Futures Look Up, But Data Driving The Loonie Lower by Richardson GMP
Equities looking to open up today and it must be on the back of earnings as most the other news doesn’t sound all that great. Turkey continues to crack down and arrest just about everybody, the GOP convention continued with a noticeable decline in plagiarism, and the IMF trimmed global growth forecasts from 3.2 to 3.1% on the back of Brexit. Oh but so far earnings season has been very good and that trumps Trump (get it) and other news.
The US trade weighted dollar is now the strongest it has been since early March and looks to be on the rise. One of the big reasons has been better economic data. The Citigroup economic surprise index for the U.S. has shot up very rapidly since the beginning of July. For perspective, the Canadian measure has been gradually losing momentum after being stronger than U.S. data in past months. The data in the U.S. has been strong enough that implied probabilities of the next Fed decision have flip flopped. After the Brexit vote they had priced in a 10% chance of a rate cut on July 27 and now it is back to an 8% chance of a rate hike. The lesson here is implied rate probabilities are the equivalent of an emotional basket case, always fun and entertaining but seldom reliable.
Back to the data and the loonie. We believe there are two primary drivers of the C$, relative yield spreads and oil. The Charts of the day has these two metrics tracked against the C$ over the past couple years, pretty tight relationships. The issue is if the US economic data continues to improve and our data continues to soften, the yield spread will likely widen putting downward pressure on the C$ or upward pressure on the US$. Higher US$ puts downward pressure on oil prices, and lower oil prices pushes the C$ lower. The good news that may mitigate this scenario is our data has been stronger than most expected over the past quarter and that has been helping hold up our dollar. Still, don’t expect the currency volatility to go away anytime soon.
Yields are ticking up slightly this morning, up a couple of basis points. Scanning the majors, its interesting to note that really it’s just U.S., Germany and Canada that are beginning to creep back up to their three month average yield. Perhaps not surprisingly, U.K. yields remain firmly entrenched near the range lows.
The Bank of England is seeing no clear evidence of a sharp Brexit hit yet. (Reuters) They’ve kept interest rates on hold, but the market is still pricing in an 86% chance of a cut on August 4th. The mass exodus of corporate headquarters isn’t happening yet. In fact, Wells Fargo is being greedy when others are fearful and just bought a nearly $400 million USD new London HQ.
Markets have cooled off a little the past few sessions, though the Dow did hit new all-time highs yesterday. It seems that the market is struggling to find that incremental buyer, but with still elevated institutional cash levels, there still some dry powder. The tight trading range over the past few days is not really surprising given the over 6% rally since the Brexit lows. Consolidation is a natural market force that typically happens after sharp moves and can manifest themselves by consolidation in price or time, or a combination of both. In time, as moving averages converge with prices, that incremental buyer is more likely to move as prices don’t’ seem as expensive with the “average” price over the (insert period) sitting just below.
While breadth and most technical all appear strong at the moment, some sentiment measures are telling us something different. The CNN Fear & Greed Index is currently at ‘Extreme Greed’, and is at its highest level since mid-2014.
The Egyptian pound continues to fall against the USD as market participants speculate that the central will weaken the official exchange rate. Like Venezuela and Argentina, Egypt’s pound has two exchange rates: the official one and the black market one. According to Bloomberg, the gap between the two is the largest it has been since 2013, with the black market rate trading at a 32% premium. Further depreciation could come with mixed results. On one hand, it is likely to promote outward investment. On the other hand, it may lead to higher inflation, which would be a problem for “a country where almost half the population is still stuck in or near poverty.” More from Bloomberg here.
There is some useful information Bloomberg’s guide to online privacy.
Diversion: Most of you might remember Bubba Watson’s golf hovercraft, now how about the new golf cart jet pack.
Microsoft reported strong earnings after the close yesterday as sales of PC related products accelerated for the first time in nearly two years up 27%. But the real story was their growth in cloud sales through Azure which grew 108% last quarter. Morgan Stanley saw profits decline 5% last quarter and is taking cost cutting efforts to boost trading and wealth management results. Their goal is to achieve 9-11% return on equity by the end of next year. Spotify is preparing for an IPO in the coming months, they are expecting to garner a valuation of $8bb. The streaming music network has more active users than Apple or Amazon. Canadian Pacific Railway reported better than expected earning this morning as the carrier reduced costs and road trains longer and cut head count.
Oil prices are flat this morning after closing yesterday below $45 a barrel. Inventories declined 1.3% on Tuesday after data showed that inventories declined 2.3mm barrels. Today’s data is projected to show that stockpiles fell for a ninth straight week. Copper pulled back yesterday after concerns gripped that market that China’s economy was slowing, while increasing domestic production. Gold prices are down over $15 at time of writing this morning as a stronger U.S. dollar is weighing on demand for the yellow metal. Positive equity earnings results are driving stocks higher and gold lower.
Fixed Income And Economics
Risk is modestly switched to the “on” position today with equity futures and benchmark bond yields pointing higher. This is in anticipation of the ECB tomorrow providing us with a policy update that is widely expected to be dovish in nature. Many are speculating that Mario Draghi and his team will expand the scope of their current asset purchase program given the expected further slowdown in Eurozone growth after Britain’s vote to leave the EU. Apart from purchasing 80 billion Euros a month of bonds beyond March 2017, economists said the ECB is likely to abandon an earlier self-imposed restriction and begin buying bonds with negative yields below the ECB’s -0.40 percent deposit rate. It could also raise the limit on how much it can buy of each bond issue that is not protected by collective action clauses as well. With swathes of the existing stock of government bonds in the euro zone now yielding less than zero — forcing creditors to pay the borrower a yield for the privilege of lending — the ECB has a limited amount of securities it can currently buy. So far there has been scant evidence that super-low yields (and now negative yields) are doing anything to boost almost non-existent inflation.
Don’t look now but front month crude contracts are trading lower by 15 cents at time of writing to $44.50 for a new two month intraday low. While strife in the Middle East region has some posturing for supply disruptions, demand for oil has actually been below typical seasonal trends thus far in the summer. A recent Reuters polls shows that China’s economic growth failed to bounce meaningfully off a seven-year low in the second quarter, on the heels of a slowdown in the country’s industrial sector and the decline of a recent slump from financial services. Drilling activity in the US continues to increase at the same time, as oilfield services provider Baker Hughes reported last Friday that the number of US drilling rigs increased for a third straight week. Toss in a report from the EIA that suggested domestic shale outputs will see oil production down by 99,000 barrels per day from July to August of this year (Texas’ Eagle ford down -48K barrels and Montana’s Bakken play lower by -32K barrels), and we’ve got a demand/supply tug-of-war as to where WTI is heading. This of course will affect the domestic high yield bond market with nearly 75% of issuers either in the up, down or midstream areas of the energy sector. Additionally, the USD/CAD cross has been straddling the 1.3000 level since early May with no discernible breakout yet to materialize. Are we building a base for a move higher or knocking on upside resistance only to fail and head lower? Questions abound for sure. The weekly DOE report is out at 10:30AM EST with the consensus calling for a large draw in crude and gasoline but a build in distillates.
Domestic new issue markets saw Dollarama Inc. come to market with a $525MM 5 year offering of senior unsecured notes that priced at just +168.90 basis points over the benchmark. This equates to only a 2.337% coupon which is remarkably low for a BBB rated issuer that sits just two notches above speculative grade. We’re not knocking the issuer in any way but the relative recession-proof nature of their business certainly helps draw investor interest in times where many are calling for a day of reckoning in the near future. This is the first issue from Dollarama in over two years and marks their largest ever deal north of the 49th parallel. Secondary demand, starved for near-par deals, was strong with the bonds trading a half point higher on the break and narrow the yield by eight basis points already.
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