USD.MXN

Whoops! And Soon, Whoops Again? 

By John R. Taylor, Jr.

Last Wednesday evening, New York time, as I sat down to write this letter, the global markets looked extremely weary, if not shell-shocked, leading me to proclaim that the end was nigh, if not already upon us. Then Kuroda rocked the world with aggressive easing exceeding that which even the more optimistic prognosticators had seen, launching a long-term liquidity-creating program that rivals that of Bernanke’s Fed. Instantly the Japanese markets took on the character of a Chinese New Year procession, with flashing lights, exploding firecrackers and general din overwhelming traders’ senses and composure. The yen was quickly crushed, dropping to new multiyear lows and, less than ten hours later, Draghi and the ECB poured cold water on Europe’s already dreary and sodden procession, doing nothing and noting that there was not much that they could do to help the Eurozone out of its fix. The ECB’s balance sheet would continue to shrink, out of sync with the Fed, the Bank of England and the Swiss National Bank, while the BoJ’s was doubling. As a result the euro strengthened against everything, but especially the yen. This is a toxic mixture, an aggressive addition of liquidity to the global marketplace, while Europe the seat of all our woes tightens its belt. Buy or sell? Obviously it depends on where you look, but the general thought has to be “don’t fight the Fed (and the BoJ),” so buy. Twenty-four hours later, further lifting the gloom, the US Department of Labor came out with a terrible Non-Farm Payroll report, with new jobs about half what the market was expecting. Terrible? Gloomy? No, that is great news! The chance of the Fed backing away from QE goes down ramatically with these numbers, so this is a great reason to buy risky assets. Not only will the Fed not rain on this parade, but the Japanese have sent one of the largest marching bands ever seen to join it. Outside Europe, this is a perfect combination for a Goldilocks market, not too hot, not too cold – growth is weak enough that interest rates stay low, allowing equities to climb.


There is a negative side of this rosy picture. It used to be called “stall speed” – when the economy is moving so slowly that any bump would cause it to fall out of the sky. Are there any bumps on the horizon? A perennial one is Europe and the probability of trouble is much higher now than it has been at any time since Draghi’s “bumblebee” speech last July 24. The Italian political situation continues to deteriorate and the social situation could be moving toward a flashpoint. With the LTRO funds rolling off, loans to the private sector down throughout the area, and loans for consumption dropping sharply, the Eurozone is very likely to see negative GDP in both the 2nd and 3rd quarters. On the other side of the world, there is still some risk that the new leadership in China will tighten too much, will try to lessen class differences, and will cut personal entrepreneurial opportunities, all for the good of the country – and to the detriment of growth. In the US, the first quarter earnings season is here and there is a good chance that the year-on-year comparisons will be negative. Other than Europe, none of these bumps seem too major, but the odds of some reversal after 6 months of great risk-on markets are high, and the reversal could be as shockingly quick as the one last week. This recent burst to the upside actually increases the risk of a sharp turn lower, most likely by the end of the next week. Get ready for the next upset.


Basket-Case 

By Joseph Palmisano

Given the weakness in the JPY, investors have been searching for more attractive opportunities to grab yield, particularly in FX markets. A chart of an equally-weighted basket of MXN, CAD, NZD, AUD and ZAR versus the JPY shows these commodity currencies are revisiting the highs last seen in July of 2007. Indeed, the BoJ’s aggressive effort to combat its deflationary economy caught markets by surprise and has led to this sharp move higher in commodity currencies, but we think it is insustainable. In Canada, for example, while GDP growth likely struck a bright note in the 1st quarter, a weaker global backdrop will weigh on growth in the 2nd quarter, particularly after the largest monthly decline in employment since the recession. In Australia, the RBA left the rates at 3% last week. However, investors expecting the Bank would water down or abandon its easing bias were disappointed, as it was reiterated that policy would be eased again if necessary to support a stillstruggling economy. The US has entered another economic ‘soft’ patch. We may not experience a summer swoon similar to past years, but it will most likely be a time to shed risk. Our analysis suggests the 2nd quarter will be rocky in terms of growth. Given that Mexico is an exportoriented economy and its main export partner is the US, where 78% of its goods are sent, and the US is by far Canada’s largest trading partner, accounting for roughly 79% of exports, these countries’ growth prospects will be adversely affected. Oil and oil products account for 14% of Mexico exports, and while the price of crude oil hasn’t done much so far this year, it is down 13.3% from its peak in March 2012. In South Africa, the ZAR will likely be driven more by domestic factors such as ongoing labor unrest than global risk drivers, as appeared to be the case since mid-2012. The SARB is uncomfortable with the sustainability of the economic recovery given the high degree of household indebtedness (currently around 76% of disposable income), with the majority of debt exposed to variable rates. In New Zealand, there is the risk of a property bubble. New Zealanders continue to leverage up, with total outstanding mortgage credit increasing by 4.3% February from a year ago - the fastest pace of growth since December 2008. The ratio of housing debt-to-GDP also continues to rise, increasing for he 2nd t consecutive quarter to 85% of GDP. The cycles call for the rally in these commodity currencies to end by late next week and then decline for a few months. Buy USD/MXN at 12.0100, USD/CAD at 1.0075 and USD/ZAR at 8.7600. They will then turn higher to end-April for an initial peak of 12.4500, 1.0300 and 9.0500 respectively. As the longer cycles call for dollar strength into early July, sell AUD/USD at 1.0650 and NZD/USD at .8665. They should decline to end-April for an initial low of 1.0350 and .8400 respectively. The longer cycles are negative to early July.