Weaker China data and Delta Concerns

The same old discussion continues to afflict equity investors as lofty valuations balance against a wall of liquidity.  So far liquidity is winning out as US equity indices are trading around record highs despite a surprise 13.5% plunge in August US consumer confidence released last Friday, which marked one of the largest declines ever in the University of Michigan series. In fact confidence fell to a level even below the COVID low, likely due to Delta variant concerns. 

The confidence data fuelled a bull flattening in US Treasuries and USD sell off.  As reflected in the confidence data, the Delta variant is increasingly threatening recovery and evidence of sharply rising virus cases even in highly vaccinated countries sends a worrying sign of what to expect going forward. 

Geopolitics will be in focus after the Taliban effectively took over Afghanistan after marching into Kabul yesterday.  This will have major repercussions in South Asia and the rest of the region.  Separately, Canada’s PM Trudeau has called a snap election on Sep 20 while Malaysia’s PM Yassin has resigned today.  Geopolitics, weak US confidence data, China’s regulatory crackdown and ongoing Delta variant concerns, with Philippines and Thailand registering record virus cases in Asia led to a cautious start to the week for Asia. 

Further direction came from China’s July data slate released today.  The data revealed weaker than expected outcomes across the board, with industrial production and retail sales alongside other data revealing further softening.  The releases provided more evidence that Chinese consumer caution has intensified in the wake of targeted lockdown measures in several provinces while industrial activity is being hampered by supply constraints and weakening demand for exports.

The Chinese data will likely provide more support to expectations of further easing in liquidity from the central bank (PBOC) and even policy rate cuts. Separately, China’s regulatory crackdown has extended further, weighing on Chinese and regional assets, but there is little sign that officials are looking to step back.   More broadly, weaker Chinese data will likely contribute to a near term tone of risk aversion afflicting global market sentiment amidst worsening Delta variant concerns, rising growth worries and geopolitical risks.

Over the rest of the week Fed FOMC minutes (Wed), in particular views on the shape of quantitative easing tapering, as well as central bank decisions in New Zealand (Wed), Indonesia (Thu) and Norway (Thu) are in focus.  The RBNZ is likely to be the most eventful among these, with a 25bp hike in its policy rate (OCR) expected amid firming data and rising inflation pressures.  Key data this week includes US July retail sales (Tue), with falls in both the headline and control group readings likely as the boost to spending from stimulus and reopening fades. 

Dollar firmer, Euro vulnerable, Yen wary

multitude of market moving events last week led to severe gyrations in risk appetite but with no clear direction for currencies. Indeed, currency markets were whipsawed as the news flow shifted back and forth. Major events such as the European Central Bank (ECB) and US Federal Reserve meetings, and US jobs data provided plenty of volatility points for markets. This week’s US data slate is less littered with first tier data, with trade data and Michigan confidence, the highlights of the week. Against this background the USD will take direction from events in the eurozone and in our view will likely trade with a firmer bias given that eurozone tensions will not ease quickly.

The EUR was relatively resilient despite a referendum (later cancelled) that could have spelled the beginning of the end of Greece’s membership in the eurozone. Nonetheless, the currency still dropped over the week. This week will be no different as markets sift through various pieces of news regarding Greece and the EU rescue plan. Although the Greek Prime Minister survived a confidence vote the EUR will remain vulnerable to a lack of detail about the EU rescue plan including but not limited to how the mechanism for leveraging the EFSF bailout fund. The longer the delay in providing such details the bigger the risk to the EUR. Data releases will be unhelpful for the EUR, with hard data such as German industrial production confirming a slowdown in activity.

Japan’s FX intervention at the beginning of last week has all but been forgotten among the plethora of other market moving news. Expectations that it would be followed up by more intervention proved incorrect as the Japanese authorities refrained from more action. Perhaps the onset of the G20 meeting stayed their hand but markets will be wary of more intervention this week. However, as the strengthening current account data in Japan will likely reveal this week, Japan’s strong external position continues to feed the underlying upward pressure on the JPY for the time being.

Interestingly FX markets appear to be reacting to growth orientated central bank policy rather than yield as reflected in the fact that EUR and GBP both strengthened despite additional quantitative easing from Bank of England at its last meeting and a rate cut from the ECB last week. This week however, inaction from the BoE will provide little direction to GBP while a likely drop in industrial production will raise fears that the economy continues to be in need of more remedial action from the central bank. GBP continues to be favoured but after having made up a lot of ground versus EUR it could lose some steam this week.

Beyond Expectations

Egypt worries continue to reverberate across markets, yet there appears to be growing resilience or at least some perspective being placed on problems there. Encouraging economic data, particularly in the US has helped to shield markets to some extent, with equity market rallying and US bond yields rising last week. The main impact of Egypt and worries about Middle East contagion continues to be felt on oil prices.

Even the mixed US January jobs report has failed to dent market sentiment; the smaller than expected 36k increase in payrolls was largely attributed to severe weather. A further surprising drop in the unemployment rate to 9.0% due mainly to a significant drop in the labor force was also well received by the market.

There will be less market moving releases on tap this week and the data are unlikely to dent recovery hopes. Michigan confidence is set to record an improvement in February whilst the December trade deficit is set to widen to around $41.0 billion. There are also plenty of Federal Reserve speakers this week including a testimony by Chairman Bernanke.

One central bank that has softened its hawkish rhetoric is the European Central Bank (ECB), with President Trichet dampening speculation of an early rate hike last week and alleviating some of the pressure on eurozone interest rate markets. Consequently the EUR fell as the interest rate differential with the USD became somewhat less attractive. The EUR was also undermined by the opposition from some member states to French and German ideas for greater fiscal policy coordination, an aim apparently not shared across euro members.

Data in Europe will be largely second tier. The EUR will look increasingly vulnerable to a further drop this week especially given the increase in net positioning over the past week to (1st February) according to the CFTC IMM data. The potential for position squaring looms large as positioning is now well above the three-month average. Stops are seen just below EUR/USD 1.3540.

In the UK the Bank of England policy meeting will take centre stage but there is unlikely to be any change in policy settings. Clues to policy thinking will be available in the monetary policy committee meeting minutes in two weeks times but it seems unlikely that any more members have joined the two voting for a hike at the last meeting.

Recent data have been a little more encouraging helping to wash off the disappointment of the surprise drop in Q4 GDP. The UK industrial production report is likely to be similarly firm on Thursday, with the annual pace accelerating. GBP/USD may however, struggle to make much headway against the background of a firmer USD and the weigh of long positioning, with GBP/USD 1.6279 seen as strong resistance.

There are plenty of releases in Australia this week to focus including the January employment data, consumer confidence, and a testimony by RBA governor Stevens in front of the House of Representatives on Friday. The data slate started off somewhat poorly this week, with December retail sales coming in softer than expected, up 0.2% MoM. AUD/USD is likely to be another currency that may struggle to sustain gains this week but much will depend on data over coming days. Resistance is seen around 1.0255.

On a final note, the weekend’s sporting events highlight how it’s not just economic data or moves in currencies that don’t always go as expected. After a solid run in the Ashes cricket England slumped to a 6-1 series loss to Australia in the one-day series, putting the Ashes win into distant memory. A similarly solid performance by Man United was dented with their unbeaten record broken by bottom of the table Wolves.

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Risk on mood prevails

The end of the year looks as though it will finish in a firmly risk on mood. Equity volatility in the form of the VIX index at its lowest since July 2007. FX volatility remains relatively low. A lack of market participants and thinning volumes may explain this but perhaps after a tumultuous year, there is a certain degree of lethargy into year end.

Whether 2011 kicks off in similar mood is debatable given the many and varied worries remaining unresolved, not the least of which is the peripheral sovereign debt concerns in the eurozone. It is no surprise that the one currency still under pressure is the EUR and even talk that China offered to buy Portuguese sovereign bonds has done little to arrest its decline.

Reports of officials bids may give some support to EUR/USD just below 1.31 but the various downgrades to ratings and outlooks from ratings agencies over the past week has soured sentiment for the currency. The latest move came from Fitch ratings agency which placed Greece’s major banks on negative ratings watch following the move to place the country’s ratings on review for a possible downgrade.

The USD proved resilient to weaker than forecast data including a smaller than forecast 5.6% gain in existing home sales in November. The FHFA house price index recorded a surprise gain of 0.7% in October, which mitigated some of the damage. The revised estimate of US Q3 GDP revealed a smaller than expected revision higher to 2.6% QoQ annualized from a previous reading of 2.5%. Moreover, the core PCE was very soft at 0.5% QoQ, supporting the view that the Fed has plenty of room to keep policy very accommodative.

Despite the soft core PCE reading Philadelphia Fed President Plosser who will vote on the FOMC next year indicated that if the economy continues to strengthen he will look for the Fed to cut back on completing the $600 billion quantitative easing (QE) program. Although the tax deal passed by Congress will likely reduce the need for QE3, persistently high unemployment and soft core inflation will likely see the full $600 billion program completed. Today marks the heaviest day for US data this week, with attention turning to November durable goods orders, personal income and spending, jobless claims, final reading of Michigan confidence and November new home sales.

Overall the busy US data slate will likely maintain an encouraging pattern, with healthy gains in income and spending, a rebound in new home sales and the final reading of Michigan confidence likely to hold its gains in December. Meanwhile jobless claims are forecast to match the 420k reading last week, which should see the 4-week average around the 425k mark. This will be around the lowest since August 2008, signifying ongoing improvement in payrolls. The data should maintain the upward pressure on US bond yields, which in turn will keep the USD supported.

Please note that this will be the last post on Econometer.org this year. Seasons greatings and best wishes for the new year to all Econometer readers.

All eyes on G20

Although we move from feast to famine this week in terms of data there are still a few events that are noteworthy. In the US the September trade balance (Wed) will be of interest with a narrowing expected. Net exports negatively impacted GDP in Q3 but this is likely to reverse in Q4. Michigan confidence at the end of week is also likely to reveal better news with a rebound expected in October in the wake of firming equities, whilst the October budget statement is likely to reveal a sharp narrowing compared to October last year. Several Fed speakers over the week will be also be in focus as markets try to gauge the level of support within the FOMC for the QE2 announced last week.

There are a few data releases of interest in the eurozone including the preliminary estimate of Q3 GDP. Worryingly the divergence across the eurozone between healthier northern Europe and weaker performing in Southern Europe is becoming increasingly stark, a big headache for the Eurozone Central Bank with its one size fits all policy. Elsewhere, in the UK the Bank of England Quarterly Inflation Report will be scrutinized to determine whether recently firmer data and sticky inflation has pushed the BoE away from following the Fed into QE2. Japan’s volatile machinery orders data marks the highlight of its calendar, with a sharp drop expected in September following two strong months.

The main event of the week is the G20 leaders meeting in Seoul at the tail end of the week. Rhetoric going into the meeting suggests little support for the US plan to limit current account surpluses to 4% of GDP and even US officials appear to have cooled on the idea. Moreover the G20 meeting will probably elicit further reaction to the Fed’s QE2 announcement. Reaction was highly critical initially but seems to have softened lately. Currencies will nonetheless, remain the major topic of discussion although expectations of a global agreement are likely to be disappointed.

The Fed’s QE2 announcement helped provide a prop to risk assets and weighed on the USD last week despite the amount of asset purchases being within expectations. The USD will remain a sell on rallies this week and once again the best way to play USD weakness is likely via the higher yielding commodity currencies, especially AUD and NZD. Scandinavian currencies also offer a good way to capitalize on USD weakness.

The EUR may also struggle this week given worries about peripheral Europe and widening in peripheral bond spreads. Ireland’s budget cuts announced last week have so far failed to shore up confidence whilst political uncertainties are also rising. Greece’s regional elections revealed that the ruling socialist party narrowly retained control allowing the government to continue with reforms suggesting a modicum of support for its debt. Nonetheless, with Irish and Portuguese sovereign worries continuing, the EUR will continue to lag. Notably the CFTC IMM data revealed that speculative EUR sentiment deteriorated in the latest week to its lowest in over a month. EUR/USD is likely to target 1.3864 after dropping swiftly below the 1.4000 level.

Perhaps best way to play EUR vulnerability is versus the AUD, with a further decline through 1.3800 likely to pave the way for a drop below the 13 September low around 1.3660. AUD/JPY may also be another cross worth exploring especially as Japan’s new fund begins buying JGBs today, which could limit JPY upside. A test of AUD/JPY 83.65 is on the cards shortly. If Australia’s October employment report on Thursday reveals another strong reading it will likely give the currency further support into the end of the week.

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