Dollar Risk Rally Runs Dry as Fed Buys Treasuries, Growth Wobbles

Credit Market

Previous

Current

Change

% Change

Outlook *

DJ Credit Default Swaps

109.961

106.967

-2.994

-2.72%

Improving

10 Year Junk-Bond Spread

689.99

680.25

-9.74

-1.41%

Improving

Credit Card Delinquencies

4.77

4.64

-0.13

-0.13%

Improving

Mortgage Delinquencies

9.47

10.06

0.59

0.59%

Deteriorating

US 3 Month Libor Rate

0.384

0.345

-0.03891

-10.12%

Deteriorating

Total Money Market Funds

2829.31

2822.02

-7.29

-0.26%

Improving

Stock Market

Last Week

Current

Change

% Change

Outlook

Dow Jones Industrial Average

10378.83

10433.97

55.14

0.53%

Improving

Dow Jones Real Estate Index

197.65

199.96

2.31

1.17%

Improving

Dow Jones Financial Index

325.81

327.21

1.4

0.43%

Improving

Dow Jones Retail Index

81.78

82.7

0.92

1.12%

Improving

S&P Volatility

25.39

23.61

-1.78

-1.78%

Improving

Put-Call Ratio

2.49

1.72

-0.77

-0.77%

Improving

Market Breadth (Adv - Dec)

0.4946

0.2030

-0.2915

-29.15%

Deteriorating

Economic Indicators

Previous

Current

Change

% Change

Outlook

GDP (Annualized)

2.8

2.4

2.4

2.40%

Improving

Mortgage Applications

0.6

13

13

13.00%

Improving

Initial Jobless Claims

458

484

26

5.68%

Deteriorating

Consumer Confidence (UMich)

74

67.8

-6.2

-8.38%

Deteriorating

ISM Manufacturing

56.2

55.5

-0.7

-1.25%

Deteriorating

ISM Services

53.8

54.3

0.5

0.93%

Deteriorating

ISM Services - Employment

49.7

50.9

1.2

2.41%

Deteriorating

Speculative interest would catch up to fundamental reality this past week. A reversal in the dollar’s favor was instigated by a technical break and reversal last Wednesday; but the momentum behind this correction was based on underlying market positioning and fundamentals. On the one hand, two-months of steady build up in ‘risky positions’ would leverage the susceptibility to a correction. Facilitating this shift was the news that the FOMC was pumping the breaks on its stimulus withdrawal by reinvesting principal payments and mortgage-backed securities and agency debt into Treasury purchases. This could have been construed as a sign that the US has been forced to loosen policy as growth and fiscal conditions deteriorate. However, with the global economy suffering similar troubles, this development was instead interpreted as evidence that investor sentiment market wide would dry up as stimulus was proving itself to be a permanent (and ineffective) crutch. Yet, despite the speculative draw to work down excess risk premium and a lasting concern that risk appetite will not be able to stand on its own – the greenback’s run has since decelerated and stalled. As has been the case for a few months now, risk aversion requires substantial and consistent support. This week has been exceptionally light on schedule event risk that would clarify US growth trends and interest rate speculation as well as unspecified threats like a potential European financial or Chinese lending crisis. We may not see such drivers gain traction until next week.

Little has changed when it comes to the financial health of the US and global markets – that is except for perception. Just a week ago, the Chinese government told the nation’s banks to stress test for a 60 percent drop in residential home prices and take off-balance sheet assets onto their books. The threat this poses to the global balance is immense; but until the situation deteriorates, market participants are willing to overlook it for now to take part in a temporary upswing. The same can be said about the European markets. Irish, Portuguese and Spanish debt auctions have met significant demand and drawn lower yields. However, this in itself is a reflection of market confidence – making it an intrinsic circle. Troubles still exist beneath the surface; but speculative interests are distracting.

Economic data has offered a mix view this past week. From a top down approach, the general pace of second quarter global growth was updated with a much stronger than expected advanced GDP reading from the Eurozone. However, this region faces the same decelerating factors that its largest peers seem to already be exhibiting. In the US, the data has been relatively light; but provocative. Monitoring the consumer (accounting for three-quarters of activity), the University of Michigan sentiment survey bounced (though is still near lows for the year) and retail sales rose 0.4 percent (though discretionary spending declined). Killing any chance of a near-term rate hike, CPI held at a 1.2 percent annual clip. And, raising credit market concerns, bankruptcies hit a five-year high and mortgage interest tumbled.

There was little arguing a correction in risk appetite this market; because the shift in underlying conditions was noted in price action for most of the largest asset classes. A high correlation between the various securities (equities, bonds, commodities, FX carry) paired with a substantial move is more often than not evidence that investor sentiment is at the root of the move. This is the case because the need to transfer capital to high-risk securities to lower risk ones is necessitated by margin and the fear that gains will turn into substantial losses. However, that being said, the pickup in confidence that would open the week was severely lacking for momentum. By definition, this is a correction rather than a reversal. The latter term denotes a change in trend that requires the development of an actual trend. That does not mean that conviction will not develop later on in this move; but some fundamental certainty will have to be established for this bounce to evolve. Unless a strong bid returns to the capital market in the near future, last week’s broad risk unwinding will stand as the prevailing trend.

In the past week, the standard bearers for the speculative market have moved little. When we leave out last Wednesday’s spectacular risk-aversion move (the EURUSD marked its biggest daily tumble in years), the capital markets have shown very little progress towards a definitive trend. That puts the markets in a very fluid position. On the one hand, July was defined by a steady appreciation in risky assets; but last week’s correction would retrace a significant portion of those gains for many of the benchmark assets. When traction is once again found, will the larger advance pick back up or will a reversal play out? Time will tell.

The typical measures of risk were relatively staid through last week’s reversal; and were unsurprisingly improved through this period. The equities based VIX Index and DailyFX currency volatility index would both ease. Even upstream indicator would relieve pressure. Junk-bond spreads would ease and credit default swaps deflated. That being said, surface risk was the only thing that truly improved. The source of the market’s uncertainty has in fact only blossomed with time. For an underlying picture of risk, we can look to the fact that yields for US and German government debt have pushed record lows despite additional sales. What’s more, the Greek/German debt yield is at a 3-month high and 3 month Libor rates continue to rise.