Modest growth in the G3 economies

January 14, 2010 — Mitul Kotecha

A few themes are already becoming evident into 2010. Firstly, the dominance of China and any news on the Chinese economy is becoming increasingly apparent as reflected in the market reaction to trade data and hike in reserve requirements this week. Despite the odd setback the second theme that is developing this year is the “risk on” environment for asset markets. Another theme is the problems and concerns about sovereign debt and ratings, which will likely intensify further.

I could add one more to the list; the underperformance of the Eurozone economy, a theme that is likely to become more apparent as the year progresses. As markets become increasingly bullish about the prospects for China’s economy the opposite is true for the eurozone. Growth over Q4 2009 appears to have lost momentum according to recent data. There is however, expected to be a rebound in November industrial production but this will follow a weak October reading, leaving overall output in Q4 looking lacklustre.

Economic conditions in Japan do not seem to be improving any more quickly, especially in the manufacturing sector as reflected in the surprisingly sharp 11.3% MoM drop in machinery orders in November. Orders have dropped by a whopping 20.5% annually sending a very negative signal for capital spending in the months ahead. Uncertainty over demand conditions has likely restrained capital spending plans whilst the strong JPY has not helped.

The US economy is showing more signs of life but even here the improvements are “modest” as reflected in the Fed’s Beige Book. Consumer spending showed some, limited improvement, whilst manufacturing performance was said to be mixed. In particular, the Beige Book noted that labour market conditions remained soft, with wage pressures subdued. Overall, the report highlighted the likely lack of urgency in a prospective Fed reversal of monetary policy.

In contrast to the modest growth improvements seen in the G3 economies, Australia seems to be powering ahead. Australian jobs data revealed a bigger than expected 35.2k increase in employment and surprise drop in the unemployment rate to 5.5% in December. The only slight negative about the jobs data was that many of the jobs (27.9k) were due to temporary hiring. Nonetheless, the report will give a boost to the AUD aiming for a test of resistance around 0.9326, and solidify expectations for a rate hike next month, when the RBA is set to hike by 25bps.

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China tightens policy

January 13, 2010 — Mitul Kotecha

Risk appetite has soured due to a combination of the rise in China’s reserve requirements, disappointing earnings including Alcoa and a profit warning by Chevron, setting the scene for a day in the red for Asian markets.  The turn in sentiment has hit commodities and commodity currencies particularly hard whilst the JPY has outperformed.  As would be expected against the background of higher risk aversion the US dollar made up some ground.

All eyes are on China and markets will now look to the implications for CNY policy.  Increasingly it seems that data and policy in China is driving global markets and aside from the hike in reserve requirements this was also evident in the fact that stronger trade data over the weekend helped to counter the impact of the soft US December payrolls report.  Further increases in the reserve ratio are likely over coming months followed by actual hikes in interest rates (likely the 1 year rate).  China’s move to tighten policy further over coming months will likely be accompanied by allowing greater appreciation of the CNY too.

The news worsened overnight as the ABC Consumer Confidence index dropped by 6 points to -47, the biggest one-week drop in the last 25 years.  US trade data also came in worse than expected, with the deficit widening to $36.4bn in November.  There is little on the data front today to keep markets occupied today, suggesting that direction will come from equity markets and with more earnings this week including Intel Corp and JPMorgan Chase & Co. there will be plenty to digest.  In the near term the tone of risk aversion is set to continue to dominate but any pull back in risk currencies is likely to prove short-lived.   

There will be more Fed speakers as well as the Fed’s Beige Book today to provide clues ahead of the January 26-27 FOMC meeting.   Aside from noting some improvements in the economy, weak labour market conditions as well as a lack of inflationary pressures will help support expectations that the Fed will hold off from raising interest rates this year.   Fed speakers include Fisher and Plosser both of whom give speeches on the US economy though neither are current voters on the FOMC.   Plosser’s comments so far have highlighted the need for a timely “exit strategy”.

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What to watch this week

January 11, 2010 — Mitul Kotecha

The 85k drop in US non-farm payrolls in December was obviously disappointing given hopes/expectations/rumours of a positive reading over the month.  There was a small silver lining however, as November payrolls were revised to show a positive reading of +4k, the first monthly gain in jobs since December 2007.  Overall, the US labour market is still gradually improving as the trend in jobless claims and other indicators show. 

The fact that the market took the drop in US payrolls in its stride highlights the fact that recovery is becoming more entrenched despite the occasional set back.  More significantly weaker US jobs disappointment has been countered by strong Chinese trade data, which showed both strong imports and exports growth in December.  Whilst the data, especially the strength in exports, will support calls for a stronger CNY, it also highlights China’s growing influence on world trade and the important role that the country is providing for global economic recovery.

Market resilience in the wake of the drop in US payrolls and positive reaction to Chinese trade data will maintain a “risk on” tone to markets this week.  In particular, the USD is set to start the week on the back foot and despite data last week showing that Eurozone unemployment reached an 11-year high of 10% and growing evidence that the Eurozone economy is falling behind the pace of recovery seen elsewhere, EUR/USD held above technical support (200 day moving average) around 1.4257, and is setting its sights on the 16 December 2009 high of 1.4591 helped by renewed Asian sovereign interest.  

The main event in the Eurozone is the ECB meeting on Thursday no surprises are expected, with the Bank set to keep policy unchanged whilst maintaining current liquidity settings.  The bigger concern for European markets is ongoing fiscal woes in the region, with press reports warning of a ratings downgrade for Portugal and still plenty of attention on Greece and its attempts at deficit reduction.  Fiscal concerns are not going to go away quickly and will clearly act as a restraint on market sentiment for European assets. 

In a holiday shortened week in the US as markets close early on Friday ahead of the 3-day MLK holiday, there are a number of data this week that will shed further light on the shape of US recovery. The main event is the December advance retail sales report on Thursday, which is expected to record a reasonable gain, helped by firm autos sales. 

Preceding this, tomorrow there is expected to be a renewed widening in the US trade deficit in November whilst on Wednesday the Fed’s Beige Book as well as various Fed speakers this week including Bullard, Lockhart, Fisher, Plosser, Evans and Lacker, will give important clues ahead of the January 27 Fed FOMC meeting.  Bullard sounded dovish in his comments in Shanghai, as he highlighted that US interest rates will remain low for some time. 

At the end of the week there will be a heavy slate of releases including December CPI, industrial production, capacity utilization, January Empire manufacturing and Michigan confidence. The outlook for these data is generally positive, with gains expected in both manufacturing and consumer confidence, whilst hard data in the form of industrial production is likely to record a healthy increase and CPI is set to reveal another benign reading.

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Gold / FX correlations

December 2, 2009 — Mitul Kotecha

There is no shortage of cash rich investors in Asia even amidst the current troubles in Dubai. Indeed, sentiment in the gemstones market is particularly upbeat, with a rare five-carat pink diamond selling for a record HK$84.24 million in Hong Kong. Perhaps this is a good reflection of abundant liquidity and of course wealth in Asia and in particular China, with talk that mainland Chinese investors were strong participants in the diamond auction.

It’s not just diamonds that are selling for record prices; gold hit a fresh high above $1,200 and once again at least part of this is attributable to the appetite of Asian central banks as well as demand from China as the country tries to increase its gold reserves. The rise in gold prices has coincided with a bullish announcement from the world’s top gold producer that it has completely eliminated its market hedges earlier than forecast due to the positive outlook on prices and waning supply.

The correlation between gold prices and the USD remains very strong at -0.88 over the last 3-months, with firmer gold prices, implying further USD weakness. In fact, the gold / USD correlation has been consistently strong over the past few months and is showing little sign of diminishing.

Over the past 6-months the correlation has been -0.91 and over the past 1-month it was -0.75.  Assuming that anything above 0.70 can be considered statistically significant, the relationship shows that USD weakness has been well correlated with gold strength and that despite talk of a breakdown in the relationship it appears to remain solid. 

As long as the bullish trend in gold continues, the pressure on the USD will remain in place.  Adding to this pressure is the fact that risk is back on for now. Markets took the news of a fall in the ISM manufacturing index and in particular the drop in the employment component in its stride even though it supports the view of a weaker than consensus drop in payrolls in November when it is published on Friday.

There are still plenty of reasons to be cautious in the weeks ahead and although we appear to be back in a “risk on” environment markets are likely to gyrate between “risk on” and “risk off” over coming weeks. At least for now, the USD looks to remain under pressure but if risk aversion creeps back up as I suspect it may then the USD will see a bit more resilience into year end. 

Moreover, central banks globally are reaching the limits of their tolerance of USD weakness and will be tested once again, with EUR/USD back above 1.5000, EUR/CHF moving back below 1.5100 and the USD/JPY set to re-test 85.00 following the relatively benign measures announced by the BoJ in which the Bank did little to stem deflationary pressure or weaken the JPY.

Posted in Asia, central banks, China, Commodities, Currencies, Economics, Economy, FX, US. Tags: , , , , , , , , , , , , , , , , , , , . 2 Comments »

Fed keeps the risk trade party going

November 17, 2009 — Mitul Kotecha

Risk is back on and the liquidity taps are flowing. Fed Chairman Bernanke noted that it is “not obvious” that US asset prices are out of line with underlying values, comments that were echoed by Fed Vice Chairman Kohn, effectively giving the green light to a further run up in risk trades. The last thing the Fed wants to do is ruin a good party and the comments indicate that the surge in equities over recent months will not be hit by a reversal in monetary policy any time soon.  

Aside from comments by Fed officials risk appetite was also boosted by a stronger than forecast rise in US October retail sales, with US markets choosing to ignore the sharp downward revision to the previous month’s sales, the weaker than forecast ex-autos reading and a surprisingly large drop in the Empire manufacturing survey in November.

Fed comments were not just focussed on the economy and equity markets as Bernanke also tried to boost confidence in the beleaguered USD, highlighting that the Fed is “attentive” to developments in the currency.  He added that the Fed will help ensure that the USD is “strong and a source of global financial stability”.  The comments had a brief impact on the USD and may have given it some support but this is likely to prove short lived. 

The reality is that the Fed is probably quite comfortable with a weak USD given the positive impact on the economy and lack of associated inflation pressures and markets are unlikely to take the Fed’s USD comments too seriously unless there is a real threat of the US authorities doing something to arrest the decline in the USD, a threat which has an extremely low probability.

It is perhaps no coincidence that the Fed is attempting to talk up the USD at the same time that US President Obama meets with Chinese officials.  The comments pre-empt a likely push by China for the US not to implement policies that will undermine the value of the USD but comments by Obama appear to be fairly benign, with the President noting that the US welcomes China’s move to a “more market based currency over time”. The relatively soft tone of these comments will further dampen expectations of an imminent revaluation of the CNY.

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