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US December NFP +156,000 – Wage Growth Will Spur the FED to Accelerate Rate Increases

The United States Department of Labor Bureau of Labor Statistics announced on Friday that total nonfarm payroll increased by 156,000 in December and the unemployment rate ticked up a tad to 4.7%. The revisions to the previous months saw the October number drop from 142,000 to 135,000 while the November figure was revised up to 204,000 from 178,000. The all important (ok not really) 3 month average now stands at 165,000 per month. Of more importance is that average hourly earnings in December increased by 10 cents to $26.00. This takes the 2016 average to 2.9% and this will get the FED to increase rates at a faster clip as wage growth typically is the precursor to inflation in a tight employment market such as in the US.

As tough as it is to find work these days, one can’t ignore the average overall unemployment rate being below 5% for all of 2016. By historical standards, 5% is considered to be ‘full employment’ which is when all available labor resources are being used in the most efficient way possible. Those that are unemployed within the ‘full employment’ are considered to be structurally or cyclically unemployed. When full employment is encountered, wages increase as the supply of labor shrinks and employees become more valuable. As those who are employed receive increasing wages, their disposable income increases and this combination has previously produced inflation.

This is the type of inflation that the FED will notice. This is the type of inflation that the FED has wanted to see for many years. This is the inflation that has to be contained by raising interest rates. This is the inflation that many central bankers in the developed world want themselves. This is the inflation that we have been hearing about that was expected in the ‘medium term’. This is the inflation that could quite possibly wreck the government-induced bubble in the bond market and send the US dollar to new highs in 2017.

As the inflation scenario unfolds in the US, the FED will quickly have to be seen to be ‘out in front of it’ meaning that they have the inflation genie under control. The FED will have to raise rates sooner and higher than the market previously thought. The difficulty here is that the widening interest rate differential globally will continue to fuel demand for the US dollar. In addition to the widening interest rate differential between the US and say Europe (socialized economy) or Japan (Abi-normal), the fiscal machine looks set to roar again in the US.

Before the new president is even sworn in on the 20th the rumors are circulating and theories are being tested on what business in America might be like with a Trump presidency. It will be very interesting to see who, what, where, when, and how the fiscal beast is unleashed and this change in approach provides my macroeconomics students with a daily update on how Trumpism is going to make America great again.

Rising US interest rates and the belief that a fiscal boost from the incoming administration will be enough to keep the US dollar headed higher, and probably a great deal higher is 2017. If the US bond market falls out of bed and volatility continues to rise in that market one should also brace for increased currency volatility as well. Stay long US dollars my friends.

 

keith@underwoodfx.com

UnderwoodFX.com 

Keith Underwood 2 Comments

Trump Change

What the Trump victory means for the FX market

OK so you’re as surprised as everyone else at the outcome of the US election and you have made currency predictions for next year. You probably added a slightly larger degree of uncertainty after the shock UK Brexit vote, but you none the less polled your FX banks for their forward looking strategic FX views, did your own research, and felt reasonably comfortable with your work product. What does a President Trump mean for the FX market? Who are the winners and losers?

Winners

  1. The US Dollar
  2. The Swiss Franc
  3. The Japanese Yen

The US dollar is still the most traded currency in the $5.1 trillion a day FX market according to the latest BIS Triennial Survey. It has been strengthening since 2011 (see broad US Dollar index chart) fredgraphin the belief that the FED will normalize (raise) interest rates as job creation continues and inflation reaches 2%. As a macroeconomics professor, my US Dollar view is torn between what appears to be two divergent Trump policies, isolationism and lower taxes. Isolation has an implicit lower dollar to help US exports, while lower taxes foster a stronger dollar over time as the US economy strengthens.

In isolationism, I don’t see Trump supporting a ‘weak dollar’ or ‘a weaker Dollar’. Weak is not in the Trump vocabulary. Period. I think the US Dollar will rise as the US economy breaks with Obama policies and adjusts positively to the Trump lower corporate taxes (the US has one of the worlds highest corporate taxes) that promote higher growth and higher tax revenues (higher tax rates increases tax avoidance and lowers tax receipts), higher spending, and higher inflation. The US Dollar is set to rise further.

The Swiss Franc is regarded as a safe haven currency when uncertainty and volatility is prevalent in the markets. Short-term traders (generally trades held less than an hour or two) will trade the franc back and forth today to make a few shekels and for those that have less enthusiasm for a Trump economic turnaround, they will find themselves increasing their exposure to the franc. As my regular readers know, I’m not the biggest fan of the Swiss Franc, given their negative interest rate policy (Negative Interest Rates: A Disincentive to Risk), but the safe harbor status of the franc can’t be ignored in times of uncertainty. Over the course of 2017 the Swiss Franc will maintain its store of value in the FX market.

The Japanese Yen has been manipulated for years by the BOJ trying to keep the yen artificially weak in the face of badly performing monetary policies and unrealistic inflation goals. Readers of my posts know well that I don’t believe that manipulation in FX ever works (3 Currency Intervention Lessons Never Learned) over time and because the Japanese have been at this for many years I think the Yen is poised to strengthen once this calamity curtain is pulled back. I have recommended buying Yen from 112.00 and I see little standing in the way of 95.00 aside from verbal intervention, which doesn’t work.

Losers

  1. Mexican Peso
  2. Canadian Dollar
  3. China

Trump campaigned on terminating NAFTA and calling it the worst trade deal ever signed anywhere. Our neighbors to the North and South will see their currencies suffer as uncertainty over a future without NAFTA lingers.

China is and has been an easy target for Trump. He will continue to skewer the Chinese on trade and currency manipulation all during his presidency. He will do this to keep the appearance of pressure on the Chinese to enact reforms that benefit the US but the reality is that China does nothing that is not in the interest of China.

keith@underwoodfx.com

www.UnderwoodFX.com

 

Keith Underwood 13 Comments

OPEC – Organization of Poor Examples of Coordination

Ho hum. The latest agreement out of OPEC is a proposed reduction of 800,000 barrels per day. Handily, the actual specific details of the reduction has yet to be finalized and that leaves who, what, where, when, and how to be sorted in November. Let’s see what can be agreed in a warring region of the world where trust is at a low and adherence to production limits are historically slippery for some.

 

800,000 may be an overly optimistic cut given that Iran has only just agreed to join the discussion. They have refused, on several previous attempts; to even show up to talks. Other oily actors like Russia seem intent to play ball by their own rules, so don’t plan for anything that doesn’t benefit them. As a non-Opec member they are likely to not participate in a reduction. Even if they did would you believe them?

 

Should Opec succeed in their production cut theatrics and sustain a higher price of $55-$60 per barrel, the higher oil price will encourage shale producers to dust off the projects that were uneconomical while oil was below $40-$45 per barrel. The higher the price goes the more potential supply realized by projects left idle before.

 

So what’s this have to do with the foreign exchange market you ask? Well, while all this hoopla is going on we will see increased headline trading (quick, sharp, short movements) in spot FX with currencies that are correlated to the price of oil. Correlation is the generalized movement of one asset versus another (either positive or negative). So if oil increases in value you might see an increase or strengthening of the Canadian dollar (oil exporter) versus a country that is a consumer (importer) of oil such as the European Union or Japan. Other exporters that could also benefit are Russia, China, Brazil and Mexico.

 

Oil has been trading sideways all year long (see chart) and anytime you have a prolonged period of consolidation or range trading, the breakout move (out and away from the previous range) will be that much greater and volatile. Think of a Jack-in-the-box toy that is wound and wound and wound until it pops. This is typically what happens the longer that a tradable asset stays within a predefined or preexisting range. Oil could be in this type of situation, but so too are many other tradable assets, due to concerted government intervention in the interest rate markets keeping rates low or even negative, for longer. See ‘Negative Interest Rates: A Disincentive to Risk’ for my pessimistic views on negative rates.

Trading range oil 2016

As such, the inflection points or ranges that has developed over months and years will ultimately break and bring with it severe liquidity shortages and violent gapping movements. Could OPEC produce a breakout moment with a viable and substantial agreement to cut production? My opinion is that they could, but we have been down this path many, many times before and I can’t really get that excited about a re-run where there is no real emergency for the cartel members to act. Expect a bland communiqué that expresses dismay at the present low price of oil, the need to keep the global economy growing (to use more oil) and production cuts that will be in the best interest of the cartel.

 

keith@underwoodfx.com 

Traded Markets Intelligence

UnderwoodFX.com

Keith Underwood 3 Comments

3 Currency Intervention Lessons Never Learned

  1. Verbal intervention is not a viable long-term strategy.
  2. Unless other major central banks join in, it fruitless.
  3. Intervention only provides better levels for hedge funds to enter the trade.

For those of you that only know verbal intervention as HID (your significant other) yelling at you to do something, in financial markets it is the action of a very influential person (central bank person or Ministry of Finance person such as Taro Aso in Japan) telling anyone that will listen that they are not pleased that the market (traders, money managers…that’s right…smart people) has not priced an asset to their thinking/liking. So, just like listening to HID when they are yelling, you jump and take notice to legitimize HID, only to resume what you were doing after they depart. Financial markets are no different.

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Keith Underwood 1 Comment

US April Payrolls a Tepid +160,000 – Buy YEN and Volatility

The headline number is 20% below the previous 3-month average of 200,00 jobs created and the February and March figures were revised down by 19,000 jobs. While the NFP number is discouragingly below expectation of 202,000, average hourly earnings has risen by 2.5% over the year. While encouraging, hourly earnings alone will not provide enough ammunition for the FED to raise rates come June. External factors such as the slowing growth in China, Japan, Europe, and US will mix with negative interest rates to halt any hopes of increases in inflation. This toxic combination of low growth and stagnant inflation will create the next bout of volatility in equity, rates, and FX.

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Keith Underwood 3 Comments

Negative Interest Rates: A Disincentive to Risk

When all else has failed, use taxes to influence investment decisions. That, to me at least, seems like the approach that 16 countries that have issued some $8 trillion of debt that are trading at negative interest rates. In effect, tax savings with negative rates to encourage investment in risky assets. Well, that’s the theory behind the negative rates but I’ve never met a tax that achieved the expected outcome. Rather, taxes typically encourage avoidance and reduce the chances of succeeding. Negative interest rates will not reverse global demographic trends (aging) and technological advances (transparency of price). In fact, they will potentially aid in reducing growth in those countries and inflict a cycle of lower growth and persistently low inflation.

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Keith Underwood 2 Comments

4 Things That Worry Me

  1. The Japanese yen (110.50 today) is strengthening versus the US dollar (52 week range 110.27 – 125.86) and the yen is typically viewed as a safe haven currency during market uncertainty and turmoil.
  2. The 10-year US treasury yield (1.74%) is lower (30% from it’s June 30th 2015 peak of 2.50%) even as inflation expectations are picking up. Safety is being sought as yields drop.
  3. Gold (1220.50) is, and has been rising, since December and now stands nearly 21% higher. Gold is also a safe haven for investors.
  4. Central bankers are using negative interest rates as a policy tool. Disaster.

 

Am I missing something here? Why are these 4 (should we add in oil as a fifth?) indicators painting such a negative picture and the world is just shrugging with acceptance? These 4 macro measures of the health of the investment community are not good. They are each, on their own, somewhat interesting, but together, these smell like the tin of tuna in the back of the fridge that was forgotten about months ago.

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Keith Underwood 2 Comments

FX Volatility on the Rise


Major currency pairs (GBP, YEN, USD, CHF) have seen significant increases of implied volatility over the course of the last several months.
Implied cross volatility pairs such as AUD/YEN and NZD/YEN have moved into crises levels not seen since 2011.
Equity portfolio managers re-hedging (liquidating dollar positions), against established long USD positions.
Market uncertainty of what the Yellen cakehole cannon might say tomorrow.


 

Equity portfolio managers (PM’s) are heading for the door. They have been selling winners (Netflix and Amazon for example) to lock in profits against the losses incurred on their dogs (European energy and banking). This liquidation (fancy word for sell at market order or ’Get me out!’) of positions is forcing PM’s to hedge their resulting USD exposure. They have sold USD aggressively over the last several months in the face of a market that has been long USD positions.

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Keith Underwood 2 Comments

3 Things to consider about the August NFP @ +173,000

  • Revisions to June and July NFP figures of +44,000 brings the 3 month average gain to +221,000
  • Average hourly earnings are up 0.56% since June and up 2.2% from August 2014
  • August NFP of +173,000 is 30% below the 12 month average gain of +247,000

 

Looking through the lens of the FED, there are positives and negatives about today’s NFP release. On the face of it, a sub-200k number is a slight cause for concern, as the bobble heads will stoke a return Read more

Keith Underwood 5 Comments

China Stirs up the Asian Currency Depreciation Pot

More government intervention by the Chinese (sound familiar?) and this time it’s in their currency rather than their equity market. The PBC today released on it’s website a stunning literacy of how it’s going to improve the central parity rate of the RMB against the US dollar. It has to be a language translation issue at play here because the information provided is little more than explaining what took place after the depreciation. It’s like they were providing color commentary on what took place and laying the blame on the strong US dollar and impending interest rate hike by the FED. I’m no China expert but I think that there are several key takeaways from this abrupt departure from the norm.

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