Dollar Fundamentals Dim Markets’ Outlook

How Did the Markets React? 

Though the October Durable Goods Orders report was only the first in a string of economic releases scheduled for release Tuesday morning, its status as the first worthy piece of macro-economic data for the markets in over a week worked in its favor.  With the cautious trading in the dollar and big moves in bonds and equities from Monday well in mind, traders came to their terminals prepared for fundamentally driven markets.  Given the categorically disappointing drop in durable goods orders though, the reaction from the different markets was unusually mixed.  Bookings for goods lasting three years or more slumped 8.3 percent last month, while the measurement excluding the effects of transportation equipment had also contracted 1.7 percent.  In historical terms, the drop in the headline number was the biggest in six years, while the core indicator was putting up its worst performance in over a year.  Together, these different calculations for essentially the same data stoke doubt in the potential growth rate of the world’s largest economy going into the final months of the year.  The durable goods report is directly related to capital spending and factory health, and therefore can indirectly offer insight into consumer demand, inflation and ultimately GDP.  However, the effect of this single report was quickly discounted only hours later.  Indicators of consumer confidence and existing home sales, as well as comments from Fed Chairman Bernanke, quickly put the market on an even keel; while expectations for the rest of the week’s data points kept speculation running.

Bonds – US 10-year Treasury Note Futures

Debt traders issued the biggest response to today’s dour durables report.   Beyond the basic concern for economic health stemming from the report, those in the treasury market were interpreting it in terms of the potential affect on the Fed’s policy outlook.  With the minutes from the Fed’s last policy meeting retaining the concern over economic softness and questionable inflation, the weak orders to US producers in October was another point of contention for what many see as an inevitable rate cut.  In fact, the concern that a rate cut was in the works after this piece of data was so high that the yield on the ten-year T-note dipped below 4.5 percent for the first time since February.  For the futures contract, prices responded to the news with a 13/32nds move higher, the biggest run of the day.

FX – EUR/USD

Currency traders continued to send the US dollar lower through today’s data, with the poor Durable Goods report sparking a 40 point jump in the EURUSD. Though a later retracement left it flat through morning trade, speculators expressed clear dismay over early fundamental data. This likely explains much of the subsequent Dollar decline, with the EURUSD reaching fresh 20-month highs at the New York session close. Initial forex reactions proved to be “correct”, with almost nothing from the breakdown of durable goods orders to suggest that conditions are improving for domestic businesses. Excluding transportation and aircraft spending, capital goods orders fell a whopping 5.1 percent through the month of October. This coincided with a likewise pronounced 1.5 percent drop in current shipments for these capital goods, implying that recently declining business investment is unlikely to rebound through the medium term. As one of the clearest sign of business confidence, this capital expenditures data points to a pessimistic outlook on the future of growth. What remains to be seen is whether subsequent economic data can bolster the ailing Greenback, as strong selling pressure seems likely to push it to further lows.

Equities –  S&P 500 Index Futures

Bearish capital expenditure data sent US equities significantly lower through early morning futures trade. The chart below shows that the initial sell-off came to a grinding halt, however, with many traders shifting holdings to less risky US stocks. This lent support to broader equity indices, with the S&P 500 actually closing 0.4 percent higher despite its earlier drop. Regardless, the sudden relief rally means relatively little for the outlook on US corporations. Instead of improved optimism leading the advance, the sudden shift to “defensive” issues and energy stocks dominated price action. Traders expressed relative ambivalence to oil prices reaching fresh monthly highs except to send the broad Energy index 1.9 percent higher through the day. Questions now remain as to whether this equity bounce will continue. Relatively light volume on the day may in fact suggest that today’s price move may prove limited, with comparatively thin trading allowing for exaggerated changes. Regardless, it seems that the moment of truth will come through the coming days of significant economic data, with tomorrow’s GDP revision to potentially cast great influence over US stock markets.