All posts by Adam Button

Adam Button is a Montreal-based strategist for ashraflaidi.com, former chief currency strategist at XForex and head of markets at CEP News.

What Are Yields Yelling

The bond market flashed warning signals on Friday and we look at what it could mean for FX. Last week, the pound was the top performer while the Canadian dollar lagged badly on  5 consecutive days of declines. The Asia-Pacific calendar is light to start the week.

USD/CAD continued to move higher in early-week trading, hitting 1.0910 from 1.0888 at the open. Otherwise, action has been light as the week gets under way.

Last week ended with US non-farm payrolls casting doubt on the strength of the US economy heading into 2014 and the report sparked some sizeable moves across assets, including a slump in the US dollar. The moves that really stood out were in the bond market as yields tumbled.

Five-year yields fell 13 basis points to 1.62% and 30s fell 8 bps to 3.80%, below the yield when the Fed announced a taper on Dec 16. The magnitude of the declines in yields should not be taken lightly, it’s either a squeeze on of over-ambitious shorts or it’s signaling a flight to quality that could spill over and lead to declines in stocks and USD/JPY.

The market is complacent in the view that economic growth will pick up toward 3% in 2014, businesses will begin to invest and inflation will track higher. That’s a reasonable line of thinking but it hasn’t been confirmed by data and significant risks remain.

Weekend news was mostly inconsequential but there was positive news from Iran where negotiators struck a nuclear deal that lifts restrictions on oil exports. The move could weigh on oil prices, especially Brent.

Commitments of Traders

Speculative net futures trader positions as of the close on Tuesday. Net short denoted by – long by +.
EUR +14K vs +31K prior
JPY -129K vs -135K prior
GBP +18K vs +23K prior
AUD -57K vs -57K prior
CAD -61K vs -58K prior
CHF +5K vs +11K prior

The market has struggled to build any significant positions in euros because of the lack of consistent trend. The move toward neutral came after the break of the 55-dma but Friday’s rebound likely confused traders further.

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The Fed is wrong about the falling unemployment rate

On Nov 1, St Louise Fed President James Bullard lauded the US labor market and said the decline in labor force participation that has improved unemployment is a result of natural demographic changes. That simply isn’t the case.

I wrote about why the Fed is wrong about unemployment in a post in October.

Why the Canadian jobs market is much healthier than the US and why the Fed is wrong

Canadian unemployment is listed at 6.9% while in the US it’s 7.3% but that vastly understates the differences in the health of the relative jobs markets.

First of all, if you go back to pre-crisis times, Canadian employment was around 6% which is something akin to full employment by Canadian standards. Before the crisis in the US, unemployment was at 4.5%. Differences in how the countries measure unemployment, helps to explain the gap.

Skipping ahead to the present, Canada is now 0.9 percentage points away from pre-crisis unemployment levels while the US is 2.6 percentage points off.

Alone that’s an interesting story but it’s not even the kicker. The real story is in the participation rate. In Canada, the pre-crisis average was around 67.4% while in the US it was about 66.1%. Today, the Canadian participation rates has fallen by 1 percentage point while in the US it’s down 2.9 percentage points.

Canadian participation rate chart 2013

It’s been a much steeper fall in the US.

US participation rate chart 10 years

The nail in the coffin is demographics

The Fed has repeatedly pointed to demographics (ie older people retiring) as the reason for US workers exiting the workforce but US and Canadian demographics are very similar. What’s more is that based on demographics you would expect more Canadian workers to be leaving the workforce than the US.

The marginal worker leaving the workforce is 55-65 years old. In the US, the 55-59 year-old cohort is around 10% of the population; in Canada it’s 12%. In the US, 60-64 year olds are 9% of the total while they’re 10% in Canada.

US population pyramid

 

Canadian population pyramid

What does it mean?

A conservative (albeit simplistic) estimate would put Canadian unemployment around 3.8 percentage points healthier than the United States, far more than the 0.4 percentage point difference in official rates.

More importantly for traders, it shows that the Fed is vastly overestimating the health of the US labor market. It suggests that far more workers are leaving the US jobs market for reasons other than retirement/demographics — they’re likely discouraged workers.

What’s more, despite the large differences in employment, Canada doesn’t have any signs of inflation. The Fed may (and probably should) taper due to the financial risks of holding a $3.6 trillion balance sheet but any argument about tapering due to improved employment or inflation risks is a canard.

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Economists only care about one kind of inflation — and it’s not coming

Economists  don’t care about rising prices

If your gas or grocery bill is higher, it doesn’t matter to central bankers. What they dread is a wage-price spiral. That’s a fancy way of saying they don’t care about inflation as long as it doesn’t mean higher wages. If prices rise without corresponding demands for higher wages, it’s a finite move — consumers will eventually have no more money to spend. If wages rise along with prices the cycle can be endless and they need to halt it.

The thing that inflation bugs miss is that wages aren’t rising, in many cases they’re going to other way. MarketWatch profiles American Axle as a symptom of the Michigan manufacturing industry.

Base pay for new hires at Axle in Three Rivers is $10.50 per hour, half the going rate of 10 years ago.

Does that sound like inflation? The story also talks about ‘huge turnout’ at a company job fair for those positions.

Globalized manufacturing has been a tremendous force to keep consumer goods cheap but it’s also leading to major competitive pressures on US wages.

This was originally published at ForexLive on August 20, 2013

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The trend is deflation, not the other thing

The most misunderstood phenomenon in macro economics in the past decade has been deflation

It’s a story that has been missed by almost everyone.

In short: Moving manufacturing and  has allowed companies to reap tremendous profits but consumer prices have been sticky. As a result, a bubble in retail square footage has formed. Over time, it will slowly correct as companies compete for consumer dollars. It’s the great unseen long-term trend in developed economies.

Don’t believe me? Visit a dollar store and marvel at the quantity, quality and complexity of the things you can buy there. In addition, realize that dollar store margins are around 32%, meaning it’s only costing the company 68-cents to get those items on the shelves.

Today’s evidence the trend to lower prices is accelerating: A UK 99-pence store has just cut its prices to 97-pence.

On Thursday, US CPI is expected to fall to 1.3% y/y — the lowest since 2010.

US CPI yy
US CPI yy

This post was originally featured at ForexLive.

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The massive US bubble that no one talks about

My belief that we are in a long-term cycle of disinflation and deflation is one of the things that sets me apart. I have written about this theme frequently and wanted to preserve some of my commentary here. This was originally published Dec 5, 2012 at ForexLive.

The US has a massive oversupply of retail floor space.

Retail square footage per capital globally
Retail square footage per capital globally

The US has 23 sq feet per capita of retail space (but as much as 46.6 sq feet). It’s difficult to come by reliable numbers, but that compares to 14 sq feet in Canada, 6.5 sq feet in Australia, 2.3 sq feet in France and 1.1 sq feet in Italy.

It’s no coincidence that the spike in retail floor space coincided with the rise of cheap imports. The US has embraced globalization more than anywhere else.

The retail pharmacy business perfectly illustrates the change.

A pharmacy used to be a little shop that dispensed prescriptions. They have grown to 20,000 sq foot (1900 sq m) stores where you can get anything.

Conventional wisdom says get people into the store and you can sell them anything but there is more to it. It’s about margins. Cheap Chinese goods have made retail margins incredibly attractive.

Goods that once cost $4 to manufacture and sold for $10 now cost $0.50 to manufacture and still selling for $10. The rise in retail square footage has been all about ripping off consumers who have been slow to adjust.

This is part one of a series. In part two I will talk about how the coming years will be payback time and the enormous ramifications for the economy.

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The change in China that could suffocate the global economy

Note: Since I rarely update this blog, I will be using it to preserve and highlight some of my favourite posts from ForexLive. I’ll start with this one from April 24, 2013:

People in Beijing don’t wake up and check the daily weather forecast; they check the air pollution index so they know what face mask to wear.

China air pollution April 23, 2013

This shocking series of pictures were taken on a ‘clear’ day. The air is described as a noxious soup. Blow your nose and it’s black.

The problem didn’t happen overnight but air pollution indexes are up 30% in 2013, and that’s if you believe the government numbers.

Chinese officials are trying to curb pollution without hurting economic growth but those goals may be incompatible.

Change could come any day. Chinese politicians live in Beijing and their children are breathing the same air and getting sick. An unusual weather pattern could hit Beijing and cause a spike in pollution that sends hundreds of thousands of people to hospitals. That could be the tipping point for radical change and the consequences for the global economy are impossible to predict.

Bloomberg should add Chinese air pollution indexes to their tickers. Today’s readings aren’t high but half the day was still worse than living in an airport smoking lounge.

The prevailing winds from China blow toward the Pacific ocean but occasionally they shift Northward and Japan and Korea are covered by smog, and they’re increasingly unhappy. If a 10,000km ocean buffer didn’t separate California from China, the United States would never tolerate being poisoned by the people taking their jobs.

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10 great trading lessons from Colm O’Shea in Hedge Fund Market Wizards

People are always asking me to recommend books about markets and trading. I have read many and there are many more on my list but for inspiration, readability and insight, few books can match the Market Wizards series by Jack D Schwager.

The latest is Hedge Fund Market Wizards, published on May 29, 2012. I want to talk about the great lessons in the first chapter, which is with macro trader Colm O’Shea. Most of the chapter can be read for free at Google books.

This chapter repeatedly resonated with me because we have a similar trading style and outlook. Let me share some of the best insights.

  1. Policy makers don’t understand that they are not in control. It’s not that speculators are in control, either, but rather that fundamentals actually matter.
  2. If you read the Financial Times, it’s all there. You don’t have to be a brilliant economist, you just have to realize when something matters.
  3. Implementation is the key to everything.
  4. Never underestimate the ability of people to be optimistic and believe that everything is going to be okay.
  5. What is important to the market is not whether growth is good or bad, but whether it’s getting better or worse.
  6. This is what strikes me about really good money managers — they don’t get attached to their ideas…. I recognize the world as I find it and I am flexible enough to change my mind.
  7. He views trades as hypothesis’ on what’s happening in the world
  8. You have to embrace uncertainty and risk
  9. Don’t set stops based on your pain threshold, set them based on the hypothesis. Start by deciding where the market would have to go for me to be wrong.
  10. Perseverance and the emotional resilience to keep coming back are critical because as a trader you get beaten up horribly.

I explored another comment O’Shea made about the madness of current economic thinking in a post at ForexLive.

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Bank of Canada Could Emphasize CAD Sweet Spot

Thursday’s Bank of Canada rate decision will be rightly overshadowed by Greece and the pending US and Canadian jobs reports on Friday but once the short-term smoke clears, the central bank will have outlined the case for a long-term CAD rally.

Economists and the market see no chance of a rate hike on Thursday, leaving the overnight rate at 1.00%, where it has remained since September 2010. The market is also pricing in almost no chance that rates are any different next March than then are right now.

The decision will feature no clear guidance on rate moves in the near future but will offer a clear indication that policymakers have seen improvement. The Bank of Canada forecast 2% growth this year but with European risks minimized and US economic trajectory improving, the consensus is moving higher.

New risks have emerged from Iran and China.

The run-up in the price of oil convinced US leaders that a war with Iran would be too costly at the gas pump. As a result, crude prices are coming down to levels that remain favorable to Canadian energy exports without stifling US spending.

Chinese leaders lowered growth estimates to 7.5% for this year after nearly a decade of sandbagging the market with 8% forecasts. The BOC is unlikely to be swayed by the change because it has also been accompanied by pledges to increase imports and lower import tariffs.

With inflation pressures low, the Bank of Canada has the luxury to wait until at least mid-summer before the market will start asking hard questions about raising rates but Thursday’s decision will be an opportunity to show that hikes are visible on the distant horizon.

Aside from more upbeat commentary, the BOC may change its key language on when the economy is anticipated to return to full capacity, or when the output gap will close. The current forecast is the third quarter of 2013. If that comes down, CAD will rally.

Even if the BOC decision is less-rosy than I anticipate, I see the Greek PSI deal proceeding as expected with the potential for upside surprises in US and (especially) Canadian jobs data. This should underpin continued Canadian dollar strength.

I shared more thoughts on CAD with a Reuters reporter in a story today: http://www.reuters.com/article/2012/03/07/markets-canada-dollar-bonds-idUSL2E8E7G2920120307

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A look at the USD/CAD chart

I have been recommending USD/CAD shorts at ForexLive for the past month based on the break of the wedge from September to mid-January.

The trade worked wonderfully at first, quickly falling from the 1.0150 entry point to below parity.Last Monday, Feb 20, the decline looked like the start of another leg down but the pair has since rebounded 100 pips after falling as low as 0.9907.

Another look at the chart is in order.

d

The pair has been trapped in a 09907 – 1.0052 range for the entire month of February — less than 150 pips. As a trend-following trader, that’s a tough way to make money.

The low coincides with the late-October low of 0.9895 and it will take a close below there to re-establish my utmost confidence in shorts. It’s also a good entry point for someone who is not in this trade.

At the same time, I have to be prudent and protect my profits. I’m putting a stop at the Feb. 16 high of 1.0052, locking in a roughly 100 pip profit.

I’m patient with trades that are in the money, but five-weeks is a long time even if the carry is positive. The run ups in oil and stocks haven’t been the negative shocks I expected for this pair.

The upcoming LTRO is a major event risk and I am expecting major volatility. If I get stopped out here, I will look to establish yen shorts as that is a trade I have been pushing for the past three weeks.

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