A bout of optimistic economic releases for the American economy had equity investors in a joyous mood yesterday, with durable good orders and the CaseShiller house price index both beating analysts expectations which helped push the S&P 500 to new record highs well into the 1,900s. The DXY caught wind of the positive economic developments, causing the USD-linked index to trade with a firm bid-tone and remain well supported in the low-to-mid 80s, while spot Gold tumbled to $1,263/ounce. Treasury yields on the long-end of the curve weren’t as enthusiastic as would be expected from the move in equities, yet the short-end of the curve did see some firming as investors repositioned flows from bonds to stocks. The slumping of the 10-year treasury yield makes us feel that there are still situational, event-driven issues with the bond market which are causing pressure on longer-term yields, with the well-noted carry trade between German bunds and US treasuries potentially one of the catalysts for the sluggish performance. The spread between interest rates on long-term US and German debt remains at its widest levels since 2006, encouraging asset managers to short German bunds and dump money into US instruments to capture the interest differential, with the ensuing demand for US treasuries keeping a lid on yields.
Speaking of yield spreads, a narrowing of the 5yr CDN-US spread kept USDCAD from sinking into the low-1.08s yesterday, as shorter-term yields in the US perked up after the slew of positive US data releases. On the technical side of things for the pair, yesterday’s price action formed a doji candlestick, which can either be a used to signal indecision in the current trend (USDCAD lower) or that a reversal is imminent. Given that some momentum indicators are starting to creep into oversold territory, and USDCAD has been grinding along the bottom-end of the range we’ve seen for 2014, the doji candle could be warning a turn for the pair is in the cards. While Canadian GDP for the first quarter is waiting in the wings on Friday, the big event risk for Loonie traders will be next week when the Bank of Canada meets on Wednesday. Make sure to speak with you dealing teams ahead of next week, as the jam packed first week of June could be a catalyst for USDCAD to break out of the recent 100 basis point range the pair has been stuck in over the last month.
The positive risk appetite exhibited in North America filtered its way through to trading in the overnight Asian session, with sentiment also helped by local reports that the People’s Bank of China may continue with a targeted easing regiment that includes cuts to bank’s reserve requirements in an effort to stabilize growth. Mitigating some of the positive sentiment on the central bank rumors was the fact that late payments on loans in China have risen to a five-year high, setting the stage for banks to report the highest portion of bad debts since 2009. The jump in late payments is troubling considering what this means for asset quality and liquidity constraints among borrowers, but also reinforces what the government is trying to purge from the system as it steers the economy on a more sustainable growth trajectory. The Shanghai Comp finished it’s session higher by 0.77%, while the Yuan weakened and pushed USDCNY up to 6.25, closing in on the highs we saw in late April.
As we do a data check in Europe, the CAC, Dax, and FTSE are all slightly in the green midway through their session, grinding higher in a low-volatility, complacent environment. Despite the optimistic mood for equities, the EUR is trading on its back foot this morning, seeing supply for the currency outstrip demand after a round of less than enthusiastic data points were released overnight. M3 money supply only grew by 0.8% compared to the previous twelve months to April, missing expectations of a 1.1% increase and sliding from the downwardly revised 1.0% print from March. Blunting some of the sting from anemic money supply circulation, private loan growth saw a upside surprise for April, coming in with a y/o/y decrease of only 1.8%, better than the 2.2% contraction from March. The numbers do little to alter the market’s perception of what the outcome for next week’s ECB meeting will bring, yet in our view it reinforces the precarious position of inflation expectations throughout the zone, and that a token rate cut from the ECB next week would not be enough of a fix to save the markets from feeling slighted. EURUSD as a consequence is trading heavy as it makes a move towards the 1.36 level, an area not seen since the middle of February. From a technical perspective, the double top in EURUSD that was formed in March and then earlier in May has been completed with a piercing of its neckline last week, and the subsequent follow-through selling now places the technical downside target in the 1.34s – but in order for that to happen the EUR bears will need some help from the ECB next week.
Heading into the North American open, equities are keeping calm and carrying on as S&P futures levitate higher and the VIX churns at lows not seen since the first quarter of 2013. FX volatility is also trading in a similar fashion, with three month implied volatility in the options market for USDCAD trading at record lows – giving traders the opportunity to pick up protection at relatively cheap levels. USDCAD spot is slightly higher this morning as a consequence of USD buying interest on the back of soft performances from the EUR, GBP, and NZD, but still within its comfortable range in the mid-1.08s. With a lack of influential economic data releases or Fed speakers during the North American session, we could be in for a quiet day; however it is likely participants will be looking to jockey for position heading into the GDP releases for the US and Canada over the next two days.
Looking ahead to tomorrow, the big data point on the economic calendar that everyone will be watching is the second revision to GDP growth for the American economy during Q1. After an already disappointing first estimate of economic growth that printed a 0.1% increase, the drag on growth from inventory accumulation at the end of 2013 and lack of business investment is expected to have intensified since the first forecast, with expectations now set to see a contraction of 0.5%. To some extent the softness in Q1 GDP has been well priced into market over the last few weeks, and considering the market is highly anticipating a stronger rebound in Q2 to make up for the challenging weather conditions in the first quarter, anything coming in around expectations or slightly better will most likely lead to some USD buying on a quasi relief rally. As such, we see the risk/reward profile for Thursday’s release being skewed to the upside for USDCAD, and while there is a good likelihood GDP growth contracted in Q1, the greater risk is the market reaction to something not quite as bad as participants are expecting.