Weekly Market View

Overview

The rush into top-rated Treasury paper continues, new record low yields set for Swiss ten-year Conf (1.05%), Bund (2.09%), German 30-year (2.58%) and US ones (3.46%%), though Brazilian, Mexican and Russian benchmark yields are up from last week’s record lows. Equity indices are lower, many for a third consecutive week, the Nikkei 225 hitting a low at 8,807 and a weekly close just below key long term support at 9000. Only the Shanghai B share index bucked the trend with its biggest daily rally since November on speculation that it will be merged with the much larger domestic A-share market. Kuala Lumpur inched to its best level since February 2008 (just under the record high 1,521 of January 2008) and Jakarta set a new record at 3,150. The yen and Swiss franc gained against all currencies, another feature of the flight to safety, hitting 85.68 and 1.0220 per US dollar, EUR/CHF a new record low 1.2971. Commodities generally sidelined though 3-month LME Tin at $21,750 is at its most expensive in a year and Nymex Natural Gas at $3.825 per MMBtu cheapest since March and close to its lowest levels this decade.

Political and Economic Developments

A series of downbeat economic statistics from the US have reinforced the new reality many are staring at, which some call gloom. July Existing Home Sales dropped 27.2% M/M taking the annualised number of sales to a record low 3.83 million (from a peak of 7.25 million in 2005). Likewise New Home Sales dropped 12.4% M/M to an annual 276K, the lowest on record in a series going back to 1963. Admittedly the ending of government purchase incentives will have skewed sales, just as cash-for-clunkers brought forward car sales, so that many are now talking of further price falls; note that the average US home is worth $204K, the lowest since 2003 – seven years of depreciation to be written off. The Mortgage Bankers Association reported a small rise to 3.51% for mortgages 30 days past due, seriously delinquent (90 days overdue) 9.85%, and foreclosures 4.57% of all loans. Though Weekly Jobless Claims dipped to 473K from 504K (highest since November 2009) the prior week, obviously a rise here will have an effect on the ability to repay loans. There are suggestions that banks are being lenient, increasingly willing to modify and reclassify debt, because very low interest rates make this the easier option, something many have already done with commercial real estate – keep it as a performing loan for an annual cost of next to nothing rather than write-downs and repossessions.

Underlying Themes

Standard and Poors downgraded Irish sovereign debt one notch to AA- adding a negative outlook on worries that bank bailouts would require even more taxpayers’ money. Interestingly the Irish National Treasury Management Agency disagreed with their methodology. NAMA, the ‘bad’ bank created to offload dodgy debt from financial institutions to create ‘good’ banks refuses to disclose what assets it holds but rather worryingly the Irish Nationwide Building Society says it sold them €591 million with a 72% haircut. Ouch! Generally spreads over ten-year Bund yields have widened to new records, Greece 950 basis points, Ireland 371, Italy 168, Portugal 340 and Spain a not quite record 190.

What to watch for next week

Monday 30th August UK Bank Holiday though the UK’s Hometrack August Housing Survey is out, Eurozone Confidence, US July Personal Income and Spending, plus Core PCE. Tuesday Japan July Industrial and Vehicle Production, Retail Trade, Labour Cash Earnings, Housing Starts and Construction Orders, plus August Small Business Confidence. UK July Money Supply and Consumer Credit, August GFK Consumer Confidence, German Unemployment, EZ16 CPI and July Unemployment, US June CaseShiller House Prices, August Chicago Purchasing Managers, Consumer Confidence and Minutes of the FOMC meeting. Wednesday 1st September, Japanese August Vehicle Sales, Manufacturing PMI’s for various European countries, UK Halifax House Prices, US Challenger Job Cuts, ADP Employment Change, Manufacturing ISM, Vehicle Sales and July Construction Spending; Sweden’s Riksbank starts a two-day rate-setting meeting (some expect a 25 basis point rise to 0.75%). Thursday UK August Nationwide House Prices, Construction PMI, EZ16 Q2 GDP, July PPI, the ECB decides on rates (unanimously expected unchanged at 1.00%), US Q2 Unit Labour Costs, July Factory Orders and Pending Home Sales. Friday Japan Q2 Capital Spending, UK August Services PMI, EZ16 July Retail Sales, US August Non-Farm Payrolls and Unemployment, then Non-Manufacturing ISM. Monday 6th September Labour Day holidays in Canada and the US.

Positioning and Technical Analysis

Summer will be over by the 7th of September and the feel is very much back to school and back to work. And what are we facing? Much the same mess as we did at this time in 2008. Banks are a varied lot, some producing results suggesting they are in rude health, most looking like the walking wounded and some, zombies that even the most creative accountant cannot help. Not surprisingly interbank trust remains at zero, cash parked overnight at central banks, top-ranked paper yielding record low rates. Next, who needs yet more money and where will it come from? Who can cut or is so desperate they must cut spending?

The march to lower yields continues

Overview

The march to lower yields continues, now coupled with the weakening of the US dollar. Excessive buying of the greenback in the six weeks to mid-June have now been unwound, the Euro hitting a high at $1.3334, dollar/yen a new low for this year at 85.07, the Singapore dollar almost matching its record low at 1.3440, and this weeks best performer the South Korean won at 1160. Benchmark US two-year TNotes’ yield dipped to a new record low 0.513%, UK five-year likewise at 1.97%, foreign currency Brazilian and Russian bonds at new record lows of 2.56% (USD 2014) and 4.65% (EUR 30-year). Five-year maturities are outperforming, flattening that part of the curve while long-dated paper remains out of favour steepening the back end; ten-year JGB’s touched 1.00% their lowest since 2003. US Treasury Inflation Protected Securities (TIPS) out to 2015 now have negative yields of up to 49 basis points; 2.5% 2016 Index-Linked Gilts yield just 7 basis points. Note that US CPI is currently running at +1.1% Y/Y, Japanese prices excluding fresh food –1.0%, so that US Treasury real rates are mostly negative while Japanese ones are some of the few yielding a real 2.00%. Stock indices rallied on average by 2.00% this week, Germany, Helsinki, Mumbai, Singapore and Sweden inching to new highs for this year, easing from here this afternoon. Commodities generally rallied, a combination of dollar weakness and weather related (see below).

Political and Economic Developments

Eagerly anticipated US employment figures out today showing joblessness remained at 9.5% but as census workers were laid off a total of 131K jobs were lost, June’s losses revised up by 96K to a loss of 221K jobs. Weekly Unemployment claims hinted as such, edging up to 479K, just under the 490K that has capped since November 13th and well above July’s 427K floor. A total 14.6 million Americans are now unemployed, 44% for over six months. Flat June earnings and consumer spending unusually remained steady as Americans save rather than shop. From a rate of roughly 2% to 4% since 1999, and 0% to 2% between 2005 and 2008, they are now saving 6.4% as they did in the late eighties. Deleveraging de rigueur.
The Bank of England, ECB and Reserve Bank of Australia left rates unchanged at 0.50%, 1.00%, 4.50% respectively.

Underlying Themes

Nature, and more specifically the weather, has unleashed just some of her infinite powers on the world this year, reminding us how fragile life is. From earthquakes, volcanoes and oil spills, now heat waves and floods. Summer temperatures in the North East of the USA and across Europe have been unusually high, Moscow hitting a record 39 degrees Celsius and triggering forest fires which have blanketed the city in thick smoke. Wheat exports have been cancelled, Ukraine and Kazakhstan hard hit too, traders declaring force majeure and front month futures on the CBOT hitting 841 cents per bushel (almost double June’s level), dragging Oats (297) and Corn (425) in its wake. One weather station in Ireland recorded its wettest summer since measuring began in 1950 and the heaviest monsoon rains in eighty years flooded vast areas of Pakistan killing 1,600, rendering four million homeless. Since mid-July the worst rainstorms in a decade batter southern China, 1,100 dead or missing and 3M evacuations.

What to watch for next week

Monday Japan June Current Account, July Money Supply and Bank Lending, Bankruptcies, Economy Watchers’ Survey, German Trade Balance and Eurozone August Sentix Investor Confidence. Tuesday UK July RICS House Price Balance, DCLG June House Prices and Trade Balance, the Bank of Japan sets rates (expected unchanged at 0.10%) as July Machine Tool Orders are released, then US Small Business Optimism, June Wholesale Inventories, Q2 Unit Labour Costs and Non-Farm Productivity as the Fed decides on monetary policy (rates expected unchanged at 0.25% but watch for possible Quantative Easing steps). Wednesday Japan June Machine Orders, July Domestic CGPI, UK Nationwide Consumer Confidence, Unemployment, June Average Earnings and ILO Unemployed, the Bank of England’s Quarterly Inflation Report, US June Trade Balance and July Monthly Budget Statement. Thursday Japan July Consumer Confidence, US Import Price Index and EZ16 June Industrial Production. Friday the 13th German and Eurozone Q2 GDP, EZ16 June Trade Balance, US Business Inventories, July CPI, Retail Sales and August University of Michigan Confidence Survey.

Positioning and Technical Analysis

We continue to feel that rather than a quiet month August will see trends develop and more chaotic conditions predominate. Many top-rated bonds should see yields tumble to new record lows, those of dubious quality likely to suffer another hit as holders are forced out. The increasingly glaring spread between the two will become the domain of specialist firms only as credit committees relegate these to speculative status. The move to generalised US dollar weakness should continue and possibly gather pace as those returning from holiday are forced to take remedial action. Stock markets will probably be subject to increasingly violent intra-day swings.

Fundamental Perspective

The market expects that a U.S. report will reveal today, that the number of U.S. lost jobs increased for a second month. Yesterday, a report showed that initial jobless claims rose 19,000 to 479,000 in the week ended in the past month, which is the most since April. This could set the Federal Reserve under pressure to take extra steps to keep borrowing costs low. On top of that Nobel Prize-winning economist Joseph Stiglitz criticized that the U.S. economic recovery is “anemic” and demanded for a “better-designed” stimulus package. As a result of that the USD is close to a weekly decrease versus 15 of its 16 most-traded counterparts. The JPY traded near to an eight-month high against the USD and was at 85.85. Economists prognosticated that a German report will indicate industrial production rose for a fourth month. Even European Central Bank President Trichet is astonished about the fast recovery in Europe. Trichet said that the interest rate is appropriate and will therefore stay at a record low at 1 percent. Based on that the EUR was close to a three month high against the USD and traded at 1.3182. The EUR/USD already gained 11 percent after it had reached a 4 year low in June.

Australia’s currency was close to a three month high versus the USD. The AUD/USD climbed 1.2 percent this week and traded at 0.9150. The Reserve Bank of Australia will release today its quarterly statement on monetary policy whereat the economists do not expect any changes in central bank’s growth and inflation prognoses. New Zealand’s currency is close to a second weekly los versus the JPY. The NZD/JPY was at 62.66 and the NZD/USD traded at 0.7299.

Based on speculations that a report today will show that jobs were added in July for a seventh straight month, Canada’s currency strengthened to a two-month high versus the USD. The USD/CAD already fell 2.6 percent since July 20th and traded at 1.0108.