis, a simple need for some form of a technical bounce after some extreme moves is finally being recognized. At the same time, there are also some positives to talk about on the fundamental front, with the most recent much better than expected Aussie growth data perhaps helping to infuse a sense of confidence into the market place.
Broadly speaking, we contend that risk correlated assets could indeed find more demand over the coming weeks, even in the face of threats in the Eurozone and fear of contagion. Since the onset of the global crisis in 2008, there has been one constant that continues to support the markets at every step of misfortune, and that is the commitment by central banks and governments to step in and do whatever is necessary to prop the local economy. This approach of doing “whatever it takes” to prevent collapse and prop up struggling economies is a new form of economics that seems to be proving effective as evidenced by the ability for the US economy to slowly emerge from recession.
What better name for this form of economics then “proponomics,” the economics of pumping liquidity into the system to prevent collapse at all costs. The strategy doesn’t concern itself with longer-term threats to the local and global economy and instead focuses firmly on fixing the short-term problem. While it is clear that the risks to the longer-term economy are potentially exacerbated through the implementation of an artificial support to the economy, it is also true that inability to step in and deal with the short-term problem would be even worse than pumping the local economy with liquidity and keeping monetary policy ultra accommodative.
Right now, the short-term threat to the Eurozone economy is more significant than the longer-term one and proponomics seems to be the most effective strategy. It now looks as though Europe will need to step up on this front and overinflate its way through the turmoil in order to prevent what could be a very serious disaster. Therefore, if Eurozone officials can step up and offer some form of reassurance that they will do whatever necessary to keep the Eurozone intact, we feel the outlook will be brighter despite the many obstacles that will still need to be overcome. The European Central Bank is scheduled to meet later today and while no change is expected on rates, we view this as a formidable opportunity for Mr. Draghi to step up and provide the necessary reassurances to both the Eurozone and global economies.

Euro Finds Renewed Bids But Price Action Still Classified as Corrective

• Risk correlated assets finding renewed bids
• German plans to strengthen Spanish banks inspire confidence
• ECB Draghi says the central bank is ready to act if necessary
• EUR/USD next key resistance comes in by 1.2625
• Bank of England rate decision due later today

Risk correlated assets have been very well bid over the past few sessions, with currencies and equities reversing sharply as market participants are able to let go of the worst of their fears for the time being. The doom and gloom sentiment that had taken hold in the previous week has faded and investors are once again warming up to the idea that the Eurozone may be able to escape the current crisis and avoid breakup. News that Germany is drafting plans to strengthen the Spanish banks without expecting further reforms or any formal aid deal has been seen as a huge positive and this has been once of the primary drivers of this latest risk-on trade.
Although the European Central Bank left policy on hold as was expected, comments from ECB President Draghi that the central bank is willing to act if necessary have also been helping to bolster sentiment. The Euro now eyes a retest and break of the previous weekly high by 1.2625, while the Yen has also been very well offered on the liquidation of safe haven plays. Still, at the end of the day, this is a market that had been in desperate need of technical correction following some intense risk-off moves, and at this point, we would attribute the recent price action more to the technicals than fundamentals.
European leadership will really need to dig in and come up with some serious plans to resuscitate the region for there to be any hope of a sustained Euro recovery. Until then, the strategy should be to look to sell these currency rallies into additional strength. Looking ahead, the Bank of England is slated for a rate decision later today. While no policy change is expected, there is a good deal of speculation that the Bank of England will shift to a more dovish stance in light of the ongoing pressures in the global macro economy.

Risk Correlated Assets Expected to Overcome Initial Resistance

• China rate cut euphoria fades; markets come under some pressure
• We suspect markets will however find support into this dip
• Euro could be looking for bullish reversal week
• Look for EUR/USD setbacks to find support in the 1.2400’s

While admittedly, markets are in an overall risk off state, we are somewhat surprised to see just how aggressively this latest selloff has played out since late in the North American session on Thursday. It seems as though the initial wave of euphoria from the China rate cut has been transformed into a deluge of fear on the potential implications from such a move. Many investors have grown discouraged with the idea that the Chinese accommodation is a reflection of just how bad things really are. While we would agree with this view in principle, we are more optimistic with the China action and suspect that it could help to once again prop the global economy.
On Wednesday, we discussed the concept of “proponomics,” a new approach to financial crisis management, where governments and central banks do whatever it takes to keep economies afloat despite any potential longer-term risks and consequences. So far, this strategy has proven quite effective at ground zero (start of global downturn) in the United States, where the US government and Fed have aggressively adopted the proponomic approach. The implementation of ultra-accommodative monetary policy and quantitative easing has helped to keep markets supported overall, providing investors with the security and confidence that they will be backed up at every turn.
Certainly, there is plenty of room for critique of this approach to financial crisis management which can also be viewed as an attempt at artificially supporting an economy that needs to be able to take its blows and handle defeat just as it was able to easily except victory in the many years of prosperity that preceded the crisis. However, for the time being, the use of proponomics has proven quite effective and the US economy seems to be gradually working its way out of recession. Moreover, there has been a coordinated effort across the globe to adopt this approach, and this has helped to further support the markets in times of panic.
As such, we look for this new form of government backstopping to continue to prop the markets, and we suspect that this resumption of risk on trade that we have seen this week could still continue for another week or so before ultimately finding resistance. The sell-off that we have seen in late Thursday and early Friday trade has been in very thin trade, and we suspect that this is the net result of the first wave of bears trying to sell back into he trend. Generally, this first wave is unsuccessful and is more of a trap than anything else. Presumably, all the markets need now is a firmer commitment to proponomics from Eurozone officials, and it seems as though things could very well be headed in this direction. ECB Draghi’s comment that the central bank is ready to act if necessary is a good move in this direction.
Technically, we also see room for additional strength in risk correlated assets before any form of renewed selling, and the Euro looks like it could still head towards the 1.2800-1.3000 area from here. The break back above the previous weekly high has also set up the potential for a bullish reversal week with the market breaking a sequence of four consecutive weekly lower lows and lower highs. We would therefore be looking for any Euro setbacks to be very well supported above 1.2450, in favor of fresh upside towards 1.3000 over the coming days. At that point however (when 1.3000 is tested) we are more skeptical of the rally being able to sustain itself even with a healthy dose of proponomics.

Dollar’s Failure to Capitalize on S&P 500’s Tumble Concerning

• Dollar’s Failure to Capitalize on S&P 500’s Tumble Concerning
• Euro Rebound Gains Momentum, Though Tangible Support Lacking
• Australian Dollar Traders Ready for the RBA Rate Decision
• Canadian Dollar: Will the Bank of Canada Rate Decision Move the Market?
• British Pound Steadying but Not Participating in Risk Rebound
• Japanese Yen: Intervention or Not, The Yen is Proving an Epic Battle
• Gold Rally Stalls as Euro Firms, Need for Alternative Store of Funds Eases

Dollar’s Failure to Capitalize on S&P 500’s Tumble Concerning

The US dollar’s hesitation is starting to look a lot like burgeoning selling pressure. Has the backdrop for global financial and economic health taken a sudden turn for the better and subsequently negated the demand for a liquidity-renowned, safe haven greenback? Hardly. On the other hand, the risk deleveraging effort through May unfolded at an incredible pace. Though implied volatility measures are still well off their respective highs, the actual progress on risk-sensitive currency pairs (like AUDUSD) and capital market benchmarks (like the S&P 500) may have pushed us to a position where sentiment has overrun tangible fundamental developments. In this instance, ‘Over-extended’ on a fundamental basis is not a function of an actual change in the bearing of economies and financial systems but the market’s expectations for where they will go.

When risk aversion kicks in from elevated heights, there are two levels of correction: one where those with existing long-risk exposure will unwind to a neutral position (like reversing a long carry trade) and another in which fear encourages market participants to increase ‘safe haven’ exposure (as with buying US Treasuries). There is evidence of both from the past month, but the amplitude of the recent drop no doubt reflects speculative interest that has added to the short-risk position, thereby leveraging the drop. As momentum cools on the decline, those that played the decline are more inclined to book profit and thereby lead to a pullback. There is an inherently temporary aspect to profit taking on speculative shorts. Eventually, the uncommitted shorts will be exercised and all that is left is the underlying trend of true risk-deleveraging – that is unless the fundamental backdrop genuinely improves, and there is little to suggest that is the case here just yet.

Taking stock of the underlying current, the capital markets are adjusting to a global economic slowdown, the international repercussions of a European financial crisis, as well as a steady decline in yields and increase in volatility. Substantially changing the bearing of this fundamental bearing is a long-term process. There is, however, one thing sharply alter speculators’ view in the immediate future: stimulus. Those that have assumed the Fed would announce a following support scheme to fill in for the expiring ‘Operation Twist’ revamp are even more certain that the Fed’s June policy meeting will result in another operation (either extending the maturity of Treasury holdings and/or buying mortgage assets). We are still weeks away from that decision, but perhaps the rumored G7 meeting Tuesday will do something to fill the time or solve the problem?

Euro Rebound Gains Momentum, Though Tangible Support Lacking

The Euro has mounted an impressive recovery over the opening 24 hours of the week. Though its gains were most prominent against relative safe havens (the US dollar and Japanese yen), the progress made against the high-yielding subset reflects on its inherent fundamental strength. Trying to point to a single development that supports euro bulls’ cause leaves us coming up short. A meeting between the EU’s Barroso and Merkel found the German Chancellor fortifying her position against EU bonds, Portugal announced financial support for three troubled banks and Standard & Poor’s said there was a one-in-three chance Greece would leave the Eurozone. Progress against the current is risky.

Australian Dollar Traders Ready for the RBA Rate Decision

We have come upon the RBA’s rate decision and expectations have been set rather high. There is more than just a dovish bias for the central bank, the markets have priced in hearty speculation that the central bank will make another aggressive move in order to head off a weakening fundamental position. According to overnight index swaps, the market believes a 25 basis point (bps) cut is baked in and the more speculatively-inclined have pushed us to a nearly 50 percent chance that the central bank will cut by 50 bps to 3.25 percent. That sets the bar rather low. If, in turn, the RBA only shaves off 25 bps, there will be a contingent of the market that may quickly find itself over-extended on a short Aussie position. This would not necessarily translate into a bullish turn for the currency (the RBA is still easing), but it could fuel a correction.

Canadian Dollar: Will the Bank of Canada Rate Decision Move the Market?

Drawing a direct contrast to the Australian policy decision, the market has shown little favor to the Canadian dollar even though it has largely escaped the dovish pressure its Aussie and kiwi counterparts have fallen under. In fact, the Bank of Canada is the only central bank amongst the majors that is actually expected to raise rates over the coming 12 months. Currently, the market is pricing in 28 bps of hikes over the coming year (that translates into a certainty of a quarter percent hike and modest speculation of more). This might not seem much for a benchmark that is only 1.00 percent; but when we juxtapose it against the RBA’s hearty cuts and the RBNZ’s questionable bearing, it looks quite good.

British Pound Steadying but Not Participating in Risk Rebound

Where the pound has suffered for the Euro-area’s financial troubles, it hasn’t really recovered with the subsequent bounce for the euro itself. It isn’t difficult to get ahead of ourselves in fretting the fall of collective currency, but things move at a more moderated and consistent pace when the topic is the slow spread of financial crisis to the region’s most fundamentally connected, non-member. Further undermining the sterling’s performance was a sovereign downgrade by Egan-Jones (to AA- from AA). Fortunate for the pound, they don’t carry the as much weight.

Japanese Yen: Intervention or Not, The Yen is Proving an Epic Battle

Both on Friday and early Monday there were bouts of tremendous volatility for USDJPY and other yen-crosses. There is debate as to whether this was evidence of intervention. The answer doesn’t change the situation all that much however. If it was, the Finance Ministry and BoJ may have lost all influence over the market through standard manipulation (something already expected). Can they follow the SNB? No.

Gold Rally Stalls as Euro Firms, Need for Alternative Store of Funds Eases

After forging the largest, single-day rally in years this past Friday; gold bulls decided to back off the gas Monday. With the euro bouncing and the dollar unable to take traction on the equities sell-off, we would assume this was the best set of safe-haven-without-liquidity-concerns that we could hope for. Nevertheless, the metal remains in a broader construct of congestion. When will it break and what bearing will it take?