China Stimulus Paying Off

For anyone doubting whether China’s monetary and fiscal stimulus measures are having any impact, the recent slate of March data releases should allay such concerns.  While a soft base early in the year may explain some of the bounce in March there is little doubt that China’s growth engine is beginning to rev again.

China data released today was firmer than expected almost across the board.  Notably industrial production rose 8.5% y/y (consensus 5.9%), retail sales were up 8.7% y/y (consensus 8.4%) and last, but not least, GDP rose 6.4%, slightly above the market (consensus. 6.3%).

This data follows on from last week’s firm monetary aggregates (March new loans, M2, aggregate financing) and manufacturing PMIs, all of which suggest that not only is stimulus beginning to work, but it could be working better than expected.   The turnaround in indicators in March has been particularly stark and has managed to overcome the softness in data in Jan/Feb.

The data is likely to bode well for risk assets generally, giving a further boost to equities, while likely keeping CNH/CNY supported.  Chinese equities are already up around 36% this year (CSI 300) and today’s data provides further fuel.  In contrast, a Chinese asset that may not like the data is bonds, with yields moving higher in the wake of the release.

Indeed with credit growth likely to pick up further this year and nominal GDP declining, China’s credit to GDP ratio is on the up again, and deleveraging is effectively over.  This does not bode well for bonds even with inflows related to bond index inclusion.

For the rest of the world’s economies, it will come as a relief that China’s economy is bottoming out, but it is important to note that China’s stimulus is largely domestically focussed.  The global impact will be far smaller than previous stimulus periods, suggesting that investors outside China shouldn’t get their hopes up.

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Firm China data boosts sentiment

It is turning into a solid start to the week for global equity markets and risk assets in general.  Growth concerns are easing and central banks globally have shelved plans to tighten policy.  Comments over the weekend that finance chiefs and central bank stand ready to “act promptly” to support growth, may also reassure markets. Meanwhile, it appears that the US and China are closing in on a trade deal, with US Treasury Secretary Mnuchin stating that enforcement mechanisms could work “in both directions”, potentially easing disagreement on of the contentious issues between the two countries.

In terms of data and events, US Q1 earnings, US March retail sales and industrial production, will be in focus this week alongside more Chinese growth data, elections in Indonesia and the second phase of elections in India.  In Europe, flash purchasing managers’ indices (PMI) for April will give some indication of whether there is any turnaround in growth prospects.  The news will not be particularly good on this front, but the surveys may at least show signs of stabilisation, albeit at weak levels.

China data at the end of last week was particularly supportive, with March aggregate financing, money supply and new yuan loans all beating expectations.  The data add to other evidence of a bounce back in activity in March, with the official manufacturing purchasing managers index (PMI) moving back into expansion territory.   The data comes off a low base after weakness in January and February, but suggests that Chinese monetary and fiscal stimulus is taking effect, with the economy steering towards a soft landing.

Chinese markets clearly like what they see, with equities maintain their strong year to date rally (The CSI Index is up over 34% year to date) and CNY remaining firm (CNY has been the strongest performing Asian currency versus USD so far this year) though China’s bond market will react less well to signs of growth stabilisation.  Chinese data this week including Q1 GDP, March retail sales and industrial production are set to add further evidence of growth stabilisation, helping to keep the positive market momentum alive.

US data this week

Despite a softer tone to US equity markets at the end of last week market tensions appear to be easing, with news over the weekend of the ousting of Ukraine’s President helping in this respect. Although US equities ended the week slightly lower the overall tone to risk appetite was firm.

The G20 meeting proved to be a non event in terms of immediate market impact although the aim to lift GDP by more than $2 trillion over the next five years appears to be ambitious to say the least. However, at least focus has shifted from austerity to growth in terms of G20 thinking.

Last week’s release of the February Markit US PMI manufacturing survey which revealed a stronger than expected reading helped to allay some concerns afflicting markets over the pace of US growth giving markets reason for optimism. Indeed, in general markets have attributed recent weakness in US economic data to adverse weather conditions rather than a shift in growth trajectory.

Unfortunately this week’s US data releases are unlikely to be particularly helpful in shaking off growth worries. Although February consumer confidence is likely to be unchanged at a relatively high reading (tomorrow) declines in new homes sales (Wednesday) and durable goods orders (Thursday) in January will not bode well while a revision lower to US Q4 GDP (Friday) will highlight a slower pace of growth momentum at the end of last year than previously recorded.

The US data is likely to be bond friendly helping to cap gains in Treasury yields as well as restraining the USD. Nonetheless, the message from a plethora of Fed speakers on tap this week will likely be one of continued willingness to maintain the current pace of tapering, with recent and current weakness in economic data being shaken off as bad weather related.

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Data releases in focus

For a change the markets may actually concentrate on data releases today rather than political events in the eurozone. The October US retail sales report and November Empire manufacturing survey are likely to paint a less negative economic picture of the US. The data will help to dampen expectations of more quantitative easing in the US but we will be able to hear more on the subject from the Fed’s Bullard and Williams in speeches today.

Overnight the Fed’s Fisher poured more cold water on the prospects of further QE by highlighting that the economy is “poised for growth”. While speculative data in the form of the CTFC IMM data shows a drop in USD sentiment to its lowest in several weeks we do not expect this to persist. The USD will likely benefit from the data today and we see the currency retaining a firmer tone over the short term especially as eurozone concerns creep back in.

The vote by German Chancellor Merkel’s party to approve a measure for a troubled country to leave the EUR opens up a can of worms and will hit EUR sentiment. But rather than politics there are several data releases on tap today that will provide some short term influence on the EUR, including Q3 GDP and the November German ZEW survey. FX markets will likely ignore a positive reading for GDP given that the outlook for Q4 is going to be much worse. The forward looking ZEW survey will record a further drop highlighting the risks to Europe’s biggest economy.

T-bill auctions in Spain and Greece may garner even more attention. Following on from yesterday’s Italian debt sale in which the yield on 5-year bond came in higher than the previous auction but with a stronger bid/cover ratio, markets will look for some encouragement from today’s auctions. Even if the auctions go well, on balance, relatively downbeat data releases will play negatively for the EUR.

When viewing the EUR against what is implied by interest rate differentials it is very evident that the currency is much stronger than it should be at least on this measure. Both short term (interest rate futures) and long term (2 year bond) yield differentials between the eurozone and the US reveal that EUR/USD is destined for a fall.

Europe’s yield advantage has narrowed sharply over recent months yet the EUR has not weakened. Some of this has been due to underlying demand for European portfolio assets and official buying of EUR from central banks but the reality is that the EUR is looking increasingly susceptible to a fall. EUR/USD is poised for a drop below the psychologically important level of 1.35, with support seen around 1.3484 (10 November low).

Greece throws a spanner in the works

Having already retraced around 50% of its losses from its high around 4 April to its low on 27 October the USD index is on a firm footing and looks set to extend gains. The USD is benefitting both from the EUR’s woes and receding expectations of more US quantitative easing in the wake of less negative US data releases.

Whether the USD is able to build on its gains will depend on the outcome of the Fed FOMC meeting, accompanying statement and press conference today. While there have been some noises from Fed officials about the prospects of more QE, the Fed is likely to keep policy settings unchanged, leaving the USD on the front foot.

Greece has thrown a spanner in the works by calling a national referendum on the European deal. The fact that this referendum may not take place until January will bring about a prolonged period of uncertainty and further downside risks for the EUR against the USD and on the crosses. As a result of the increased uncertainty from the referendum, growing doubts about various aspects of last week’s agreement as well as hesitation from emerging market investors to buy into any European investment vehicle, peripheral bond spreads blew out further, and the EUR dropped.

The immediate focus will be on emergency talks today between European leaders in Cannes where Greek Prime Minister Papandreou has been summoned at a time when his grip on power appears to be slipping ahead of a government confidence vote on Friday. EUR/USD looks set to slip to support around 1.3525.

The Swiss National Bank’s floor under EUR/CHF has held up well since it was implemented in early September. How well it can be sustained going forward is questionable especially given that risk aversion is intensifying once again. A weaker than forecast reading for the Swiss October manufacturing PMI yesterday falling further below the 50 boom / bust reading to 46.9 highlights the growing economic risks and consequent pressure to prevent the CHF from strengthening further. However, now that Japan has shown its teeth in the form of FX intervention the CHF may find itself once again as the target of safe haven flows.

Technical indicators revealed that GBP was overbought and its correction lower was well overdue. However, GBP looks in better shape than the EUR even in the wake of some mixed UK data yesterday. On a positive note, UK Q3 GDP surprised on the upside in line with our expectations coming in at 0.5% QoQ. However, the forward looking PMI manufacturing index dropped more than expected in October, down to 47.4 suggesting that UK economic momentum is waning quickly.

EUR/GBP looks set to test its 12 September low around 0.8259 but GBP/USD remains vulnerable to a further pull back against a resurgent USD. Overall, GBP’s resilience despite the implementation of more quantitative easing by the Bank of England has been impressive and I expect it to continue to benefit from its semi safe haven status

European agreement at last

Following a drawn out period of discussions European officials have finally agreed on a haircut or debt write off of around 50% of Greek debt versus 21% agreed in July. In addition the EFSF bailout fund will be leveraged up to about EUR 1.4 trillion, with the new EFSF scheduled to be in place next month. The haircut for Greek debt is aimed at ensuring that Greece’s debt to GDP ratio drops to 120% by 2012.

The reaction of markets was initially favourable with EUR/USD breaching 1.40 and risk / high beta currencies bouncing. I doubt that the upward momentum in EUR can be sustained, however, with plenty of questions on the mechanics of the deal, especially about leveraging the EFSF fund, remaining. I suspect that the EUR may have already priced in some of the good news.

Data releases, especially in the US are offering markets more positive news. Following on from firm readings for US durable goods orders and new home sales, today’s US Q3 GDP expected to reveal an acceleration in growth to a 2.5% annual rate, will help to alleviate recession fears to some extent. The USD may benefit if the data reduces expectations of further Fed quantitative easing especially given the recent comments from some Fed officials indicating that the door is open to more QE.

In Japan attention was firmly fixed on the Bank of Japan policy meeting and the prospects for FX intervention to weaken the JPY. In the event the BoJ kept its overnight rate unchanged at 0.1% as expected and expanded its credit program by JPY 5 trillion and asset purchase fund to JPY 20 trillion.

The measures are aimed to easing deflation pressure but the real focus in the FX market is whether there is any attempt to the weaken the JPY. I am currently in Tokyo and here there is plenty of nervousness about possible FX intervention being imminent. Speculation of such intervention will likely help to prevent USD/JPY sustaining a drop below the 75.00 over coming days.

EUR to struggle to extend gains

Once again the USD index failed to break above its 100-day moving average, its third failure to do so over recent weeks. The USD is now trading below its 20- and 50- day moving averages and looks vulnerable to further weakness. However, much will depend on the travails of the EUR and how quickly the boost to this currency fades following last week’s Greek austerity plan approval.

The USD was helped last week by the relative move higher in US bond yields, which saw 2-year yield differentials between the Eurozone and US drop below 100bps for the first time since the beginning of April. Given that the six-month correlation between 2-year bond yield differentials and EUR/USD is at a very high level, it is reasonable to assume that this will remain an important factor driving the currency pair going forward.

The yield differential narrowing seen last week has reversed as German yields have moved sharply higher this week, however. This is in large part attributed to more positive developments in Greece but nonetheless, it has helped to push the EUR higher.

Ratings agencies may yet spoil the party for the EUR, with S&P’s warning that Greece’s debt rollover plans may put the country’s ratings into select default, fuelling some caution. Should ratings agencies downgrade Greek debt to junk it will not only be international investors that will re-think their exposure to the country but the European Central Bank (ECB) could also stop holding Greek debt as collateral for loans although an official from the Bank noted that this would happen only if all the major ratings agencies downgrade Greek debt to default.

Attention is now turning to the implementation risks of austerity measures and asset sales. While Greece’s contribution to eurozone GDP is small, the pain of implanting more budget cuts will push the economy deeper into recession and reveal the stark divergences in growth in the eurozone at a time when the ECB is hiking interest rates.

In reaction to such concerns there is likely to be a series of measures announced over coming days and weeks to boost growth according to Greece’s finance minister. As the S&P comments and implementation/growth concerns suggest, the EUR may struggle to extend gains, especially as the currency is looking increasingly stretched at current levels, with this week’s ECB rate hike largely in the price. Top side resistance for EUR/USD is seen around 1.4598.

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