Strategy Report

Investors Mixed After Cryptic Start to 4Q Earnings Season

Those investors, who entered this round of earnings season expecting good news, received it. On the other hand, those investors who were expecting abysmal indicators saw their prediction come to fruition as well. Why has this occurred? Various blue chip and financial sector earning reports released over the last week have provided anything but solid insight into what’s on the horizon for 2010. Even as companies show robust changes in their bottom lines and balance sheets, trepidation continues to linger and has proven to weigh on investor sentiment since last Monday. On the surface, much-improved earnings-per-share data suggests that equity markets are ready to continue their bull run from last March. Upon a second review, however, excitement building over a so-called “end” to the recession appears to be a bit premature.

Two trends are dominating the analysis of earnings thus far: the equity market response and the bond market response. Better-than-expected earnings-per-share data from banks have offered equity securities investors hope that profitability is resuming and earnings growth will become a positive trend going forward; yet, at the same time, the loan losses disclosed by other institutions indicates that consumers are still struggling. JPMorgan Chase & Co. exhibited both sides in their most recent earnings: while revenues surged to over $3.3 billion dollars on strong investment banking results, and thus pushing fourth quarter EPS to $0.40 (against $0.30 expected), it suffered tremendous losses on mortgage and credit card loans. Even as non-financial sector companies begin to show steady revenue growth and solid earnings data – Intel Corp and IBM come to mind first, as both outperformed analysts’ expectations – the bank data offers the most telling insight into the future of the market. Sizeable losses at banks indicates that consumer credit isn’t mending as quick as desired or forecasted, and, going forward, could remained depressed should unemployment continue to hover around ten percent for some time. If consumers and business struggle to find footing in a market about to have stimulus withdrawn from it as an asset bubble begins to build, it’s not evidently clear who will seek loans in order to trigger profit growth for banks down the line.

Written by Christopher Vecchio, CFDTrading Research
Please send any comments about this report to Cvecchio@fxcm.com

4Q Earnings Season Leaves Investors Guessing Ahead of Releases

With Alcoa posting a $227 million dollar loss, the fourth quarter earnings season has gotten off to a rough start.  However, according to analysts’ forecasts, earnings for the companies in the S&P 500 Index are expected to more than double the levels measured through the end of 2008.  Companies have seen their revenues handicapped by a tepid recovery from the worst recession in modern history. As a reflection of what is considered ‘good’ data in current conditions, government labor data recently reported the unemployment rate held near a 26-year high at 10%,  while net payrolls fell by 85K jobs in December.   Considering consumer spending accounts for an estimated 80 percent of economic activity, the outlook for business income remains challenging. However, considering the marked recovery in the financial markets through the end of the year and expectations of a robust holiday shopping season; there may be more to work with for bulls than underlying fundamentals suggest.  To garner a sense of what the 4Q earnings season may hold, we will draw comparison to the previous quarter and look at analyst expectations for the upcoming numbers.

Third quarter earnings were well ahead of analysts’ expectations, as over eighty percent of S&P companies reported earnings that surprised to the upside.  This was a record high for companies beating estimates according to Bloomberg which has tracked the data back to 1993.  The results were not all positive, however, as most sectors were unable to post year-over-year growth and revenues failed to keep pace with earnings.  The latter was attributable to weak consumer spending and it forced companies to cut costs to maintain an acceptable profit margin.  For perspective, this was the third consecutive quarter of better-than-expected results for the broader market.  However, this can be partially attributed to especially low forecasts founded on concerns related to the weak pace of recovery and anemic consumer spending in the U.S and abroad.

Looking ahead, this round of earnings figures could have a profound effect on market sentiment. Expectations for fourth quarter results are high; but this time around investors will no doubt be more judicious in their assessments of the sector’s health. Ultimately, the source of earnings will be the take away for investors: whether or not companies were able to move beyond the cost-cutting schemes of early 2009 and fill in with a steady revenue stream, as the United States and other countries around the world recommenced growth. Although the markets are likely to remain relatively quiet ahead of next week, volatility should pick up as traders adjust their expectations heading into the dense round of reports. However, depending on how these corporations performed as a whole, lingering cynicism regarding a double-dip recession in 2010 could be amplified or dispelled.

Written by Rab Jafri, James Russell, and Christopher Vecchio, CFDTrading Research

Central Bank Rate Decisions Outlook

Federal Reserve Rate Decision Outlook:
Rate hike expectations for the Federal Reserve remain muted as commentary by Chairman Bernanke and others alluded to a prolonged period of “exceptionally low levels of the federal funds rate for an extended period.” Prior to raising the target rate, Fed officials are likely to wait until after programs meant to boost credit and liquidity reach their end in Q1 2010. This includes $1.25 trillion in agency mortgage-backed securities and approximately $175 billion in agency debt, as well as other initiatives including funding and lending facilities. Trading action in Fed Funds futures imply that June 2010 may be the first meeting in which an increase of any sort is foreseen by a majority of investors. Despite speculation, a decision to raise rates will be contingent on whether the FOMC revises higher its expectations on growth and inflation. Certainly, inflation fear remains suppressed although the core CPI, a commonly used gauge for price growth, has crept up to 1.7% in October from a low of 1.4% in August.

Bank of Canada Rate Decision Outlook:
Bank of Canada officials have maintained borrowing costs at 0.25% on concerns that the appreciation of the Canadian dollar may offset the recent rebound in economic activity.  After the central bank’s October policy meeting, forecasts were adjusted slightly higher for economic growth through 2009 and expansion for 2010 was forecast at 3.0 percent.  Price levels, however, are expected to remain below the 2% inflation target into 2010 so hawkish policy is unlikely at this time.  Investors are not pricing in any chance of a rate hike according to Credit Suisse overnight index swaps and Governor Mark Carney remains committed to the current low rate through the second quarter of 2010.

European Central Bank Rate Decision Outlook:
The Governing Council has kept the ECB rate at 1.00% for the past seven months, while President Jean-Claude Trichet has cited recent economic improvements in the euro area.  Real GDP returned to growth in the third quarter following five quarters of contraction, with bank officials projecting positive real GDP growth in 2010 and 2011.  Despite this positive forecast, the market currently prices in no expectation that the ECB may move rates 25 bps at the next meeting.  This is likely due to the ECB declaring that the outlook remains subject to “high uncertainty” and “low inflationary pressure” over the medium term.  However, President Trichet may be preparing for a future rate hike after the ECB’s decision on December 3 to end long-term emergency loans and tighten the terms of its final 12-month tender.

Bank of England Rate Decision Outlook:
BoE officials have maintained the benchmark rate steady at 0.50% for eight consecutive meetings and voted to increase its £175 billion asset purchase program to £200 billion.  The UK’s economic recovery has struggled to gain footing as GDP contracted 0.4% in the third quarter and the jobless rate sits at 7.8%.  According to central bank officials, “financial conditions remain fragile” as lending remains tight and spending still weak.  Market participants currently price in no expectation that the BoE will hike rates by 25 bps at the next meeting as the economic recovery looks to gain traction and price levels remain tepid.  Looking forward, however, the market expects a 69 bps increase in the benchmark rate as the central bank has concerns that inflation will rise in the medium- to long-term.

Swiss National Bank Rate Decision Outlook:
The Swiss National Bank has maintained its target rate at 0.25% (with a range between 0.00% and 0.75%) for a full year as the economy was struggling to recover and price levels remained low.  In the third quarter, however, Swiss GDP grew 0.3% after yearlong contraction.  Investment rose by 3.4% in the third quarter, its largest increase since 2003, and exports climbed 2.6% after falling 2.2% in the second quarter.  Exports, essential to the Swiss economy due to weak domestic demand, rose thanks to improving economic conditions for European trade partners and a stabilized Swiss Franc.  Looking ahead, the SNB will likely be slow to raise rates due to concerns over weak consumer demand and rising unemployment.  There is currently no market expectation of a rate increase at the next meeting and only a 31 bps increase over the next twelve months.

Bank of Japan Rate Decision Outlook:
In an unscheduled move in December, Bank of Japan official decided to ease monetary policy further with the introduction of a new funding operation of three month loans expected to reach a maximum size of ten trillion yen. The key rate has been held at 0.10% since the end of 2008, and given the central bank’s tendency in the past, along with persistent deflation; an increase is not expected in the year ahead. Indeed, core CPI in October posted a fall of 1.1%, the largest contraction in prices since recording began in 1971. Another factor hampering rate hike expectations is economic growth, with GDP up just 1.2% in preliminary third quarter readings while bank lending slowed to a 1.9% annual increase.

Reserve Bank of Australia Rate Decision Outlook:
The RBA shows few signs of slowing down its tightening policy as the central bank raised the cash rate for a third consecutive time in December. The decision to increase the rate by twenty five basis points to 3.75% came amid significant improvements to the economy, one of few major nations that narrowly avoided recession. To their credit, Governor Stevens cites regional financials with lower toxic assets that enable quicker recovery in credit markets. Also supporting growth has been the A$42 billion in fiscal stimulus. The OECD now expects the economy to expand 0.8% in 2009, and while inflation remains a concern, the RBA stated that recent “material adjustments” will consumer prices in check. Consequently, investors’ expectations for rate hikes have declined sharply, from 12-month expectations of 216 basis points increase to 102 basis points early in December.

Reserve Bank of New Zealand Rate Decision Outlook:
Since lowering the official cash rate to 2.5% on April 30, 2009, the RBNZ has refrained from raising the key rate even as GDP climbed for the first time in over a year. The economy grew in the second quarter at a 0.1% pace, with further expansion possible as retail sales climbed for in the third quarter. While neighboring Australia began to tighten rates to avoid an inflation threat, Governor Bollard of New Zealand sees no cause for concern as CPI remained below two percent in the past two quarters. Market participants have pared their bets, expecting 163 basis points of increase in the next twelve months, down from expectations of 235 basis points in late October. Ultimately, the bank has remained adamant in its latest meeting with no intention to change the OCR “until the second half of 2010″.

Written by James Russell and Roman Kadinsky, CFDTrading Research

Currencies, Oil, Gold: Global Macro Forecast

If 2008 seemed like the last gasp of life across financial markets, then 2009 was a collective sigh of relief. As central banks dropped interest rates to record lows and governments frantically doled out some $2 trillion dollars in stimulus, the sheer panic that seized investors after the collapse of investment banking giant Lehman Brothers began to recede: the sharp declines in leading economic indicators began to slow, credit markets showed cautious signs of life, and a glimmer of hope began take root across the world’s exchanges. The first quarter proved dismal, but by March a sense that Armageddon had been averted had started to become the consensus view.

What happened next can only be appreciated in light of the carnage of the previous year. Having stared down a near-collapse of the global financial system, overjoyed investors began piling into so-called “risky assets”, setting off sharp rallies in equities, commodities, and high-yielding currencies. Sure, the world economy was far from healthy, but anything that was better than the dark days of late 2008 was good enough. This also brought a sharp decline in the US Dollar, which had previously banked on the sophistication of US financial markets and its unparalleled liquidity and flourished amid the mayhem as a natural safe haven asset. The result was a bipolar marketplace torn between “risk” and “safety” where gains in the Dollar meant declines across nearly every major asset class, and vice versa.

Eight months hence, capital markets have advanced to lofty levels: the MSCI World Stock Index equity benchmark has returned to pre-Lehman levels and are trading at the highest levels relative to earnings since 2002; crude oil is pushing $80/barrel having bottomed near $41 in January; gold is setting record highs above $1100; and high-yielding currencies like the Australian and New Zealand Dollar have retraced close to 80% of the drop that began last year. With the worst now increasingly behind them, however, investors seem to be gaining a sense of sobriety after the intoxicating exhilaration of surviving the credit crunch. The sustainability of the recovery after stimulus is withdrawn and concerns about runaway inflation as a result of ultra-loose monetary policy crop up more and more often, with calls for a retracement of the risk rally starting to mount in earnest. Indeed, October may yet prove to have been a watershed month as the MSCI World Stock Index dropped the most in since February while the VIX index of US stock options volatility that is often seen as a proxy for investors’ risk aversion gained the most in a year. As 2009 comes to a close, we examine the macroeconomic trends that are likely to play out in the year ahead.

Guided by Risk – Euro, Swiss Franc and the ‘Commodity’ Dollars

As the currency of the world’s second-most liquid and developed financial market, the Euro is the natural antithesis to the US Dollar and so will tend to rise and fall on the greenback’s fortunes. It is no wonder then that the EURUSD exchange rate is tightly linked to global equity markets considering the US unit’s standby safe-haven asset status. To that effect, the continuity of the stocks rally is the critical question driving EURUSD trading, with any correction lower likely to carry the pair along for the ride. Further, the Euro’s exchange rate to the Dollar is consistently about 99% inversely correlated with that of the greenback’s value against the Swiss Franc, suggesting that whatever happens with EURUSD is likely to be mirrored in USDCHF.

The so-called “commodity dollars” are also an all-but-pure reflection of the risk versus safety dichotomy. This is particularly the case with the antipodeans, who boast the highest interest rates in the G10 and so are the most attractive buys for yield-seeking “carry” trades. Reasonably, FX carry trades flourish when investors value returns over safety, making the Australian and New Zealand Dollars over 90% correlated with global stock performance (as measured by the MSCI World Stock Index).

Where Interest Rates Still Matter – The British Pound

The Pound is one of the few major currencies amid the polarized world of risk versus safety trading that is being driven by the most traditional of currency market catalysts: interest rates. Indeed, GBPUSD shows an impressive 85% correlation with the spread between next year’s March and December 90-day UK interest rate futures, the difference between priced-in borrowing costs in the first and the fourth quarters that reflects the market’s expectations for Bank of England monetary policy for 2010. For the moment, traders seem to be betting that the Fed will lag behind the their counterparts at the BOE, but this may soon change considering UK policymakers decided to expand their “unconventional” monetary stimulus measures (known as quantitative easing) while in the US the bank has been slowly but deliberately moving to unwind similar programs, hinting that perhaps Ben Bernanke will beat Mervyn King to raising benchmark borrowing costs and send the greenback higher.

Marching to Its Own Drumbeat – The Japanese Yen

The trajectory of the Yen is shaped largely by the impact of cultural factors on economic life in the world’s second-largest economy. Japan’s savings rate is high relative to other developed countries, reflecting the high cost of living on an island with limited space and scarce home-grown resources. This translates into Japanese investors’ preference for safe, liquid assets that offer a stable income over a long period of time. Typically, this means US Treasury bonds. Understandably, this means USDJPY is closely correlated with the Treasury yields. The relationship may prove to guide USDJPY higher in the year ahead with the US budget deficit set to hit a record-high11% of GDP this year and remain dangerous 9% in 2010: the Treasury will need to issue an unprecedented amount of debt to finance the shortfall, driving prices lower and sending yields and consequently USDJPY soaring in the process.

Hedging Against ‘The Great Inflation’ – Gold

The decision to effectively “print” money to secure adequate credit access on the part of the world’s top central banks has produced a spectacular rally in the price of gold. Ever the standby store of value, the metal has proved attractive as a hedge against what investors fear will be a period of runaway inflation as record-low interest rates and churning printing presses flood the market with currency and send prices soaring. However, it seems plausible the “great inflation” may not come after all. Focusing specifically on the US (as gold is priced in Dollars), the money multiplier ratio that determines the total impact on the Fed’s liquidity injections on the money supply has fallen to the lowest level in over 25 years at about 0.8. Meanwhile, the velocity of money (the speed with which it changes hands) has fallen to the lowest level since 1987. Put simply, this means that any newly-created supply is being absorbed into the economy at the slowest pace in over two decades, and with only about 80 cents of each Dollar that the Fed prints actually coming through. If this proves to show that concerns about an imminent spike in inflation have been overstated, a downward gold correction will not be far behind.

Playing Catch-Up with Speculators – Oil

As many other commodities, crude oil began to rebound as risk appetite reversed course higher in March 2009. The speculative nature of the rally is not difficult to identify: data on net positioning in the light, sweet crude contract from the US’ Commodity Futures Trading Commission shows that commercial long positions have been consolidating near 6-year lows since September 2008, while speculative positioning surged to the highest level in at least 26 years in October. In the near-term, this makes oil prices as vulnerable to a downward correction in risk sentiment as stocks and related currencies (see above). Looking further out, however, the big question is whether global demand can catch up to underpin prices at relatively higher levels. Separate forecasts from the IMF, the IEA and OPEC concur that this year will see the first meaningful decline in energy demand, with a shallow rebound of about 0.4% expected in 2010 on the back of global stimulus efforts. However, even such a modest rebound may prove too optimistic if: governments and central remove stimulus too soon, mistaking a brief policy-induced reprieve with the beginnings of a true recovery; or, if speculatively-driven oil prices rise so high as to cripple the recovery and weigh on demand. The latter seems imminent, considering OPEC has recently noted that oil at $90-100/barrel would be a significant hurdle to global output even as crude traded within a hair of that range near the $80 level.

Expectations For The World Economy Going Forward

The global economy is expanding again, led by growth in China and other emerging markets that have shown surprising resiliency through the economic crisis.  So far, the recovery has been founded on liberal stimulus efforts taken by the world’s governments and central banks.  Initially, these drastic measures were essential to preventing a recession from turning into a depression and perhaps falling into a true financial collapse.  However, the debt and deficits cannot be supported for long; and this support is therefore only a temporary safety net.  In this transition period where growth has not been fully established and rates are still extraordinarily low, we are nonetheless seeing a building interest behind speculation.  In the fray, the benchmark U.S. dollar, due to low interest rates and ample stimulus that has led to cheap money, has taken up the mantle of primary funding currency through a revival of the carry trade.  However, many of the dollar’s peers hold similar benchmark interest rates and the expectations for returns are therefore very low.  With time, growth will solidify and interest rates will eventually rise; and with such a tangible fundamental foundation, carry interest will build, trends will develop and volatility will settle.

Taking a look at the 12 month growth and interest rate forecast for the industrialized world, there is a good probability that speculative interests and rates of return will be significantly higher in a year’s time.  Economic growth should help the credit markets stabilize and capital will return to the private sector to once again provide funds for capital-intensive projects.  As this occurs, central banks will likely coordinate a removal of quantitative easing and begin to hike interest rates around the globe.  Banks, borrowing at higher rates, will lend money to high-yielding projects to ensure that the more expensive terms of their loans are met.  Two years ago, when economic growth was strong and interest rates high (Fed Funds rate over 5%), lending was met with high-quality private-sector borrowers expecting strong returns in the bull market.  Over the past two years, however, the economy has slowed and the credit markets have frozen up.  Central banks reacted to this situation by loosening monetary policy to provide more liquidity to the markets, yet much of this liquidity provided to banks has been placed in reserves as most lending has appeared too risky and volatile in the trying economic times.  If growth expectations are met going forward into 2010 and interest rates are higher, quality capital should once again make its way into a profitable private sector.

Written by James Russell, CFDTrading Research
Please send any comments about this report to JRussell@fxcm.com

CFD Provider FXCM: New Lower Contract Sizes on Global Stock Indices, Oil and Gold

For Immediate Release:

Media Contact: Jaclyn Sales, jsales@fxcm.com

London, 20 October 2009FXCM LTD (www.fxcm.co.uk) began offering CFD trading in addition to forex trading in September 2009 allowing traders to trade forex, global stock indices, oil and gold—all on one platform.

On 18 October 2009, FXCM LTD, in a continued effort to perfect the CFD product offering, reduced the minimum contract sizes on their global stock indices, gold and oil instruments. This means that less margin will be required on many CFD instruments in order to place a trade. Just like trading forex, traders will be able to put up less equity to trade their opinion on stock indices, oil and gold.

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•    NEW LOWER MARGIN REQUIREMENTS for Global Stock Indices, Gold and Oil
•    Analyse Charts, Place Trades and Track Positions All from One Screen

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1.    The MMR column in the Simple Dealing Rates window will be updated to reflect the correct margin amounts per lot for CFD instruments on 25 October 2009.
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3.    Currently, two days prior to the monthly expiration of US Oil, FXCM will roll forward ALL open oil positions. On 18 October 2009, FXCM will only roll forward the net open US Oil position on the client account. For example, if you are long 10 US Oil and have another short 5 US Oil position, FXCM will roll forward the net open position, which in this example would be a buy of 5 US Oil to the next contract month. For further details on trading US Oil please view the complete product guide.

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FXCM Holdings LLC Facts

As of June 2009

•    FXCM Holdings LLC has over $100 million in capital.
•    More than 150,000 live accounts trade on platforms offered by FXCM.
•    An average of $365 billion in notional volume is traded each month on platforms offered by FXCM.
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Risk Disclaimer:

* FXCM is compensated through the bid/ask spread except where otherwise noted. Please note commission charges apply for certain classes of non-standard accounts such as Active Trader.

† Without proper risk management, currency trading has a high degree of leverage which can lead to large losses as well as gains.

Leveraged Contracts for Difference (CFD) and foreign exchange (Forex) trading carries a high degree of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade CFDs and/or foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with CFD and forex trading, and seek advice from an independent financial advisor if you have any doubts.

3Q Earnings Season May Draw More Skeptics This Time Around

Few have forgotten the impact that the US second quarter earnings season had on the markets. Better-than-expected earnings reports were the norm and the impact on sentiment was clear. Risk appetite was feed and stocks rallied for the weeks afterwards. However, the accounting for that period was special as it confirmed the recovery was taking place for the corporate sector. This time around, enthusiasm will be generally more muted. No longer are we merely looking for a rebound from the worst of the crisis; instead, market participants will analyze the data for the pace of the recovery. And, should the market reflect on the numbers with a little more skepticism; they may very well be disappointed by what they see.

Taking a look at the general cut of the second quarter earnings numbers, it is safe to say that cash flows, revenue, invest and all other relevant measures of health are far below the figures we had come accustomed to up through 2007 and even 2008. The full brunt of the recession and financial seizure has severely stalled economic activity; and in turn demand for goods and services has naturally shriveled. With domestic US demand continuing to shrink as wages wither and unemployment marches higher, tight credit conditions prevents expansion and economic hardship and protectionist measures cool exports; the outlook for corporate earnings over the coming years (much less the past three months) looks anemic.

What should we look for specifically to gather a sense of direction from this data? The most important consideration is how the markets respond to the data. Better-than-expected or not, if the general consensus is one of skepticism for the future, sentiment can collapse under its own heights. At the same time, the surprises as compared to forecasts will act as a good catalyst for market activity either way. We should watch the numbers from the biggest corporations – those that represent the entire business sector. This is the first week for major releases; so expect the volatility to begin here (if at all).

It is especially important to watch the announcements from the four major US banks this week. While the rest of the firms’ numbers will be reasonable measures of economic health; the banks health is a necessary measure for growth, credit conditions and financial stability amongst other things. Write downs are especially important. The IMF has projected that the world’s banks have only accounted for half of their losses (and the US specifically 60 percent). Accounting rules may have allowed for roll over losses; but defaults and mortgage security-based losses will factor in sooner or later. Also, as the catalyst for the bullish drive during the second quarter season, Goldman Sachs will likely be under greater scrutiny than its peers.

Written by: John Kicklighter, Strategist for CFDTrading.com
Questions? Comments? Send them to John at jkicklighter@cfdtrading.com.

The Interest Rate Game: What Pace Will the Fed, ECB, BoE, BoJ and RBA Take Next Year?

We are coming out of the shadow of the worst financial crisis in modern history; and investors seem antsy to put their capital back to work and recover some of the wealth lost between 2007 and 2009. After a couple months of stabilizing, however, at the beginning of the year; we have seen the market recovery set a remarkable pace. For investors and traders looking to put their money to work, it is absolutely vital to ask whether a 52 percent rally in the Dow Jones Industrial Average or record high in gold is truly reflective of underlying fundamentals. If it doesn’t, then capital appreciation on speculative interests will eventually collapse and pull the markets back in line with reality.

What is the qualifier for the fundamental health of the markets? Simply, risk versus reward. Both sides of this equation are heavily influenced by group discretion and speculation; yet there is a tangible foundation to work from on both sides. Since our primary concern in today’s markets is the factors to support a bull market, we will concentrate on expected returns. There are two sources of return on any investment, capital appreciation and yield.  On the whole, the former only pays off should the markets continue to rise. In contrast, dividends and yield is the consistent income that keeps large investors and pools of wealth in a market for the long haul (if it were all short-term funds, we would see incredible volatility). And, the source of each economy’s rate of return is the benchmark yield set by its central bank.

The interest rate outlook is generally positive in that the next move expected to come from most of the world’s largest central banks will likely be a hike. Therefore, the real consideration is when the banks will start moving and what pace will they maintain. We’ll look at those central banks that support the most liquid currencies and use this as a gauge to establish whether their markets are overbought or right in line with fundamentals.

Federal Reserve (Fed)

Since the US is the largest economy in the world, there is unique interest in the Fed’s activities. The nation’s recovery is on pace with the global rebound. However, the dour outlook for genuine expansion after growth turns positive has kept policy officials on a reserved course. Chairman Ben Bernanke has repeatedly stated his intention to leave the benchmark unchanged at its range between 0.00 and 0.25 percent until at least the middle of 2010. However, many believe that should inflation become an issue, this schedule will be moved up. Fed Fund futures show there is no significant speculation of a potential hike until the January or March meeting. However, overnight index swaps from Credit Suisse account for 75 basis point worth of tightening over the 12 months, which would likely represent a slow return to a hawkish pace. Note that back in August, the outlook for a hawkish turn was far more intense.

European Central Bank (ECB)

Just six months ago, the European Central Bank was expected to be the first central banks to reverse pace and hike rates. This hawkish outlook was developed through the groups’ decision to bring an end to their steady stream of rate cuts at 1.00 percent when many of its comparable peers (the Fed, the BoE, etc) extended their efforts as far as possible. However, since that neutral policy was adopted, President Jean-Claude Trichet has used his renowned transparency to dampen expectations of a near-term hike. For hawks, the bank’s decision to let its unlimited auctions expire and a return to growth for German and France has paved the way for a hike. However, doves point to negative inflation and the struggle for other regional economies in recovery from recession. In the end, speculation has set precedence for the market. After the RBA’s unexpected rate hike, the market is now pricing in over 100 bps of hikes over the coming year. So, while the first hike may not come for some time yet, its pace is expected to be more consistent.

Bank of England (BoE)

The United Kingdom’s economic growth outlook is dour. While other industrialized economies are already well into their respective recoveries; the UK has distended its record-breaking slump into the second quarter. More worrisome is the fact that more timely indicators offer a very poor trend of their own and the government will soon have to cut its spending. While the central bank could focus on inflation; such trends are not yet developed enough to overtake the need to facilitate growth. Furthermore, with the BoE still considering expansion of its extraordinary 175 billion pound bond program  and cutting its deposit rate to encourage lending, the market will be able to better gauge the eventuality of hikes when these more extreme policies are unwound.

Bank of Japan (BoJ)

The Japanese yen is the quintessential funding currency and for good reason. The nation’s target interest rate has held very close to zero for decades as credit and economic conditions didn’t really recover from a banking crisis. The interest rate outlook for this economy is extremely low (5 bps over 12 months) and so it should be with deflation and new financial troubles. However, while this outlook will encourage the global market to use the yen as a funding currency for the carry trade, it doesn’t mean equities and other assets will be held down as well.

Swiss National Bank (SNB)

Often considered a compliment to the European Central Bank, the SNB has indeed tried to keep pace with the policy taken in its largest trade partner (the Euro Zone); but conditions have been so severe in the 2007-2009 recession that officials have had to extend their efforts to stabilize markets and inflation while encouraging growth. The target range for the benchmark Libor is set between zero and 0.75 percent; but it is effectively an average at 0.25 percent and as close to zero as they can go without taking the stigma that such a low would carry. The outlook for Switzerland is very reserved. Normally, the central bank only deliberates on interests rates once a quarter. What’s more, protectionist measures through currency intervention and pressure on the nation’s banking privacy laws has created significant hurdles for policy officials to handle before they can consider hikes.

Bank of Canada (BoC)

The Bank of Canada is often compared to its US counterpart; but this juxtaposition often colors the BoC in a brighter light. The Canadian and US economies are tightly intertwined as they are each other’s largest trade partners; but the severity of the former’s recession and financial seizure has been notably less severe than the latter’s. Indeed, domestic demand and commodities have provided a buffer to the unfavorable winds; but the recovery from Canada’s worst has been just as measured as it has been for the US. Recently, the Canadian dollar appreciated significantly against most of its counterparts through its links to the commodity bloc; but the BoC Deputy Governor Jenkins explicitly warned that Canada’s and Australia’s economies were very different (suggesting growth and domestic demand shouldn’t be overlooked) and the RBA hike didn’t clear the way for the BoC to follow suit.

Reserve Bank of Australia (RBA)

Australia is one of the strongest economies among the G-20. The economy has been able to avoid a technical recession, domestic demand is surprisingly stable and the financial system is robust. And translating this optimism to action, with the global economy on pace for recovery, the RBA has taken the initiative by being the first among its peers to hike rates. At 3.25 percent, the Aussie benchmark is already at a significant premium to most other nations (and the economy is far more stable and markets more accessible than its emerging market counterparts).  Governor Glenn Stevens, after lifting the benchmark rate, suggested he would lift rates again relatively soon. With swap traders pricing in a 100 percent probability of a 25bps hike in September (and a modest chance of a 50bps) along with 178 bps of tightening through the next 12 months, Australian markets are well positioned to lead a bullish drive until other nations significantly catch up.

Reserve Bank of New Zealand (RBNZ)

Often times, the New Zealand economy and its policy authority follow pace with its larger trade partner, Australia. However, the current contrast between the two couldn’t be more different. While Australia is pushing ahead with solid growth, New Zealand is still trying to establish a recovery from its steep recession. RBNZ Governor Bollard has vowed to keep the benchmark at 2.50 percent until “late 2010,” but market participants are nonetheless pricing in a little over 150 basis points of hikes over the coming 12 months. While this may seem to be well off the mark, it may be more reasonable than one would expect. While the central bank is not likely to hike in the near term (they are still trying to talk down their currency and a hike would only feed its appreciation); they will eventually turn to a hawkish regime and the authority is known for taking an unexpected an aggressive pace. What’s more, New Zealand is known on the global scale as a high-yield market. As long as risk appetite is rising, New Zealand markets will similarly be lifted.

Written by: John Kicklighter, Strategist for CFDTrading.com
Questions? Comments? Send them to John at jkicklighter@cfdtrading.com.

How Valuable is Gold?

This past week, gold has surged to a new 18 month high, pushing once again through the prominent $1,000/oz milestone. A simplistic fundamental rundown of this high profile move is that demand for gold has soared as a speculative commodity investment or perhaps a safe haven to protect against overvalued equities or maybe even a hedge against forthcoming inflation. All of these arguments have been made; but none of them are particularly realistic at this point. The real reason gold has climbed to such heights: the US dollar.

Gold in Dollars

How do you value a physical good or financial instrument? Sometimes there is a theoretical point system assigned; but the most common method is by pricing the security against a currency. However, currencies themselves are not fixed. Their value can be implied by goods, inflation or other currencies. And, sometimes, there are significant changes in the fiat store of wealth – like the dollar’s plunge over the past six months.

So what happens when we look at one of the world’s favorite trading instruments through different currencies as a base for value?  Trading out the dollar for the euro and Australian dollar, it becomes clear that gold itself is far more stable than what we would think by looking at the traditional troy-ounces-per-dollar measurement. This is just a few alternative views; but we could theoretically value gold by the amount of Dow Jones Industrial Average contracts or barrels of crude it is worth. There is a limit to the usefulness of using different measurements. Since most gold futures contracts and a significant portion of spot gold is purchased using dollars, it is a meaningful gauge. Ultimately, there is no ‘real’ or ‘objective’ current value for gold; but when treating it as an asset, it is good to know whether you are looking at the real demand for the commodity itself or a reflection of the underlying valuation tool.

Various Views on Gold

This above chart is what most of us are used to seeing. It is gold valued in terms of US dollars. From a technical perspective, we can see that the past two weeks have forged a significant advance that puts the commodity above its early June highs and – more importantly – through the $1000/oz figure.

A look at the standard $/oz version of gold shows how meaningful the $1,000 level is on a historical basis. We have approached this general region a number of times in the past; but the drive has consistently failed in or around the meaningful milestone. Since October of last year (immediately after the worst of the financial crisis had passed), we have seen gold steadily trend higher against its dollar benchmark. Momentum suggests a meaningful break may come soon if not now. And, if it doesn’t; the reversal will be one that lasts for many months.

So we have looked at gold in terms of dollars; but what about the currency itself? Here we have the dollar index (valued through a weighted average of the most frequently used currencies of exchange when the greenback is spent or purchased. We can see the same general pattern (inversed) that gold has developed since October.

Now that we have indentified the other side of the standard gold valuation and the impact it can have on the generally accepted price, we should swap it out to see what impact we have on the underlying commodity. Using euros in the stead of dollars, we can see that gold has actually depreciated from the time risk appetite started to recovery back in Feburary/March; and has stabilized in a tight range between 700 and 650 euros/oz for the past five months.

Now let’s use a currency that has strong commodity ties. Australia is one of the top gold producers and exporters in the world. Using the nation’s currency to value the metal shows the same general depreciation as the euro and a similar range pattern through the past three to four months.

Gold Triangle Break

Gold’s rally pushed through what may be the top of a triangle.  Price remains beneath highs in February and April but a rally above there puts the all time high at 1034 (March 2008) in jeopardy.  Structurally, even a new high is probably just temporary.  An unorthodox top in wave B of an expanded flat would pave the way for wave C to eventually drop below 681.  Interestingly, the 1999-2008 rally is equal to the 1976-1980 rally in terms of price.  2008 momentum, as measured by RSI, did not reach the 1980 level.  This creates a significant divergence that is typical of major turning points.  Even allowing for a new high in  gold, the metal appears much closer to a top than a bottom.

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