It is all about the US debt situation at the moment, and we take a look at the growth, debt and unemployment issues in the country in focus.
According to research firm Almanac, since 2000, the Dow has averaged a 0.42% rise in August, making it the sixth best month of the year, with utilities and staples showing clear outperformance. July has averaged a 1.02% advance over the last eleven years, so traditionally this had been a great month to be long equities and the index. However, this year saw the index down 4.2% in July, so the extent to which this quantitative analysis holds true is yet to be seen. Given the extremely bearish outlook on risk assets at present, if the market is fully appeased by the US debt ceiling compromise, August could be a stellar month as traders cover short positions and initiate fresh longs (despite a stalling US recovery).
US growth being called into question
There is simply no positive way to spin last Friday's GDP release in the US. Only last May the consensus was that second-quarter 2011 GDP would be 3.3%. Although this was lowered throughout the year, the final outcome of 1.3% was below expectations and around three times lower than what would traditionally be seen at this stage in a recovery. To make things worse, first-quarter GDP expectations were revised down from 1.9% to 0.4%, and the fourth quarter spiralled from 3.1% to 2.35%! US recovery has stalled, and a best-case scenario would be around 2% growth this year. We have seen the Bush tax cuts extension, an $860 billion fiscal stimulus, cash for clunkers, as well as other measures; to get a 2% read this year would disappoint most economists. The US economy requires at least 2.5% growth just to maintain the current jobs rate, and more than 4% to really put a dent in the 9.2% unemployment rate.
This week is 'jobs week', and all the lead indicators will be announced prior to Friday's non-farms report. All eyes will be on the US ISM manufacturing reading (employment component), ADP private sector jobs data, jobless claims report and services ISM (employment component). As we saw last month, these leading indicators were not a particularly good predictor of non-farms results; however, as it stands the market is looking for 90,000 headline jobs and 115,000 private sector jobs to be created. A better-than-expected read would certainly help risk assets such as equities, commodities (with the exception of gold), AUD/USD, USD/JPY and USD/CHF.
Obama reassures, but markets are still anxious
During early Asian trade on August 1, President Obama notified the world that the framework of a $2.4 trillion debt and deficit deal was done and agreed by the leaders of both chambers of congress. As one would expect, risk assets rallied strongly on the back of the announcement and the sheer relief that the US will likely avoid default. The deal will cut about $1 trillion off the deficit over the next ten years, with a joint bipartisan committee advising how best to trim $1.2 trillion in spending in a second phase of the process, taking the total cuts to around $2.4 trillion
Whilst this is clearly positive, the market needs clarification from the three rating agencies on whether the measures have done enough to avoid a rating downgrade. Some say that a debt downgrade is priced into the USD, equities and even US treasuries. However, as for the timing of when the agencies will show how they stand is anyone's guess, and until we get this clarity upside could be limited.
Potential short-term trading opportunities
If the market gets a sense that the ratings agencies are appeased, participants could look to buy USD/JPY and USD/CHF, which have been hit extremely hard and are both at, or near, all-time lows. AUD/USD should also benefit from the risk appetite, as should base metals and global indices.
If there is a downgrade by one or more agencies, then expect to see further buying of JPY and CHF, with markets seeing further headwinds. There is a real possibility this could materialise, but the bigger story is that we are seeing global austerity playing out now; with a $14.3trillion deficit, does the US really deserve a AAA rating? Austerity is happening in Europe, the UK and now the US. After years of reckless spending, it is time to curb the excess. However, this won't help the global growth story which, as previously mentioned, is struggling to gain traction even with accommodative fiscal and monetary policy.
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Updated: 01/08/2011
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