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Rebound in Global Equities Sending Dangerous and Misleading Message
Written by article default Tuesday, 16 August 2011 09:41
While Monday was an impressive day for broader risk appetite and US equities, the US Dollar did not fare as well, with the Greenback getting hit hard against most of the major currencies on a combination of weaker local fundamentals and a downgraded fear over the threat of rapid deterioration in global sentiment. The higher close is US stocks on Monday was significant as it officially erased all of the declines seen in the previous week and did a good job of injecting a fresh sense of confidence into the markets.
However, we would continue to caution investors who feel that the worst is behind us as a good deal of this rally has come from artificial forces that might ultimately not be able to support the move. If we just review actions in recent days, we have seen a fresh bailout package in Europe that is far from perfect, a US debt ceiling resolution that seems more like a band aid than any long-term structural fix, more bond buying out from the European Central Bank in an effort to prop the local economy, a Fed monetary policy that is committed to remaining ultra accommodative if necessary until 2013, talk of QE3, central bank currency interventions from the SNB and BOJ, and banned short sales in European equities to prevent excessive and rapid equity declines, amongst other things.
We therefore wonder if you removed all of these actions from the equation where in fact we might actually be today and how different the world would really be. Our point is not that these actions are unnecessary, but that they are in fact artificial and extreme measures that have been implemented in an effort to produce a softer landing for the global economy. Ironically, these actions that are used to prevent additional fear and uncertainty have had the enhanced effect of stimulating risk appetite and opening market rallies in which the global community feels as though they should continue to buy risk on dips as governments will always be there to support the pullbacks.
But with global stimulus and central bank accommodative measures nearly exhausted, there doesn’t appear to be much more ammunition left to throw at the recovery, and we would expect that when fresh concerns arise over the coming days and weeks, there will be less of an official response to support these concerns. US economic data and growth prospects are still quite gloomy, while the eurozone economy is far from out of the woods. Meanwhile, we still have the potential for a major cooling down in the Chinese economy which we contend will be the third phase of the global market recession which began in 2008.
After all is said and done, the actions taken by central banks and governments are indeed necessary, but we feel that the way the markets have interpreted these measures has been far too optimistic, particularly with respect to global equity market performance. We still believe that we will see yet another downturn in global equities over the near-term and that the prospects for a material recovery in these markets over the coming months are less than favorable. Instead we see choppy market conditions that are more consolidative with any recoveries coming much slower than we have seen in the past. If quantitative easing and other stimulus measures implemented by Japan in the 90’s have yet to still fully realize a recovery in Japan all these years later, then does it not stand to reason that a global effort of ultra accommodation and stimulus will produce an even longer period before the global economy can really recover?
Moving on, there was a good deal of central bank speak on Monday, with both Fed Lockhart and Fed Lacker on the wires. Although the two central bankers are in slightly different camps on their approach to monetary policy, both acknowledged that the language to keep monetary policy ultra accommodative through 2013 was contingent on the performance in the local economy. Lockhart said that the bar was very high for the offering of additional easing measures, while Lacker who was opposed to QE2 and would therefore likely vote down any notion of additional accommodation, made it clear that policy could reverse if economic conditions changed. Lacker who will become a voting member of the FOMC next year is clearly much more concerned at this point with the longer-term impacts of the ultra accommodation on the economy. Fed Lockhart did not shy away from politics in his remarks after saying that Congress could have prevented the S&P downgrade had they handled things better.
Looking ahead, the focus shifts back to economic data with German and eurozone growth data and UK inflation readings highlighting the European session. US building permits, housing starts and industrial production take center stage in North America. US equity futures and commodities consolidate their latest moves, but it is interesting to see gold still so well bid despite the latest rally in global equities. This goes back to our earlier argument that investors should still be wary of the latest rebound in sentiment.
ECONOMIC CALENDAR
TECHNICAL OUTLOOK
EUR/USD: The market continues to adhere to a bearish sequence of lower tops since May, with a fresh lower top now in place by 1.4535 ahead of the next downside extension back towards and eventually below 1.4000. In the interim, look for any intraday rallies to be well capped ahead of 1.4500, while only back above 1.4535 negates. Short-term support now comes in by 1.4240 and a break back below should accelerate declines.
USD/JPY:Setbacks have stalled out just ahead of the 76.25 record lows from March, with the market dropping to 76.30 ahead of the latest reversal. Given that we are seeing the rate by record lows, we would not at all be surprised to see the formation of a material base in favor of significant upside back towards the 82.00 area over the coming sessions. However, the overall structure still remains bearish and it will take a break back above 80.00 to officially alleviate downside pressures and confirm reversal prospects. Short-term resistance comes in by 77.30 and a daily close above will encourage bullish reversal prospects. Below 76.25 negates.
GBP/USD: The market remains locked in a broader downtrend off of the April highs, and a fresh lower top is now sought out somewhere ahead of 1.6550 in favor of the next downside extension back towards the recent range lows at 1.5780. Ultimately, only a break back above 1.6550 would delay bearish outlook and give reason for pause, while back under the 200-Day SMA at 1.6085 should accelerate declines.
USD/CHF: The latest sharp reversal off of record lows just shy of 0.7000 is encouraging and could finally be starting to signal the formation for a major base. Weekly studies are also confirming with the formation of a very bullish bottom close. From here, look for an acceleration of gains back towards the 0.8500 area over the coming days with setbacks expected to be well supported above 0.7500 on a daily close basis.
Written by Joel Kruger, Technical Currency Strategist
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