South Korea Update: Look out Below

There is scope for further downside in South Korean equities. The long-term trend-line from 2012 lows in EWY was broken with a small downside gap around 55, which would imply a lower price projection around the 48 support zone.

The weekly EWY chart shows that bulls lost control near the 64 resistance area. The preceding bullish candle set-up discounted weakness on the macro level, which placed pressure on the Bank of Korea to ease policy measures. 

This thesis was short-lived, as expressed in my April 25 note on South Korea. The Chaikin Money Flow (a volume-related oscillator) turned positive around late May, which would have been a signal to buy EWY around 55 support and sell near 64 resistance.

Currently, the break lower in EWY appears oversold, as shown by the relative strength index (RSI). While this could signal near-term support around 48, a sustained counter-trend move is unlikely so long as decreasing momentum on the MACD remains. 

The Korean Won's recent decline against the Japanese Yen is also an important factor, which could strengthen support. However, a long-term downtrend remains for JPY/KRW, which keeps a bearish bias intact for EWY. 

Pressure to ease as South Korean shares advance

Slower global growth and declining inflation adds pressure on the Bank of Korea to cut interest rates. If the Korean Won depreciates due to lower rates, a boost to exports could follow, which will add further support for Korean equities.

South Korea has joined the Asian stock market rally. The top chart shows a bullish advance in the South Korea iShares ETF (EWY). A pull-back is likely, which could offer opportunity to build positions.

The recent move is supported by improving momentum as the MACD turned positive. The most recent positive inflection occurred near the 2013 bottom in EWY. The MACD histogram (blue bars) is more sensitive to price changes within the longer trend, thereby providing an early signal of an advance at the start of 2015.

The last panel offers confirmation from the Chaikin Money Flow (CMF), a volume-related oscillator. The CMF is a measure of buying pressure compared to the total volume over the past 21 days. The CMF recently turned above zero, indicating the potential start of an upward trend. Further confirmation of sustained momentum is needed if a pull-back (with declining volume) around the 66.00 resistance level nears.

For a technical view of South Korea's KOSPI index, read Nicole Elliott's 4/23 column in the South China Morning Post. Nicole identifies a potential breakout from major long-term resistance going back to 2007.

South Korea (a "closet developed-market country"), is not unique in its latest breakout. China, Japan, and Europe are trending higher on policy support. As investors cover their shorts, expect increased flows outside of the US. This will likely precede a pick up in global growth.

This should be a positive for emerging markets - a group that has evolved to track ex-US/Canada country performance (EAFE index). However, despite the recent counter-trend breakout in the emerging market ETF (EEM) relative to the S&P 500, more confirmation is needed given increasing signs of a pull-back along the long-term downtrend.

Given further confirmation in the months ahead, positive signals from international equities could imply a breakdown in the US Dollar and an advance in commodities -- all of which provide support for inflation.

Repost: What Abe wants, Abe gets. Japan's battle on the Yen

Updated from Jan. 2013: 

Aggressive measures by the BoJ and a staunch tone by PM Abe must continue to maintain pressure on the Yen. But is the recent rally enough? Japan's Economy Minister stated on Monday [Jan. 2013] that "the Yen has come to a good level....if it falls to a three-digit level it would boost import prices, weighing on the everyday life of the nation."

The market needs progress, not just rhetoric in order to play its part. PM Shinzo Abe is building up the pressure, and he has a history of speaking out about the Japanese economy, but has done little to actually show for it. Abe was elected as the 90th PM of Japan by a special session in 2006, but only served for less than a year. Perhaps now is his time to shine as he stood on a strong platform of pressuring the BoJ to tackle deflation by means of inflation with aggressive monetary stimulus and greater cooperation with the newly elected government. The monetary-fiscal cooperation interferes with the Bank's legal independence, but talks still continue amid the threat of a constitutional change to the BoJ's independence so long as the Bank abides by Abe's recommended 2% inflation target. 

So called 'Abeconomics' has a direct market effect, causing a bounce off 2012 September lows in USD/JPY to extend to its current rally. The market's reaction is welcomed as a softer Yen helps boost Japanese exports and paves the way for inflation. But will this inflation come with growth? Abe's [2013] $117bn stimulus is projected to boost GDP by about 2% while creating 600,000 jobs. Nomura estimates that the the stimulus will help deliver real annualized GDP growth of 3.5%; and with ongoing disaster recovery from the 2011 tsunami, we could see more government-led growth. Economists worry that this is a big gamble for a sustained recovery. Nikkei Business Daily cites the growing probability of large spending in rural regions and the government's ability to prioritize projects. This is why there is so much pressure on the monetary side. 

In comes Shirakawa, the current BoJ Governor. Shirakawa announced an additional $128bn as part of the Bank's monetary easing programs in the fall [2012]. Japan's total spent on asset-buying programs has now past the $1tn mark, which is quite excessive. Meanwhile, the Japanese economy is stuck in its fourth recession since 2000. Much of this downfall is due to a strong Yen which halts export growth. A sluggish global economy,  and the struggle to recoup from the 2011 tsunami disaster is added pressure on Japan. Nevertheless, the Japanese economy has continued its  constant debt buildup and fiscal woes for about 20 years now. At some point, this cannot be sustained. 

The market implications are clear. Further Yen weakness could continue so long as the BoJ abides by Abe's commands. The market needs to see progress on Abe's strategy in order for the Yen to weaken by theory. The USD/JPY shorts could pave the way for the April appointment of the next BoJ Gov, creating another profit opportunity in the pair. So far, Abe is meeting this week with monetary policy experts to begin the discussion on who will be the next BoJ Gov. Abe stated that he is looking for a "bold leader...someone who shares our views." [in comes Kuroda, current BoJ Gov.]

Exports: Latin America and the Caribbean

China will become an important source of growth for the LatAm region over the next decade. A diversified export pattern will help LatAm countries form a genuine strategic partnership with the world's fastest growing economy, according to a recent initiative by the Economic Commission for Latin America. Domestic policy should support industrial growth and commerce that will expand employment opportunities and contribute a wider mix of exports to the global economy.

Smaller Caribbean and African nations are often squeezed out of world trade through unfair competition and suppressed by three negative forces: debt, corruption, and aid. China provides an outlet for trade and economic growth. Despite a slowdown in China, its global resource grab has been resilient. LatAm countries should attract higher levels of Chinese investment as slower end-market demand weighs on raw commodity prices. This will provide a strategic opportunity to expand domestic growth while inefficiencies in China could influence a global quest for yield. The ECLAC initiative is an important first step.

Investors take an opportunistic approach as economy improves

The US economy is expected to strengthen this year, with consensus around 2.6 percent growth. Global business confidence continues to improve with manufacturing in the lead.  With both consumers and businesses more optimistic heading into the new year, the combined strength in shipments could lead to a rise in equipment investment which bodes well for a rebound in global business activity. Consumption growth also rose in November, with core retail sales reflecting better than expected holiday spending despite some concerns about budget priorities in the lower-income group. The general backdrop suggests that investors could continue to seek higher returns in riskier assets that are more economically sensitive as the focus returns to fundamentals.

Allocation still favors equities
Fund managers are increasing weightings in developed market equities: Europe, Japan, and the US being the most favorable markets. There is still the chance for a pull-back in equities this year. The S&P 500 started 2014 in the red, and Asian shares followed lower as the Nikkei moved below 16,000. This could reflect some positioning amid lower volume, but some analysts suggest that this could be another buying opportunity.

For now, there is still room to extend margin debt as traditional bond outflows continue. Historically, investors have been extraordinarily leveraged during market rallies such as the tech bubble in 2000. Times are different now as fundamentals improve and central banks continue to support a stimulative environment. The case is stronger in Europe where valuations are still relatively cheap and in Japan where more easing from the BoJ coupled with large pension funds shifting allocation to equities could prove attractive from a global perspective.

Economic slack remains
Despite the optimistic outlook for 2014, there are still some concerns in the real economy. The lower income group tends to be hit the hardest during budget issues which leads to political dithering. Wage growth has improved, but labor productivity has risen by only 0.3 percent on year, but the rise to 3 percent during the third quarter of 2013 was impressive given the solid GDP report and non-farm payrolls during the same period. Andrew Smithers of Smithers & Co states that bad news on productivity could lead to signs of realism that will continue to make the case for a low rate environment. If the market outlook is premature, higher inflationary expectations without the true fundamental backdrop could be a problem.

An opportunistic approach
After a period of lower interest rates and soft demand for loans, US large cap banks could benefit from an improving economy especially as the yield curve steepens. Profit margins expand as banks borrow at lower short-term rates and lend at higher long-term interest rates. The rebound in housing and auto demand suggests that consumers are more comfortable with taking out loans as the economy improves.

Industrial strength is leading demand for non-residential construction where wages are higher and supply is limited. This will be an important year which will test the true strength of the economy. We are still in a stimulative environment, and even as the Fed reduces its pace of asset purchases, rates could find some comfort around 3.5 percent on the 10-year this year. Financing conditions are still favorable for many sectors which could support expansion. For example, US airlines are posting stronger gains as nominal GDP is upwardly biased, but we will need to see capacity expand as demand picks up to confirm further strength into the next year.

Challenges for Australia as China reforms point to slower growth

Despite recent signs of modest economic improvement, Australia is likely to remain on a tightrope for quite some time as the country’s mining boom slows down. Recent economic data from China shows strong improvement, but that could change as leaders are set to implement significant reform measures that could slow growth in the near-term. The market is well aware of the challenges ahead for Australia, and several important risk factors suggest that the Australian dollar is likely to remain subdued, especially as it struggles to sustain a rebound off summer lows.

China’s Third Plenum matters

A four-day, closed door meeting between China’s leaders to discuss the economic and political agenda for the next decade just concluded and expectations are high for significant reform. China must pave the way towards a market economy that will redirect credit away from inefficient state-owned-enterprises (SOEs) to much more efficient private enterprises. The new agenda should loosen the state’s control over capital allocation, which starts with reducing the limits on wealth transfers.

Continue reading at Saxo Bank's TradingFloor.com

Asia Focus: AUDUSD up on Australian CPI but pares gains in Asia

Australia's housing sector helped boost Q3 figures. Photo: Shutterstock

Australia’s third-quarter CPI report was impressive despite remaining subdued on the headline print at 2.2 percent on year from 2.4 percent in Q2, which is still at the lower range of the Reserve Bank of Australia’s target of two to three percent for annual inflation.

The market was expecting slower CPI in Q3, but the trimmed mean figure beat consensus at 2.3 percent on year. The Reserve Bank of Australia (RBA) places more weight on trimmed mean CPI, so the recent rise could sustain the RBA’s more favourable tone on the economy.

Furthermore, the Q3 Aussie CPI report showed a greater contribution from the housing group, which suggests that recent data are starting to reflect the low rate environment. The RBA is now watching the higher AUD. 

Also, top China banks tripled debt-write offs as investors fear default. The seven day repo rate rose 42 basis points in Asia which; lingering fears on banking -- China's weak-spot, was behind the sudden AUDJPY drop during the Asia session. Key China PMI data ahead on Thursday to watch for as well. 

Continue reading at Saxo Bank's TradingFloor.com

Trade Idea: Buy-the-dip opportunity in AUDUSD

US back in business, markets sell the fact

A bipartisan bill to reopen the US federal government and avert default passed in the Senate and House of Representatives and was ultimately signed by President Obama at the eleventh hour on Wednesday. US politicians repeat the same procedure year after year and the market priced in a last minute compromise as US equities advanced ahead of the initial Senate vote. However, USD declined as legislatures approved the bill — a classic “buy the rumour, sell the fact.”

Continue reading at Saxo Bank's TradingFloor.com

Australian economy modestly improved but still fragile

The Reserve Bank of Australia (RBA) softened its dovish view on the economy after the summer when headlines of a possible soft landing in China and declining terms of trade shifted the focus onto the vulnerable Aussie dollar. AUDUSD sustained a nice rise after recent China data came out ahead of market expectations, but domestic data did not suggest that Australia was out of the woods.

That could be changing now as recent confidence and employment data point to a modest improvement, which could keep the RBA satisfied for the remainder of the year at least.

Continue reading at Saxo Bank's TradingFloor.com

Bernanke brings us back to reality as US remains on a tightrope

The Federal Reserve decided to maintain its pace of asset purchases, and the typical kneejerk reaction followed, but the important take-away is that many in the financial media were too optimistic. A lot of the noise leading up to the September Federal Open Market Committee (FOMC) meeting was largely a result of impatience and political speculation, with little regard to the independent structure of the Federal Reserve and its dedication to supporting the economy rather than paving the way for future successors or allowing the market to dictate monetary policy.

Federal Reserve Chairman Ben Bernanke’s press conference allowed everyone a chance to pause, reflect, and return to our trading desks with a more disciplined approach to interpreting information.

Continue reading at Saxo Bank's TradingFloor.com

Economic Update - Rise in yields puts economy to the test

As the Fed struggles to clearly communicate its plan for tapering, or lack thereof, rising yields continue to linger as the US economy is put to the test. Forecasts for economic growth in the latter part of this year remain, but with the possibility of drifting monetary support, the market is increasingly nervous about the true state of the economy. A good headline figure, but a weak underlying trend is the usual case now, but many remain positive on the housing recovery. Regional expansion continues to show some bright spots thanks to the Shale Boom, but rising rates are making a significant impact on the local level. Finally, with little progress on the fiscal front, all eyes are on the Fed for its next major move.

Divided Fed

Tim Duy's latest "Fed Watch" post argues that the Fed is deeply divided and that Bernanke is essentially pulling the strings. Half are for and half are against tapering, but Bernanke had to be the deciding force to lay out the plan for eventual tapering as the cost of continuing QE are too high. In doing so, the 7% unemployment target and inflation pickup to 2% (economists predict somewhere around 1.4% by Q3 2013) should also be met. We assume that the FOMC is on board with this, but Bullard stated that these thresholds were not voted or approved by the board, so it's just a reasonable outlook to help guide future policy decisions. This makes the overall message confusing to those wanting a definite answer, but there are many factors to consider before a decision is made to taper.

Inflation data looks promising with producer prices at 2.5% y/y for June, and CPI inflation rate at 1.4% in May (June figure posted on 7/16/2013). Consumer inflation expectations are at 3.3% over the next 12 months, up from the June projection of 3% according to the U.Michigan Consumer Sentiment Survey. However, the growth side faces some hurdles after the IMF issued a lower outlook on global growth that could hit home.

US growth expectations are at a 2.3% pace for Q3, to 2.6% for Q4. With China and Europe posting slower growth, will the US rise above or coincide with global pressure? UPS lowered its forward looking guidance and expects a slowdown in the US industrial economy. Nevertheless, economists are still positive on the second half of 2013, but a lot still rests on the Fed.

The market needs greater clarity, and if the message is not clear, then perhaps the board is a bit uncertain about timing. The scare factor will remain present in the market as investors price in the fact that tapering will eventually occur. The recent USD sell-off after Bernanke's "dovish comments" - which was just a jolt back to reality - is another sign of over-reaction. Better data are supporting yields, but the real question is whether or not the economy is ready perform on its own feet. The first real test will be how well the housing market performs as rates rise.

Higher rates sparking fear in housing?

As the 30yr fixed mortgage rate climbed to 4.51% this week - currently at a two year high - the total number of mortgage applications fell 23% from the prior week, according to data from the Mortgage Banker's Association. The refinance index slipped 4% as higher rates are becoming less appealing, but are still historically low! This is still a lax environment that will keep the housing market afloat. We could see activity picking up to lock in these historically low rates.

Refinance applications still represent about 64% of existing mortgages, with about 35% coming from the HAMP program. Generally, foreclosures are way below 2009 peak levels, and there is a noticeable lag between judicial and non-judicial states - factoring in the process of going through state courts to finalize a foreclosure. The extra steps involved in foreclosures could spur auction activity. Remember that cash buyers are out there and investors are fueling the housing recovery. People who have accumulated wealth and saved up during the down times, are returning on the backs of an improving economy. On the basic level, the picture is still not structurally sound. Employment figures are still stuck near that 3 month average, and first time homeowners are lagging in the lost generation facing increasing debt; resulting from the student loan crisis which will create a greater economic strain down the line. The market is ripe for the come-back household and market investors. Housing activity is directly tied to the local level where states are slowly entering recovery mode.

Rate impact on the local level

The 10yr yield continued to rise near 2 year highs when yields topped near 2.74% in 2011. Improving economic data and the bond sell-off on fears of Fed tapering contributed to the recent 10yr performance. Yields have since declined off the 2.70% level to around 2.60% after Bernanke's dovish comments. It's interesting to see the impact of rising yields on the local level.

General Conditions --

States are working to close budget gaps and many have improving outlooks. Problems still remain with pension obligations and other liability short-falls, but the regional recovery is starting to shape the US economy. Many opportunities that can easily get lost in the macro fray are occurring locally, and the trend is moving inward. The Shale Boom pushed North Dakota out of 38th place in real GDP terms in 2011 to #1 in growth from 2011-2012, with 10.84% in per capita real GDP according to the US Bureau of Economic Analysis. However, a Pew Stateline article stated that other states are not faring too well. Alaska's production is significantly lower, and Wyoming's tax revenue is down almost 17% from its pre-recession peak. With supply exiting Cushing to refineries on the Gulf coast, many are starting to question whether expanding railroad infrastructure instead of pipeline growth will keep up with the Shale Boom. Generally, we are seeing more public/private partnerships in transportation and infrastructure funding, and overall visible supply in the muni market is still low for the summer.

Capturing Yield --

With economic opportunity present, and some problems still needing a fix, investors are keeping a close eye on yields. Much of the focus is on protection; Morgan Stanley's Municipal Bond Monthly report put it best: "yield pickup on the longer end remains relatively flat...are investors adequately compensated for additional interest rate risk?" We could expect investors to either limit duration in muni portfolios or demand greater yield on the long end.

Markets show focus on Fed after employment report

*May NFP: 175k vs 163k, downward revision by 12k for previous 2 months

*May Unemployment Rate: 7.6% vs 7.5% exp

Despite the US economy adding more jobs than expected for the month of May, the breakdown and trend are still meager. We're not out of the woods yet, and at this pace, the Fed is less likely to back down without significant labor market improvements.

There was not much excitement on the headline figures, but it does show that the trend in payrolls is broadly flat. The breakdown shows consistent gains in the service sector with low wage jobs capturing a larger share of the labor market. After looking at the employment reports from the past few months, the May report provides further proof that QE efforts are providing little help to boost employment. The Fed is clearly looking for significant improvement to break above trend in labor growth; unfortunately the monthly change in nonfarm payrolls is not enough to sustain a recovery. We will need to see consistent gains above the 200k level supported by wage growth and other economic improvements for the Fed to send a clear signal of optimism. Even so, the worry still remains that monetary stimulus has gone too far and perhaps we will need stronger fiscal policy to help speed up a recovery.

The markets believe that the Fed is less likely to ease off the pedal given recent data. FX markets were choppy with the USD given a modest boost with most pairs. Treasuries pared earlier gains as yeilds moved higher with the 10yr up 3 basis points to around 2.12% following the employment report. Yields have bounced off 1.60% support to show a firm rise for May as the bond sell-off leaves many in question. It's really all about the Fed at this point, and the summer FOMC meetings will be very important for any sway or persistence on the scale of asset purchases. Remember the weak ISM report sparked an initial safety run to treasuries, but the rise was short lived as the markets remain weary over an indecisive Fed. Stocks opened firmly in NY, giving a clear signal for the Fed to remain in action.

We still have a recovering housing market, but pay attention to 30yr mortgage rates nearing the 4% mark which could slow the recovery. Many investors are driving the demand for new homes, so the underlying picture of broader economic growth is still in question. Consumer spending is picking up, but we still have some fiscal problems looming with sequester cuts having a negative impact as well.

Canada - Hold your applause

The employment picture looks a lot better north of the border as Canada added 95k jobs in May, mostly full-time. Unemployment inched down to 7.1% with construction adding 43k jobs in May, marking a 5.8% rise y/y.

Although this is a stellar report, worries still remain about the housing bubble, especially given the rapid growth in construction jobs. Construction has been the main driver of these good headline prints, and we have to wonder about what this means for future supply of new homes as the demand side grows a little skeptic.

A report by the OECD labels Canada as the third most overvalued real estate market in the developed world - no surprise there. Look back at April 2013 building permits which shows that Canadian municipalities issuance was up by 10.5% from March due to higher construction intentions for multi-family dwellings. The total value of permits is now back above trend. Meanwhile, declines in institutional and industrial construction remain. Household debt and expenditures are troubling, yet there is more housing supply on tap. You can keep building, but home buyers are aware that prices are just too high to enter right now, and will eventually force that much needed correction in housing prices.

Lessons from Lagarde - St.Gallen Symposium

Christine Lagarde, Managing Director of the IMF, gave a rare 50min long Q&A session at the St.Gallen Symposium. Tough questions regarding the survival of the Eurozone, whether the IMF is in fact the World Government, and others pertaining to global policy decisions were posed. Lagarde is aware that the current system is flawed, especially when she goes silent to the mention of some smaller countries within (or thinking of joining) the Eurozone, and whether or not they should be involved in such a collective group that is clearly not working for the generation of unemployed youth.

The argument is that the Eurozone in its current form, is not sustainable; which is why it must continue to evolve with not just increased oversight, but an improved structure that is quick to realize problems in its critical banking system. With that foundation, according to Lagarde, structural problems should be addressed on an individual basis - no one size fits all approach. The conversation shifted to austerity and whether or not it is acceptable to call it a failure; especially given that it was pushed by the IMF for nearly all constituents in its program last year. 

Austerity was not balanced, and it is true that the results show a prolonged economic dip instead of painting a path to recovery like many officials hoped for. The quick and painful cuts and higher taxes just to receive the next credit tranche was the problem. Now Lagarde suggests a slower pace of austerity in which structural issues are addressed for the long term. This is how it should be done, and frankly the pressure of competing authority with the Troika and IMF rushed a lot of these fiscal snaps. Hopefully with some time granted after the German election, we could see some organizational structure and better thought out policy on the country level. Lagarde says the same stands for the US in its austerity measures, although we still don't have a sensible budget in place to do so. 

Lastly, Lagarde's comments on Japan were interesting. Abe's promise of structural change seems like the best approach, but the monetary side still leaves many in question. Lagarde would like to see better utilization of Japanese talent - particularly women. The demographic imbalance in Japan is very worrying and will definitely skew the dependency structure. 

-- Also, the third prong approach of the IMF caught my attention. Providing technical assistance to emerging countries for better surveillance of their financial markets is a key investment. That sums up a few main points, but the full video is definitely worth watching. 

Economic Update - Are we in transition mode?

There is still an air of economic uncertainty in the US, but there is hope. Hope that this year will mark the start of a recovery. The struggle to reach that point places an emphasis on the string of economic indicators and the reality behind them. We know that the Fed is keeping a close watch and is considering its options should the economy show signs of strength later this year.

March FOMC Minutes

The latest minutes were released early to several high ranking officials and the joke goes that if they can't get an email right, what makes us so sure that they can get the timing of a QE exit correct. Nevertheless, the minutes for March were released to the public during the morning hours EST instead of the usual afternoon time. It showed the evident discourse among FOMC members about when the phase out of the controversial and much extended QE program (reaching a record $3.22 trillion) will occur. We get a feeling that the consensus is for later this year when some economists expect a pick-up in the US economy.

Even still, members said that if labor market conditions improved as anticipated, it would probably be appropriate to slow purchases later in the year and eventually stop by year-end. There is still the possibility of returning to QE-lite because uncertainty still lingers, and the Fed might feel the need for continued support.

The debate over when to put a nail in the QE coffin is nothing new. The past few minutes have brought to light the concerning nature about balance sheet risk and the economy's ability to continue growth without the artificial push. The first mention of this was back in Q4 of 2012 which sparked an immediate stock market sell-off. Now, investors are aware of the ageing QE program, to the point where recent attention shifted to negative news from Cyprus which then caused a plunge in treasury yields.

The Breakdown

We can't ignore the healthy rise in equities. Some wonder if it is inspired by QE or just last minute bids on a general fear of missing out on some good gains. The fact is that QE has shifted asset allocation away from the usual safe-havens and stimulated a risk-on investment environment. But we have to take a step back and remember the fundamentals behind the recent low from early this year in which equities used as support for a rally. Stock market gains are not matching earnings and economic data, which suggests that a mix of sentiment and the quest for yield is the driving force. The stock market was bogged down with debt ceiling and fiscal cliff bickering at the start of 2013 which created a good buying opportunity. Technicals looked right and investors took advantage of the dip.

A deeper look into the economic fundamentals display some evidence of a transition to recovery. We see wealth gains mainly in the form of equities and a pick-up in housing construction and building activity. Consumers are still deleveraging which allows for spending. For example, refinancing could mean that savings are free to be allocated to more productive areas such as home improvement. A deeper look into the data gives us an understanding of how consumers are economizing during the economic transition.

Consumer debt has dropped to more comfortable levels, and credit can pick-up to reflect some confidence in the consumer's ability to borrow. However, the employment picture looks bleak. With a significant decline in labor force participation and a stagnant low-wage environment, there is little evidence to support a healthy labor market. Most of the activity is coming from the capital side of the growth equation. The fact is that most are under-employed and we are seeing households stick together - income sharing to phase out the negative in anticipation of a return to normalcy in which every member of the household is fully employed and self sufficient. Until we get there, a lot of the data might reflect only a half-truth.

We also have a demographic battle in which economic activity is missing the matriculation of first time buyers and the fresh labor pool of earners and spenders. The stark reality is that student debt is holding back the younger population resulting in higher defaults and the lack of entry level opportunity that is commensurate to the cost of study. Close attention to the Northeast housing and consumer market will be an important indicator to track this, as a great share of college graduates populate that region.

China marches back, but the West still looks ill

Good China trade and industrial data caught investors by surprise. There is a renewed sense of optimism in emerging markets overall. But some concerns over China's local debt problems and demographics keep the longer term outlook on a tightrope. The hope is that the new government will be quick to address these issues.

We will need full strength of the West for a clear sign of a global pick-up. Europe still looks weak with new sprouts of headline cases like Cyprus still in the mix.

The uncertainty is still there - look at the peso's fall against the greenback on Thursday as a signal that there is some concern about the ability of the US to boost the global economy. The Americas need the demand from the US, and LatAm markets can be an important indicator for foreseeable strength in terms of trade.

Long term view relies on current policy action

At some point, we will see sustained growth. Whether it starts later this year or rolls into 2014, there is evidence of transition and signs of hope. But the real question is how will we be able to keep the economic engine going.

Take a close look at the coming budget negotiations. Approach the issue with a clear mind and hear out both sides. Compromise on a long awaited budget will pave the way. We desperately need a framework to guide us through a recovery, or else we will get more of the same out of control spending and borrowing. There is doubt that whatever deal is reached, it will not be enough to address the serious fiscal deficit issue and economic folly that is inherently structural.

Immigration should be an important focus to keep the US as the most reasonable place to innovate. Innovation is part of the global market, and we must remain competitive. Higher education is taken up by more foreign students who will be at the helm of the growth. Look at Canada's latest plan for guidance.

Lastly, there is belief in the states. Despite underfunded pensions and liability short-falls, states have been busy strengthening their fiscal position. Most states are in a good cash position and the supply of municipal debt has declined. Investors are starting to see less risk, and the latest Census data shows an increase in state tax revenues. The revenue plans are highly strategic and take advantage of areas of productivity such as drilling out West. Some regions of the US are doing far better than most, and perhaps there's a good  model out there for solid growth.

Rumble Down Under: Australia will soon face reality.

Raging bushfires ripped across southern Australia, soon matched with heavy rain and tornadoes. The extreme weather events of January were as heated as the political turmoil that will place the country on a shaky path full of uncertainty. Australian summers are always a bit wild, and its politics follow the same type of disorientation. The long campaign season leading up to the September election is likely to steer conversation away from critical economic matters for the sake of a popular agenda that is common on all sides of the political spectrum. Like the US, Australia will face long-term fiscal problems and will lack the right leadership necessary to grow an economy that's actually in a better condition than most. This has some near term market implications which will hopefully be a signal for responsible leadership.

 Political Uncertainty

The political turmoil began in the summer of 2010 when then Deputy PM Julia Gillard was elected unopposed as Prime Minister after the former PM Kevin Rudd lost the support of his party and resigned. Despite weathering the global economic storm of 2008 by avoiding a negative hit to GDP, Rudd's controversial policies regarding climate change and a mining tax were largely opposed by both opposition and members of his own Labor party. At this point, it was assumed that Gillard's administration was better able to correct those unpopular moves and get the job done. In the words of her right hand man Treasury Secretary Wayne Swan: returning to a budget surplus will be done "come hell or high water."

The Labor party is riddled with failed promises after implementing a complex mining tax and a continuous budget deficit. Much of this has been blamed on the high value of the Aussie dollar and external pressures on commodity prices which weighs on mining activity. Tax revenue is on the decline, but there has been little effort to get a handle on spending. PM Gillard has called an election for September 14th in order to allow more time for a healthy political debate. In what will mark the longest campaign session in Australian history, this leads many to believe that the real reason is for the Gillard administration to show economic proof in hopes of a better turnaround. While no one expects a budget surplus in time for the election, there are some hopes for a pick-up in economic activity abroad during the latter part of this year which can have a positive effect on Australian output. So far, voters are not buying it.

As the Labor party looks more unstable, polls are showing a greater preference for the current opposition leader Tony Abbott. The polls are a blow to Gillard and shows that there is a growing mistrust for the Labor party on key issues such as the mining tax, immigration policy, and the economy. Rudd is more popular than Gillard, and there is some speculation that he might be drafted to lead the party despite his expressed lack of interest to do so. Throughout all of this political turmoil, the market response has been largely muted; guidance has been provided from a mix of risk appetite and the slump in commodity prices. However, the market is not quick to lay its hand off the economic pulse.

Economic Risk

It's clear that Labor hasn't held up to its promise. The Australian economy is largely held up thanks to the limited downside during the 2008 crisis under Rudd's leadership. Housing prices are still high and haven't seen a significant correction yet. Structural issues are evident and unemployment is still elevated for the nation.

The more pressing issue that will likely stem out for a long time is the looming budget crisis. Treasury Secretary Swan revealed a collapse in tax revenues of nearly $4bn mainly due to a slowdown in mining activity. Swan stated that the government will need to raise revenue and cut expenses, but spending cuts are essentially part of an austerity agenda. "Delivering another deficit is driven by Gillard government's core values about jobs or working Australians" said Swan. The RBA has already taken measures to offset future austerity measures by cutting its official cash rate.

Hopes for a pick-up in mining activity are complicated. The latest mega-project Origin Energy's Australia Pacific LNG project amounts to a whopping $2bn development budget while also freeing up expenses by slashing 850 jobs. The fact of the matter is that costs are building up and there is a capital strike. Similar to the US, Australian shareholders are demanding dividend income. Shell's plans are on hold for its Gorgon LNG project in hopes of getting a hold on higher capex expectations. A Dec FT article warns:

"If these issues are not addressed then new investment in Australia’s LNG industry could dry up in 2017, warn industry executives and analysts, and new suppliers based in Canada, east Africa and the US will move to capture a lucrative prize: 90m tonnes of annual uncontracted Asian LNG demand. 

Australia is poised to overtake Qatar as the world’s biggest LNG exporter as seven colossal projects reach full capacity over the next five years. But the industry is also facing serious headwinds as a consequence of its rapid growth. A second wave of developments and project extensions, worth an estimated A$150bn, is at risk from rising labour costs, infrastructure bottlenecks and the strong Australian dollar." 

Tony Abbott has a plan to boost productivity by way of a major infrastructure-spending boom if elected in September. This is not the way to go as the government will just break even with a return through tax revenue. It will just swell the deficit to another low level with no long term objective of fostering sustainable business activity. But Gillard has no star plan of her own and will likely keep some form of the mining tax with no efforts to offset lower revenue with spending cuts. Australia cannot continue to rely on the sways of its offshore trading partners to dictate economic conditions at home.

The economy is still relatively stable despite these looming fiscal troubles. The recent lift in consumer sentiment could indicate more breathing room for the RBA. The rise in share prices is also welcomed. However, lower commodity prices and concern that risk taking has gotten too far could stall significant  growth. Consumers are still cautious about taking on more debt despite the pick-up in household wealth. Consumer spending and unemployment expectations have leveled out. Australian households are cautious about job prospects which is keeping the consumer on the sidelines - and businesses are taking note as well by holding onto cash.

More room for an Aussie decline, but expect a bumpy road

AUD/USD is trading along a declining channel, with a recent slump attributed to a Reuters report on chatter in global markets that a hedge fund had been liquidating positions in commodities. RBA members have also expressed concern about the effects of a high AUD. These concerns were actually brought up at the start of this year when AUD/USD traded around 1.0590, and has since declined off those levels. Concerns about an overvalued currency are also seen in New Zealand where RBNZ Gov Wheeler stated that the NZD is still too high and that the RBNZ is ready to intervene if necessary despite some signs of a stronger than expected economic rebound.

The recent decline in AUD/USD is also correlated to lower risk appetite following the latest FOMC Minutes which suggests some unease among Fed members about a scale-back in asset purchases.

Moments ago, AUD/USD was given a boost after RBA Gov Stevens expressed confidence in the current level of interest rates. He went on to state that the high AUD/USD was weighing on the economy which inspired the previous rate cuts. However, Stevens did reiterate that rate cuts are more likely than increases. The recent lift in AUD/USD might be the result of over reaction from the markets given the lower outlook by the RBA. The central bank lowered its growth and inflation forecasts and pointed to concerns that mining investment could reach a crest this year. Lower hiring demand from resource companies could also lead to a softer labor market. Additionally, the strength of the Aussie is being watched for indications of higher inflation.

The lengthy political debate and fiscal issues deserve great attention. Investors should keep an eye on Australia especially given the recent evidence of declining money flows. FT Alphaville published an insightful article which cites data from the Japanese Ministry of Finance showing that Japanese investors were selling Aussie assets at an increasing rate. Japan holds about 20% of Australia's national sovereign debt, according to FT.

What Abe wants, Abe gets? Japan's battle on the Yen.

I cringe every time I read a headline from Japan. Rounds of stimulus borrowing and spending is a big gamble for an economy that's not structurally sound, and the well orchestrated softening of the Yen is overstretched and looks ripe for some good profit taking. This means that aggressive measures by the BoJ and a staunch tone by newly elected PM Abe must continue to maintain the pressure on the Yen. But is the recent rally enough? Japan's Economy Minister stated on Monday that "the Yen has come to a good level....if it falls to a three-digit level it would boost import prices, weighing on the everyday life of the nation."

The market needs progress, not just rhetoric in order to play its part; and this could continue to play on with the coming BoJ meeting in about two weeks. PM Shinzo Abe is building up the pressure, and he has a history of speaking out about the Japanese economy, but has done little to actually show for it. Abe was elected as the 90th PM of Japan by a special session in 2006, but only served for less than a year. Perhaps now is his time to shine as he stood on a strong platform of pressuring the BoJ to tackle deflation by means of inflation with aggressive monetary stimulus and greater cooperation with the newly elected government. The monetary-fiscal cooperation interferes with the Bank's legal independence, but talks still continue amid the threat of a constitutional change to the BoJ's independence so long as the Bank abides by Abe's recommended 2% inflation target. 

So called 'Abeconomics' has a direct market effect, causing a bounce off 2012 September lows in USD/JPY to extend to its current rally. The market's reaction is welcomed as a softer Yen helps boost Japanese exports and paves the way for inflation. But will this inflation come with growth? Abe's latest $117bn stimulus is projected to boost GDP by about 2% while creating 600,000 jobs. Nomura estimates that the the stimulus will help deliver real annualized GDP growth of 3.5%; and with ongoing disaster recovery from the 2011 tsunami, we could see more government-led growth. Of course, the way to do this is through private sector growth accompanied by a sound economic structure. More supply growth by way of stimulus could face the consequence of left out demand which would do little to boost prices. Economists worry that this is a big gamble for a sustained recovery. Nikkei Business Daily cites the growing probability of large spending in rural regions and the government's ability to prioritize projects. This is why there is so much pressure on the monetary side. 

In comes Shirakawa, the current BoJ Governor. Shirakawa announced an additional $128bn as part of the Bank's monetary easing programs in the fall. Japan's total spent on asset-buying programs has now past the $1tn mark, which is quite excessive. Meanwhile, the Japanese economy is stuck in its fourth recession since 2000. Much of this downfall is due to a strong Yen which halts export growth, the sluggish global economy,  and the struggle to recoup from the 2011 tsunami disaster. Even still, the Japanese economy has continued its  constant debt buildup and fiscal woes for about 20 years now. At some point, this cannot be sustained. 

The market implications are tricky. USD/JPY has soared enough, but not yet touching that 90 mark. Abe would like to see more JPY weakness to aid in his aggressive growth strategy. However, with USD/JPY shorts back in the game, we could see some profit taking. Over the past two weeks, the USD/JPY breather has extended for longer time-frames, but has always returned with a rise to continue the the upward trend. This could indicate some positioning as traders decrease exposure to the pair ahead of a correction or just pure uncertainty. Further Yen weakness could continue so long as the BoJ abides by Abe's commands in its coming meeting. The market needs to see progress on Abe's strategy in order for the Yen to weaken by theory. Remember that Shirakawa's term as BoJ Gov is up in April, so there is the possibility for this to continue, albeit at a softer tone (assuming no sharp correction). The USD/JPY shorts could pave the way for the April appointment of the next BoJ Gov, creating another profit opportunity in the pair. So far, Abe is meeting this week with monetary policy experts to begin the discussion on who will be the next BoJ Gov. Abe stated that he is looking for a "bold leader...someone who shares our views." 

US following in Japan's footsteps? Further reading:

Charts: US debt following Japan's trajectory

Japan's debt ceiling showdown

Facing Austerity. Head-on.

Assuming this isn't outdated by the Mayan calendar, 2013 will be the year of austerity. It's already here, but its impact will be more apparent in the coming year as it dampens the extent of a full recovery as governments continue on with an unbalanced check book. This process is inevitable and in some cases necessary to break out of an economic slump with some sort of fiscal sanity. The problem is not just in the US where this coined term of  a 'fiscal cliff' is actually what has been planned; its just the extent and distribution of the scale-back that's up for debate. As expected, the developed world is set for a stalled recovery with room for only modest improvement that will still lie below full  potential, especially given the new Fed thresholds on employment and inflation. Emerging countries will continue to face some struggles, but they will be busy stimulating during this time.

Some form of the fiscal cliff is inevitable. The fiscal framework of our nation is designed with limits to be  amended as we go to ensure that we are somewhat responsible to continue running the country on a balanced footing. This is why Congress has the power of the purse, but constant partisanship never gets us to that ideal point of leadership. In this case, we see extreme political strategy that surprisingly hasn't seen the kind of backlash that Europe has. The fact of the matter is that each proposal includes spending cuts that target many entitlements that we have grown accustom to but are clearly unsustainable. Our complex tax code deprives us of key revenue while the spending outlook will continue to dig us deeper into deficit. Whatever is agreed upon will still decrease our potential to accelerate economic growth.

We must address the political strategy, because this will determine whether or not we will ever get it right. The White House has cleverly used this 'balance' myth by shying away from real reform and spending cuts. If you really dig into the budget, many of those line items are highly sensitive because so many people rely on entitlements especially during these times. No one is willing to take bold action, and would rather gradually scale down the effects of costly programs that truly have a demographic mishap such as social security and medicare. When Republicans pressure spending cuts and reform, the White House has blamed lack of revenue as the reason for imbalance and then automatically factor in tax hikes and cuts on the middle class to show the 'only' way to balance the books. This type of thinking is a far step-back from reality.

Governments Ready?

Elsewhere in the developed world, governments have realized the problem and are cutting their forecasts. Canada, which relies on a US comeback in order to fully push on with full potential, has pushed its expectations back by one year to around 2015 when the country should return to surplus. The country also decreased its revenue projections over five years, and will essentially rely on decreased government spending in order to balance the books. In the UK, the Autumn Statement called for a decrease in welfare entitlement spending which caused quite a stir among its dependents. The ECB decreased its growth forecasts for the eurozone, and Germany is set to feel a pinch with declining industrial production. Lastly, Australia's Finance Minister Swan admitted during an unscheduled press conference on Thursday that the country is unlikely to achieve a budget surplus this year, breaking the major platform in the Labor Party's election pledge. Meanwhile, Australia's Prime Minister Gillard is on vacation; once again shying away from addressing fundamental issues.

Greece is a special case. Yes, we all know this. But it has essentially become the hallmark of austerity, and could set precedent on how its done (whether the country is proceeding in the right or wrong direction is a separate discussion). The fact is that Prime Minister Samaras is quick to work on structural reforms and grow the economy as part of the strict terms of its long awaited aid tranche of short term rescue loans. Closing in on its  sixth year of recession and +20% unemployment, Greece's real problem is demographic. Greek youth are fleeing the country, choosing school over work, or are busy protesting austerity in the streets of Athens. The country is one of the worst in the world for setting up a businesses given the impending legal costs, and the businesses that do come to fruition are short lived. Most of the people are employed by the government; and working for a broke employer disrupts the dependent system to begin with. Austerity at its finest. Or maybe just pure socialism.

Central Banks Prepared?

Central banks are ahead of the game, but it still won't provide a full cover-up of the underlying fiscal set-back. The Fed removed its 2015 guidance and agreed on additional asset purchases which suggests that the US economy is still under performing. The RBA cut rates and hinted at a mining peak which should help prepare for some fiscal tightening down the road for Australia to eventually reach a budget surplus.

The bottom line is that fiscal tightening is ahead, and this will force us to struggle along the recovery stage, performing below our full potential. Banks may have access to easy capital thanks to the easing mechanisms of central banks, but that money will remain stashed on the balance sheet until the political storm passes. Businesses will not invest unless there is some certainty on corporate taxes and the consumer's ability to be productive. We will all be a bit shaken with a change in the status-quo.

Check out: Rising stars of the fiscal cliff - Maya MacGuineas of Fix the Debt

The US must seize the economic opportunity

 

This past election was about who will be in charge of the nation's long road to recovery from the 2008 downfall. In the month leading up to election day, the US reported encouraging figures which at first glance seemed to indicate that we are on a path to a sustained recovery. The disappearance of housing inventory and a low rate environment inspired some support for a sector that was at the heart of the recession. Unemployment continued its decline to 7.9%, but still the overall trend remains weak with a lot of Americans simply settling for lower wages to make ends meet. Let's not forget about the long term unemployed facing declining skill levels and personal discouragement. It's clear that a recovery is in sight, but many challenges are ahead that will disrupt the progression.

Despite the debatable policies of the last four years and failed attempts to try to get the economy going (ie QE and fiscal stimulus), the private sector surely has struggled, but it carried along to continue doing business. Individuals and businesses don't rely on government wholeheartedly to keep moving; it is in our nature to keep the economy going. Surely, the pace at which we do this can be fine tuned by government forces. We know that businesses have high amounts of cash, but are cautious to invest and hire because of the high level of uncertainty. The private sector needs proof of a sustained recovery in order to take that risk to naturally stimulate a return through growth. So far, the government has discounted many of these potential decisions, and the political dithering is causing the economy to under perform.

Two examples that support this claim are seen in the recent earnings season and our domestic energy sector. Earnings came out relatively good at face value, but the slew of negative profit outlooks is very troubling. The fact of the matter is that consumers are spending because the cost of living is higher. This does not necessarily mean the price of goods are higher; lower wages decreases our purchasing power and uncertainty about what's to come forces us to spend rather than save. This fuels revenue growth in key sectors such as consumer cyclical. Companies that deal with trade and logistics such as UPS and FedEx have expressed some concern about future demand despite having the capabilities to continue running smoothly.

In energy, we have a clear distribution problem that cuts directly into the business of drilling. Despite the opening of some federal lands during the last four years, the pipeline network to actually fuel demand is severely lacking and the decision to block Keystone until after the election only adds to the problem. Drillers know the economics don't work just by having access to a glut of supply; a concrete energy plan is needed and will get us on a solid track to recovery. This could truly be America's new innovation moment, but again it has been discounted. A lame duck session is unlikely to get this rolling.

Furthermore, the market has responded to the electorate decision, and it clearly supports my stance. Despite an immediate rise in equity futures following the election results, equities came to terms and reversed direction to the downside. Treasuries saw a significant rise as yields declined. Gold and silver soared with gains at 1.91% and 2.76% respectfully. This indicates a level of risk-aversion due to both the near term uncertainty and the longer term assurance of monetary easing.

The fiscal cliff poses a large threat to the economy, and House Speaker Boehner said it best - we have to build a house on rock instead of a house on sand. No doubt there will be some bickering, but this is our chance (once again) to reverse years of economic folly that is already deeply rooted in the US. The spending limit is a mandate that has been abused year after year to continue along an unsustainable path. Recoveries come and go, but we need to make sure that we have a country that has its books in order to limit the downfall. Boehner is calling for a new growth/reform model that is open to greater revenue, but it will require lots of work. That's what these next four years should be about. We must continue the fight outside of the ballot box and vote with our dollars. Trust in ourselves to make it through, and be prepared for any outcome. Four years should not be the end all. Make it a legacy.

Long term troubles for the US and Europe despite year end breather. Who will win?

The events of the past few weeks suggest that a forceful attempt to get things right by year end will only last for so long. The authoritative approach by frustrated central banks; Germany's clever stalling strategy with Spain; and corrections in Canada's housing market, all point to a much awaited year-end breather. This is what we want to see, but the long term outlook is still troubling.

Let's start with Spain.

On Thursday, Spain announced its budget and economic reform measures which includes planned spending cuts for 2013. The government stated that the 2012 revenue target will be met, but plans to tap 3bn euros from the Social Security reserve fund to cover pension payments was quite the shocker. 

The fact that the demographic make up of Spain skews towards the elderly, coupled with high youth unemployment means that these crucial reserve funds are not growing at a sustainable rate to accommodate the pace of payouts.  Austerity measures will lead to further slowdown with no major growth in employment, and Spain will need to find a way to meet its liability needs; a larger pool of government dependents being one of them. Policymakers need to remember that most Spanish households actually rely on the retirement payments from the elderly family member to stay afloat.

Bank of Canada dovish on Western friends, positive on China

On September 7th the Bank of Canada issued a report concerning the dutch disease; with Governor Carney's remarks intended to ease concerns about the high Canadian dollar's adverse effect on trade sensitive sectors. However, the report failed to address how policy makers will respond to Canada's growing troubles in manufacturing productivity and inflated housing sector. Instead, the report shared some insightful information on the BoC's negative outlook on the US and Europe. Canada is strategically aligning its economy to meet the long term resource demands of the emerging world, most notably from China.

Canada's global projections are on point and deserve greater attention. It is in Canada's best interest to remain well informed about the global economy.