US Sentiment Plunges, Nine Fail Stress Tests

An ugly fall in US consumer sentiment may be pointing to storm clouds on the US economic horizon. In Europe, bank stress tests were better than expected. Fridays CFTC report showed a sharp fall in EUR longs.

Market moves were relatively small on Friday. CAD was the top performer and AUD lagged. The S&P 500 gaining 0.6% to close out the week at 1316.

The preliminary reading on consumer sentiment from the U of Michigan fell to a dismal 63.8 from 71.5 (exp 72.5). Its the lowest reading since March of 2009, when the stock market bottomed.

We dont think markets fully appreciated the potential ramifications of such a low number, perhaps due to summer doldrums or its late-week release. This is historically a telltale indicator of consumer spending and the economic outlook. Its also among the best early warning signs of trouble. We arent overly alarmed because its only one number but unless its revised significantly higher and we start to see improvement in August, this is the first evidence of a potential double dip. Whenever the survey has been this low in the past, the US has been in a recession.

Some economists are pointing to worry about the debt ceiling as a cause but to us that sounds far fetched. Dysfunctionality in Washington is rampant and aside from some fringe talk about economic calamity and bounced cheques, we doubt the average American is frightened about not receiving a government cheque. To us, it sounds more like Wall Street economists are trying to find a positive spin because they are loath to downgrade Q3 forecasts (after badly missing on Q2). Goldman Sachs bit the bullet late on Friday cut its estimate to 2.5% from 3.25% and others are likely to follow.

European banks stress test anticipation led to a whirlwind of speculation and rumours but in the end only nine banks failed and 16 narrowly passed. The better-than-expected result spurred a short-covering rally in EUR/USD but the pair closed the day virtually unchanged.

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Other economic indicators were mixed. Industrial production climbed 0.2% compared to the 0.3% expected; core CPI fell 0.2% compared to -0.1% expected and the Empire Fed index hit -3.8 compared to the +4.2 expected.

As Kyle mentioned earlier, a shocker came out of Australia as Westpac Bank forecast the RBA will cut rates in December by 25 bps and introduce 100 bps of cuts by the end of next year. We have warned about risks to the Australian economy but this goes way beyond what we or the market is pricing in and would imply deep fall in AUD/USD (~10 cents).

Fridays CFTC commitment of traders report showed EUR longs cut to 12K from 43K but otherwise, most traders were opening positions against the USD. Yen positioning nearly doubled to 28K from 15K. Canadian dollar longs jumped to 15K from 7K. Longs in AUD, NZD and CHF also edged higher. The pound remains the only currency held net short against USD but it improved to -24K from -31K.