Outook for Selected Markets and Currencies

A to-the-point overview of 7 selected countries/regions and associated currencies. It is good to back away from day-to-day business and look at the big picture once in a while, to spot underlying differentials in financial and economic contexts between various zones. A quick look into the fundamentals of a few curencies and markets. Note that macro outlooks must NEVER be used alone for short term forex trading, but they do help to provide background and for long term strategies. Enjoy!

​USA and USD
The US economy is in dual mode, with some indicators suggesting the Fed needs to start tightening (core inflation, unemployment, initial jobless claims, bankruptcies), while others suggest a prolongued period of low rates is still required to get things back to “normal” (capacity utilization, employment rate, industrial production, corporate profits, housing).
 
There is still considerable slack in the US economy, which is seen in the various labor market indicators, production, and still-low inflation, even if core inflation is on the high side. There is little reason to tigthen policy, which is indeed already priced in – market analysists are looking at the same data we are and are coming to the same conclusion.
 
This explains the mixed messages the Fed is sending, as Yellen and FOMC members struggle with this unconfortable situation while at the same time thinking of the global market backdrop, with recent Brexit and a possible slowdown in Canada, its number one export market.
 
The isssue is the confusing stop-and-go talk of the Fed. As mentioned earlier, the Fed may only be in a hurry to “normalize” rates to bring the rate further above zero, to have a bit of breathing room. But that seems a dangerous route to take, relative to status quo, and a simple cost-benefit analysis seems to tilt the odds towards very low probability of the Fed making a move for a very long time.
 
Watch for these to start looking better before expecting higher probabilities of Fed tightening:

• Industrial production
• Employment rate and other labor market indicators
• Capacity utilization
• Core inflation increasing convincingly towards 3%

 
Otherwise the Fed is likely to remain on pause, and all the huff and puff is essentially just noise. Since all this is priced in, the USD has a neutral stance by itself, but of course its relative value will depend on what happens elsewhere.
 
Bias: neutral
 
 
Euro Area and EUR
Brexit has probably caused a slowdown in the UK, one of the Euro Area’s main export markets. After 2 recessions (2009-2010 and 2012-2013), the Euro Area is struggling with a dual mode as well, with Germany doing very well, Italy on the brink of collapse, and France in stagnation. Core inflation is very low and considerably lower than the target of “close to but below 2%” and total inflation is essentially at zero.
 
After an aggressive round of QE from mid 2014 to early 2016, it remains to be seen how much more QE is in the books. The depreciated EUR helped the big German exporter, but the Zone remains fragile due to structural issues that are not likely to be “fixed” any time soon, if ever. With a negative interest rate, the ECB hopes to sput credit and money creation to avoid prolongued deflation.
 
Business confidence is on the low side, but capacity utilization is generally “healthy”, although this was pre-Brexit measures. Zew Economic Sentiment Index sank in July due to post-Brexit reactions and expected slowdowns in the UK, with an already-slow-but-positive industrial production activity.
 
The personal savings rate is increasing, which could suggest a drop in consumption and spending, and a general slowdown in activity going forward.
 
The ECB has a hawkish tradition, but it might become difficult to keep status quo going forward, especially with 2 major negative risks in the mix: UK and Italy in a slowdown, with Italy saddled with bad performing loans and mountains of bond risk for the major Euro Area members.
 
Bias: negative
 
 
Japan and JPY
Japan is still stuck in debt-deflation and the recent signals we are getting are those of further weakness. Japan’s number one export market, China, is slowing down considerably, with business confidence and other indicators signaling further weakness ahead.
 
Within Japan, all macro indicators suggest weakness ahead: business confidence, inflation, credit growth, capacity utilization, sentiment surveys, etc. Most point to a slowdown and a need for monetary expansion.
 
The trouble for Japan is the sky-high government debt. It seems the government may have hit a limit to extra bond issuance, which puts the brakes on fiscal stimulus financed by printed money. Yet there is still the possibility of JPY depreciation via massive purchases of CNY and USD. It is yet to be seen if this is in the books, but at this point, with deflation and a target of 2% inflation, and extra weakness, the options seem to be decreasing with every passing week.
 
There were massive capital inflows to Japan on global market stress, and the currency appreciated after a bounce off the key 100 technical mark for USD/JPY. But the macro picture seems to tilt the odds to further depreciation going forward.
 
Bias: very negative
 
 
UK and GBP
Brexit did not cause a massive pullout of the government bond market, as can be seen by the 10-year bond yield, which is trading at close to historical lows. After a massive post-Brexit depreciation, the Pound holds steady versus the main currencies, and the anticipated “major crash” has yet to materialize.
 
With inflation on the low side but still positive, and a generally solid pre-Brexit context, the UK is equipped to deal with the fallout of potential capital outflows and falling exports caused by Brexit, especially with the total assurance from BoE that it will intervence massively should the situation require it.
 
After a massive monetary expansion in 2012 and 2013, the Bank of England stands ready to act if Brexit does indeed cause a significant blow to activity, although it remains to be seen if the actual data will match the doo, scenarios that many have in mind. As a major economy with highly developed financial markets, the UK borrows mainly in GBP, which means the impact of the depreciation is not on the domestic economy. The slowdown is likely to happen, and maybe even a recession, but the total crash of doom sayers is not currently visible.
 
The likely negative effect will be on the Pound versus the USD, especially if initial major economic data suggests weakness, and this effect will be mostly driven by mass psychology in the short run. In the long run, the UK is structually more solid than the Euro Area.
 
Bias: negative
 
 
Canada and CAD
After a “mini recession” in 2015, Canada seems in a moderate expansion, with elements of a “mixed bag” that looks like the US situation. Inflation is not a problem, with core on target and total inflation steady just below target, but exports, the employment rate and the participation rate suggest some weakness, along with credit loans to private sector contracting and both consumer confidence and capacity utilization on the low side.
 
The moderate growth along with a solid housing market and the passing of the oil shock that hit Western Canada gives us a neutral mode, with the BoC on hold, with a neutral bias on rates.
 
Bias: neutral
 
 
Australia and AUD
A recent significant drop in total and core inflation have increased the probability of a rate cut, but the central bank holds steady for now, seemingly waiting to see if further weakness is coming or if it is just a soft patch. Like New Zealand and Canada, monetary authorities are worried about excessive household debt and bubbles, but the monetary bias seems tolted to a rate cut.
 
The relatively large trade deficit (even in historical terms and even for an island) suggests a depreciation could come down the road, as Australia is not like a major market destination for global funds as is the USA. Retail sales and housing show signs of slowing and add to the negative bias, especially with the 2 slowing trading partners, Japan and China.
 
Bias: moderately negative
 
 
New Zealand and NZD
The 2015 slowdown was countered by rate cuts, which are now having the expected effect. The economy is doing well, with solid job growth and solid indicators in general, although house prices could create negative wealth effects, which is one worry of monetary authorities. Another indicator preventing monetary tightening is inflation, which remains below the 1-3 target range. All in all, the outlook is positive and monetary tightening could be in the books if inflation picks up a bit going forward. Otherwise is neutral stance is to be expected.
 
Bias: moderately positive


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