Strategy Reports

USD

Despite an increase in risk aversion in June, the month ended up being difficult for the U.S. dollar whose index contracted by 0.65% to close the month at 86.019. The index nevertheless traded as low as 85.091 at some points.

The moves came despite a 5.2% decline in the S&P 500 and a 3.55% drop in the Dow Jones Industrial average, with both indexes finishing off the month at their lowest levels since October 2009.

Although much of the concerns come from speculation of a slowdown in Europe, the moves are also attributable to some downbeat economic data.

The ISM manufacturing index for May fell to 59.7 from 60.4 while the non-manufacturing index remained unchanged at 55.4. More notably, however was a 431k gain in nonfarm payrolls for May, faster than the prior month’s 270k increase, but slower than forecasts for a 536k gain. The kicker was in the private sector jobs component, which only created 41k jobs contrary t expectation for a 180k gain and prior 218k increase.

To add insult to injury, retail sales excluding auto fell by 1.1% month-over-month compared to calls for a 0.1% increase, and durable goods excluding transportation rose only 0.9% versus forecasts for a 1.0% increase. In additional final Q1 GDP was revised lower to a 2.7% annualized growth rate despite forecast for a 3.0% gain.

On the inflation front, core CPI remained at 0.9% year-over-year.

Meanwhile on the central bank front, the FOMC left its benchmark interest rate unchanged at 0.25%, as expected, but toned down the language on the economy, suggesting that things may be slowing down in the United States.

Implied market forecasts have only 31 bps worth of rate hikes priced in for the next twelve months.

Given recent developments, the USD started to resume its role as a risk averse currency, managing some gains against many major currencies as the month developed. That being said, it wasn’t enough for the USD to definitively outperform.

Going forward, the main concern remains whether or not the European fiscal crisis is going to cause a global economic slowdown, and possible relapse in the U.S. economy. June also saw the end of the first time homebuyer tax credit, causing many to believe that a fresh downgrade of the U.S. housing sector is in the works.

EUR

June was a topsy-turvy month for the euro, which, when all was said and done, only lost 68 pips against the USD to close off the month at 1.2238. That being said, EUR/USD hit 1.1877, its lowest since March 2006, over the course of the month.

The declines were primarily due to fresh concerns surrounding the region’s ability to slash budget deficits. The euro continued to suffer as traders watched Portuguese, Greek and Spanish bond yields rise at every national bond auction, suggesting that countries are slowly having more difficulty raising capital.

In addition, Moody’s downgraded Greece to junk status, and there are concerns that Spain will be the next to follow down the chopping block.

Stocks were mixed, with the eurostoxx giving up 0.73%, but the German Dax surprisingly managing gains of 0.36% (the only major stock index to record a gain in June).

That being said, the weakness in the euro is proving a boon to European exporters, with Germany’s Ifo business climate index rising to 101.8 despite calls for a decline to 101.2 from 101.5. Meanwhile the nation’s employment record was solid, with the unemployment falling 45k in May and 21k in June, with the unemployment rate falling to 7.7%.

Meanwhile, euro zone GDP advanced 0.6% year-over-year, beyond calls for a 9.5% gain, and euro zone CPI fell to 1.4% in June, compared to calls for a 1.5% gain and prior 1.6% increase.

On the monetary policy front, the European Central Bank seems context to continue buying government bonds and holding liquidity auction for the banking system, suggesting that while the status quo is firmly in place, there are little chances of a rate cut.

Implied market forecasts have 40.2 bps worth of rate hikes priced in for the next twelve months.

Going forward, the story stays the same. Watch the ratings agencies for further downgrades to Spain Portugal, Greece, Ireland, or Italy.

GBP

June was a great month for the pound sterling, which, bolstered by solid promises to cut the budget deficit, shot up against major currencies.
When the dust had settled, cable has amassed a respectable 407 pip gains against the USD to close off the month a 1.4945. The main attraction, however, was the 2772 decline in EUR/GBP which closed at 0.81876.
 

As stated previously, the main culprit for the moves were very though promises from the UK’s newly elected Conservative government, which pledged to slash the budget deficit to £20 billion by 2015 to 2016. The government also said the UK would borrow £149 billion from the public this year, falling to £116 billion in 2011 and then £89 billion the following year. In addition, it plans to hike the value added tax to 20% from 17.5% starting January 4, and hike the capital gains tax on high income earners to 28%, with middle and lower income earners to pay 18%. Also, a levy on bank balance sheets will be introduced starting in 2011.

The news sparked a ripple of upbeat reaction from the ratings agencies, which said the nation may manage to hold on to its AAA rating if it adheres to the plans.

The Bank of England was also hawkish in June, with Monetary Policy Committee Member Andrew Sentance voting for a 25 bps rate hike at the beginning of the month citing inflation pressures. The move gave additional support to the pound sterling.

Economic data was on the backburner for the UK in June, although annual CPI growth fell to 3.4% from 3.7% the month prior, further than calls for a 3.5% level. Also, jobless claims declined by 30.9k in May, further than expectations for a 20k contraction. The claimant count rate also unexpectedly fell to 4.6% despite calls for no change to the prior 4.7% level.
 

Sterling also ignored a 4.36% drop in the FTSE 100.

Going forward, we have yet to receive definitive assessments from the ratings agencies regarding the UK budget, but everyone is expecting the nation to hang on to its AAA rating.

If the UK gets cut, expect sterling to drop. On the other hand, if the hawkish momentum at the Bank of England persists, that would be sterling positive.

Implied market forecasts for priced in 25.2 bps worth of hikes in the next twelve months.

JPY

The global risk aversion proved to be a boon to the Japanese yen which gained 283 pips against the USD to close off the month at 88.43.

Economic fundamentals and central bank speak were completely ignored in June, with markets buying the yen aggressively on the back of massive declines in global equities, and speculation that the global economy could be heading towards a double-dip recession again.

For starters, a move by the Bank of Japan to make direct loans to the private sector was broadly ignored by the yen. Additional funds to the Japanese system should in theory have been a negative for the currency.

On a side note, implied market forecasts have no rate hikes or cuts priced in for the next twelve months.

Meanwhile the region’s economic fundamentals continues to strengthen with GDP growing 1.2% quarter over quarter in Q1 despite calls for a 1.0% gain, and annualized growth up 5.0% versus forecasts for a 4.2% increase.

Also, Japanese deflation slowed in June, with Tokyo CPI falling 0.9% year-over-year compared to expectations for a 1.3% slide and prior 1.4% shortfall. Meanwhile National CPI was down 0.9% in May versus calls for a 1.1% slide and prior 1.2% decrease. Again, bearish results for the yen.

On the flip side, the Nikkei 225 fell 3.74% over the course of the months, adding to the currency’s gains.

Going forward, risk appetite continues to be the main driver behind the Japanese currency, and all signs point to more strength in the yen.

AUD

June was a dismal month for the Australian dollar which, despite stronger economic fundamentals, was weighed down by a dovish sounding central bank, and concerns of a global economic slowdown.

While AUD/USD finished the month off only 51 pips lower at 0.8408, the pair seesawed between a high of 0.8859 and 0.8083.

Starting the bearish momentum was a decision to leave rates unchanged at 4.50% by the Reserve Bank of Australia, along with the affirmation that rates are fine where they are, and that there are concerns about the impact of the European fiscal crisis on the global economy.

Implied market forecasts have 2 bps worth of rate cuts priced in for the next twelve months, with a 10% chance of a cut at the next meeting.

AUD was also weighed upon by some deteriorating economic data out of China (note that many trades view the Australian dollar as a proxy for Chinese economic performance).
On the equities front, S&P/ASX failed to give the currency a lift with the index declining by 2.91%.

The only redeeming factor for the currency was its economic performance, with GDP rising 0.5% in Q1, in line with expectations, but annual growth higher by 2.7%, beating the consensus for a 2.4% increase.

Also, the country created 26.9k jobs in May, faster than forecasts for a 20.0 increase, and the unemployment rate unexpectedly fell to 5.2% from 5.4%.

Going forward, keep an eye out for China, which will continue to weigh on the Australian dollar if growth continues to slow. The currency is also susceptible to the risk picture in equities.

CAD

June was a tough month for the Canadian dollar, which gave up 194 pips against the USD to close off at 1.0639.

The declines were mostly due to increases in risk aversion, heightened by a possible slowdown in the global economy.

The TSX alone was down 3.48%, and the gains in NYMEX crude were insufficient to support the currency.

A notable development for June was a 25 bps interest rate hike form the Bank of Canada to 0.50%. Although the markets were expecting the move, the central bank appeared reluctant to continue hiking rates, given a weak accompanying statement to the decision.
As a consequence markets have priced in a 64% chance of a hike in July, with 94 bps worth of hike

s for the next twelve months.

Otherwise, Canada’s economic fundamentals were mixed in May, with the economy creating a solid 24.7k jobs for the month, faster than expectations for a 15.0k gain, but the unemployment rate remaining at 8.1% in spite of forecasts for a drop to 8.0%.

On the flip side, core retail sales were down 1.2% on the month despite calls for a flat reading and GDP came in flat for April in spite of expectations for a 0.2% gain.

Going forward, it seems the Canadian dollar is being battered by global risk aversion, but supported by strong crude oil prices and rate hike expectations.

For now, at least risk aversion is the dominant theme.

NZD

June was a relatively good month for the kiwi dollar which managed to outperform on the back of upbeat economic fundamentals and a hawkish stance from the Reserve Bank of New Zealand.

At the end of the month, the Kiwi dollar was one of the few outperformers, with NZD/USD gaining 42 pips to close the month at 0.6874.

The story begins at the beginning of June when the Reserve Bank of New Zealand hikes interest rates by 25 bps to 2.75%, in line with expectations. The central bank also promised that more monetary policy tightening was in the works. Consequently, markets have priced in a 76% chance of another 25 bps hike at the next meeting, with 109 bps worth of hikes pried in for the next twelve months.

In terms of economic performance, Q1 GDP was in line, with the economy growing 0.6% on the quarter and 1.8% on the year.
Going forward, we know that the Australian and New Zealand dollars tend to mimic one another, but that with the RBNZ hiking and the RBA holding, that correlation may break down somewhat.

CHF

The Swiss Franc was the outperformer of the month, with USD/CHF collapsing 775 pips at 1.0774 and EUR/CHF tumbling 1042 pips at 1.3184.
The primary culprit was the Swiss National Bank which said that the deflation threat in Switzerland was virtually over, promoting no additional foreign exchange interventions to keep the franc weak.

The SNB’s decision to leave rates unchanged at 0.25% was all but ignored by the markets which bought the currency aggressively on the back of the end of interventions by the SNB.

Implies market forecasts have priced in only 19 bps worth of rate hikes for the next twelve months.

Otherwise, the economic data were mixed, with the economy growing only 0.4% quarter over quarter in Q1 despite calls for a 0.7% increase, but rising 2.2% year-over-year compared to calls for a 1.8% gain.

Also, the unemployment rate remained unchanged at 4.0-% despite forecasts for a decline to 3.9%.

Meanwhile, CPI, slowed to an annual 1.1% growth rate in May from 1.4% previously, further than forecasts for a 1.2% growth rate.

Going forward, watch CPI. If it starts falling further, the deflation threat could cause the SNB to renter its weak Franc position.

COMMODITIES

June was a great month to be in commodities, with concerns about budget deficits and risk aversion feeding the gold rally to new record highs.

At the end of the month, Gold had added another $25.07 per ounce to finish at $1242.25, but not before setting a new record high at $1265.30.
 

The primary motivating factor behind the move was concerns that more government will have trouble paying down the budget deficits, weakening the value of their currencies.
Indeed, as confidence in FX continues to wane, gold continues to move higher, and this trend shows no signs of slowing for now.

Silver was unable to capitalize on the move, rising only $0.055 to close at $18.615 in June.

On the crude oil front, the commodity managed gains of $1.66 in the NYMEX contract to finish at $75.63, but nevertheless remains under pressure on the back of concerns surrounding the global economic recovery. If global fundamentals start deteriorating, expect Crude to decline.