The health of the banking industry continues to remain an issue, which is likely to be in question for quite some time. Recently, Standard and Poor’s cut the credit ratings of three of the largest U.S. securities firms and also, on the fourth largest U.S. bank.
Housing concerns in the U.S. and overseas are worrisome, taking S&P futures lower, before what appears to be a temporary short covering advance.
The U.K.’s largest lender to landlords said they would have to raise more capital, which is stirring up renewed concerns about mortgage related losses in the U.K. and also in the U.S.
Not all of the news is bearish. Some of the recent economic reports have been coming in a little better than expected. Durable goods, for example, were only down .5% when a 1.5% decline had been anticipated and durable goods, excluding transportation, were up 2.5%, when a .5% decline was guessed. However, prices only temporarily advanced on the durable goods news and there was some disappointment when GDP was reported up only .9%, which was the guess.
Better than expected corporate earnings from a large computer manufacturer were ignored and there was only temporary strength when the personal income report showed a .2% increase against a guess of up .1%. Personal spending was up .2%, as anticipated.
First quarter nonfarm productivity was revised to up 2.6% from an originally reported up 2.2%. Once again, better than expected news could only marginally support the market.
It appears as though futures are underperforming the news, as it becomes more apparent that the world economy is slowing.
As the International economy weakens, we can anticipate a downturn in the U.S. export business and, in turn, reduced corporate earnings. Our analysis suggests the much-heralded pillar of strength for the U.S. economy, the export sector, will become less robust.
All of our fundamental and technical work suggests the main trend for stock index futures is lower.
This bear market will continue for many months. Continue to trade from the short side on rallies.
EURO CURRENCY – WEEKLY
We continue to see a pattern of futures tending to over perform the news.
Some temporary pressure came into the euro after a report showed unemployment unexpectedly increased in Germany in May. There were 4,000 more people out of work, compared to expectations of a decline of 25,000, which was first increase in unemployment in two years.
A surprising 1.8% drop in German manufacturing orders could only put temporary pressure on the euro. The median guess for this report was up .5%.
Another example of futures over performing the news was when the euro was able to trade higher, even though German retail sales unexpectedly fell by 1.7% in April.
There was an exaggerated move to the upside on news that German import prices increased more than anticipated in April.
In addition, there were sharp gains when European Central Bank President, Jean-Claude Trichet, said their benchmark interest rate could be increased as early as next month, in light of the fastest inflation rate in almost 16 years. The current interest rate stands at 4%.
In the longer term view, we can expect the euro to trade higher against the U.S. dollar, as the European Central Bank continues to follow their mandate to fight inflation by raising interest rates, rather than to focus on stimulating a potentially weaker economy.
Expect the euro to make historical highs against the U.S. dollar and against the British pound.
SWISS FRANC – WEEKLY
The Swiss franc gained as credit market worries took stock index futures lower, and in turn, caused traders to liquidate “carry trade” positions.
In addition, the Swiss franc was also supported by news that inflation in Switzerland increased more than expected, which was at its fastest pace in almost 15 years.
Because the Swiss National Bank is not quite as hawkish as the European Central Bank, we can expect the Swiss franc to lose ground to the euro. However, against the U.S. dollar, the Swiss franc is likely to trend higher.
BRITISH POUND - WEEKLY
The British pound fell sharply after U.K. mortgage approvals dropped to their lowest level in about nine years. Banks processed 58,000 loans for house purchases, which was the least amount since the series started in 1999, according to the Bank of England. In addition, a U.K. factory index report fell to the lowest level since July of 2005. It was reported that 20% of homebuyers in the U.K., with weak credit histories, dropped behind on their mortgage payments in the first quarter of this year. In addition, home prices fell for the 8th month in May and are expected to continue to decline.
The British pound was hurt by news that the U.K. services sector unexpectedly contracted for the first time since 2003. Also, consumer confidence fell to its lowest point in four years, while service companies eliminated jobs at the quickest pace since 1996.
The Bank of England kept their benchmark interest rate unchanged after the central bank predicted inflation levels would advance above their upper limit. The official interest rate remains at 5%, which is the highest of the Group of Seven countries. Accelerating inflation levels will likely prevent the Bank of England from cutting interest rates anytime soon. However, it is expected that the U.K. central bank will lower interest rates later this year.
The anticipated bearish interest rate differentials should cause the U.K. currency to work lower against the U.S. dollar.
JAPANESE YEN - WEEKLY
It does not look as thought the Bank of Japan will be in a position to raise official interest rates anytime soon. Their benchmark rate remains at a very low .5%.
A weakening Japanese economy has taken its toll on the yen. Even when there is bullish news, there appears to be only a muted response. For example, the Japanese yen moved little on a report showing job vacancies fell to a three year low in April.
Some of the more recent pressure on the yen was due a mild recovery in stock index futures. The yen and stock index futures have an inverse relationship, since the yen is often used as a “carry trade” vehicle. In the “carry trade,” investors obtain funds in a country with low borrowing costs and invest in other countries that have higher interest rates, earning the difference between them.
Expect prices to hold in the 93.50 to the 94.00 area.
CANADIAN DOLLAR - WEEKLY
The Canadian dollar has come under selling pressure as commodity prices have started to weaken.
Another bearish factor is the apparently more accommodative stance from the Bank of Canada. There currently is some talk that Canada’s central bank may soon be cutting official interest rates in an attempt to support a weakening economy.
Expect the Canadian dollar to trade in a range of 96.00 to 102.50 over the near term.
Ultimately, we can expect prices to break out to the upside, as it becomes more apparent that the Federal Open Market Committee will be forced to lower interest rates again.
AUSTRALIAN DOLLAR – WEEKLY
The Australian dollar temporarily dropped after the country’s retail sales in April fell .2%. This news was offset by ideas that high interest rates will continue to attract funds into Australia. The Reserve Bank of Australia’s benchmark interest rate remains at a very high 7.25%.
The Australian dollar recently advanced after the Australian GDP grew twice as fast as analysts had expected.
In addition, a rebound in commodity prices helped the Australian dollar to advance to a 25 year high against the U.S. dollar.
The long-term trend for the Australian dollar is higher and a one to one parity with the U.S. dollar is the next upside target.
EURODOLLARS – WEEKLY
All charts proved by APEX.
Earlier in the week there was some selling pressure ahead of a series of U.S. Treasury auctions totaling $49 billion.
Some of this pressure can be attributed to comments from Federal Reserve Bank of Dallas President Richard Fisher, when he said the Fed would increase interest rates if the public began to expect larger increases in consumer prices.
This pressure was limited when former Fed Chairman Alan Greenspan said the U.S. is more likely than not to move into a recession, according to the “Financial Times.”
Futures were able to hold up well even though Fed Chairman Bernanke said an increase in inflation expectations was a “significant concern.” He also said policy makers “need to monitor that situation closely.”
Growing evidence of a slowdown in the world economy helped the front end of the curve to trade higher, while mostly lower equity prices in the U.S. and overseas were also viewed as supportive.
We believe that the financial markets have incorrectly priced in a 66% chance of a 25 basis point increase in fed funds target to 2.25% on or before the December 16th meeting.
It has been noticed that, in the past, when Fed Chairman Bernanke was faced with the dilemma of either fighting inflation by raising interest rates or supporting the economy by lowering interest rates, he has chosen to lower interest rates.
The Fed is talking tough on inflation now, but ultimately, when the economy continues to weaken, they will cut interest rates again. We are definitely in the minority by saying that our work continues to show there will be no increase in interest rates from the FOMC this year and, to the contrary, it is likely that there will be one or two more rate cuts before year end.
Expect higher prices for Eurodollar futures, as it becomes more obvious that the world economy is slowing.
If you have questions or comments on this article, please contact Alan Bush at 1.800.243.2649 or email 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.
