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The Interest Rate Report

by Eaven Horter

The trend is your friend…until it’s not

11/20/2009

Eaven Horter; ehorter@pfgbest.com, (312) 563 8165

Apologies for the lack of research since my last post on November 4^th, but I was out sick; luckily not the Swine Flu!  Let’s look back to that piece because frankly, my views haven’t changed much.  Of the two scenarios I laid out on the morning of November 4^th, I chose Scenario 2: 

“The FOMC does not change their language on rates.  Look for the 10 year T-Note futures to top out above 119-08 and 10 year T-Note cash yields to approach 3.35%.  This would add a small pop to stocks, a drift down in the USD and an increase in the price of gold; we are already seeing this scenario partially priced into the markets today.”

This scenario has pretty much played out, although this week’s weak economic data added to the level of risk aversion in the markets, giving strength to the USD and pushing 10 year T-Note futures towards a new resistance of 120.

We are continuing to experience the push and pull of risk aversion versus dollar weakness/interest rate concerns.   Post-FOMC comments, the US Dollar Index fell from 76.30 on November 4^th to 74.67 on November 16^th; a 15 month low.  This move, coupled with weak economic data, played into a rebound in the US Dollar Index, bringing us a full point higher today at 75.67.  With these moves, the stock markets spiked up but have fallen from their highs on November 16^th.  I feel there is still some more room for the US Dollar Index to climb, with first resistance around $76.25-30, then $77.50 and near term support at $74.75.

Next week should bring heavier volume trading on the 23^rd and 24^th and then a tapering in action beginning shortly after the 7 year T-Note auction on the afternoon of the 25^th given Thanksgiving.  Although we’re looking at a holiday week, numerous important data releases are occurring, so look for an increase in the VIX:

November 23^rd: Existing Home Sales, 3 month and 6 month T-Bill auction (~ total of $62bn) and then the 2 year T-Note Auction (~$44bn)

November 24^th: Q3 GDP, Case Shiller HPI, Consumer Confidence, 4 week T-Bill auction and then 5 year T-Note Auction (~$42bn).

November 25^th: Durable Goods Orders, Personal Income, Initial Jobless Claims, Consumer Sentiment, New Home Sales, EIA Report and the 7 year T-Note auction ($32bn)

Considering the numerous focus points of next week, I feel we should continue to see a pull back across the markets, excluding the USD, with a renewed aversion to risk.  For one reason, I believe we’ll see continued profit taking from gains made in November and increased concerns regarding the housing sector.  I believe we will see a downside correction in GDP for the 3^rd quarter, although only slightly.  I believe consumer confidence will slip again given the increasing unemployment rate and the impressively grim “underemployment” rate of 17.5% for October.

What’s to Come:

With this in mind, look for the S&P 500 to cross support at 1080, with solid support at 1065.  Look for Crude Oil to trade down to support just under $76 and then back up to resistance just above $80.  Late this week, 10 year T-Note futures bounced off of their support @ 120. However, given the possibility for negative surprises next week from economic data, coupled with the short/mid-duration treasury auctions, we will see a bounce between 118-16 to 120-16.

However, if data next week surprises to the upside, which is much less likely, we could see the USD break support of $74.75 and approach $74.50 and 10 year T-Note futures approach the lower end of the channel.  Although there is room for the dollar to approach the $72 level we experienced in March 2008, it will be very difficult for this to actually happen for two reasons.  First, foreign central banks are in the process of deflating their currencies versus the USD.  Second, the FOMC is slowly, and slyly, changing their verbiage towards a stronger dollar “policy.”

As the FOMC continues their “strong dollar" verbiage, not policy, the USD should strengthen as this verbiage is actually acting like policy for now.  Transparency from the FOMC is very important and it will be interesting to see how directly they address the USD and how its value is affecting the rest of the world and not just our economy over the coming weeks.  A weaker dollar makes sense for the US in order to balance our deficits and spark growth, especially exports.  Also, given the US has been prodding the Chinese to appreciate the Yuan for years now, a weaker dollar may be an interesting work-around to force the Chinese government to adjust their policies.  Looking out to when the FOMC might adjust rates, I still believe we will see a hike in the 2^nd quarter of next year; a rate reset to 50bps or 75bps is still an extremely low rate and well below historical levels.

Additionally, as foreign central banks continue to sell their currencies and buy the USD to offset the appreciation of their currencies, we should see upside kicks to the USD, especially as the US Dollar Index bounces off of support levels just below $75; this is one reason for the recent strength in the US Dollar index.

As we approach December and year-end, my main concerns are for potential profit taking at the end of the year as well as increased foreign central bank intervention and commentary.  With the massive gains that have occurred across the board in stocks and commodities, I believe we may experience a pullback in the 2^nd half of December from the recent highs alongside a strengthening of the USD.  However, outside of the profit taking, domestic and foreign central bank verbiage and policy will weigh heavily on markets as foreign nations begin to unravel their stimulus policies.  However, are investors ready for this unraveling and do they actually believe economies are strong enough to move forward on their own?  Only time will answer these questions, but it seems to me like the world economy is on a choppy but upward trajectory towards recovery.

Eaven Horter
PFGBEST Research Team
ehorter@pfgbest.com

FOMC Release and Year-end

11/4/2009

Eaven Horter, ehorter@pfgbest.com or (312) 563-8165

The FOMC comments are again in the spotlight today (215pm EST) and all ears/eyes will be focusing on what change in language may appear throughout the minutes.  Look for my overview of the minutes after the full copy is released but in the meantime, here are three themes to focus on: 

1. Will their language on “extended” low interest rates stay the same?  My thoughts are yes.
2. Will their language on stimulus related housing stay the same? I believe for the most part it will but I think they will look to more clearly define the exit.
3. Will their language about the rebounding economy change? I believe they will focus on the improved 3^rd quarter expansion.  However, they will also allude to the stimulus programs associated with this growth and discuss the probabilities for the continuation of our rebound – slow and shaky.

We have come a long way from last Fall/Winter and our economy is continuing to improve.  However, I do not believe we are out of the recession yet and we still have many challenging quarters ahead of us.  Growth, whether less negative or actually positive, is on the horizon and will help alleviate fears.  We as a nation will continue to regroup and come together to move our economy forward but it will be a herky-jerky move up, not a straight path to the upside.

With this being said, don’t look for rapid economic expansion or skyrocketing returns in the stock market over the coming months.  Since the Dow hit 10,000, investors have become more wary of the fundamentals of our recovery and are hesitant to put additional monies to work within stocks.  The massive amounts of retail money that has gone into bonds over the past few months and the small rebound in the USD is evidence of this risk aversion and considering we’re approaching year end, I wouldn’t be surprised to see a trimming of profits to shore up a positive year.

In-line with my previous comments from October, watch for the general markets’ continued focus on FOMC language related to stimulus and interest rates as well as a focus by investors on risk aversion.  The USD is still a huge driver of the markets but it is now not only affected by current and future interest rate considerations but also by an increased aversion to risk.  This tug-of-war will create increased volatility within the markets and if economic data falter, look for risk aversion to beat out low-interest rate concerns.  However, if other nations continue to raise their interest rates and the US does not, look for interest rate concerns to win out, with a potential move down to as low as $73 in the US dollar index near the beginning of 2010.

Looking back at the past few weeks, I believe one consideration for the stronger dollar were the prospects for an interest rate hike to occur sooner than later given such strong 3^rd quarter performance; this performance was more stimulus driven and is not sustainable at the pace it occurred.  The earliest prospects for a rate hike would be Q2-2010 but most likely Q3-2010, so the carry trade should still exist for several months.

I do want to draw attention to the growing unified approach the world governments/central banks are taking.  For example, the G20 meetings later this week along with the IMF comments from earlier this week all point to a more organized global approach to tackling the crisis our economies/central banks are experiencing.  This is a VERY positive step in the right direction and I believe it will allow for more appropriately targeted solutions to our individual and global woes: Two thumbs up!  As our nations continue to come together to solve global and not just regional issues, Central Bank comments from nations outside of the US will be in focus even more than the already have been.  In addition to the Australian comments from earlier this week, focus on comments from the European Central Bank and the Bank of England on November 5^th.  I believe these may weigh on investors’ hopes for a quick economic recovery.

Looking back to other comments I made in early October related to currency concerns, we are continuing to see international Central Bank action to correct the falling dollar/rising commodity trend.  Look at Australia, who once again raised rates another 25 bps to 3.50% and to India’s Central Bank’s purchase of 200 tonnes of (gold) bullion to balance their currencies.  This purchase by India brings up an interesting point with gold as we are now no longer just looking at a pure “the USD is falling and interest rates will rising” concern; we are also looking at a true supply/demand relationship.  This added component to the gold equation will definitely move gold to the upside in the near term as other countries consider snatching up the remaining gold stockpiles from the IMF; let’s just hope the scramble doesn’t become a sprint.  I think this does point to a bubble in gold prices, especially if we see a “run” on existing inventories.  However, when the FOMC does raise interest rates next year, look for a correction in gold to occur as gold has been a larger “risk aversion” play than “inflation” play.  Over the long run though, I believe you will continue to see diversification out of currencies by international countries into more commodities, such as gold.  Here’s an interesting statistic to think about that I saw in a November 3^rd article by Javier Blas on www.ft.com:

“China’s current gold reserves represent only about 1.6% of its total foreign reserves, in spite of its recent purchases from local miners, a vastly smaller percentage than the global average of 10.5%.”

So, let’s boil the above down into two scenarios to consider for today:

Scenario 1: The FOMC changes their language and drops “extended” from their message.   Look for a sell-off in bonds, with 10 year T-Note futures approaching 113 ½ and 10 year T-Note cash yields approaching 3.80%.  This should spark a rally in the USD and a drop in gold; stocks will most likely fall in the near-term but should hold their ground for the most part.

Scenario 2: The FOMC does not change their language on rates.  Look for the 10 year T-Note futures to top out above 119-08 and 10 year T-Note cash yields to approach 3.35%.  This would add a small pop to stocks, a drift down in the USD and an increase in the price of gold; we are already seeing this scenario partially priced into the markets today.

My view is that scenario 2 is most likely.  Look to buy 10 year T-Note futures prior to the FOMC release below 117-24, stop 117-16, then sell above 118-18, then enter new sell position in 10 year T-Note futures above 119, stop 119-10, hold till at least 117-24. Look to go long gold DEC calls a few strikes above the current trade price or even consider selling DEC puts below a 1060 strike – focus on locking in a moderate level of profit.

Please call or email me with any questions: Happy trading!

ehorter@pfgbest.com or (312) 563 -8165

Eaven Horter
PFGBEST Research Team
ehorter@pfgbest.com

GDP, Earnings and Initial Claims after a USD bounce

10/29/2009

Eaven Horter

ehorter@pfgbest.com, (312) 563-8165

We have about 15 mins to go until GDP and Initial Claims are released.  Additionally, we're going to see some substantial US companies release earnings throughout the day.  As alluded to last Friday, the USD saw a continued bounce in the first half of this week, although larger than expected, accompanied by profit taking throughout the stock markets and strength in the bonds.  It's interesting to point out the decreasing swings in bond strength/weakness; we've been bouncing off of 117 and 118 1/2.  I see this occurring because of the perceived weakness in fundamentals across the globe and the fact that we've passed through some technical levels, most notably EUR/USD @ 1.50, which brought some profit taking into the USD fall.

Look for continued volatility in the USD and bonds as investors balance two paradigms:

1) Growing perception that stimulus, albeit short-term, has been the main driver in making the economic recovery look much stronger during the 3rd quarter.  This, in conjunction with continued job losses and lack of available credit, finally seems to be turning investors thoughts towards a more muted recovery, thereby decreasing the likelihood for an increase in US interest rates in the near-term.

2) However, due to these expectations for a slower recovery, investors are beginning to reduce their risk appetite, which seems to be increasing their appetite for bonds and USDs.

Look for this push/pull to continue through to year's end, with US interest rate expectations and the value of the USD continuing to be market drivers.  I wouldn't be surprised to see cash yields approach 3.48-50% today with a strong GDP number, inline initial claims number and in-line earnings; look for 10 year T-Notes to approach 117 1/2.  If GDP comes in much less than expected or we have a horrible downside surprise in corporate earnings, which I doubt, look for a push up to 3.35% in cash yields, renewed weakness in the USD Index to just above $76, and 10 year T-Notes approaching 118 3/4.

Trade for today:

Sell 10 year T-Note (ZNZ9) near 118-06 and look to take profits just above 117-18 (place stop at 118-12)

Feel free to call/email me with any questions!

Eaven Horter
PFGBEST Research Team
ehorter@pfgbest.com

There is a substantial risk of loss in trading futures and options.

Past performance is not indicative of future results. The information and data in this report were obtained from sources considered reliable. Their accuracy or completeness is not guaranteed and the giving of the same is not to be deemed as an offer or solicitation on our part with respect to the sale or purchase of any securities or commodities. PFGBEST, its officers and directors may in the normal course of business have positions, which may or may not agree with the opinions expressed in this report. Any decision to purchase or sell as a result of the opinions expressed in this report will be the full responsibility of the person authorizing such transaction.

There is a substantial risk of loss in trading commodity futures, options and foreign exchange products. Past performance is not indicative of future results.