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Weekly Market Analysis
Stepping Through the Fog

by Karl Schamotta | July 22, 2016

Currency traders are slowly creeping through the smog this morning, pushing range-bound exchange rates incrementally forward as they struggle to see the economic fundamentals that might drive divergences through the latter half of the year.

Some of the mist began to clear around the United Kingdom’s economy, however, with yesterday’s weaker-than-forecast retail sales number combining with today’s purchasing manager survey release to drag the pound sterling down by more than a hundred basis points as we went to pixels.

The preliminary Markit survey of sentiment among business executives fell by the most in its 20-year history over the month of July, consistent with the belief that the referendum will materially impact growth through the purchasing, hiring, and investment channels. Economists now expect output to shrink by 0.4 percent during the third quarter. This will put pressure on rookie finance minister Philip Hammond to open the fiscal stimulus taps, and on Mark Carney to lower benchmark interest rates and engage in further quantitative easing.

Only two days ago, the Bank of England released its monthly report, saying, “As yet, there was no clear evidence of a sharp general slowing in activity” – reminding us of the male model who falls off a cliff, and halfway down thinks to himself, “So far, so good”.

In a development that emphasizes just how incredibly trigger-happy currency traders have become, the yen remains almost a full percentage point stronger after Bank of Japan Governor Kuroda said that his institution won’t use “helicopter money” in its fight against deflation. The thing is – the comments were actually made more than a month ago, echo statements he has made for many years, and are directly in line with the government’s long-articulated stance against the idea.

We suspect that expectations for additional quantitative easing have been blown out of all proportion, with market participants making large leveraged bets that Haruhiko will be forced to activate his high-speed printing presses at next week’s meeting. Instead, it seems quite possible that the institution will issue an unnaturally positive forecast and hand the baton to the government, forcing Shinzo Abe to launch a fiscal stimulus programme in the months to come. Either way, the stage is set for further yen volatility in the coming week.

After staging a remarkable comeback over the past six months, it appears that the crude oil market has run out of steam, falling almost ten percent in the last three weeks on a massive inventory build in largely landlocked American storage hubs. With the driving season set to begin winding down over the next month, refinery maintenance poised to take capacity offline, and producers busy hedging output out into the distant future, oversupplied participants are looking at ways to ship the excess out of the US and into global markets. If this gains momentum, the United States will have fundamentally reversed the flow that has dominated the global economy for most of the last century, putting pressure on oil exporters in the Middle East and in countries like Canada.

The loonie is staging a mild reversal, coming off its crude-related monthly nadir earlier this morning when May retail sales beat expectations by a modest margin. This certainly doesn’t come as a shock from our perspective – skyrocketing home prices in most of the country’s major cities are effectively putting Automated Teller Machines in many Canadian households. As long as values are rising and banks are willing to lend against those values, citizens will have money to spend. You’ve doubtless seen a version of this movie before – but this one has more Canadian content.

Have a great weekend, and remember to stay well hydrated – with water, or American beer.

Karl Schamotta

Counterparties:

Suggested reading to accompany your Turkish coffee tomorrow morning:

Bloomberg: McDonald’s Stops Selling Big Mac in Venezuela due to Bread Shortage 

The Economist: The Big Mac Index

Evonomics: The Future of Economics Uses the Science of Real-Life Social Networks

NY Times: Why Land and Homes Actually Tend to Be Disappointing Investments

Pulse: How Britain Stronger In Europe Blew It

Priceonomics: Does Using Airplanes to Put out Forest Fires Actually Work?

Better Dwelling: Chinese Media Is Now Warning Canada’s Housing Crash Will Be Worse Than The US

Bloomberg: China’s Services Boom Risks Premature ‘Deindustrialisation’

Wonkblog: It Takes Way Too Long to Build New Housing in Expensive Cities

Reuters: More Pain Seen for U.S. Crude as Product Glut Adds to Gloom

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