Markets remain volatile on continued position squaring
17/Jun/2013 • Currency Updates•
Markets remained volatile last week, but we still did not see any of the systematic “risk on/ risk off” moves that had accompanied previous corrections since the end of the 2008-9 crisis. Different asset classes moved in a largely uncorrelated manner. The only theme that can be identified among the volatility is that the most popular trades of the last few months (short Yen, long emerging market assets, e.g.) continue to suffer the most punishment. This, in our view, is a clear indicator that we are seeing nothing more serious than a tactical unwinding of overcrowded trades, rather than the kind of generalized deleveraging that marked the 2008-9 collapse.
In FX markets, we are seeing continued pressure on the positions that had become more extreme among speculative futures traders. We have been flagging for some time that the IMM commitment of traders report from the CFTC pointed to a record short yen and long dollar position among such traders. Market moves have closely tracked this data so far, as the dollar sells off against most major currencies, and the yen rallies at rates not seen since the 2008-9 crisis. The latest report, out last Friday based on the previous Tuesday data, shows a significant clearing of the short euro position, while the short yen position remains largely unchanged. We therefore think that the euro rally has mostly run its course, but expect to see continued high volatility in the yen.
Macroeconomic news out of the United Kingdom maintained their positive momentum last week. Industrial production in April rose slightly, rather than the contraction most analysts had been expecting. Construction activity in April dropped 6.5% m/m. However, this data is not seasonally adjusted, and this drop is considerably better than what we typically see in April. Together with labour market stabilization and modest pay growth in April, output data appears to be validating the pick up we had seen in PMI sentiment indices. We are therefore no longer expecting an August increase in the Bank of England Gilt purchase target, and have revised our sterling forecasts accordingly.
We had mixed macroeconomic news out of the Eurozone. April industrial production were a tentative sign that the dichotomy between a strong core and a weak periphery is returning. French and German industrial production surprised to the upside, rising a strong 2.2% and 1.2% respectively, but there was further deterioration in Italy and Spain. Further, Italian 1Q13 GDP growth was revised further down from the already dismal initial reading: from -2.1% to -2.6% saar.
The return of the strong core/weak periphery paradigm is surely an improvement from the uniformly dismal news we had grown accustomed out of the eurozone, but it hardly constitutes significant improvement for the prospects of the euro. The common currency has been supported lately by excessive short positioning among speculative traders, but we expect the downward trend to resume now that the short overhang has been largely cleared.
Retail sales last week provided further confirmation that worries about a Spring slowdown in the US are overdone. Weekly jobless claims, which is the best high-frequency indicator of the health of the US economy, are also testing new cycle lows, below the 340,000 level. Together with the previous week decent payroll report, these reports make us more comfortable with our (slightly revised) forecast of 2% GDP growth for this quarter, and 1.75-2.75%% GDP growth for the full year. All eyes now shift to the Fed meeting next week, followed by a press conference. In it, Chairman Bernanke is expected to shed further light on the key question obsessing traders over the last few weeks: will the Fed start to “taper” QE3 in September, or will it wait till December? Watch this space for a Special Report on this critical issue.