Bonds Under Pressure, UK Parliament Rejects Election Again

Market sentiment remains positive as hopes of a US-China trade deal continue to provide a floor under risk sentiment amid hopes that the escalation in tariffs can be reversed.  Weak Chinese trade data over the weekend has largely been ignored and instead markets have focused on further stimulus unleashed by China in the wake of the cut in its banks’ reserve ratios, which freed up around USD 126bn in liquidity to help shore up growth.  Expectations that the European Central Bank (ECB) will this week provide another monetary boost by lowering its deposit rates and embarking on a fresh wave of quantitative easing, are also helping to support risk sentiment though a lot is already in the price in terms of ECB expectations.

One of the casualties of the turn in sentiment has been bonds, with yields rising in G10 bond markets.  For example US 10 year yields have risen by around 18 basis points since their low a week ago.   The US dollar has also come under pressure, losing ground in particular to emerging market currencies over the past week.  Safe haven currencies such as the Japanese yen (JPY) and Swiss franc (CHF) have fared even worse.   As I noted last week I think the bounce in risk appetite will be short-lived, but how long is short?  Clearly markets anticipate positive developments in US-China trade talks, and it seems unlikely that risk appetite will deteriorate ahead of talks, at least until there is some clarity on the discussions.  Of course a tweet here or there could derail markets, but that is hard to predict.

Sterling (GBP) has been another currency that has benefited from USD weakness, but also from growing expectations that the UK will not crash out of the EU without a deal.  Developments overnight have done little to provide much clarity, however.  UK Prime Minister Boris Johnson failed in his bid for an early election on October 15, with MPs voting 293 in favour of an election against 46 opposed;  Johnson required two-thirds or 434 MPs to support the motion.  Johnson is now effectively a hostage in his own government unable to hold an election and legally unable to leave without a deal.  Parliament has been suspended until October 14, with Johnson stating that he will not delay Brexit any further, reiterating that he is prepared to leave the EU without an agreement if necessary.

This would effectively ignore legislation passed into law earlier blocking a no-deal Brexit forcing the PM to seek a delay until 31 Jan 2020. Separately parliament passed a motion by 311 to 302 to compel Downing Street to release various documents related to no-deal Brexit planning, but officials are so far resisting their release.  A lack of progress in talks with Irish PM Varadkar in Dublin on Monday highlights the challenges ahead.  GBP has rallied following firmer than expected Gross Domestic Product data (GDP) yesterday and growing hopes that the UK will be prevented from crashing out of the EU at the end of October, but could the currency could be derailed if there is still no progress towards a deal as the deadline approaches.


Currency frictions

I would like to apologise for the lack of posts over the last couple of weeks. I have been on a client roadshow presenting our macro and markets outlook for 2013 to clients across Asia. Having returned the mood of the markets is clearly bullish as risk assets rally globally. Recovery hopes are intensifying as tail risk is diminishing while central banks continue to keep their monetary levers fully open.

A heavy slate of US data releases this week will keep markets busy but overall I see little to dent the positive tone to risk assets over coming sessions. The main events this week include the US January jobs report (forecast +160k) and Fed FOMC meeting (no change likely) while consumer and manufacturing confidence, Q4 GDP and December durable goods orders are also on tap.

In the Eurozone attention will focus less on data but more on Eurozone banks’ balance sheets, with further capital inflows likely to be revealed, marking another positive development following last week’s strong payback of LTRO funds. Elsewhere, industrial production in Japan is likely to reveal a healthy gain while an interest rate decision in New Zealand (no change likely) will prove to be a non event.

As fiscal and monetary stimulus measures are largely becoming exhausted or at least delivering diminishing returns the next policy push appears to be coming from the currency front. The issue of ‘currency war’ is once again doing the rounds in the wake of Japan’s more aggressive stance on the JPY leading to growing friction in currency markets.

In contrast the easing of Eurozone peripheral strains have boosted the EUR, in turn resulting in a sharp and politically sensitive move higher in EUR/JPY. Central banks globally are once again resisting unwanted gains in their currencies, a particular problem in emerging markets as yield and risk searching capital flows pick up. Expect the friction over currencies to gather more steam over the coming weeks and months.

In the near term likely positive news in the form of large capital inflows into Eurozone peripheral banks and sovereign bond markets will keep the EUR buoyed. The USD in contrast will be restrained as US politicians engage in battle over the looming budget debate and spending cuts despite the move to extend the debt ceiling until May.

GBP has slid further and was not helped by the bigger than expected drop in Q4 GDP revealed last week which in turn suggests growing prospects of a ‘triple dip’ recession. The lack of room on the fiscal front implies prospects for more aggressive Bank of England monetary policy especially under the helm of a new governor and in turn even greater GBP weakness.

Euro gives up its gains, GBP tracks lower

Although attention may briefly turn to the Fed FOMC outcome tomorrow the lack of progress to resolve’s Europe’s crisis threatens to inflict much more severe damage onto global markets. Against this background the European summit at the end of the week will be particularly important but the scope for disappointment remains high.

As with news of Spain’s banking bailout the positive EUR reaction to the Greek elections has faded even more quickly than I anticipated. EUR/USD’s inability to build on gains above 1.2700 despite extreme short market positioning, highlights the lack of confidence in resolving the crisis. EUR/USD appears to be increasingly following the moves in peripheral bond spreads and the news here is not good either especially in Spain, with spreads continuing to widen out.

The G20 communiqué offered no support to the EUR, with little by way of concrete measures while Germany continues to stick to its stance of no renegotiation of Greece’s bailout terms. The EU finance ministers summit in a couple of days time may provide some relief but only if concrete measures are outlined. In the meantime EUR/USD will continue to remain under pressure. As noted yesterday, I look for a test of EUR/USD 1.2515 which could happen as early as today.

Considering that the prospects of a further round of Bank Of England quantitative easing has grown as hinted at by BoE Governor King, GBP has shown some resilience. Indeed, it is not clear that GBP will weaken if and when the BoE expands its balance sheet again. My analysis reveals that the reaction of GBP has been mixed both to the announcement and implementation of asset purchases.

Inflation data will provide some clues to the room for further monetary stimulus while the minutes of the last MPC meeting two weeks ago will provide some inkling of the support within the Committee for fresh QE. CPI is likely edge higher but this will be due to seasonal factors, while the minutes will likely reveal two dissenters.

GBP meanwhile, will continue to track the EUR with the currency pair trading in a 0.80-0.81 range. EUR’s drop overnight has taken the wind out of GBP’s sails, but strong technical support will be found around GBP/USD 1.5601.

Euro on the front foot

The G20 meeting of leaders in Mexico over the weekend did not make much progress in terms of increasing the size of the International Monetary Fund (IMF) or increasing support for the Eurozone. A decision on this has been delayed until the next meeting on 19-20 April. Instead attention has turned to the various bailout votes across Eurozone countries and discussions over increasing the firewall (by boosting the size of the bailout fund) around the Eurozone periphery. Germany continues to oppose any increase in the firewall. Sentiment will hinge this week on the outcome of these events rather than data releases.

The USD has come under growing pressure but this is as reflection of a stronger EUR rather than inherent USD weakness. Data releases in the US have continued on a positive track yet the USD has failed to benefit as higher US bond yields have been matched elsewhere. Business and consumer confidence measures over coming days are also likely to reveal some encouraging outcomes while the Beige Book will report improvement in economic activity but the USD will continue to be restrained.

The EUR is looking increasingly stretched from a fundamental perspective yet technical indicators show it to be on a stronger footing. EUR/USD will find strong resistance around the 1.3550 level and the currency could still stumble over coming days depending on the outcome of Wednesday’s ECB Longer term refinancinf operation (LTRO).

Various policy events will also help dictate EUR direction including national parliamentary votes on the Greek bailout and the EU Summit. Theoretically a large uptake by banks at the LTRO could result in more EUR liquidity and a weaker EUR but the reality is quite different. Improved sentiment in peripheral bond markets as LTRO funds are used to buy local debt are helping the EUR to push higher, with its short covering rally gaining more traction.

GPB has come under pressure in the wake of a stronger EUR, but we still expect EUR/GBP’s charge to falter. My quantitative models show that the currency pair is overbought and we will likely struggle to break above 0.85. If it does, EUR/GBP 0.8562 will prove to be a strong resistance level. UK data this week will likely give some support to GBP, with the manufacturing purchasing managers index (PMI) set to strengthen further. However, the release of a relatively dovish set of Bank of England (BoE) Monetary Policy Committee (MPC) minutes has helped to undermine GBP for the time being, meaning that any recovery will be limited in the near term.

Q1 Economic Review: Elections, Recovery and Underemployment

I was recently interview by Sital Ruparelia for his website dedicated to “Career & Talent Management Solutions“, on my views on Q1 Economic Review: Elections, Recovery and Underemployment.

Sital is a regular guest on BBC Radio offering career advice and job search tips to listeners. Being a regular contributor and specialist for several leading on line resources including eFinancial Careers and Career Hub (voted number 1 blog by ‘HR World’), Sital’s career advice has also been featured in BusinessWeek online.

As you’ll see from the transcript of the interview below, I’m still cautiously optimistic about the prospects for 2010 and predicts a slow drawn out recovery with plenty of hiccups along the way.

Sital: Mitul, when we spoke in December to look at your predictions for 2010, you were cautiously optimistic about economic recovery in 2010. What’s your take on things after the first quarter?

Click here to read the rest…

Greek Saga Rumbles On – Does Anybody Care?

The debate over Greece continues to rumble on. France and Spain requested a separate summit meeting of the 16 heads of eurozone countries immediately before the full 27-member EU summit starting tomorrow but this was met with resistance. Meanwhile, Germany has called for “a substantial contribution” from the IMF towards a Greek aid package, whilst maintaining that no EU deal will be reached for Greece at the summit.

Frankly, the whole Greek saga has become extremely boring, with the lack of agreement about how to fix it doing little to inspire confidence. In particular the fractured opinion amongst EU leaders highlights the difficulties in reaching an agreement in a union made up of so many conflicting interests. At most the summit may agree on the conditions for a rescue package for Greece rather than a package itself. This will leave markets unimpressed,

US new home sales data today is likely to paint a slightly better picture with a small gain expected, albeit following the 11.2% plunge in the previous month. Sales will be helped by the extension of the home buyer tax credit. The US February durable goods orders report is also released today, with a small increase expected. A smaller gain in transport orders suggests that the 2.6% jump last month will not be repeated.

In Europe, the key release is the March German IFO business climate survey and a rebound is likely following February’s decline, helped by warmer weather and a weaker EUR. Flash readings of Eurozone March purchasing managers indices (PMIs) are also released but these are unlikely to extend gains from the previous month. Despite expectations of firmer data the EUR/USD is vulnerable to a further decline, with support around 1.3432 in sight for an imminent test.

Attention in the UK will turn to the pre-election Budget and particularly the government’s plans to cut spending and reduce the fiscal deficit. Failure to provide a credible blue print to restore fiscal credibility will damage confidence, heightening the risks of an eventual sovereign ratings downgrade and more pressure on GBP which appears destined for another drop below 1.50 versus USD.

Most currencies have remained within ranges and the most interesting currency pair is EUR/CHF having failed to react to verbal warnings from the Swiss National Bank (SNB) about excessive CHF strength. EUR/CHF looks vulnerable to a further decline unless the SNB follows up rhetoric with action. Even if there is FX intervention by the SNB it may prove to be a temporary barrier to a market with an eye on the psychologically important 1.4000 level.

Despite the pressure on the Japanese government and Bank of Japan (BoJ) to engineer a weaker JPY, export performance has proven resilient, with exports jumping 45.3% on the year in February, helped by the strength of demand from Asia. Unfortunately this is doing little to end Japan’s deflation problem and even if there is less urgency for a weaker JPY to boost exports, JPY weakness will certainly help to reduce deflationary pressures in the economy. USD/JPY is stubbornly clinging to the 90.00 level, with little inclination to move in either direction.

Fed discount rate move boosts dollar

The Fed’s move to hike the discount rate by 25bps has set the cat amongst the pigeons.   Although the move was signalled in the FOMC minutes yesterday a hike in the discount rate was not expected to happen so soon.  The Fed sees the modifications which also include reducing the typical maximum maturity for primary credit loans to overnight, as technical adjustments, rather than a signal of any change in monetary policy. 

Nonetheless, the market reaction has been sharp, with the USD strengthening across the board and short term interest rate and stock futures falling.  Although the reaction looks overdone and will likely be followed by some consolidation over the short term, the move will be interpreted as the beginning of a move towards monetary policy normalisation despite the Fed’s insistence that this is not the case.  The firm USD tone is set to remain in place for now but the bulk of the strengthening has likely already occurred following the announcement.  

The Fed’s desire to reduce the size of its burgeoning balance sheet, which at $2.3 trillion is roughly around three times its size before the financial crisis began, will imply further measures to reduce USD liquidity over the coming months.   A withdrawal of liquidity could have positive implications for the USD but given that the Fed is still some months away from hiking the Fed Funds rate, interest rate differentials will not turn positive for the USD for a while yet. 

The move has however, changed the complexity of the FX market and likely shifted currencies into new lower ranges against the USD.  There were plenty of reasons to sell EUR even before the Fed move and the discount rate hike inflicted further damage on EUR/USD which dropped below the key psychological level of 1.35.  GBP and commodity currencies were also big losers, with GBP/USD below 1.55.  Key technical support levels to watch will be EUR/USD 1.3422, GBP/USD 1.5374 and AUD/USD 0.884.

US Federal Reserve Balance Sheet ($trillion)

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