Outlook & Review 9 Nov 2009

Much ado about nothing? Last week was one of the busiest financial market weeks in recent history, with a stream of important economic data and a flurry of central bank rate meetings. So much for the fanfare though – it all turned into a bit of a washout as everyone stayed on script.
In fact, the S&P 500 managed to claw back some 3.2%, but flat-lining was more the order of the week, as markets adopted something of a “wait-and-see” attitude. The MSCI Emerging market index climbed 2.4%, oil squeezed out a 0.9% gain and the dollar complicity declined, despite a growing chorus of carry-trade worriers.

Unsurprisingly, the Fed kept its key wording in place. The market’s eagerness to pre-empt the rate tightening cycle should serve as a clear rebuttal to ideas that fixed income markets are smarter. In the UK, the BoE also followed consensus, increasing QE by £25 bln; and the ECB remained relatively quiet on matters of tightening market conditions. Sovereign debt prices fell over the week, negatively correlating to rising equity prices.

Sidenote: It is worth mentioning, however, that the ECB’s emergency one-year operations, which will end next month, are attracting less interest (only €75 bln issued in September). If ECB “QE” is drying up, how are euro-area governments going to finance themselves in 2010? Certainly the ECB will provide further funding if needed, but we may first see an interesting test of euro-area confidence.

The big mover of the past week was clearly gold, which rose some 4.6%, passing the $1,100 level at one stage (it closed at $1,095.70). In a quiet week for currencies, bullion was bulled by the Indian central bank’s announcement of a 200mt purchase from the IMF.

Yes, this is a whopping move, and yes, it impacts near-term supply and demand. But, I would caution against seeing it as a game-changer in the gold market. First, India has around $300 bln of FX reserves, so this move hardly diversifies it. Second, as the UK well proved by selling gold a few years ago, governments and central banks are no better at timing markets than the broader public. Third, and perhaps most important, India is the world’s largest gold-for-jewellery market. In fact, weakening Indian demand is often cited to explain falling gold prices. Last week’s move looks like little more than a macro hedging strategy.

If there is a story to tell in the gold trade, it is that this is the first time any central bank has publicly bought above the $1,000 mark, which might make that level less difficult to defend. But more broadly, this trade served to demonstrate that there is far less gold than money in circulation – certainly not enough to renew the gold standard or even diversify FX reserve risk in any meaningful way.

Just ten years back, most of today’s big FX reserve holders were near-bankrupt and borrowing from the IMF. Note then, how quickly surpluses can be achieved when the right policies are followed. And let’s remind ourselves that such large reserves are neither economically efficient nor stable: the G20 needs to address these global imbalances. And yes China – that includes you!

The coming week will be a quieter one, at least in terms of scheduled drivers. A good chance, then, for the market to chew through all the results of the previous week. Discount for unrealistic last minute expectations (like the expectation of the Fed changing its wording) and it all seems to balance out quite smoothly. The jobs data may weigh somewhat, more because of the psychological 10% level than anything. Plus, the closer we get to year end, the more inclined investors may be to collect their profits and take a break. But, the Fed has reminded that free money is here to stay for some time.

We are due a correction. But, few people have benefited from the entire rally since March, and even fewer are willing to step out of the market early. For now I am looking for this correction to continue, but not in a dramatic fashion. Happy trading to you all.

Here are some of the key data points we will be watching this week.

Tuesday
US – Redbook. News on consumer activity in going into 4Q.

Wednesday
US – Veterans Day Holiday. Equity and futures markets are open, but no major economic data are due.

Thursday
Europe – Industrial Production (Sept). Supportive of the recent economic recovery in the region.
US – Treasury Budget (Oct). In the face of soaring stimulus spending and market concerns about the dollar, the fiscal budget is attracting ever more attention. The market is looking for -$150 bln, a larger than expected deficit may weigh on bond prices.

Friday
Europe – 3Q GDP. Europe is expected to have grown 0.6% MoM, far less than the US and still down 3.9% YoY.
US – International Trade (Sept), Consumer Sentiment (Nov). Trade data for August was relatively optimistic, showing a narrowing of the deficit. Oil imports and prices were higher in September though, so today’s expectation will be lower. The market will be watching YoY export levels more closely than ever, for signs of US economic rebalancing. The university of Michigan’s consumer sentiment is seen rising slightly in November, but the range of expectations includes the possibility of a fall MoM.