Fiscal Deadlock/China data

This week kicked off with a heavy China’s Sep data slate and Q3 GDP today.  The data releases were positive, revealing yet more signs of strengthening recovery. Industrial production, retail sales, jobs and property investment all beat expectations while Q3 GDP fell short. The data supports the view that China will be one of the only major economies to record positive growth this year. This bodes well for China’s markets and will likely also filter into improving prospects for the rest of Asia.

In contrast US recovery continues to be at risk, with fiscal stimulus discussions remaining deadlocked; a 75-minute conversation between House Speaker Pelosi and Treasury Secretary Mnuchin yielded no progress at the end of last week.  Pelosi has now given a 48-hour deadline to agree on stimulus while Senate majority leader McConnell has scheduled a Senate vote on a more targeted $500bn bill tomorrow. Talks are scheduled to continue today but there still seems to be little chance of a deal this side of elections. 

On the data front, US Sep retail sales data registered broad-based gains on Friday, with headline sales up 1.9% m/m (consensus 0.8%). In contrast, industrial production fell a sharp 0.6% m/m in Sep (consensus +0.5%).  Lastly, Michigan consumer sentiment rose in the preliminary Oct report to 81.2 from 80.4 in Sep (consensus 80.5).  The lack of a fiscal deal means that the prospects of a loss of momentum in the US economy has grown, something that will become more apparent in the weeks ahead. US data is limited this week and instead focus will remain on progress or lack thereof, on fiscal stimulus as well as the Presidential debate towards the end of the week. 

Another saga that is showing little progress is EU/UK Brexit transition talks.  The stakes have risen, with UK PM Johnson warning UK businesses to prepare for a hard exit while threatening to abandon talks completely.  On a more positive note UK officials are reportedly prepared to rewrite the contentious Internal Market Bill, which may appease the EU.  Credit ratings agencies are running out patience however, with Moody’s downgrading the UK ratings by one notch to Aa3. The pound seems to be taking all of this in it stride, clinging to the 1.30 level against the US dollar, suggesting that FX markets are not yet panicking about the prospects of a no deal transition.

Several emerging markets central banks are in focus this week including in China (Tue), Hungary (Tue), Turkey (Thu), and Russia (Fri).  Of these Turkey is expected to hike by 150 basis points, but the rest are likely to stand pat.  Most central banks are taking a wait and see approach, especially ahead of US elections. Reserve Bank of Australia meeting minutes tomorrow will garner attention too, with clues sought on a potential rate cut next month.  


Quantitative easing and the USD

US earnings are coming in ahead of expectations, with Q2 income at the 42 S&P 500 companies reporting so far beating estimates by 11% whilst revenues are 3.3% ahead of forecasts, according to Bloomberg. The overall tone to equities looks positive helped by expectations of an agreement by BP to sell some of its assets and strong earnings reported by Apple after the close of US trade.

Market sentiment was also boosted by speculation that the Fed will embark on fresh monetary stimulus measures. Although there has been no indication that Fed Chairman Bernanke will announce such measures at his semi-annual testimony to the Senate today and to the House tomorrow, speculation of Fed action is rife and there is likely to be some questioning of Bernanke on the issue in the Q&A. If in any way quantitative easing is hinted at by Bernanke, it will act to undermine the USD.

US economic data is helping to compound expectations of further quantitative easing, with yet another weaker than forecast release in the form of a 5.0% drop in June housing starts as hinted at by the bigger than expected drop in homebuilders confidence on the previous day. Separately ABC consumer confidence declined more than expected in the week to July 18, its third consecutive weekly decline, supporting the evidence that consumer confidence is deteriorating once again.

In the absence of major data releases Bernanke’s testimony will be the main driver for markets but earnings from Coca-Cola and Morgan Stanley will also be of interest. Elsewhere the minutes of the Bank of England’s July MPC meeting will be under scrutiny. MPC member Sentance is expected to have voted for a rate hike at the meeting, but any sign that other members joined him, will give GBP a lift. Sentiment for European assets continues to improve, with Greece concluding a well received T-bill auction and Ireland auctioning EUR 1.5bn in 6 and 10-year bonds. Both were heavily oversubscribed although concerns over Hungary continue to linger.

There continue to be various leaks about the European bank stress tests. Banks are expected to detail three scenarios in the results including estimated Tier 1 capital ratios under a benchmark for 2011, an adverse scenario and finally, a “sovereign shock”, according to a document from the Committee of European banking Supervisors. Importantly and perhaps a factor that could hit the credibility of the tests, the sovereign shock scenario is said to not include a scenario of default on sovereign debt.

I continue to see downside risk for the EUR in the wake of the test results, with a “buy on rumour, sell on fact” reaction likely. EUR/USD is vulnerable to a short-term drop to technical support around 1.2763 but much depends on Bernanke’s speech today. Leaks, suggest that around 10-20 banks could fail the bank stress tests, with a total funding requirement in the region of EUR 70-90 billion. Confirmation will have to wait for the official release on Friday ahead of which most currencies are likely to remain range-bound.

Euro Has That Sinking Feeling

The reaction to the US May jobs report shows that markets are particularly susceptible to negative US news at a time when growth fragilities in Europe are becoming increasingly apparent. Coupled with worries about Hungary, risk aversion has jumped.

Unsurprisingly the EUR took the brunt of pressure. Rhetoric over the weekend may help to assuage some fears but I suspect it is too late now that the cat is out of the bag. Hungary’s government maintained that it will meet this year’s budget deficit target of 3.8% of GDP. European Union officials also attempted to calm market concerns, downplaying any comparison of Hungary to Greece.

The overall EUR/USD downtrend remains intact. Renewed doubts about German participation in the EU/IMF rescue package, with the German constitutional court potentially blocking its contribution, will add to pressure as well as a UK press report titled EUR ‘will be dead in five years’ . The January 1999 EUR/USD introduction level around 1.1830 has now moved squarely into sight.

It is unlikely that data and events this week will do much to reverse the market’s bearish tone. Highlights include the ECB, BoE and RBNZ meetings in Europe, UK and New Zealand, respectively. The ECB (Thursday) is highly unlikely to shift its monetary policy stance. Given some opposition to bond purchases from within the ECB council the comments in the accompanying statement will be closely monitored. The BoE will also leave policy unchanged on the same day but the RBNZ is set to begin its hiking cycle with a 25bps move.

On the data front the US slate includes the Fed’s Beige Book, April trade data, May retail sales and June Michigan confidence. The Beige Book is likely to reveal some improvement in activity with little sign of inflation, whilst the trade deficit is set to widen further due to a higher oil import bill. Retail sales will reveal an autos led increase in the headline reading but more subdued core sales, whilst consumer confidence is set to rise for a second straight month.

There will be more attention on rhetoric from EU officials rather than eurozone data, with the Eurogroup of Finance Minister’s and Ecofin meetings garnering more interest. In Japan, politics will take centre stage, with the new cabinet line up in focus following the confirmation of Naoto Kan as Prime Minister. Comments by the new PM himself will be of interest, especially with regard to combating deflation and in particular any elaboration on his penchant for a weaker JPY.

All-in-all, the week is unlikely to see a let up in pressure on risk trades and will start much as the last week ended. Although the market’s attention is on the EUR, it should be noted that the AUD has lost even more ground so far this month although the EUR remains the biggest loser in terms of major currencies so far this year (vs USD). In the case of the AUD the move reflects a massive unwinding of long positioning (as reflected in the latest CFTC IMM data which shows that speculative AUD positioning has dropped to its lowest since March 2009).

In contrast in the case of the EUR where positioning is already very negative, the move simply reflects deteriorating fundamentals. The fact that European officials are showing little concern about the decline in the EUR (why should they given that the currency is now trading around fair value) and in some cases encouraging it, suggests that there is little to stop EUR/USD from dropping much further and parity is looming a lot closer.

What A Disappointment!

Ok so after talking up US data releases over recent weeks the big one namely the May jobs report, came as a disappointment. To recap, payrolls rose 431k, which was less than market consensus. Hiring due to the census which by its nature will be transitory was however, in line with expectations, at 411k, leaving ex-census hiring at a measly +20k.

Believe it or not, the trend in payrolls is one of improvement but the May outcome came as a blow to a market with bullish expectations, especially following earlier comments from the US administration hinting at a robust outcome. The disappointment was compounded by talk of a +700k payrolls outcome, which proved widely off the mark. The unemployment rate did drop more than expected, by two ticks to 9.7%, but this was due to disaffected workers dropping out of the labor force rather than an inherent pick up in job conditions.

Combined with worries about a new target in the sovereign debt crisis in Europe, this time Hungary, markets quickly tanked and risk aversion jumped. So much for relative stability! The concerns were sparked by Hungarian officials themselves, with a spokesman for the Prime Minister warning about the fiscal mess inherited from the previous government. The real blow came when the spokesman compared Hungary to Greece and reportedly said that talk of a default was “not an exaggeration”.

Suffice to say, markets are set up for tense and nervous week in which risk trades are set to suffer further. EUR/USD once again proved to be the weak link dropping below the psychologically important level of 1.20 and the EUR introduction rate around 1.1830 has moved sharply into focus.

AUD and NZD outperformance

Just as the euro looked as though it was showing some signs of rebounding following the battering it received in the wake of the downgrade of Greece’s credit ratings, S&P placed Spain on credit watch negative from neutral, which helped drag EUR/USD all the way down again. Expect more to come as sovereign risk concerns / fiscal deficit remain in focus. EUR/USD was helped by the usual sovereign demand, preventing a test of technical support around 1.4625 but another push lower is likely over the short term.

Despite a tough budget from Ireland yesterday, it alongside the likes of Latvia, Ireland, Hungary and Portugal will remain on the ratings agencies’ hit lists. Eurozone periphery bond spreads have widened sharply against bunds but even larger countries in Europe such as Italy have seen an increase in funding costs. Added to these concerns are the lingering uncertainties about Dubai as reflected in the continued rise in CDS.

In contrast, growth worries are receding quickly in Australia where another robust jobs report was released. Employment rose 31.2k in November, with an upward revision to the previous month, to 27.2k from 24.5k initially. The details looked good too, with much of the jobs increase coming from full time hires (30.8k). The jobless rate fell to 5.7% compared to 5.8% in October. Taken together with the hawkish slant to the RBNZ statement, the data will help keep the AUD and NZD resilient to any sell off in risk trades.

The decision by the RBNZ to leave interest rates unchanged at 2.5% came as no surprise. However, Governor Bollard did shift away from the earlier pledge not to hike interest rates until H2 10 and stated that a hike could come around the middle of 2010. The RBNZ also upgraded its growth forecasts. A rate hike could come even earlier in my view, a factor likely to keep the NZD well supported.

Markets will digest more interest rate decisions today, in the UK and Switzerland. No change is likely from both the BoE and SNB but the issue of QE will remain at the forefront, especially given the split decision by the BoE MPC at the last meeting. As for the SNB the usual concerns about CHF strength are likely to be expressed but the tone of the SNB’s comments are likely to remain dovish, expressing little urgency to begin implementing an exit strategy.

The US data slate is light but does include weekly jobless claims and October trade data. There will be more interest than usual on the claims data given the surprise in last week’s payrolls report. Claims have been on an improving trend declining at a more rapid pace than previous recessions and markets will eye the numbers to determine whether they point to further improvement in payrolls or whether they suggest the November data was merely an aberration.

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