Citi FX Weekly Roundup 06 02 2011 PDF

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Technicals Technical Developments in the Foreign Exchange and Asset Markets

02 June 2011

CitiFX Technicals Portfolio

Tom Fitzpatrick (1-212-723-1344) Shyam Devani (44-207-986-3453) Alex Good (1-212- 723-3469) [email protected]

Weekly Roundup Chart of the Week: Fixed income - “Are we there yet” •

This week we refocus on the directional and curve moves on fixed income (U.S.) and ask the question- Have they run their course or is there more to come.

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Our conclusion is – “No we are not there yet” and we expect these moves to continue in the weeks ahead.

Foreign Exchange •

This week we take another look at USDJPY and suggest that the next significant directional move will be lower given the recent moves and setups in U.S. Fixed Income markets

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There is still a lack of building clocks to support any sustainable uptrend in USDJPY at this stage

Equities •

Possible bearish weekly candles on numerous major U.S. Indices. Watch the weekly closing prices

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Overall we are still of the bias that further weakness in Equities lies ahead.

Commodities •

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Few developments to note of this week. We are still concerned that the LMEX can post further losses and that we may go through a short term correction on in Gold within the overall uptrend

Emerging Markets •

The move up in the ADXY Index over the past week look corrective and another leg down is expected

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Key levels are under threat on the Shanghai Composite Index.

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Supports highlighted last week on other EM Indices have so far held and should be monitored closely.

Market Commentary - for Institutional Client use only. Refer to information, disclosures and qualifications at the end of this publication.

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CitiFX Technicals

02 June 2011

Chart of the Week: Fixed income - “Are we there yet”  

This week we refocus on the directional and curve moves on fixed income (U.S.) and ask the question- Have they run their course or is there more to come. Our conclusion is – “No we are not there yet” and we expect these moves to continue in the weeks ahead.

U.S. 2 year yield- how low can we go?

?

Source: Aspen Graphics / Reuters 02 June 2011

This is the third very well defined double top in as many years in the 2 year yield. So how did the others perform and where might we go now? 1. October-November 2009: Double top was completed that suggested as far as 33 basis points on an absolute basis or 53 basis points on a percentage change basis. (While historically we would have just looked on an absolute basis that becomes problematic when the yield is so low as it could theoretically target a move to negative interest rates. Therefore we think that we should assess the potential on both scales). The low actually posted on 27 November 2009 was actually 61 basis points so the break fell short on both counts. 2. May-June 2010: Double top was completed that suggested as far as 26 basis points on an absolute basis or 44 basis points on a percentage change basis. The low actually posted on 04 November 2010 was actually 32 basis points so the break went to more or less the midpoint of the 2 targets. Without doubt the QE2 guidance from the Fed over the summer helped this move go so far. 3. May 2011: Double top has been completed that suggests as far as 10 basis points on an absolute basis (seems a stretch to be honest) or 22 basis points on a percentage change basis. Both of these levels suggest new lows in the trend. Given the reticence of the Fed at this point to even talk about renewed accommodation (rather they talk about ways of withdrawing the accommodation) anything close to these levels would suggest economic and/or financial market stress. This could be anything from renewed concerns in Europe to a sharp deterioration in U.S. economic data or even an event not yet on the “radar screen” Whatever way you look at it the break on the chart above is not very constructive. In both 2009 and 2010 price action was quite choppy around the break point (50 basis points this time) before we headed lower so do not be surprised (given this low level of yields) if price action is quite volatile around any “headlines” So, bottom line, this chart suggests a minimum target of 22 basis points.

Market Commentary - for Institutional Client use only. Refer to information, disclosures and qualifications at the end of this publication. 2

CitiFX Technicals

02 June 2011

U.S. 5 year yield - Break still suggests lower levels.

Source: Aspen Graphics / Reuters 02 June 2011

The pattern here is again similar to what we saw in 2009 and 2010. In 2009 the break lower seen in November was not actually sustained as yields in general actually bottomed out in November 2009. In 2010 the target of the break was significantly overshot, a dynamic that again can be attributed to the onset of QE2 and the fact that the 5 year period was right in the “sweet spot” for Fed purchases. While the present pattern looks somewhat similar to November 2009 period the momentum of this move lower looks more reminiscent of the 2010 break in May/June of that year. While we hold below the break point at 1.80% the minimum target on this move would be for a fall to 1.25% U.S. 10 year yield- Important supports have given way

Source: Aspen Graphics / Reuters 02 June 2011

Posted a perfect 76.4% pullback and subsequent break lower suggesting further losses (in yield are likely). Some interim support at the channel base (2.94% is possible), but while we hold below the major break area (3.05-3.10%) further downside looks likely overall. Initial supports below here are met at 2.89% and 2.68% and then the October 2010 low at 2.33%

Market Commentary - for Institutional Client use only. Refer to information, disclosures and qualifications at the end of this publication. 3

CitiFX Technicals

02 June 2011

U.S. 30 year yield- Seems to have a very clear target.

Source: Aspen Graphics / Reuters 02 June 2011

Completed a very clear head and shoulders top with the break below 4.36% The target on this break would be for a move to 3.86% U.S. 5 year yield minus U.S. 2 year yield curve - history repeats.

08 April, 2011

08 April, 2010

Source: Aspen Graphics / Reuters 02 June 2011

On 8th April 2011 this chart completed a perfect 76.4% pullback and started to move lower again. This is exactly what happened last year, also on 8th April. How far can we go here? In the chart itself there is no obvious target. Last year it eventually went as low as 70 basis points, but again, that was driven by QE2 and the Fed is heavily resistant at this point to QE3. If we look at our targets on the charts above ( 5 year yield to 1.25% and 2 year yield as low as 22 basis points) that suggests a move towards 1.03% at a minimum looks likely. In reality the scope for 5 year yields to get to, or overshoot its target looks to be higher than for 2 year yields. As a consequence, a break below the 1% level is quite possible here. Below 1% the 76.4% pullback level is met at 90 basis points.

Market Commentary - for Institutional Client use only. Refer to information, disclosures and qualifications at the end of this publication. 4

CitiFX Technicals

02 June 2011

U.S. 30 year yield minus U.S. 10 year yield(weekly)- The Q.E. chart

160 basis points in November 2010

Source: Aspen Graphics / Reuters 02 June 2011

For over a quarter century, this chart struggled to break above the 105-110 basis point area (Just as the 2‟s 5‟s chart failed 3 times at 161 basis points in 1992,2003 and 2010) But last year it broke decisively above that level. What changed? QE2. As the Fed clearly reversed course and signaled the intention to further expand its balance sheet this spread surged. (Again because the 10 year was also in the sweet spot of QE2 while the 30 year was not) As a consequence this spread surged to 160 basis points as much more aggressive buying of the 10 year than the 30 year was seen (Bull steepening).Thereafter, as yields started to rise (Buy the rumour, sell the fact yet again) this curve began to bear flatten. Between Dec 2010 and April 2011 it constantly tried to break back below the 105-110 basis point level to no avail. Initially that bearish flattening was suggesting increasing conviction that o The economy was on a recovery path o QE2 would end on time. However, the failure to break below was suggesting some doubts. Then 2 things happened. Firstly, the Fed did not end QE. Ending QE would be withdrawing accommodation whereas the Fed announced it would continue to invest the proceeds. This is akin to the market expecting a Fed funds rate increase and the fed staying on hold. They did not ease further but they did not tighten either. They also articulated that with regard to QE it was the size of the balance sheet that counted not the continued adding of liquidity. (We will revisit this). Secondly, all of a sudden the economic data started to deteriorate quite significantly. Now when we look at this chart a whole new picture looks to be emerging.

Market Commentary - for Institutional Client use only. Refer to information, disclosures and qualifications at the end of this publication. 5

CitiFX Technicals

02 June 2011

U.S. 30 year yield minus U.S. 10 year yield (Daily)

Source: Aspen Graphics / Reuters 02 June 2011

Having failed to make inroads below the 105-110 basis point area this is now looking very much like a double bottom and is testing good resistance in the 118-121 basis point area. A break above here would suggest a move higher to at least 135-140 basis points in a renewed bull steepening environment. In addition if we get that move and also see the 3.86% target reached on the 30 year yield chart it would suggest U.S. 10 year yields back to 2.41-2.46%-unlikely a good news development (U.S. 30 year yield minus U.S. 10 year yield curve) minus (U.S. 5 year yield minus U.S. 2 year yield curve) - The curve of the curves.

Source: Aspen Graphics / Reuters 02 June 2011

Is breaking higher just as it did in May-June 2010. The present pattern is a very clear inverted head and shoulders that suggests a move, at minimum to + 30 basis points. A move to our minimum 2‟s - 5‟s target (103 basis points) and our minimum 10‟s 30‟s target (135 basis points) would leave this curve at 32 basis points. As we see last year, the ultimate move was far higher than would have been projected as Q.E. 2 was put on the table.

Market Commentary - for Institutional Client use only. Refer to information, disclosures and qualifications at the end of this publication. 6

CitiFX Technicals

02 June 2011

So where does this leave us? The Fed has a dual mandate- Growth/employment and inflation As detailed in our “Techamental charts” recently o Economic growth stands at 1.8% despite over 3 ½ years of monetary easing, an effective zero% interest rate policy for over 2 ½ years, 2 rounds of quantitative easing, huge fiscal stimulus,payroll tax holiday,tax cut extensions etc. GDP - hardly inspiring The tank is empty

Over 3 ½ years of monetary easing, an effective zero% interest rate policy for over 2 ½ years, 2 rounds of quantitative easing, huge fiscal stimulus, payroll tax holiday, tax cut extensions etc.

Source: Aspen Graphics / Bloomberg 02 June 2011

ISM got to a level above 60. Historically, anything more than this has been a “high bar”. By the time this level is reached the economy is normally growing strongly and employment has improved materially leading the Fed to raise rates. This has not happened this time suggesting that cost cutting, inventory growth, global growth etc, have been more responsible for this than domestic demand. ISM - Past its best?

Source: Aspen Graphics / Bloomberg 02 June 2011

Only twice to a level decisively above 60 in last 40 years. (And not since 28 years ago in 1983)

Market Commentary - for Institutional Client use only. Refer to information, disclosures and qualifications at the end of this publication. 7

CitiFX Technicals

02 June 2011

And growth is normally higher when ISM peaks (without the unprecedented stimulus)

Source: Aspen Graphics / Bloomberg 02 June 2011

And the Fed has normally already moved back to a tightening cycle

Source: Aspen Graphics / Bloomberg 02 June 2011

Market Commentary - for Institutional Client use only. Refer to information, disclosures and qualifications at the end of this publication. 8

CitiFX Technicals

02 June 2011

Consumer confidence looks to have peaked in February and is rolling over. If so, it is worth noting that the prior 2 peaks and turns were in Jan 2000 and July 2007 respectively. Within 2 and 3 months respectively the peak in the S&P 500 had been put in. Consumer confidence- Rolling over? IF so………….next to go?

Source: Aspen Graphics / Bloomberg 02 June 2011

Consumer confidence and the S&P 500 Peak in Mar. 2000

Peak in July 2007 Peak in Jan 2000

Peak in May 2011?

Peak in Oct. 2007

Peak in Feb 2011?

Source: Aspen Graphics / Bloomberg 02 June 2011

Market Commentary - for Institutional Client use only. Refer to information, disclosures and qualifications at the end of this publication. 9

CitiFX Technicals

02 June 2011

Unemployment got down from the 10.1% peak in October 2009 to 8.8% in March 2011 and now stands at 9% over 1 ½ years after the peak was reached. Contrast this with the fact that it deteriorated from 4.4% in May 2007 to 10.1% 2 years and 5 months later. Initial claims dipped below 400k to a low of 375k and are rising again. Underemployment stands at 15.9% (Employment adjusted for part-time jobs and those who have left the labour force) Unemployment

Moves from 4.4% to 10.1% in 2 years and 5 months 18 months later and it is only 1.1 percentage points off the high despite unprecedented fiscal and monetary stimulus

Source: Aspen Graphics / Bloomberg 02 June 2011

Initial claims- Perfect 76.4% pullback and rising again

Source: Aspen Graphics / Bloomberg 02 June 2011

Market Commentary - for Institutional Client use only. Refer to information, disclosures and qualifications at the end of this publication. 10

CitiFX Technicals

02 June 2011

Underemployment stands at 15.9%

Source: Aspen Graphics / Bloomberg 02 June 2011

Housing activity remains very firmly wedged close to the lows of the fall with lower interest rates having provided little relief compared to the last cycle. Building permits

Source: Aspen Graphics / Bloomberg 02 June 2011

Market Commentary - for Institutional Client use only. Refer to information, disclosures and qualifications at the end of this publication. 11

CitiFX Technicals

02 June 2011

National association of homebuilder’s index

Source: Aspen Graphics / Bloomberg 02 June 2011

Way below the expansion line (50) and still below the worst levels seen in the 1989-1991 housing fall (20) 30 year fixed rate mortgage- 40 basis points below the 2003 low seen as we hit 1% on Fed funds…BUT

Source: Aspen Graphics / Bloomberg 02 June 2011

In June 2003 housing had been expanding for 12 ½ years and prices were rising In June 2003 there was no credit crisis and the transmission mechanism worked In June 2003 unemployment was 6.3% and underemployment 10.3% As a consequence the housing market became a “piggy bank” and the last hurrah for cheaper and easier credit and capital withdrawal to stimulate spending power. Today we have not had a sharp incremental drop in mortgage rates and credit remains tight, housing activity is on its knees, housing prices have dropped and unemployment is high. In effect we do not have inflation in the one place we need it to devalue the stressed debt levels.

Market Commentary - for Institutional Client use only. Refer to information, disclosures and qualifications at the end of this publication. 12

CitiFX Technicals

02 June 2011

Inflation remains subdued at a core level (although that still gives us negative real interest rates) but is very buoyant at a headline level. Core CPI is 1.3% and rising

Source: Aspen Graphics / Bloomberg 02 June 2011

Core PPI is 2.1% and rising

Source: Aspen Graphics / Bloomberg 02 June 2011

Headline CPI is 3.2% and rising

Source: Aspen Graphics / Bloomberg 02 June 2011

Market Commentary - for Institutional Client use only. Refer to information, disclosures and qualifications at the end of this publication. 13

CitiFX Technicals

02 June 2011

Headline PPI is 6.8% and rising

Source: Aspen Graphics / Bloomberg 02 June 2011

The problem is not that there is no inflation. It is the wrong kind of inflation. We need inflation in housing but have it at the “cost level” and in other assets (Equity markets etc.) Cost push inflation in a slow growth, high unemployment, high debt situation is as corrosive as any type of inflation. Consumers with limited discretionary spending capability and no wage increases can no longer “go to the well” to support spending (increasing debt at cheaper financing while taking equity out of homes). As a consequence this inflation is a “tax”, a “fiscal drag” at a time when there is little scope for further monetary or fiscal stimulus to offset it. It is somewhat disingenuous not to believe that existing monetary policy and fiscal policy in the World‟s largest economy is not a factor here. Existing policies are debasing the World‟s reserve currency and its buying power leading to real things (Commodities) going up in USD terms in price. In addition as developing nations resist the USD depreciation by increasing their USD reserves the problem gets worse. They diversify these reserves which weakens the USD further helping commodities go higher still. This results in higher inflation in these countries which causes a feedback loop where the U.S. is no longer importing disinflation. In addition it makes the developed World take a higher burden of USD depreciation which could lead to increased fears of protectionism down the road. Like it or not the Fed has become the “Central bank of the World “ in a global economy that has become deregulated when it comes to trade and investment. How long can this continue? It is evident from recent feedback from the Fed that some of these concerns are starting to resonate along with their concerns about the size of their balance sheet and the implications of growing it further. This leaves the Fed between a “rock and a hard place” as the next chart emphasizes.

Market Commentary - for Institutional Client use only. Refer to information, disclosures and qualifications at the end of this publication. 14

CitiFX Technicals

02 June 2011

Fed balance sheet overlaid with S&P; Copper; Crude; Asia USD index; AUDUSD; Silver; USDMXN (inverted)

Fed tries to withdraw and asset markets/economic data come under pressure

Source: Aspen Graphics / Bloomberg 02 June 2011

Early each year since 2007 ...