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Research Note: June 10 Beige Book Outlook
Jacob Oubina, Currency Strategist
Summary Outlook: The Fed's Beige Book report, prepared for the June 24 FOMC meeting and scheduled for release at 1400EDT/1800GMT on Wednesday, June 10th, is likely to highlight a still weak economy with some tentative signs that the worst of the recession is behind us. As in prior Beige Book reports, the overall market response is likely to be muted. However, a much rosier than expected outlook could see risk trades rally in size.
Trading Strategy: The most notable reaction is likely to come in US equities and the commodity complex, with a brighter economic projection potentially eliciting a substantial rally in both. The commensurate FX reaction from this "risk on" trade would be to sell the US dollar. The buck has seen an 88% inverse correlation with oil prices over the last month and a 97% negative correlation with gold. As such, we would look for any rally in the commodity complex to see the greenback take a hit. Further gains in crude oil would likely elicit a rally in EUR/USD towards the 1.42/1.43 zone. Meanwhile, AUD/USD probably retests 0.8130/50 while USD/CAD revisits 1.0900 under this scenario. As such, establishing long EUR/USD, long AUD/USD and short USD/CAD positions ahead of the Beige Book release makes sense in our view. We would establish tight stops to protect against the risk of weaker than anticipated headlines, which would likely nip the risk and commodity rallies in the bud.
Research Analysis: The latest Beige Book will cover economic activity from early April through late May and here is how we expect some of the more important components to have evolved.
Consumer spending remains on shaky ground. The April personal income and spending report suggests the government stimulus is not working out as planned. Despite a government induced 0.5% gain in personal income (nearly 80% of this was transfer payments), spending dropped -0.1% on the month. It seems consumers merely took the handout and socked it away. Indeed, the personal savings rate jumped to 5.7% on the month from 4.5% prior and is at the highest now since early 1995. More recent spending data also look dismal. May chain store sales sank at a -4.6% annual rate after posting a downright ugly -2.7% decline the previous month. If that wasn't enough, the Redbook weekly retail sales report showed a monthly decline of -4.3% through the first week of June as well. The Fed will likely note worries that retail spending is likely to languish as consumers continue to unwind a near two-decade unsustainable credit expansion.
Employment looks to have hit bottom in terms of the pace of job losses and we expect the Fed to say as much. The most important leading indicators (aggregate hours and temporary employment) within the May employment report have clearly carved out a bottom. Meanwhile, the somewhat obscure Challenger employment report released last week showed that the annual rate of announced job cuts fell to the lowest since May 2008 and suggests we could be on our way to a sharp correction in terms of initial jobless claims towards 400,000 by mid-summer - from a current rate well above 600,000. Lastly, The Conference Board's Employment Trends index was released earlier this week and the annual rate jumped to the highest since December. The metric leads the annual growth in nonfarm payrolls by about three months and suggests the bottom of the employment cycle occurred in the first quarter.
The outlook on the credit marts will be a mixed one. Interbank lending has clearly improved and spreads continue to narrow on the corporate front. The TED spread (3-month Treasury/3-month Libor spread) has slipped all the way down to 47 basis points and this is now in line with the two-decade average. Baa corporate spreads are now sitting at 394 basis points and this is a vast retracement from the 622 cycle highs. The Baa spread is still above a normal 220, but the improvement is notable nonetheless. The main credit market concern will be on the mortgage front. Despite the Fed's best efforts, 30-year mortgage rates are nearly 70 basis points above the April lows of 4.85%. Should the recent back-up in the 10-year Treasury note continue (it has surged 185 basis points from the 2.05% December lows) we could be seeing mortgage rates with a six-handle in a matter of weeks.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
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