Financial Futures and the Global Economy
By Alan Bush, Archer Financial Services
THE MACROECONOMIC VIEW
There are clear indications that the global economy is in recovery. However, it is also clear that the improvement is an uneven one from a geographical point of view. For example, the recovery in China's economy actually appears to be moving to beyond just recovery. In fact, there is talk that China's economy is approaching the bubble stage. China's Customs Bureau reported that exports increased 45.7% in February from the year ago period, when the median guess called for a 38.3% advance. China reported that their inflation level hit a 16 month high and new loans were more than anticipated. This prompted fears that China could withdraw some of their economic stimulus. In addition, there is a growing belief that China's central bank will increase reserve ratios or interest rates in the near future.
The euro zone economy was beginning to show some signs of life until the sovereign debt default risk of holding Greece's debt came to the forefront. Investor sentiment quickly turned negative due to the sovereign debt issue, but is now improving, as it appears that the worst of the Greek sovereign debt crisis is out of the way. French President Sarkozy promised support for Greece, when he said the euro zone is ready to rescue Greece, if the government needs additional assistance in an effort to limit their massive budget deficit. Recently, the government of Greece passed an additional round of austerity measures and many analysts believe that Greece is doing as much as they are able to do now. There were press reports that Greece may get a $75 billion bailout from the European Union.
The U.S. economy is also showing some signs of improvement, although the various sectors of the economy are recovering unevenly. For example, in their statement from the March 16 Federal Open Market Committee meeting, the Federal Reserve said the labor market is stabilizing and business spending has risen, while inflation remains subdued.
We are seeing over half of the economic reports in the U.S. coming in stronger than the analysts' estimates. For example, February housing starts were 575,000, which compares to an estimate of 570,000 and housing permits were 612,000, when 601,000 were anticipated.
Retail sales numbers have been strong, as well. Advance February retail sales were up .3%, which compared to an estimate of a .2% decline and retail sales, excluding autos, were up .8%, when a .1% advance was anticipated.
Most of the world's major central banks are maintaining, or only slowly removing their emergency economic stimulus that was established at the height of the global recession. This historic central bank policy of extreme accommodation is likely to have more pronounced positive effects on the global economy in the months to come.
U.S. INTEREST RATES
Since the blow off top was made in the Treasury markets in December 2008, prices have moved sideways. However, the short end of the curve continues to remain firm on the belief that the Federal Open Market Committee will be slow to increase the fed funds target. Currently, financial markets are factoring in a 73% probability that the Federal Open Market Committee will increase their fed funds target by 25 basis points to 50 basis points on or before their November 3 meeting. This feeling was underscored by the release of the Fed's March 16 meeting when the FOMC decided to maintain their current accommodative credit policy. The FOMC left the federal funds rate unchanged at zero to 25 basis points, where it has been since December 2008. They also pledged to keep interest rates low for an "extended period of time" in an effort to help the economy. Futures were temporarily encouraged by the Fed's status quo statement, since a minority of analysts believed that the keeping interest rates low for an "extended period" language could have been eliminated.
Another reason to believe that the nation's central bank will be slow to increase interest rates is a report that President Obama will nominate San Francisco Fed Bank President Janet Yellen to be Vice Chairman of the Federal Reserve. She has a history of being dovish on interest rate policies. In addition, in an effort not to appear political, the FOMC in the past has shown a tendency to not change interest rate policies just ahead of national elections. Even though the "on hold" Fed policy will support the front end of the curve, it is likely that the bearish influence of stronger than expected economic growth will be the dominate influence for the back end and will put pressure on the longer dated Treasuries. Even though the longer dated Treasury issues are holding up relatively well recently, our fundamental and technical research suggests that we are in the early stages of a new multiyear bear market for Treasury futures and the thirty year Treasury bond is likely to be the weakest performer.
Chart provided by APEX
CURRENCIES
The U.S. dollar topped approximately one month ago due to the growing belief that the Fed's federal funds target will be increased later rather than sooner. These greenback unfavorable interest rate differentials are likely to dominate the fundamentals now that the euro zone's sovereign debt issue is, at least for now, out of the headlines.
Chart provided by APEX
The euro has recently firmed due to news that European finance ministers, recently meeting in Brussels, agreed to a strategy for emergency loans to Greece. The euro was also supported by news that German investor confidence fell less than anticipated in March. The ZEW confidence index fell to 44.5 from 45.1 in February. The median guess was 43.5.
Chart provided by APEX
Earlier this month the British pound fell after Moody's Investors Service said the U.K. is moving "substantially" closer to losing its AAA rating, as the cost of servicing their debt increases and after a report showed that U.K. manufacturing unexpectedly contracted in January. The Office for National Statistics said manufacturing output fell .9%, which was the first drop in five months. The median guess for this report called for a .2% advance. In addition, there are lingering concerns surrounding the U.K.'s budget deficit problems, which are 12% of gross domestic product. This is close to the 12.7% budget shortfall that has been plaguing Greece. The pound was also pressured by reports that commercial banks in the U.K. could soon be downgraded by rating agencies.
More recently, the pound was able to gain after it was reported that U.K. home prices increased at their quickest rate in over seven years and after the National Statistics Office reported that U.K. jobless claims unexpectedly fell 32,000, last month, which was the fastest rate since 1997. A 6,000 increase was expected by analysts. The pound was also supported after the quarterly Bank of England survey said consumers' inflation expectations advanced to their highest levels since November 2008. A higher inflation level, at least for the industrialized countries, is thought to be a sign of a pickup in economic activity.
Chart provided by APEX
The Swiss franc advanced to a 17 month high against the euro on ideas that the Swiss National Bank may be less inclined to intervene in foreign exchange markets now that the Swiss economy is showing additional signs that it will outperform the euro zone economy.
Chart provided by APEX
Earlier this week the Japanese yen came under pressure on the belief that the Bank of Japan will ease monetary conditions further at their policy meeting on March 16-17. There was follow through pressure on the yen when it was reported that the Bank of Japan, at that meeting, decided to double the size of a loan program that was designed to counter deflation. This change in policy is a form of easier credit, which is bearish for the yen. The yen was also undermined by threats of BOJ intervention against the yen.
Chart provided by APEX
The Canadian dollar is likely to trade higher due to favorable interest rate differential expectations, along with prospects of higher commodity prices. It was recently reported that the Canadian economy grew at an annual rate of 5% in the fourth quarter of last year, which was the fastest rate of growth since 2000. Currently, financial markets are factoring in a 22% chance that the Bank of Canada will increase their benchmark interest rate by 25 basis points to 50 basis points at their June meeting and there is virtually a 100% probability that they will increase the rate by 25 basis points at the July meeting. In addition, the World Economic Forum in Geneva said Canada's financial system is the soundest in the world. The Canadian currency was also helped by the belief that Canada may be the first of the Group of Seven nations to eliminate its budget deficit. Expect higher prices for the Canadian dollar.
Chart provided by APEX
The Australian dollar is at its highest level since January 20. The fundamentals remain bullish. It was reported that job vacancies in Australia increased by the largest amount in almost ten years. An increase in job listings, in Australian newspapers and on the internet, increased by 19.1% in February from January.
The minutes of this month's Reserve Bank of Australia meeting showed policy makers increased borrowing costs due to the belief that the inflation risks associated with of faster economic growth outweighed the possible risk for renewed financial market instability. The Australian currency is also being supported by ideas that the RBA will continue to increase interest rates. Currently financial markets are pricing in a 33% chance that the Reserve Bank of Australia will increase their benchmark interest rate by 25 basis points to 4.25% at their policy meeting on April 6. Of the ten most heavily traded currencies, the Australian dollar was the best performer against the U.S. dollar in 2009. Our analysis tells us that there will be a repeat performance. The Australian currency is likely to be the strongest currency again this year.
Chart provided by APEX
STOCK INDEXES
Our research continues to tell us that the downturns in stock index futures prices that we experienced last July, November and in late January and early February of this year were only corrections in a bull market. Futures have recently shown a tendency to temporarily come under pressure on bearish news, before a new leg to the upside. Over the last six months, prospects of tighter credit from the nation's central bank continued to get pushed farther out into the future. It appears that Federal Reserve policy is likely to remain accommodative for a longer period of time than many analysts are expecting and some of the primary government securities dealers do not believe that the U.S. central bank will raise interest rates until the second half of 2011. We believe that the next tightening of credit from the Federal Open Market Committee will not take place until 2011.
Chart provided by APEX
The accommodative Federal Reserve policy, along with a strengthening economy will be able to overcome all other influences, including the political ones. S&P500 and Dow futures are now at their highest levels since October 2008 and NASDAQ futures are at their highest levels since September 2008. Continue to trade from the long side on weakness. Our research continues to tell us that this bull market will continue through 2010.
If you have any questions or comments or would like more information about this article, please contact Alan Bush at 1.877.690.7303 or email him at alan.bush@archerfinancials.com.
Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. The views and opinions expressed in this letter are those of the author and do not reflect the views of ADM Investor Services, Inc. or its staff. The information provided is designed to assist in your analysis and evaluation of the futures and options markets. However, any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to ADMIS. Copyright © ADM Investor Services, Inc.
