Still Buying On Dips

US stocks had a positive end to the week despite the ongoing uncertainty over a new fiscal stimulus package.  A buy on dips mentality continues to hold on any sell off in equities and risk assets in general.  Although President Trump is now calling for a much larger stimulus, Treasury Secretary Mnuchin has only edged close to Democrats demands for a $2.2 trillion stimulus, by offering $1.8 trillion.  This was subsequently rejected by House speaker Nancy Pelosi.  A deal this side of the election still looks unlikely given the differences between the two sides in not just the size, but also the content of further stimulus.  Either way it’s doubtful this will stop equity markets from moving higher in the interim.

Although markets will continue to keep one eye on the approach of US elections this week – especially on whether President Trump can try to claw back some of the lead that Democratic Presidential contender Joe Biden has built according to recent polls – it is a busy one for events and data, especially in Asia.  Key US data releases include US September CPI inflation (Monday) and retail sales (Fri) while in Australia a speech by the RBA governor (Thu) and employment data (Fri) will be in focus.  In Asia monetary policy decisions by central banks in Indonesia (Tue), Singapore (Wed) and Korea (Wed) will be in focus though no changes in policy are expected from any of them. 

In Singapore, the 6-monthly policy decision by the Monetary Authority of Singapore is unlikely to deliver any major surprises.  Singapore’s monetary policy is carried out via its exchange rate and the MAS is likely to keep the slope, mid-point and width of the Singapore dollar (SGD) nominal effective exchange rate (NEER) band unchanged amid signs of improvement in the economy. Singapore’s government has announced several fiscal stimulus packages (February 18, March 26, April 6, April 21, May 26, August 17) helping to provide much needed support to the economy, with total stimulus estimated to amount to just over SGD 100bn.  Much of the heavy lifting to help support the economic recovery is likely to continue to come from fiscal spending.

In Indonesia, the central bank, Bank Indonesia (BI), has been on hold since July and a similar outcome is expected at its meeting on Tuesday, with the 7-day reverse repo likely to be left unchanged at 4%. However, the risk is skewed towards easing. Since the last meeting the economy has suffered setbacks. Manufacturing confidence deteriorated in Sep, consumer confidence has also slipped while Inflation continues to remain benign. However, BI may want to see signs of greater stability/appreciation in the Indonesia rupiah (IDR) before cutting rates further.

Chinese data including September Trade data and CPI inflation (both on Thursday) will also be scrutinised and will likely add to the growing evidence of economic resilience, that has helped to push China’s currency, the renminbi (CNY) persistently stronger over recent weeks.  Indeed, the CNY and its offshore equivalent CNH, have been the best performing Asian currencies over the last few months.  This is a reflection of the fact that China’s economy is rapidly emerging from the Covid crisis and is likely to be only one of a few countries posting positive growth this year; recent data has revealed both strengthening supply and demand side activity, amid almost full opening up of China’s economy.

US Dollar Sliding, Gold At Record Highs

Risk sentiment has turned south and the US stock rotation out of tech into value has gathered pace, with the Nasdaq ending down for a second straight week.  Gold is turning into a star performer, registering a record high today, while the US dollar continues to lose ground.  Economic activity is slowing, second round virus cases are accelerating in places that had previously flattened the curve, while US- China tensions are heating up.  Attention this week will centre on US fiscal discussions while US-China tensions remain a key focal point.

Reports suggest that Senate Republicans and the US administration have agreed on a $1 trillion coronavirus relief package.  This will be the opening offer in discussions with Democrats (who had passed a $3 trillion package in House in May), with less than a week before unemployment benefits expire.  Whether the $1 trillion on the table will be sufficient to satisfy Democrats is debatable and a figure of around $1.5 trillion looks plausible. Time is running out and pressure to reach a compromise is growing.   Further uncertainty will likely weigh on US markets in the days ahead.

US-China tensions remain a key focus for markets. Worries about a dismantling of the Phase 1 trade deal still looks premature even as China has fallen behind in terms of purchasing US imports.  The closure of the US consulate in Chengdu following the closure of the Chinese consulate in Houston will be seen as a proportionate move, that is unlikely to escalate matters.  Nonetheless, a further escalation is inevitable ahead of US elections in November, with a broad array of US administration officials becoming more aggressive in their rhetoric against China.  As such, further sanctions against Chinese individuals and companies could be on the cards.

The week could prove critical for the US dollar given that it is breaching key technical levels against a host of currencies, with the currency failing to benefit from rising risk aversion recently. While not a game changer the European Union “recovery fund” is perceived as a key step forward for the EU, a factor underpinning the euro.  Key data and events over the week include the Federal Reserve FOMC meeting (Wed), US (Thu) and Eurozone Q2 GDP (Fri) and China purchasing managers indices (PMI) (Fri).  US Q2 earnings remain in focus too.  Before these data releases, today attention turns to the German IFO survey (consensus 89.3) and US durable goods orders (consensus 6.8%).

 

Risk Aversion to remain elevated

It remains a tumultuous time for markets, gripped by a cacophony of concerns ranging from the lack of resolution to the Eurozone debt crisis to the failure to reach agreement on raising the US debt ceiling and associated deficit reduction plans. Mingled among these is the growing evidence that economic growth is turning out weaker than expected. Meanwhile Europe’s crisis appears to be shifting from bad to worse, as reflected in a shift in attention towards the hitherto untouched Italy although Italian concerns have eased lately.

The release of the EU bank stress test results at the end of last week have not helped, with plenty of criticism about their severity and rigour following the failure of only 8 banks out of the 90 tested. Expectations centred on several more banks failing, with much more capital required than the EUR 2.5 billion shortfall revealed in the tests. Answering to this criticism officials note that there has already been a significant amount of capital raised over recent months by banks, but this will be insufficient to stem the growing disbelief over the results.

Attention is still very much focussed on Greece and reaching agreement on a second bailout for the country, with further discussions at the special EU summit on July 21. The contentious issue remains the extent of private sector participation in any debt restructuring. The decision to enhance the flexibility of the EFSF bailout fund to embark on debt buybacks has not helped. Consequently contagion risks to other countries in the Eurozone periphery are at a heightened state. Despite all of this the EUR has shown a degree of resilience, having failed to sustain its recent drop below 1.40 versus USD.

One explanation for the EUR’s ability to avoid a steeper decline is that the situation on the other side of the pond does not look much better. Hints of QE3 in the US and the impasse between Republicans and Democrats on budget deficit cutting measures tied to any increase in the debt ceiling are limiting the USD’s ability to benefit from Europe’s woes. Moreover, more weak data including a drop in the Empire manufacturing survey and a drop in the Michigan consumer sentiment index to a two-year low, have added to the worries about US recovery prospects.

Against this background risk aversion will remain elevated, supporting the likes of the CHF and JPY while the EUR and USD will continue to fight it out for the winner of the ugliest currency contest. Assuming that a deal will eventually be cobbled together to raise the US debt ceiling (albeit with less ambitious deficit cutting measures than initially hoped for) and that the Fed does not embark on QE3, the EUR will emerge as the most ugly currency, but there will be plenty of volatility in the meantime.

Data and events this week include more US Q2 earnings, June housing starts and existing home sales. While housing data are set to increase, the overall shape of the housing market remains very weak. In Europe, July business and investor surveys will be in focus, with a sharp fall in the German ZEW investor confidence survey likely and a further softening in July purchasing managers indices across the eurozone. The German IFO business confidence survey is also likely to decline in July but will still point to healthy growth in the country. In the UK Bank of England MPC minutes will confirm no bias for policy rate changes with a 7-2 vote likely, while June retail sales are likely to bounce back.

US Dollar Facing Battle On US Debt Ceiling

President Obama, the Fed’s Beige Book and a firm reading for US retail sales provided some temporary relief for the beleaguered USD but this soon gave way to renewed pressure. Obama proposed cutting around $4 trillion from the fiscal deficit over the next 12-years, similar in size to Republican plans, but structured differently. Separately the Beige Book relatively upbeat, noting “widespread” economic gains across sectors. Finally, whilst top line retail sales were slightly softer than forecast ex-autos sales were upbeat, with upward revisions to the past month.

President Obama’s deficit reduction plans sets the stage for a fractious political battle regarding the $14.3 trillion debt ceiling. Having averted a government shut down following a late agreement between Republicans and Democrats the USD will have a much bigger challenge to face in the weeks ahead. Obama has stated his support for raising the debt ceiling but if agreement is not reached by around mid May (or July if temporary measures are introduced), the US government may effectively default.

When will the USD lose its funding currency mantle? The approach of the end of quantitative easing (QE2) by end June 2011 (assuming the Fed sticks to the plan) will be a particularly important period for the USD. Assuming that there will be no QE3 much will depend on how proactive the Fed is in reducing the size of its balance sheet. This remains unclear and judging by the variety of comments from Fed officials over recent weeks, there is plenty of debate within the Fed FOMC about the pace of balance sheet reduction.

St Louis Fed President Bullard (non-voter) maintained his hawkish stance by highlighting his preference for reducing the Fed’s balance sheet rather than hiking interest rates as a first step towards policy normalisation. There will be further clues both in terms of Fed thinking as well as inflation pressures.

Fed speakers including Duke, Kocherlakota and Liang, Plosser, Tarullo, Lacker, Baxter and Evans will give further clues. CPI inflation data will also be in focus, with headline inflation likely to be boosted by higher energy prices but core inflation likely to remain well behaved. Despite Bullard’s comments the majority of Fed officials appear to be taking a more cautious stance, suggesting that the USD will remain under pressure for a while yet.

The EUR continues to capitalise on generally weak USD sentiment despite nervousness about the details of Portugal’s bailout program. More worryingly for the EUR is ongoing speculation about Greek debt restructuring, with S&P ratings agency noting that the risk of Greek debt restructuring was almost one in three and the Zeit newspaper reporting that investors could lose around 50-70% in a restructuring. Although plans to restructure have been denied by the Greek government this has not stopped Greek bond yields from skyrocketing.

Shaking Off The Bad News

Markets managed to shake off the initial shock of the SEC’s fraud case against Goldman Sachs following news that the charge was not approved unanimously, but with a 3-2 vote. This was interpreted by some to imply that there was more of a political rather than economic bias behind the charge, with two Democrats voting for and two Republicans voting against and SEC Chairman Schapiro siding with the Democrats.

Stronger than forecast earnings from Citigroup and a bigger than expected 1.4% jump in US March leading indicators also helped to calm market nerves, with US equities closing higher and the VIX volatility index reversing some of its spike higher. Attention is still firmly fixed on earnings and with 121 S&P 500 companies due to release earnings this week including Apple, Goldman Sachs, Johnson & Johnson and Yahoo today.

Nonetheless, it is difficult to see sentiment improve too much against the background of ongoing worries about Greece as reflected in the renewed widening in Greek debt spreads yesterday. Moreover, the negative economic impact of the spread of volcanic ash from Iceland, and potential for more lawsuits related to CDOs from regulators as well as investors, against banks, will continue to act as a drag on market risk appetite.

Earnings have been positive so far into the season and as seen overnight, this is helping to counter market negatives, giving risk appetite some support. In turn, this will give risk currencies some relief but given the gyrations between positive and negative news it is difficult to see most currencies breaking out of recent ranges.

My overall bias is for positive earnings and data to overcome the negatives this week, leaving the likes of the AUD, NZD and CAD as well Asian currencies firmer. The EUR and GBP are likely to remain the weakest links, with both currencies set to retrace lower and EUR/USD finding plenty of sellers above 1.3500.

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