Our weekly preview strategy guide for traders and investors of all major asset classes Emphasis on the growing threat to the value of financial assets, and how to achieve currency diversification for lower risk and better returns either via conservative forex trading or currency diversified income investing
Review of Last Week
Top market movers last week were:
- Speculation About Coming Greek Elections From Latest Polls
- China Stimulus Hope And Disappointment
- Spiking Spanish, Italian Bond Yields, bad Italian bond sale
- Terrible U.S. Jobs Report
Plenty has already been written about all. We’ll discuss below what they mean for the coming week, along with the lessons and ramification for various asset classes.
The short version:
- The picture for some is less clear than for others. For one particular asset type and assets related to it, the week was a likely multi-month turning point.
- Europe, the U.S., UK, Japan, and China continue to show evidence of slowing to varying degrees, with the EU continuing to be a potentially lethal threat to the global economy. If history is any guide, more money printing is likely on the way. We’ll discuss that in detail and what to do about it.
1-2: EU Event Risk
Of course, the EU remains the big threat.
News Feeding Greek Election Speculation
The recent failed election raised the odds of Greece reneging on its bailout agreements, defaulting, and sparking the dreaded disorderly default and contagion that risks engulfing the EU and probably global economy in a larger version of 2008’s Lehman bank collapse. No surprise that further polls and other news feeding speculation of the results will continue to move markets. A pro-bailout result allows the EU to continue to play for time. An anti-bailout government means the EU must decide quickly about many things, essentially whether to let assorted banks and governments fail, or print money to pay for them. Yes, perhaps more fundamentally, the EU needs to decide whether to centralize budgeting authority, become more like the U.S. of Europe, etc., in order to ensure the EU’s future or just give up and restrict the EU to the nations that can be saved. However the more immediate issue is whether to keep a lot of insolvent governments and banks on life support via various schemes involving more debt and, money printing, or pull the plug now and decide how the pain is to be distributed.
Other Contagion Threat Barometers
We could see further sovereign and bank credit downgrades and evidence of rising bond yields, most significantly in Spain and Italy. Both local events and those in Greece could be a factor.
Watch also for signs of cash continuing to flow out of GIIPS banks. Last week we started seeing repeated references to “denomination risk.” The term refers to the risk that depositors could find their EUR deposits suddenly converted into a new local currency if the nation exits the EZ in order to regain the ability to print its own money as needed. Such a move would likely come with capital restrictions preventing residents from freely holding or exchanging other currencies of more reliable value. If it happens once, fear of a similar fate for other GIIPS depositors is likely to spark further cash outflows.
Greece remains the likely flashpoint for now.
3-8: All Eyes On Central Banks: When Will Money Printing Begin?
Next week we have 5 potentially significant central bank events:
- 4 central bank rate decisions from the RBA,(Tuesday) BoC (Tuesday), ECB (Wednesday), and BoE (Thursday): Given the dour data in the EU, U.S., UK, and China, the bias is clearly dovish, with rate cuts possible from all but the BoC. There is a growing body of opinion however that suggests that because a number of central banks are leaning to cutting rates anyway, they might get better results by announcing a coordinated effort later this month around the time of the G-20 meetings
- The Fed’s semi-annual monetary policy report (Thursday): Arguably the most significant data out last week were the disastrous U.S. jobs reports, because the chances of additional U.S. stimulus moved from the possible to the probable. Markets will be watching for hints of QE 3. We suspect Bernanke will not tip his hand yet. The Fed’s next policy announcement on June 20th, after both the Greek elections and G-20 meetings. If the elections yield an anti-bailout government and threat of Greek default, he may feel forced to act with some sort of stimulus (aka some combination of more debt and money printing). We suspect he’d prefer to do this as part of a coordinated response around the time of the G20 meeting. The idea is that the calming effect on markets would be greater, and volatility in the forex markets would be reduced, if multiple central banks ease together.
9: More Evidence of a China Slowdown
There was more bad data out of the BRICS, though it’s the major data from China that has the by far the most market moving potential. Look for more news stories related to the slowdown there or speculation about the wave of data due out Saturday June 9th. The actual reports themselves are more likely to affect the opening of the following week.
10: Delayed Reaction To U.S. Jobs Report Especially In Asia
As always, Asian markets are closed by the time the U.S. jobs reports are out, and so when these reports rock markets as they did last week, Asia plays catch up at the open. Given the bleak results, Asia will likely be opening lower and staying there unless there’s new countervailing bullish news.
11: Technical Picture
Using the S&P 500 as our overall risk barometer, the picture we get from last week is of continued technical breakdown and the door now open to further lows.
S&P 500 WEEKLY CHART JULY 2009–MAY 2011 04 JUN 03 0353
Source: MetaQuotes Software Corp, thesensibleguidetoforex.com
Note in particular:
The prior week confirmed the end of sideways movement from February – April and the start of a new leg lower with”
- Violation of multiple support levels including the 10 (blue), 20 (yellow), and even the 50 (red) week (= 200 day) EMAs. Violation of the 50 week / 200 day EMA typically signals the decisive end of the uptrend.
- A decisive break below key psychological support of 1300.
- The index is now likely to test the 1265 area, which includes the 61.8% Fib retracement of the prior May — August 2011 decline.
- Medium term momentum is now bearish:
The 10 and 20 week EMAs are now heading lower and the 50 week EMA is now flat
The index is now firmly in the lower end of its weekly double Bollinger band sell zone (the area bounded by the lower green and orange bands), suggesting more downside ahead.
Other Calendar Events
These could be market moving if things are otherwise quiet and the above likely sources of market moving events stay relatively dormant.
Canada: Building Permits – Canada continues to show relative health that we believe will ultimately cause the CAD to attract greater safe-haven flows than before despite its traditional place as the #3 top risk currency.The CAD should benefit from being one of the most likely currencies among the 8 majors to see rate increases.
ISM Non Mfg PMI: Given the dour sentiment from the U.S. and elsewhere a positive report could restore the USD’s status as the least dirty shirt among the safe haven currencies.
UK: Construction PMI
Australia: Jobs reports
UK: Services PMI
Canada: Ivey PMI
Japan: Current Account
Australia: Trade Balance
UK: PPI Input
Canada: Jobs reports, trade balance
China CPI, PPI, Fixed Asset Investment, Industrial Production
Lessons and Ramifications
Here are a few observations and conclusions from the above.
Gold & Other Currency Hedges Are the Big Winners
Whatever happens in Europe in the coming weeks, the short and simple version is that all likely scenarios involve either significant or gargantuan degrees of money printing depending on which one or combinations of the following we see:
- Continued Greek bailout (relatively small in near the term)
- Greek default and EU bank system bailout (potentially much larger, magnitude uncertain depending on how many banks and governments rendered insolvent and in need of aid)
Stimulus programs of various forms have at best slowed declines at the cost of piling on more debt and making the ultimate payback more painful. The only question remaining is how the burden is shared between nations and between the public and private sector and how. The history of the past years suggests at minimum the public sector will bear a huge part of the cost. Because higher taxes or cuts in services are less popular than assorted forms of money printing that fund more borrowing (they don’t oppose what they don’t understand), money printing is coming. That may not bring significant inflation while the global economies continue to struggle, though the risks of inflation and loss of purchasing power in the coming years clearly are rising.
At a minimum, we’ve got EUR printing on the menu. Yes, Germany opposes it. They always have, and have yielded each time when faced with risk of Greek default and contagion. Maybe this time it’s different. German behavior for the past 3 years suggest otherwise. The past three years also suggest a high chance that the Fed and other central banks will be involved in some fashion.
Leaving aside the EU, Friday’s miserable U.S. jobs reports alone convinced the markets that QE 3 is once again firmly on the menu. If you don’t believe me, the gold chart is a fine barometer of what markets believe about the likelihood of money printing.
First, some brief background. As we’ve noted repeatedly, gold rises when markets fear loss of purchasing power from one or more of the most widely held currencies, the USD and EUR. It falls when these fears recede OR are overridden in panic times by the need for liquidity.
Here’s a weekly gold chart.
WEEKLY GOLD CHART DECEMBER 2010–MAY 2012
Source: MetaQuotes Software Corp, thesensibleguidetoforex.com
What the chart shows: After the initial panic following the Greek elections of June 6th (liquidity is top priority), gold spiked this past week, with virtually all of the gain shown above coming on Friday following the U.S. jobs reports.
What it means: Markets believe that QE 3 has now gone from being possible to probably in the coming months. That will dilute the value of the USD like any money printing program is expected to do, feeding demand for the prime currency hedge, gold.
What To Do?
Gold and other currency hedges are likely beneficiaries of events in the coming week and beyond.
With the USD, EUR, GBP, and JPY all facing continued printing and low rates, their loss of value, along with anything denominated in them, is the likely outcome, even if depressed conditions suppress inflationary pressures in the near term.
Most of us are far too overexposed to one or more of the above currencies. We all need to diversify out currency exposure just like we need to diversify by asset and sector type. The problem is, most kinds of currency trading don’t work for most people.
Disclosure: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.