Weekly Review: Dollar Surges as FOMC Remains Optimistic About the Economy

This week, the global financial markets continued to stabilize following weeks of increased turmoil. Here are some of the most important updates of the week.

Cryptocurrencies

This week, the cryptocurrencies market started positively. On Tuesday, the currencies reached a weekly high with bitcoin reaching a high of $11,797.

Since then, the currencies started going down with bitcoin reaching its weekly low on Thursday when it reached $9,574.

The downward movements happened as traders took profits following a multi-week rally that started a two weeks ago. Since then, the currencies have risen by more than 50%.

The positive news came from South Korea which moved from threats to embracing the currencies.

Central Banks

This week, we received multiple words from key central bankers. On Tuesday, we received minutes from the Royal Bank of New Zealand’s last meeting. The minutes showed that while the members were optimistic about the economy and the hegemony of the global economy, they remained highly concerned about the ballooning mortgage debt. Week-to-date, the AUD is lower 1.50% against the dollar.

On Wednesday, the BOE held the inflation hearings where the members reaffirmed their past statements about hiking rates if inflation continues to rise. The pound is low by 0.44% against the dollar.

Global Stocks

The global stocks were significantly down this week as traders started questioning the long-term prospects. As of this writing, the Dow and S&P are down 0.94%, 1%, while the DAX and Nikkei were up 1.31% and 1.26% respectively. In the United States, the biggest stocks gainers were Home Depot, Exxon Mobil, and United Health, which gained by 1.32%, 1.30%, and 0.87% respectively.

Currencies

The dollar index was up by 1.41%. The upward momentum for the dollar came as investors forecasted that the Fed was likely to raise interest rates. This came after the Fed released the minutes for their latest FOMC meeting. The minutes showed that the Fed officials were optimistic about the economy, which they believe will be boosted by the tax cuts. Against the Euro, Yen, and Pound, the dollar was up by 0.77%, 0.40%, and 0.31% respectively.

The Canadian dollar continued its multi-month decline, falling to a low of 1.2742. The Australian dollar was also down by 1.50% against the dollar.

Commodities

Gold was up marginally this week. It started the week by reaching a high of $1,349 before losing those gains to currently trade at 1,333. The downward trend came as the dollar strength intensified and as the volatility started to come down. Its poor cousin, silver fell by 0.72% while platinum and palladium fell by 1.51% and 0.35% respectively.

In the crude oil markets, the crude oil continued its upward momentum with the Brent rising by more than 2% and WTI by 1.62%. The upward momentum continued as the EIA data showed reduced stockpiles in the US. The data showed that stockpiles fell by 1.6 million barrels to reach 420.8 million barrels. The data showed that oil production was unchanged to 10.2 million barrels per day.

In the coming week, traders will focus on manufacturing data from China, employment data from Germany, inflation data from European Union, US GDP growth, and manufacturing data from the US.

Sources:

https://www.wsj.com/news/types/central-banks

http://markets.businessinsider.com/indices

https://www.bloomberg.com/markets/stocks

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Week in Review: Crude Oil Disappoints, as the Dollar Triumphs

This week, the focus among traders was about volatility. As you recall, a common theme among investors in the past year has been about the lack of volatility in the market. During the year, the CBOE VIX index, also known as the fear index, was on historic lows.

On Friday last week, all this changed when the jobs report came. Investors started getting worried about inflation, which pushed the VIX higher by more than 100%. Global stocks slumped while bond yields rose.

This week, the global market failed to find a support and yesterday, the S&P 500 officially entered the bear market. As such, these low prices could persist because historically, a bear market tends to stay for more than 72 days.

The chart below shows the weekly performance of the major global stocks.

This week, the Bank of England held its first meeting this year. This meeting ended with the committee leaving interest rates unchanged. However, investors watched the messaging from the committee which was more hawkish than expected. Shortly after the data came out, the pound rose to the highest level in five days. Later in the day, it started to go down. As of this writing, the pound is down 60 bps against the dollar.

This week, the dollar has been a winner, with the dollar index up by 2.04%. This index weighs the dollar against the major currencies like the pound, euro, and yen. The surge in the dollar is attributed to the perceived notion that inflation could peak up which will lead to higher interest rates.

The surge on the dollar has had a negative reaction to gold, which has shed more than 2.3% of its value. As I have written before, gold and the dollar have one of the best negative correlation in the financial market. In most cases, when the dollar rises, gold tends to fall as investors exit their gold positions. This is because many investors buy gold for its store of value and its use as a currency.

This week, there was no major news or data from the EU. The only significant information came from Germany where Angela Merkel and the opposition party made some progress on coalition building. The euro was off by 2%, which was attributed to the stronger dollar.

In New Zealand, the RBNZ met for the first time this year. In their decision on Wednesday, the committee left interest rates unchanged. They announced that they were pleased with the progress of the economy which is experiencing full employment. After the meeting, the Kiwi was little changed against the dollar.

In the cryptocurrencies industry, the main currencies experienced mixed returns. Early in the week, bitcoin reached the lowest point in months when it crossed the $5,000 level. After a senate meeting in the United States, the SEC and CFTC emphasized on the need to regulate the industry instead of implementing a full scale ban. This led the currencies to recover some of their losses.

A big disappointment this week was in crude oil. This week, the EIA reported that the United States had crossed more than 10 million barrels of oil every day. This led the commodity to fall from the three-year high to the current $60.

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Bank of England Review: Brace for Rate Hikes

Today, the Bank of England’s (BoE) Monetary Policy Committee (MPC) completed its two-day policy meeting.

In their meeting, the committee voted unanimously to leave the interest rates at the current level of 0.5%. The traders expected this.

What the traders didn’t expect was the committee’s deep statement. In the statement, they unanimously agreed that there were chances of interest rates rising earlier than expected.

As we wrote yesterday, traders were expecting three rate hikes this year with the initial one coming in May. In addition, as we mentioned, the current meeting came at an interesting period in the financial markets where volatility has risen and the global stock markets. Also, the meeting came at a time when there are uncertainties in the UK, crude oil are rising, and the inflation rate is above the target.

In the meeting, the committee unanimously agreed to set the inflation rate target of 2% and agreed to raise the growth forecasts of the UK economy. They also agreed to maintain the stock of the non-financial investment-grade corporate bond purchases at 10 billion pounds. They also voted to maintain the bond purchases at 435 billion pounds. This language was similar to that of their September meeting which came a month before the first hike.

In the highly anticipated letter to the chancellor, Carney said:

“Monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent over the forecast period than anticipated at the time of the November report.”

There are downsides to the MPC’s projections. First, the policy statement did not factor in the case for increasing oil prices. Today, the price of crude oil has soared to the highest level in three years, which could affect the country’s inflation. For the short term, Carney suggested that inflation could accelerate.

Also, the meeting did not factor in the risks presented by the Brexit. In their statement, the committee agreed to forecast the growth leaving all factors on Brexit constant.

Before the meeting, traders were waiting for the language of the statement. They wanted to hear whether any committee member would dissent and bring more hawkish views.

Traders were also waiting for the language Mark Carney would use in the press conference. In the conference, Carney talked about their thinking about the current UK economy, the uncertainties ahead, and the risks associated with Brexit.

On the economy, he said that the committee expected the UK economy to continue growing, with the unemployment rate slowing, and wages rising. On the uncertainties surrounding Brexit, he said that future forecasting was still possible even with these uncertainties.

After the interest rate decision, the pound, which was trading lower against the dollar, rose to the highest level since Monday. As of this writing, it is trading at the 1.3976 level.

Before the decision today, traders expected the bank to have 3 more rate hikes this year with one coming in May. Today’s statement suggested that the hike could come early and forecasted two more hikes in the next three years.

In the press conference, Carney made it clear that the rate hike program, which is two years behind the Fed, would be better for jobs and maintaining the inflation rate. He also maintained that the hike will be gradual and that the committee will use forward guidance to warn investors beforehand.

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Exciting Times as Volatility Returns

One of the major hallmarks of the Bull Run after the financial crisis was the lack of volatility. The implications of this lack of volatility has been dire. In the past few quarters, the trading revenues from big investment banks has fallen while others have been forced out.

As shown in the chart below, the Chicago Board’s volatility index peaked in 2008 when it soared to slightly below 100. After the peak, the index started declining. Last year, it spent all its time at the all-time low level.

Surprisingly, it was at these prices when global risks were rising. For example, the VIX had very little movements even when North Korea tested its missiles. It remained at historically low levels even when Trump was threatening fire and fury to North Korea. It also remained low at a time when hurricanes and fires engulfed a significant part of the United States.

All these were signs of complacency among investors. By being complacent, they believed that markets would always move up. They bought the dips whenever they happened.

For traders, the lack of volatility was a bit difficult because it was near possible to make trading decisions. How do you do comprehensive technical analysis when financial assets are only moving up?

The lack of volatility also attracted many traders to the risky world of cryptocurrencies. Most people who rushed to buy bitcoins and other cryptocurrencies knew nothing about them. All this pushed cryptocurrencies to almost a trillion dollar valuation before they started to crash in January.

To measure the volatility or fear in the financial markets, traders use the CBOE Volatility index, also known as VIX.

This index was started in 1993 by CBOE. At the time, the index was created to measure the expectations of the 30-day volatility implied by at-the-money S&P 100 index option prices. Later, the CBOE teamed with Goldman Sachs to update the VIX model. The updated VIX is based on the S&P 500. It estimates the expected volatility by averaging the weighted prices of the S&P 500 puts and calls over different strike prices.

Often, a rise in volatility leads to low stocks price as investors put their funds from the stocks.

For a while, an anonymous trader (or group of traders) started to bet that the era of low volatility was almost over. The trader(s) is commonly known in the financial markets as 50 Cent.

In March last year, CNBC reported the trader had continued to lose money by betting that volatility would peak up. At that time, he had lost more than $75 million. At the end of last year, the trader had lost more than $197 million.

50 Cent was not alone in this. Recently, another trader, known as VIX Elephant started accumulating VIX options. In December, he bought more than 2 million VIX contracts. He lost between $20 and $30 million that month.

Starting Friday, the volatility the elephant and 50-cent have bet on for years has returned. In the past five days, the VIX index has gained by more than 100%. The VIX has gained as investors have become increasingly worried about inflation, which could accelerate the rate of interest hikes. For traders, the return of volatility is welcome because it increases the swings of financial assets and thus increasing the potential for returns. Of course where there is volatility there is risk, something a fact that some trading on volatility may overlook.

Source:

http://fortune.com/2018/02/06/bitcoin-stock-volatility-vix-sec/

https://www.bloomberg.com/gadfly/articles/2018-02-06/regulators-let-wall-street-turn-vix-index-on-its-head

https://www.ft.com/content/4eeac462-0bb9-11e8-8eb7-42f857ea9f09

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BoE Preview: Will Carney Live to the Expectations?

BoE Preview: Will Carney Live to the Expectations? Today, the Bank of England’s (BOE) starts its two-day meeting, which will culminate in tomorrow’s decision on interest rates.

The meeting comes at an interesting period for the global financial markets. As you already know, global markets have seen significant swings in the past two days. These swings have wiped out most gains they had established in the first month.

The market turbulence started on Friday when the Bureau of Labor Statistics (BLS) announced the January’s jobs numbers, which beat expectations. After this release, global investors started thinking again about the chances of high inflation which would trigger an increased pace of rate increases.

Therefore, today’s meeting comes at a very different time compared to the previous meeting when everything seemed normal.

For this meeting, investors expect the bank to leave interest rates unchanged at 0.50%. Therefore, tomorrow, traders will not focus on the headline numbers.

Instead, they will focus on two things. First, they will focus on the letter from Governor Carney to Philip Hammond explaining the current rate of inflation. As you recall, the rate of inflation in December soared to 3.1%, triggering the letter-writing scenario. In January, the inflation rate dropped marginally to 3.0%.

Second, they will focus on the statement from the MPC. This statement will help them decide on the expected pace of rate increases.

In the recent past, despite the increasing market volatility, traders have placed a 50% chance that the BoE will hike interest rates in May. They have also priced in two more rate hikes, possibly in September and in December.

The problem for this is that sky-high expectations often lead to disappointments.  As you recall, in the November meeting, the BoE raised interest rates for the first time. While traders were pleased with the headline number, they were disappointed that the officials omitted language they had used previously saying the markets were underpricing the rate trajectory. At the end, the pound fell by more than 14 bps while the 10-year gilt yields fell by 8 bps. This was the biggest drop since the rate cut in 2016.

In other words, traders have become more hawkish which could complicate things for the BoE. Disappointing language could lead to another sell off in the pound amidst another one in the stocks market.

In addition, the decision comes at a time when the pound is doing well. In January, it climbed more than 50 bps against the dollar, which is its best start of the year on record. In addition, large money managers have increased their bullish bets on the currency to the highest level since 2014.

The meeting comes at a time when Brexit is a hanging cloud. Yesterday, a note released by the EU increased the complexity of the situation. According to the note, the EU will be at will to punish the United Kingdom, even by increasing tariffs and shutting down their market unless the UK made concessions. All these issues have made the political environment in the country very difficult for Theresa May who is struggling.

Sources:

https://www.bloomberg.com/news/articles/2017-09-13/boe-preview-pound-may-benefit-as-hawkish-tone-seen-in-rate-vote

http://gulftoday.ae/portal/e17668bb-aa5a-4fc3-8bd4-3e7696b720b1.aspx

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USD/JPY: More Downside

USD/JPY: More Downside. In the past year, the USD/JPY has been a boring pair. Unlike other currency pairs, this pair has traded in a narrow range with a high of 115.29 and a low of 107.67.

As shown below, the pair has had a near-perfect horizontal support and resistance.

Today, the pair erased the gains made in the past five days when the pair moved from a low of 108.39 to a high of 110.48. The pair is currently trading at 108.93.

The decline is associated with the current global sell off in equities, which started in the United States on Friday.

To predict the future movements of the pair, I used the 6-month chart, which shows the downward pressure may take the pair downwards to the 107.32 level.

An alternate scenario is where the pair bounces back after establishing a double bottom. This could see the pair touch the 108.8 level.

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With Global Indices Overbought, Is the Bubble About to Pop?

After the financial crisis of 2008/9, the financial markets around the world have seen tremendous growth. Consider the 5-year chart below of the major global indices.

As seen, the NASDAQ has led the way, gaining by more than 150% while the FTSI 100 has been the laggard, gaining by just 18%. This is attributed to the risks posed by Brexit on the UK economy.

At the same time, the CBOE Volatility index, which measures the volatility in the financial markets, has stayed at significant lows as shown below.

The surge in the global stocks markets is associated with the central banks decisions. After the crisis, the global central bankers moved to rescue the economy by introducing low interest rates. They also started a large scale asset purchase in what is known as the quantitative easing. In other words, they printed billions of dollars to buy treasuries and mortgage backed securities.

So far, only the Fed has moved to end the stimulus package. Other banks have issued forward guidance on when they will end the packages.

Another reason why stocks have done well is because of corporate earnings. In the past five years, corporate earnings in the United States and in around the world have risen significantly. For example, in 2010, a company like Facebook was making a few billion dollars in annual revenues. Last year, the company brought almost $30 billion in revenues. At that time, a company like Snapchat never existed. Last year, the company made billions of dollars.

Therefore, corporate earnings and easy money have led the stocks market to grow. Another reason which is less talked about is crude oil. As shown below, the price of crude oil has lost about 32% in the past 5 years. This year, the major indices have continued to break records every day.

For traders, the daily movements of stocks, currencies don’t matter. This is because, they can always buy and sell financial instruments and exit within a short period.

For long-term investors however, these are difficult times because of the difficulty in finding reasonably-valued companies. Some of the most loved companies like Amazon, Tesla, and NVIDIA are overvalued based on multiple valuation measures like ratio analysis. For example, Tesla, which makes electric cars, is currently valued at more than $50 billion, which is close to that of General Motors, which is selling more electric vehicles than Tesla.

From a technical perspective, all the major indices are in the extreme areas of being overbought. Consider the chart of the Dow and NASDAQ below.

Dow Jones Industrial Average

NASDAQ Composite

Hang Seng

The overbought situation is seen among all the major indices.

The challenge at this time is that Central Banks are moving to Quantitative Tightening, which is the opposite of easing. By tightening, they will normalize interest rates and end purchases. Still, the interest rates are at historical lows. In the United States, the administration has brought corporate taxes to significant lows.

For investors, the fear is that markets are in a bubble, which could pop at any time. If it pops, as it happens during periods of tightening, the central banks might not have any options to save the financial market. Historically, when there is a financial crisis, central banks move to lower interest rates while policy makers move to lower corporate taxes. They do all this to stimulate the economy. Now, with interest so low, and with the tax plan passed, it would be difficult for the policy makers to contain a recession if the bubble pops.

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End of an Era at the Federal Reserve

End of an Era at the Federal Reserve. Today is an interesting day for Federal Reserve watchers. Today, Janet Yellen will issue her final statement as the Federal Reserve chair.

To many people, it is a sad day but to others, it is the new norm. In 2014, Barrack Obama appointed Yellen to the prestigious position. Late last year, the current president, Donald Trump decided not to reappoint her. Instead, he selected her colleague, Jerome Powell who was recently confirmed by the Washington committees.

Yellen’s tenure has been a success on many fronts. The unemployment rate has continued to go lower reaching a 17-year low while more than 10 million jobs have been created. Her policies for gradually raising rates have set the United States on a path less taken by other central banks.

In Europe and some parts of Asia, the central bankers are still in quantitative easing mode and maintaining their supportive policies.

Yellen will also be remembered for her forward guidance policies. Contrary to her previous colleagues like Ben Bernanke, Yellen has embraced the principle of not surprising the markets. For example, many traders last year expected the Fed to raise rates by three times. It did.

The opposite of this is dangerous to many traders. Without forward guidance, they are left to come to their own conclusions on what the Fed would do. A good example of this is what happened in 2015 when the SNB decided to remove the peg on their currency. Traders lost billions and trading houses went bankrupt.

Today, at 1:15 (GMT), Automatic Data Processing (ADP) will release its data on private employment change for December. Analysts expect the agency to show that companies created 191K jobs which is lower than they did in November. Traders watch this number because it usually comes a day before the main employment numbers by Bureau of Labor Statistics.

The big news today will be about the FOMC, which will complete its two-day meeting. This will be Yellen’s last meeting at the Fed because, after exiting the chair role, she will also exit her governor role.

Markets expect the Fed to leave the rates unchanged following the rise they did in December. Because of forward guidance, they have been a bit accurate on this. Traders will however want to get insight into the minds of the Fed officials.

They will want to know three things. First, they will want to hear the Fed’s opinion on the current inflation rate. As you know, the inflation rate has remained stubbornly below the Fed’s target of 2%. Secondly, they will want to know their economic projection. In this, they will also want to hear from the Fed about the risks they anticipate in the American economy. Finally, they will want to know about their assessment on the Trump’s tax plan.

With the tax plan, the economy is expected to receive trillions of dollars which companies had packed overseas to avoid hefty taxes. In addition, corporates and individuals have seen their taxes slashed. In today’s meeting, traders will want to assess the feelings and opinions from the Fed about these tax cuts.

The meeting comes at a time when the dollar is at a three-year low against the major currencies. It also comes at a time when the United States government is sending mixed signals on the future of the dollar. While Trump favors a strong dollar, his treasury minister favors a lower dollar.

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