Beware Of Nikkei Impact On SPX
The mighty dollar is losing its luster as it declines for the second day in a row. This time the weakness is not caused by only profit taking although it contributed to the sell-off. The real driver of the pullback is disappointing U.S. data. Following this morning's economic reports, the EUR/USD broke above 1.30 and USD/JPY tested 101. U.S. stock futures gave up their earlier gains and traded lower at the open. While we don't feel that the data was terrible enough to warrant this reaction in currencies and equities, the long dollar / long stock trade is getting crowded and any piece of bad news was enough reason for investors to bail.
Data Dump
First quarter GDP growth was revised down to 2.4% from 2.5% as lower government spending and weaker inventory rebuilding offset stronger personal consumption. U.S. jobless claims also rose to 354K from 344K and continuing claims reached 2.986 million, up from 2.923 million. While they missed expectations, these economic reports don't take the country off the road to recovery. While the economy grew less than expected in the first quarter, consumer consumption saw its biggest gain since the fourth quarter of 2010. Healthy U.S. demand should eventually lead to faster inventory replenishment and stronger underlying growth. Jobless claims increased but the absolute amount of claims filed is still relatively low and consistent with a continued labor market recovery. We feel that in due time, investors will realize that the Fed's plans for tapering asset purchases won't change because of today's economic reports.
It's A Correction
However there is a lot of uncertainty in the equity and currency markets. The Nikkei plunged 5% overnight and while the volatility is contained in Asia for the time being, it is making U.S. investors nervous. Between the volatility in Asian markets and threat of less stimulus from the Federal Reserve it may be difficult for the S&P 500 to make new highs. The following chart shows the correlation between the SPX and NKY. If Japanese stocks continue to fall it could indirectly trigger a top in U.S. markets as uncertainty spreads around the world. For USD/JPY, a top in stocks accompanied by continued selling of foreign bonds leaves 103.74 as the near term top. Further gains would now require additional action by the Bank of Japan.
Kathy Lien, Managing Director of FX Strategy for BK Asset Management.