(Reuters) - A string of Europe's largest firms issued surprisingly upbeat profit reports on Thursday, bolstering an abrupt renewal of investor confidence in the region after months of debt turmoil and fears for the euro.
Broader economic data added to the theme, following some startlingly strong numbers last week -- euro zone economic sentiment rose strongly in July and German unemployment fell to its lowest level since November 2008.
Economists said the underlying performance in the region as a whole was never quite as bad as suggested by incessant news of debt default dangers in Greece and other southern European economies badly bruised by the recession of 2008-2009.
But they also cautioned that the abrupt swing toward a more positive mood did not change the fact that the region's economy is likely to heal only slowly with harsh government austerity measures poised to bite in the months ahead.
On the day, the upbeat news from some of Europe's biggest companies was nonetheless impressive and came on the heels of surveys last week which showed an unexpectedly high level of growth in both the manufacturing and services sectors in the region.
Publicis (PUBP.PA), the world's third-largest advertising group in terms of revenues, posted better-than-expected profit figures for the first half, declared its outlook better than previously envisaged, and the company's boss went as far as to declare the bad times over.
"We really have the feeling of being at the end of economic crisis, or even having put it completely behind us," Publicis CEO Maurice Levy told reporters.
His remarks were not isolated.
Dutch staffing firm Randstad (RAND.AS), second largest in the world in its field, said it was not seeing signs of a double dip in the economy, with companies continuing to hire more staff, notably in Germany and France.
"We are seeing growth everywhere. Even in Greece we are seeing the usual pattern. We are not seeing signs of a second dip," Randstad Chief Financial Officer Robert-Jan van de Kraats told Reuters.
Europe's debt market crisis spilled out of Greece late last year when markets took fright at the size of the country's deficit and ballooning debt, knocking the euro and European assets as investors started to fret about the risk of debt default in the region despite a Greek bailout.
Drugs and engineering giants gave good readouts too.
France's Sanofi-Aventis (SASY.PA) beat second-quarter earnings expectations, AstraZeneca (AZN.L) posted strong results and German chemicals maker BASF (BASF.DE) surpassed analysts' earnings expectations for the sixth straight quarter, bolstered by a rebound in the car and electronics industries.
German engineering conglomerate Siemens (SIEGn.DE) posted a better-than-expected 40 percent rise in fiscal third-quarter operating profit, helped by cost cuts and the export fillip from a weaker euro -- an exchange rate advantage ironically spawned by the debt crisis and investor fears that at some stages fueled questions about the common currency's very survival.
That debt market crisis propelled debt refinancing costs to record highs for governments in places such as Portugal, Ireland and Spain in May-June, but they have fallen back sharply in many cases in the last 10 days or so, suggesting investors sense the worst of the danger has passed.
The premium investors demand to hold the 10-year bonds of Ireland and Portugal instead of the equivalent debt of safe-bet Germany has fallen about 18 percent in less than two weeks and markedly too in Spain.
MOOD SWING
All that reflects a suddenly more positive take on Europe as the region additionally gains attractiveness in relative terms for global investors after a string of somewhat disappointing news on the U.S. front in recent weeks.
Investment bank UBS, where economists have long argued that investors were perhaps overly negative about the fiscal woes of the region, published a note that captured the shift in mood as far as they see it.
"Today our Global Strategy team upgraded Europe to Neutral (from Underweight) as they position their portfolio for a more positive tone," said the note.
"We continue to promote Europe on compelling valuations, economic data and relief for the banks to boot," UBS said, noting that Germany's Ifo index of business sentiment registered its biggest leap in 20 years in July, British second-quarter GDP was much stronger than expected and the fact that "stress tests" on banks across the region had proven mostly reassuring.
Other signals that the crisis was petering out include sharp drops in the price of credit default swaps (CDS), which provide protection against debt default and which soared in May.
The Markit iTraxx SovX index of Western European CDS prices is now at 114 bps, 54 basis points below its highest closing level of 168 basis points, seen on May 7.
In addition to a renewed focus on economic activity, signs are that investors are also encouraged by the existence of the 750-billion-euro standby lending facility euro zone governments have put in place to stem debt crisis contagion.
Despite some skepticism, investors also appear reassured by the fact that all but seven banks passed so-called stress tests of their financial resilience [ID:nLDE6661JE]. Bank shares in Europe, as measured by the STOXX Europe 600 bank index .SX7P, are up 7.4 percent since the stress test results emerged on July 23. and 25 percent up from the trough they hit in early June.
NOT SO FAST
At Deutsche Bank, however, economist Gilles Moec warned against getting carried away about the economy's recovery.
"There's no big change in terms of the underlying macro picture: we're in for slow growth," said Moec.
After poor first-quarter GDP figures in much of Europe, the second-quarter is expected to be stronger by definition more than as a result of any major upswing, and government stimulus deployed to combat the recession is still in place, with much of the post-recession austerity yet to come.
Economic growth is expected to be a modest 1.1 this year and 1.3 percent in 2011, according to a Reuters poll of 40 economists that was published in mid-July [ID:nLAG006340]. That follows a GDP drop of 4.1 percent in 2009.
"What is really impressive is the speed at which investors' focus has shifted away from hammering Europe to having a more sober look at the U.S.," said Moec.
A Reuters poll of 15 Europe-based asset managers showed on Thursday that European investors boosted fixed-income allocation to a 2010 high in July, although, as Mauro Ratto, head of Europe and Asia management at Pioneer Investments, put it:
"Concerns about the euro government debt crisis seem to be receding. However, most warning signs are still flashing red ... the prospect of budget tightening is unlikely to improve European growth rates."
(Additional reporting by William James and Jeremy Gaunt in London, Lionel Laurent in Paris and Reuters company news reporters across Europe; Editing by Mike Peacock and Stephen Nisbet)
€ The euro depreciated vis-à-vis the U.S. dollar today as the single currency tested bids around the US$ 1.2950 level and was capped around the $1.3045 level. The common currency continues to orbit the psychologically-important US$ 1.3000 figure as traders weigh an improving eurozone sovereign outlook against a deceleration in U.S. economic activity. Dealers reacted to last Friday’s eurozone bank stress tests results by pushing the euro back above the US$ 1.3000 figure on the perception the European banking system should be able to withstand additional dislocations in the sovereign credit market. European Central Bank officials talked up the stress tests late last week and yesterday, suggesting the eurozone received more than a passing grade. Data released in the eurozone today saw the June M3 money supply increase 0.2% y/y and the ECB’s bank lending survey will be released tomorrow. German data saw the August GfK consumer confidence survey climb significantly to 3.9 from the prior reading of 3.6 and the June import price index was up 0.9% m/m and 9.1% y/y. Provisional July CPI data will be released tomorrow. French data saw total June jobseekers off 8,600, an indication of an improving labour market there. In U.S. news, dealers reacted negatively to a lower-than-expected July consumer confidence print of 50.4, compared with the previous revised total of 54.3. These data suggest consumer spending may be relatively weak as final private demand is limited by current sentiment. Other data saw the July Richmond Fed manufacturing index decline to +16 from the prior print of +23 while the May S&P/CaseShiller home price index was up 0.47% m/m and 4.61% y/y. MBA mortgage applications, June durable goods orders, and the Fed’s Beige Book will be released tomorrow. Philadelphia Fed President Plosser yesterday suggested the current economic situation does not warrant additional Fed stimulus but added the FOMC is prepared to move if and when needed. Euro offers are cited around the US$ 1.3265 level.
¥/ CNY The yen depreciated vis-à-vis the U.S. dollar today as the greenback tested offers around the ¥87.90 level and was supported around the ¥86.80 level. Dealers pushed the yen lower today on expectations Bank of Japan could ease monetary policy further. Demand for Japanese government bonds remains strong and this is a signal that many investors expect Japanese yields could fall further. There is still talk the government may look to protect the psychologically-important ¥85 handle by selling yen for U.S. dollars or other currencies in what would be the country’s first official yen-selling intervention in several years. Many BoJ-watchers believe the central bank will maintain its ultra-accommodative monetary policy for at least two more years. Japanese banks have been investing in longer-dated debt and the swaps market to record profits as yields on five-year JGBs move lower. Data released in Japan overnight saw the June corporate service price index decline 1.0% y/y, lower than the previous -0.8% May result and the latest evidence that deflation remains a major problem for the Japanese economy. The Nikkei 225 stock index lost 0.07% to close at ¥9,496.85. U.S. dollar bids are cited around the ¥86.29 level. The euro moved higher vis-à-vis the yen as the single currency tested offers around the ¥114.10 level and was supported around the ¥112.75 level. The British pound moved higher vis-à-vis the yen as sterling tested offers around the ¥136.65 level while the Swiss franc moved lower vis-à-vis the yen and tested bids around the ¥82.30 level. In Chinese news, the U.S. dollar depreciated vis-à-vis the Chinese yuan as the greenback closed at CNY 6.7784 in the over-the-counter market, down from CNY 6.7790. Data released in China overnight saw the June leading index decline to 102.84 from the revised prior tally of 103.25. People’s Bank of China reported China’s economic fundamentals remain “good” and said the recent deceleration in economic growth will likely stabilize.
£ The British pound appreciated vis-à-vis the U.S. dollar today as cable tested offers around the US$ 1.5575 level and was supported around the US$ 1.5440 level. Cable reached its strongest level since February 2010 as traders reacted positively to a surprise +33 print in July CBI reported sales, up from the prior reading of -5. Additionally, none of the £355 million in corporate bond securities Bank of England said it would purchase in its twice-weekly program was tendered today, the first time investors did not seek a BoE bid since March. This is indicative of improving sentiment in the credit markets. A perceived relaxation of terms in the Basel 3 capital accord terms is also supporting sterling. The key functions of the Financial Services Authority will be relegated to the BoE. Cable bids are cited around the US$ 1.5270 level. The euro depreciated vis-à-vis the British pound as the single currency tested bids around the £0.8345 level and was capped around the £0.8415 level.
CHF The Swiss franc depreciated vis-à-vis the U.S. dollar today as the greenback tested offers around the CHF 1.0635 level and was supported around the CHF 1.0480 level. Data released in Switzerland today saw the June UBS consumption indicator improve to 1.810, up from the revised May result of 1.712 and its highest level since July 2008. Swiss unemployment remains at about half the level as the eurozone’s rate and this is resulting in positive economic activity. There is some speculation Swiss National Bank may have intervened by selling francs today given the significant move lower for the currency but SNB would not confirm this speculation. U.S. dollar offers are cited around the CHF 1.0980 level. The euro appreciated vis-à-vis the Swiss franc as the single currency tested offers around the CHF 1.3795 level while the British pound moved higher vis-à-vis the Swiss franc and tested offers around the CHF 1.6525 level.
MORNING BRIEFING: BP reports Q2 loss of $17.15 billion; CEO Hayward steps down
What’s new: United Kingdom: BP CEO to step down, Robert Dudley to step in as CEO Switzerland: UBS beats Q2 forecasts Euro zone: EU toughens sanctions on Iran China: IMF says Yuan ‘substantially undervalued’ Forex: Euro inches higher to 2-month peak versus US Dollar
Today:
Rates in Asia and Indices: EURUSD: 1.3021 - 1.2979. USDCHF: 1.0503 - 1.0482. GBPUSD: 1.5530- 1.5479. EURJPY: 113.30 – 112.79. USDJPY: 87.06 – 86.84. DowJones: 10'525.43 +0.97% NASDAQ: 2'296.43 +1.19% S & P 500: 1'115.01 +1.12% Nikkei: 9'496.85 -0.07% Shanghai: 2'586.71 -0.08% Gold: $ 1'184.80 Crude Oil: $ 78.89
Comments: BP confirmed Tuesday that under fire CEO Tony Hayward will step down in October, to be succeeded by fellow executive director Robert Dudley. Dudley, the US executive managing BP's response to the spill in the Gulf of Mexico, is poised to get the top job, a move that could soften US criticism of the British oil giant, sources close to the company said.
Iran said on Monday it was ready to resume talks on a nuclear fuel swap, a surprise that came shortly after the European Union agreed tougher sanctions, including a block on oil and gas investment. EU foreign ministers approved a range of extra restrictions on Iran that went well beyond U.N. sanctions agreed last month and included a ban on dealing with Iranian banks and insurance companies and steps to prevent investment in Tehran's lucrative oil and gas sector, including refining.
The International Monetary Fund believes that the Chinese Yuan is "substantially undervalued", the Wall Street Journal reported on Tuesday, citing two unidentified IMF officials. A US Treasury official also said on Monday that the Yuan remained clearly undervalued and that the Treasury Department was closely monitoring it. The Yuan has risen 0.7% since the People's Bank of China announced its depegging from the Dollar on June 19th.
Sterling reached a three-month high against the US Dollar on Monday, extending gains in the aftermath of strong UK economic growth data and tracking gains in other higher-risk currencies following European bank stress tests. The Euro inched up towards a two-month peak above $1.3000 on Tuesday; however traders remained cautious as they await clarity on Deutsche Bank's exposure to euro zone sovereign debt.
The Euro is up 0.1% today against the Dollar to 1.3010, while against the Yen, the single currency is up 0.3% to 113.22. The Sterling remains above 1.55 up 0.10% so far today. RTFX Trend for EURUSD remains bullish, which is registering a 0.78% profit since 22nd of July, while GBPUSD also bullish since the 22nd is up 1.49% from 1.5259. RTFX Asset Management Service, Shiva, is enjoying an 11.66% gain so far in July.
The substance and meaning of Friday’s Stress test results are still be hotly debated. Financial pundits are putting enormous emphasis on the European open as the barometer of the market’s sudden confidence in the results. We are still unconvinced about the stress tests and doubt that a single market open/trading day will create the directional rush some participants are looking for. FX markets initially took on risk in Asia but the gains were quickly eroded.
Seven of the EU banks, out of a total of 91, failed the stress test. The test did not find any troubled institutions in countries such as Italy and Portugal and just one in Greece. Of the banks that did fail, they only needed to 3 million Euros to meet their Tier-1 capital ratio of 6%, quite a low figure for major banks. The EU’s widespread denial of the possibility of a sovereign default is vexing to analysts, but it’s understandable from a political and market stability standpoint.
Overall, if the purpose of this test was to gauge the probability of a sudden bank collapse in the EU, than it misses the mark. We maintain the view that Europe’s problems are largely structural and thus no test will address these problems. The macroeconomic assumptions used in the adverse scenarios were not very difficult nor believable. Ireland’s GDP growing 1% is not an emergency scenario.
Markets will continue to watch LIBOR and credit-default swap spreads carefully as well as the equity markets’ reactions – especially to see which banks come under heavy selling pressure.
The Euro’s strength is limited as domestic growth prospects will diminish as the austerity measures kick in. Global growth is still decelerating and the credibility of the single currency has been damaged in recent years. In addition, we have our eye on the Swiss Franc to outperform across the board. The Swiss version of the stress test, released Friday prior to the EU test, was more rigorous and comprehensive. With the added scrutiny, market participants can be confident in Switzerland’s banking sector. We suspect capital will continue to flow from Europe, into Switzerland, as investors seek out a safe haven for their assets.
We are still very impressed with the UK growth figures released last Friday. Q2 GDP figures came in well ahead of expectations at 1.1% q/q and 1.6% y/y, ahead of the 0.6% q/q & 1.1% y/y expectations. While PMC member Posen has raised the question of further QE to prevent the UK’s economy from taking another dip, we are leaning more to the views of Sentence that inflationary pressure needs to be tackled now. We will be watching for the opportunity to go Long sterling, especially in the EURGBP.
Today’s final thought is on the Yen. There has been a noticeable lack of rhetoric surrounding its recent strength. The current government coalition believes that markets themselves should set prices, even though there has been no noticeable erosion in exports (June exports increased a whopping 27.7% y/y). This week’s June CPI will be in negative territory and we believe it’s only a matter of time until Japanese rhetoric begins and we see the Yen lose ground.
Today's Key Issues (time in GMT): 07:30 SEK Jun trade balance; last SEK2.7 bln surplus. 07:30 GBP Details of UK financial supervision reform. 14:00 USD Jun new home sales, 335k AR eyed; last 300k. 00:00 PLN Interest rate announcement, % 3.50 exp/prior
EurUsd Well, the European stress tests were just as underwhelming as expected, so for now EURUSD’s short-term uptrend remains intact and the markets look pretty directionless this Monday morning. Our gut instinct is that the medium-term direction for this pair will be lower, but in the short-term we would be willing to play this one either way depending on the outcome of a potential symmetrical triangle pattern now visible on the hourly chart. The lower edge of the triangle coincides with the short-term uptrend line, so a break below that support (currently 1.2825) would be the signal to go short with a target below around 1.2480. Given that target is some distance away, supports on the downside are a potential hazard at 1.2793 (Friday’s low),1.2733 (21 Jul low), 1.2683 (14 Jul low) and 1.2522 (13 Jul low). Should the bullish triangle scenario play out instead then we need a break above 1.2950 to trigger long entry, and eye a target above at 1.3300. Next resistance is expected at the 100-day moving average 1.2874, 1.3028 (20 Jul high) and 1.3093 (10 May high).
GbpUsd After the false break of the 6-week uptrend last week GBPUSD has bounced emphatically higher, and impressive UK GDP figures on Friday has catalysed the rally further to highs of 1.5501. In doing so, the pair has now surpassed the 15 Jul highs at 1.5472 and is now expected to make a move on the more significant 1.5525 (15 Apr high). Above there lies yet more technical resistance (namely the 200-day moving average 1.5558 and 23 Feb high 1.5575) which should stall the rally on the first visit, but beyond there the skies are clear for a run on 1.6000. Nearest support is back down around 1.5350 pivot level, with the lower edge of the 6-week uptrend now coming in below at 1.5280. Should the trend break lower once more then first stop on the downside will be 1.5125 (last Wednesday’s low), followed by 1.5080.
UsdJpy The bearish flag pattern we had been tracking last week has now decisively been dead and buried by the move back above 87.50, and if anything we look to be carving out a range between 86.25 –87.75. At current levels towards the upper end of the range, the most attractive strategy is to sell some and await a return to 86.50ish levels, but ensuring we keep a tight stop on the topside to keep the risk/reward ratio manageable. There is a possibility that from here, a break above that range ceiling (87.75) could indicate a double bottom chart pattern has been activated, and if so, we should be getting long there and aiming for a target above of 88.85.Sellers are expected to step in around 88.00 (former pivot), 89.15 (12 Jul high) and 89.50 (28-29 Jun high).
UsdChf Finally, someone told the bulls about the break of the 3-week downtrend channel and we managed to get a bullish engulfing candlestick pattern on the daily chart to finish the week; it only took about 3 days... The decisive burst higher on Friday afternoon hit a peak of 1.0564 but progress has been halted by resistance coinciding with the 19 Jul highs, so for now the pair is now consolidating above 1.0500. We see a potential bullish flag pattern on the hourly chart that suggests a break above 1.0560 should be taken as the signal to go long, with a target on the topside around 1.0715; however we think buying on a dip to 1.0500 (the lower edge of the flag) also represents decent value with 1.0450 likely to offer some protection below. Only resistance levels above to be wary of are the 14 Jul highs at 1.0618 and the 200-day moving average at 1.0640.
A decline in US 3-month libor below 0.50% coupled with solid Q2 company earnings have buoyed demand for carry trade strategies, driving high yielding and commodity currencies through key resistance levels vs the USD. It is debateable how long momentum can be sustained in a context of faltering momentum in the US. The idea that additional policy stimulus by the Fed could be required and would re-flate risk assets appears misplaced when elsewhere fiscal stimulus is withdrawn and liquidity is unwound. With the EU bank stress tests finally behind us, we look ahead to a G10 calendar next week dominated by the MPC testimony to the TSC and the first estimates of US Q2 GDP. Month-end implies currency and bond portfolio rebalancing. In five of the last six months, the re-weighting resulted in EUR/USD firming an average 0.5%. In contrast, GBP/USD only gained in month-end fixings in March and May.
Recap
The recap for fx this week reads very similar to that of two weeks ago. A rally in global equities propelled the AUD to the top of the G10 table, helping the currency to gains of 3.3% vs EUR, 2.6% vs USD and 2.5% vs GBP. A 1.1% q/q jump in UK Q2 GDP boosted GBP and helped the pound to record a 1.3% gain vs the JPY and 1.2% vs the EUR. GBP/USD ended the week above 1.5350, having traded as high as 1.5450. EUR/USD was equally unable to cling on to the best levels above 1.29 as profit taking emerged on the release of the EU bank stress tests following earlier bidding on a 3-year high for the German IFO.
UK Q2 GDP surpassed the most bullish estimates as the ONS reported a 1.1% q/q jump in output vs 0.3% in Q1. This still leaves the economy 4.7% below the starting pointof the recession in 2008, and will not tempt the MPC to change its view that the economy may weaken in the second half of 2010. The MPC minutes were remarkably more dovish on growth and members Posen and Dale did not hold back to warn of the dangers ahead. Retail sales also beat consensus estimates by climbing 1% in June. A marked decline in the retail deflator to 1.3% and a fall in inflation expectations back below 3% will comfort the MPC about the inflation outlook. Public finances recorded a bigger deficit in June, with borrowing reaching £14.5bln and data for May revised up to £17.0bln.
A good start to the week for UK rates reversed on Friday on the strong GDP release, causing yields to end the week on a high. 5y swaps climbed to 2.47%, up 6bp on the week. 10y yields rose above 3.40% to a 3.43% high. A deceleration in inflation pressures should keep yields capped going into August, with downside risk to the US macro data providing better levels to buy. The 3mth Libor/Ois spread widened one bp to 24bp. The 2y/10y swap spread widened 2bp to 198bp, and 10y swap spreads stayed flat at 2bp. A disappointing 2016 gilt sale drew lower than previous cover of 1.38x (1bp tail) .
G10 FX - GBP/USD, ST Trend Still Bullish
Back in June we noted that by flirting with a return to the 1.4784- 1.55 trading range in place between February and May, GBP/ USD had approached a crossroads, and how an improved technical picture and a rebound in correlations with equities and commodities pointed to further upside in the short-term (1.54 topside). This week we review our call and state that even though GBP/USD has posted impressive gains in July, there is no compelling case to drop the bullish near-term picture. Though the correlation of GBP/USD has eased back to statistically insignificant levels since the June comment (see chart), the divergence between UK and US macro indicators (see chart) brings the potential of further upside over the coming weeks before potential profit taking sets in ahead of the August MPC meeting and the Inflation Report on August 11.
The retreat of USD crosses since June has been led by a net change in speculative positioning and is marked by a net reduction in short JPY, EUR and GBP contracts. Disappointing US macro data since June has added downside USD pressure and is fuelling talk that the Fed may engage in a new round of policy stimulus in Q3/Q4 to prevent the economy from losing further steam. Though the jury is out whether the Q2 slowdown is a blip or start of a downtrend, a decline in US 3-mth libor below 0.50% and a rally in short-dated FF futures curve indicates that the market is taking a more pessimistic view. Additional US measures would threaten to drag the USD lower vs non-QE currencies or currencies where exceptional measures are gradually phased out.
Though strong UK Q2 GDP (+1.1% q/q) took the market off guard and lifted GBP/USD above 1.54, one cannot ignore the dovish observations by the MPC and individual comments by members Posen and Dale. This could lead investors to re-engage in accumulating GBP short positions into early August. To what extent the Budget will bear down on the Bank's growth and inflation forecasts will become clear in the next Inflation Report. Minutes from the July MPC meeting hint that growth prospects may be scaled back. Depending on whether inflation and inflation expectations also recede, talk of additional policy loosening (a greater than 50% probability accordng to MPC member Posen) would cloud the outlook for GBP vs other G10 currencies, especially those where performance is linked to positive interest rate spreads and elevated correlation with equities and commodities.
Based on our quantitative metrics, the correlation of GBP/USD with risk assets has receded markedly to the point that price action in stocks has become statistically insignificant for short term direction. Rate differentials between the US and the UK have also faded as a driver for GBP/USD, offering no clear sense of direction for the cross. Though we are tracking changes in correlations closely, this means is that markets are inclined to put more weight at present on corporate flows and a divergence between US and UK macro indicators, but with confidence about deficit reduction equally playing a part.
Technically, to sustain the upward short-term move GBP/USD has to overcome 1.5454, the July 15 high. Beyond 1.55 lies a cluster of resistance at 1.5524 and 1.5578. A breakout of the February- May range would bring 1.5814 into play.
(Reuters) - Federal Reserve Chairman Ben Bernanke said on Wednesday the U.S. economy faces "unusually uncertain" prospects, and that the central bank was ready to take further steps to bolster growth if needed.
"Even as the Federal Reserve continues prudent planning for the ultimate withdrawal of monetary policy accommodation, we also recognize that the economic outlook remains unusually uncertain," Bernanke told the Senate Banking Committee.
"We remain prepared to take further policy actions as needed to foster a return to full utilization of our nation's productive potential in a context of price stability."
Bernanke, delivering the central bank's semiannual report to Congress on monetary policy, said Fed officials believe the U.S. economy is still on a path to recovery.
"Although fiscal policy and inventory restocking will likely be providing less impetus to the recovery than they have in recent quarters, rising demand from households and businesses should help sustain growth," Bernanke said.
For now, he said the Fed expects economic conditions will warrant an exceptionally low benchmark federal funds rate for an "extended period" -- repeating a vow the central bank has kept in place for more than a year.
Bernanke stopped short of describing what steps the Fed might take if growth were to falter. Analysts say the central bank could resume asset purchases or lower the rate it pays banks to park their excess reserves at the Fed.
"The testimony was not particularly optimistic," said Lawrence Glazer, managing partner of Mayflower Advisors in Boston. "It implied that the Fed had a relatively cloudy view of the future."
Stocks turned lower to trade down modestly after the testimony was released, while the dollar extended losses versus the yen and U.S. Treasuries rallied, with the 30-year bond gaining a full point.
Stocks had risen on Tuesday in part on speculation the Fed could ease monetary conditions further.
After emerging from its longest and deepest downturn since the Great Depression, the U.S. economy began expanding again about a year ago. It grew at an annualized 2.7 percent in the first quarter.
But stubbornly high unemployment, a fresh drop in housing activity and a slowdown in manufacturing have raised fears of a "double-dip" recession.
In response to the financial crisis and deep recession, the Fed slashed interest rates to near zero and bought more than $1.5 trillion in mortgage and Treasury bonds.
Bernanke spent much of his testimony reviewing tools the Fed has at its disposal to remove the extraordinary monetary stimulus pumped into the economy during the 2007-2009 crisis.
He said there was broad agreement among Fed officials that asset sales will eventually play a role in withdrawing some of that accommodation. But he also noted that any such sales would be flagged well in advance.
Bernanke said a weak job market will likely remain a drag on consumer spending, and said it would take a long time before the economy can restore the nearly 8.5 million jobs lost in 2008 and 2009.
Against that backdrop, Bernanke indicated inflation is not a concern, and is unlikely to become a problem any time soon.
He said Fed policymakers "expect continued moderate growth, a gradual decline in the unemployment rate, and subdued inflation over the next several years."
Anxiety over high debt levels in Europe have added an important element of uncertainty to the global economic recovery. Bernanke said such worries had driven U.S. stock prices lower and corporate credit premia higher.
He argued the Fed's reopening of foreign exchange swap lines with overseas central banks has helped eased pressures in interbank lending and kept credit flowing in the U.S. financial system.
The euro depreciated vis-à-vis the U.S. dollar today as the single currency tested bids around the US$ 1.2890 level and was capped around the $1.3005 level. Data released in the U.S. today saw the June headline consumer price index off 0.1% m/m and up 1.1% y/y while the ex-food and energy core component was up 0.2% m/m and 0.9% y/y. Additionally, May net long-term TIC flows came in at US$ 35.4 billion, down from the revised prior reading of US$ 81.5 billion, while May total net TIC flows moved higher to US$ 17.5 billion from the prior revised tally of US$ 13.0 billion. Finally, the mid-July University of Michigan consumer sentiment indicator fell sharply to 66.5 from the prior reading of 76.0. The July NAHB housing market index will be released on Monday. Yesterday, U.S. Senate passed key financial regulatory reform laws that will seek to strengthen oversight over systemically-important firms, increase some of the Federal Reserve’s powers, and seek to avert another major credit crisis like the one that unfolded three years ago. Critics of the new legislation suggest it does not address the massive imbalances caused by U.S. wholesale mortgage giants Fannie Mae and Freddie Mae. Former Federal Reserve Chairman Greenspan this week said the U.S. government should let the Bush tax cuts lapse this year to boost tax revenue and reduce the federal budget deficit. San Francisco Fed President Yellen testified this week in her Senate confirmation hearing to become the new Fed Vice Chairman and noted job creation remains a “high priority” to bring down “painfully high” umemployment. Minutes from the most recent Federal Open Market Committee meeting were released this week and indicated a growing concern over the economy. Fed Chairman Bernanke will deliver his semi-annual economic report to Congress next week. In eurozone news, the European Central Bank’s July monthly bulletin this week reported some eurozone jobs “will be permanently downsized.” Data released today saw the EMU-16 May trade balance decline to -€3.4 billion from the revised prior reading of €300 million. Data to be released on Monday include the May current account balance and May construction output. Euro offers are cited around the US$ 1.2830 level.
¥/ CNY
The yen appreciated vis-à-vis the U.S. dollar today as the greenback tested bids around the ¥88.25 level and was capped around the ¥87.50 level. Data released in Japan overnight saw June nationwide department store sales decline 6.0% y/y while Tokyo-area department store sales were off 5.5% y/y. Bank of Japan maintained its economic assessment for the third consecutive month in July, reporting “Japan’s economy shows further signs of a moderate recovery, induced by an improvement in overseas economic conditions.” It added “Japan’s economy is likely to recover at a moderate pace.” As expected, Bank of Japan this week lifted its economic growth forecast for the fiscal year ending March 2011 to 2.6% from its April estimate of 1.8%. BoJ also reduced its forecast for the next fiscal year to 1.9% from 2.0%. Bank of Japan’s Policy Board this week kept its benchmark unsecured overnight call rate target unchanged at 0.1%. Dealers expect the government will increase its pressure on the central bank to ease monetary policy further, perhaps by expanding the number of Japanese government bonds it purchases. BoJ Governor Shirakawa reported the BoJ “already expected the pace of the economic recovery to slow down in coming months” following its “rapid” rebounds from late last year. The central bank is also now predicting consumer prices excluding fresh food will decline 0.4% this fiscal year, down from April’s -0.5% forecast. Notably, the central bank maintained its forecast that calls for a 0.1% increase in core inflation in the fiscal year starting April 2011. The Nikkei 225 stock index lost 2.86% to close at ¥9,408.36. U.S. dollar bids are cited around the ¥86.29 level. The euro moved lower vis-à-vis the yen as the single currency tested bids around the ¥111.50 level and was capped around the ¥113.35 level. The British pound moved lower vis-à-vis the yen as sterling tested bids around the ¥132.00 figure while the Swiss franc moved lower vis-à-vis the yen and tested bids around the ¥82.00 figure. In Chinese news, the U.S. dollar depreciated vis-à-vis the Chinese yuan as the greenback closed at CNY 6.7747 in the over-the-counter market, down from CNY 6.7781. The slowdown in economic growth reported in China this week caused Chinese interest rate swaps to decline to one-year lows. Many data were released in China this week. First, second quarter real gross domestic product growth decelerated to +10.3% y/y from the prior reading of 11.9%. Gross domestic product is now up 11.1% y/y but most economists expect growth to decelerate further this year. Second, the June purchasing price index was up 10.8% y/y, down from +12.2% y/y. Third, the June producer price index and June consumer price index were up 6.4% y/y and 2.9% y/y, respectively. Fourth, June retail sales growth slowed to 18.3% y/y. Fifth, industrial production growth slowed to +13.7% y/y from the prior reading of +16.5%.
(Reuters) - The euro fell while Bund futures jumped on Tuesday as ratings firm Moody's cut Portugal's rating to A1 with a stable outlook.
The euro fell around 40 ticks against the dollar to the day's low of $1.2523, while it also hit a session low against the pound at 83.51 pence.
"The downgrade is going to weigh on the euro in the short-term and doesn't bode well ahead of the bank stress tests due next Week," said David Tinsley, economist at National Australia Bank.
Bund futures erased losses, rising to a session high of 129.47, up 13 ticks on the day.
The Portuguese/German 10-year yield spread widened to 290 basis points, around 4 basis points wider versus Monday's settlement.
The cost of protecting Portuguese government debt against default also rose. The five-year credit default swap climbed to 286 basis points from 279.5 bps at the New York close on Monday, according to monitor CMA DataVision.
Portugal's PSI 20 .PSI20 index fell 0.3 percent, while Europe's FTSEurofirst 300 .FTEU3 pared gains, but still traded up 0.5 percent at 1,030.68 points.
(Reuters) - Democrats will have little margin for error this week as they push for final congressional approval of the most comprehensive rewrite of financial rules since the Great Depression.
Senate Majority Leader Harry Reid hopes to take up the sweeping legislation as Congress returns from a weeklong break, even though he has not yet locked down the 60 votes needed to clear a procedural hurdle in the 100-seat chamber.
The House of Representatives has already approved a final version of the bill, which imposes a range of tough new restrictions on the industry in an effort to avoid a repeat of the 2007-2009 financial crisis. After a year and a half of work, Democrats are eager to send it to President Barack Obama to sign into law.
Passage of the bill would give them a second major legislative achievement, alongside healthcare reform, to show voters as they try to retain control of Congress in elections this November.
In the Senate, Reid can count on 57 Democratic votes for the measure, which would create new consumer protections and saddle financial firms with tough new restrictions.
Republicans Susan Collins and Scott Brown have indicated that they are inclined to support it as well.
But that still leaves Reid one vote short. Republicans Olympia Snowe and Charles Grassley have backed the bill earlier in the legislative process, but neither has said whether they will support the final version.
Reid could pick up another Democratic vote if West Virginia Governor Joe Manchin promptly appoints a successor to fill the seat of the late Senator Robert Byrd.
While Manchin is expected to name a Democrat who supports the Wall Street reform bill, it is unclear if he will name a successor in time for a vote this week, in which case Democrats may have delay action.
Analysts, however, expect Reid will ultimately get the votes he needs to send the measure to Obama, as moderate Republicans will be hard-pressed to justify a "no" vote after winning a wide range of key concessions.
"I think everyone's pretty comfortable that they have the numbers," said Jodi Lashin, a lawyer at Pryor Cashman who has been tracking the bill closely.
Alan Lancz, president of Alan B. Lancz & Associates in New York, said a failure to move the bill to a final vote would add another layer to the concerns of investors.
"If it doesn't pass, there will be a slight positive, but there will be worry as to whether it will come back in a worse form down the road," Lancz said. "If it's just delayed, it might actually worry investors more as to what else is being planned or added to the bill."
Since hitting a 2010 high in April, the KBW Banks Index has fallen nearly 15 percent as concern grew on how the legislation would crimp industry profits.
COULD HAVE BEEN TOUGHER
With a nervous eye on the coming elections, Democrats hammering out the sweeping bill rode a wave of public disgust against Wall Street, perhaps the only address in America less popular with voters than Capitol Hill.
Despite the best efforts of industry lobbyists, the legislation actually got tougher over the past year as it moved through the chambers of Congress.
Financial firms will face a range of new restrictions, from increased scrutiny of consumer loans to limits on their trading activities.
But the industry managed to soften the impact of many of the bill's harshest provisions during a final all-night negotiating session.
Banks would be barred from trading for their own profits under a provision named after former Federal Reserve Chairman Paul Volcker. But lawmakers softened the "Volcker Rule" to allow banks to maintain small investments in hedge funds and private-equity funds, and gave them further leeway by opting to loosen the way they measure those stakes.
Though consumer loans will come under new scrutiny from a consumer-protection authority, auto dealers -- among the largest players in this area -- won a hard-fought exemption.
And while Wall Street banks will have to spin off much of their lucrative swaps-dealing activity into separately capitalized affiliates, lawmakers at the last minute allowed banks to keep many types of swaps in-house.
Even when Obama signs the bill into law, its ultimate impact will not be known until regulatory agencies put it into an effect -- a process that will take years.
"In broad and significant areas, (the legislation) endows regulators with wholly discretionary authority to write and interpret new rules," lawyers at Skadden Arps wrote in a research note.
The bill has been criticized for failing to make changes to Fannie Mae and Freddie Mac, the government sponsored mortgage finance companies that have taken more than $145 billion from taxpayers since being seized in 2008.
White House spokesman Robert Gibbs said Republicans should not use that as an excuse to vote against the financial reform bill. "We are going to reform Fannie Mae and Freddie Mac," Gibbs said Sunday on NBC's Meet the Press.
(Reporting by Andy Sullivan; Additional reporting by Matthew Lynley in New York and Corbett B. Daly in Washington; Editing by Tim Dobbyn)
Stronger than forecast employment data from Australia and Canada along with short covering in risk assets boosted the AUD, CAD, NZD and NOK, but doubts over momentum have not disappeared as markets square up to the first reports of US Q2 company earnings. With market positioning still overwhelmingly short EUR, we look for bearish EUR trends eventually to be reasserted on profit taking ahead of July 23, release date of the bank stress tests. Correlation with risk assets remains elevated for higher yield and commodities currencies, but with the balance tipping in favour of a second rate hike by the Bank of Canada later this month, the CAD looks well placed to resume its upward move vs the AUD. The prospect of a 7th drop in the UK claimant count rate in June may neutralise this month's rally in EUR/GBP. Greece will tap the capital markets on Tuesday. Recap
A rally in global equities propelled the AUD to the top of the G10 ranking, helping the currency to log a 4.7% gain vs the JPY, a 4.4% gain vs GBP and a 4% profit vs the USD. GBP fell against all G10 peers, but losses were limited to 1.3% vs the EUR and 0.7% vs the USD. The weakness in sterling was partially attributed to the compression in UK/G10 yields. UK/EU 2y benchmark yields fell into negative territory for the first time since February. The unwinding of safe haven flows put the JPY at the bottom of the G10 table, with losses ranging between 5% vs the AUD to 0.4% vs GBP, despite the report of record JGB buying by China in May and a 0.5% upward revision by the IMF to Japan's 2010 growth outlook.
UK economic data came up short of expectations this week for most of the releases, except for the bullish report by the NIESR on Q2 GDP. The NIESR estimates that the economy expanded by 0.7% q/q in Q2, down from an upward revised 0.9% in Q1. The BoE left Bank rate and the APF unchanged at 0.50% and £200bln, respectively. The services PMI slipped to 54.4 in June from 55.4 in May, marking a 3rd drop in 4 months. The global trade deficit widened to £8.0bln in May, a 3-month high as imports rose 2.4% to £29.5bln, the highest since Jul-08. Industrial output rose a stronger than forecast 0.7% m/m in May, and PPI output price inflation slowed to 5.1% in June vs 5.7% in May (core up to 4.8%).
A mixed week for UK rates but overall yields stayed within the tight recent ranges and close to the cycle lows observed since mid-May. 5y swaps finished the week at 2.44% and 10y yields dropped back to 3.32% following a very solid session on Friday post weaker PPI and trade data. The prospect of lower June CPI data next week could bring the prospect of new lows and a bull flattening of the 2y/10y curve. The 3mth Libor/Ois spread narrowed a fraction to 22.5bp. EUR libor/Ois also tightened to 27bp (-5bp). The 2020 gilt sale drew very solid demand and was covered 2.45 times (0.2bp tail). G10 FX - EUR/USD Update: No 'Stress'?
The rally in EUR/USD from a 1.1877 low in June to a 1.2722 high on July 9 begs the question whether the negative trend has reversed and whether additional upside should be targeted. Though additional gains towards the 1.2800-50 area cannot be ruled out in the short-term, we think bullish EUR momentum is set to fade over the coming weeks and drag the cross back below 1.25.
Rationale for the EUR/USD bounce since June:
1/ record short EUR positioning and consequent short covering
2/ a deterioration in the US economic backdrop vs Germany and a tightening in actual and implied EU/US rate differentials
3/ fading of the USD as safe haven refuge since SNB policy tweak on Franc (June 17)
4/ cautious optimism surrounding recent EUR government bond auctions, a successful transition from ECB one-year LTRO to a 3- month tender Key factors to watch
1/ A rise in the Eonia swap curve is not a sign that the monetary policy bias at the ECB is normalising. A change in ECB money market operations since the expiry of unlimited one-year liquidity last week and the drain of excess liquidity explain the rise in the 3-mth Eonia swap rate above 0.70%, but this does not imply that the chance of an ECB rate hike has now increased. President Trichet confirmed this in the July 8th press conference and council member Stark has also warned not to read too much in higher money market rates. Uncertainty in the months ahead, bank stress tests and nervousness in funding markets will keep the ECB sidelined into 2011, but may result in EUR libor rates staying above US and UK libor equivalents.
2/ The stalling of US economic growth in Q2 is in contrast to Germany where activity has accelerated. Early indications show that the euro zone economy probably expanded in Q2 at the fastest rate since Q1-08 (+0.7% q/q) whereas in the US, dreadful housing and weak confidence and labour market data suggest the opposite, causing speculation of the Fed resuming asset purchases. This has helped EUR/USD to rally from the 1.1877 low but in our view only partially explains the break above 1.25.
3/ As we have stated before, the aversion for the USD follows the decision of the SNB on June 17 to drop its ultra-dovish stance and halt its policy of Franc intervention as deflationary pressures in Switzerland recede. This has promoted the swissy as the new refuge of choice. The starting point of the USD reversal in June also incidentally coincided with the appointment of Japanese PM Kan on June 4, though Mr Kan's explicit desire for a weaker yen means one should not overstate Japanese politics for the retracement in USD/JPY below 88.0. The move does not reflect the heavy buying of foreign denominated government bonds (Treasuries) by Japanese investors over the last 8 weeks. Instead, record buying of short-term JGBs by China may have kept the JPY artificially strong, though the safe-haven status of the JPY cannot be underestimated if US Q2 company earnings disappoint.
4/ A widening of the EU/US 2y benchmark spread has been a powerful driver of EUR/USD as chart 2 demonstrates. In comparison to the 10y spread, the correlation of EUR/USD with 2y spread recently rose to 0.8. The 2y spread now stands at 15bp, the highest since March. The deterioration in US macro data bears some explanation for the move in spreads, though the reversal from overbought conditions in short-dated bunds also has to be cited as bank shares bounce back ahead of the release of the EU stress tests on July 23. An unsatisfactory response to the latter would inevitably cause EUR sentiment to wobble and the compression in EU/US spreads to resume, even though EU governments have committed to backstop facilities to recapitalise individual institutions. This would possibly include the 440bln eur stability mechanism agreed in May.
5/ Speculative IMM positioning has been overweight EUR short contracts for most of Q2 and has only recently started to reverse some of these positions. At -83,500 contracts, overall EUR shorts are still above recent norms (see chart 3), suggesting that the market retains a still 'natural' bearish view of where EUR/USD is headed. However, the counter-argument is also true and argues that the scope for short covering remains powerful if USD sentiment continues to sour.
6/ The correlation of EUR/USD with risk assets (S&P 500) flipped markedly in July, with the sharp fall pointing to complete opposite price behaviour between stocks and the currency pair. In other words, the sharp fall in equities has not translated into safe haven USD flows, as the dollar index testifies. The release of US Q2 earnings from next week onwards will in our view be key to sentiment in risk assets. Positive results may help negative US D sentiment to stabilise, with participants potentially also inclined to take profits in EUR/USD ahead of the release of the stress tests on July 23.
(Reuters) - The International Monetary Fund upgraded its 2010 global growth forecast on Thursday on the back of robust expansion in Asia and renewed U.S. private demand, but warned the euro area's debt crisis posed a big risk to recovery.
The IMF said downside risks have risen sharply mostly because of financial market turbulence resulting from Europe's debt crisis, but a double-dip world recession was highly unlikely.
The IMF raised its 2010 world output forecast to 4.6 percent from 4.2 percent in April's review of the global economy, but kept its 2011 view unchanged at 4.3 percent.
The world economy shrank 0.6 percent in 2009 as a result of the global financial crisis.
"The baseline forecast that we have, has nothing like a double dip," Olivier Blanchard, the IMF's chief economist, said at a briefing in Hong Kong for the organization's latest World Economic Outlook and Global Financial Stability reports.
Financial stocks have fallen this year on worries about the impact of the euro area's debt crisis and more lately on concerns that the U.S. recovery is faltering following a string of weak data.
"In this context, the new forecasts hinge on implementation of policies to rebuild confidence and stability, particularly in the euro area," the IMF said in the reports.
While uncertainty about bank regulation has added to investor concerns, the IMF focused the majority of both reports on the implications of the euro zone sovereign crisis.
In the news briefing, Blanchard said the European bank stress test disclosures due on July 23 were an important step toward transparency but underscored that countries must return to a sustainable level of fiscal spending.
Under one scenario -- assuming shocks to the global financial system resulting from Europe's debt problems are as severe as those experienced in the wake of Lehman Brothers' failure in 2008 -- world GDP growth in 2011 would be reduced by 1.5 percentage points.
SOME 2011 GDP FORECASTS CUT
Persistent weakness in the U.S. housing and labor markets, euro zone debt problems and a slowdown in growth of manufacturing activity in Asia have made investors speculate the global economy will slow sharply for the rest of the year.
The IMF on Thursday cut its 2011 growth forecasts for Britain, Canada, the euro zone, emerging economies and Japan.
The euro area's 2010 GDP was seen expanding 1 percent, unchanged from April, although the 2011 GDP forecast was trimmed by 0.2 percentage point to 1.3 percent.
The 2010 U.S. GDP growth forecast was raised to 3.3 percent from 3.1 percent in April, and the 2011 growth forecast was increased to 2.9 percent from 2.6 percent.
The biggest downward revision to GDP forecasts was in Britain, which last month unveiled a plan to cut a record budget shortfall to almost nothing in five years.
The IMF expects 2010 GDP growth of 1.2 percent, down 0.1 percentage point from a previous forecast, and 2011 GDP to rise 2.1 percent, down 0.4 percentage point.
The biggest upward revisions to growth were in developing economies. Brazil's 2010 growth forecast was raised by 1.6 percentage points to 7.1 percent and its 2011 forecast was lifted by 0.1 percentage point to 4.2 percent.
It raised its 2010 forecast for China's growth to 10.5 percent from 10.0 percent.
POLICY CHALLENGE
The fund said the most prominent challenge for policymakers was to restore financial market confidence without choking recovery.
Indeed, governments in advanced economies around the world have been putting forth plans to shrink their outsized fiscal deficits in order to maintain the confidence of bond market investors, who have been demanding higher premiums to hold risk.
Those plans will have to be balanced with growth-friendly monetary conditions.
"At a global level, policies should focus on implementing credible plans to lower fiscal deficits over the medium term while maintaining supportive monetary conditions, accelerating financial sector reform, and rebalancing global demand," the IMF said.
Asia was highlighted in the report.
An inventory-driven rebound in 2010 will fade to more sustainable growth across the region in 2011. However, trade and financial linkages to Europe pose risks for Asia.
The IMF said Asian central banks were well equipped to deal with potential market seizures with U.S. dollar swap facilities, and many governments in the region had room to loosen fiscal policy if needed.
Kenneth Rogoff, former chief economist at the IMF, said on Tuesday that he did not expect the global economy to slip back into recession, although there were prominent risks.
Rogoff, speaking at a conference in Hong Kong, also said China faced a property market bubble. Although officials were doing the right thing by trying to clamp down on real estate, the ultimate impact on the banking system was uncertain, he said.
Concerns of a downturn in the 16 member euro area continue to gather pace as the spotlight slowly places focus on the fact that government actions to scale back stimulus measures will put the Euro-Zone at risk for a double-dip recession by the end of the year. Currently, indebted members of the bloc are embarking on austerity measures even though self sustaining procedures have yet to be achieved.
Talking Points
• European Financial Markets Begin to Panic • EU Stress Tests May Not Disclose Much Information • Insurance Against Greek Default Rises to Two Year High
Though Greece remains in the headlines at the moment, it is a matter of time before countries like Spain and Portugal tap into the EU-IMF life line of approximately 1 trillion dollars as banks face higher borrowing costs. The three month EURIBOR has continued its northern journey as banks in the 16 member euro area find it difficult to secure liquid funding as lenders panic. Though they are not as severe as the Lehman collapse, strains in the European banking sector are coming to life amid fears of counterparty default. However, this adds increasing concerns for the region as lenders are incurring higher borrowing costs in euro and dollar funding. As Barclay’s Capital Analyst states, “The system is just not working [in Europe]. We’re approaching the third year of liquidity support and still the market cannot survive unaided.
Greece is now entering in what looks to be the next step in its crisis as insurance against the country defaulting reached a two year high. Despite being one of the bloc’s smallest members, market participants fear that a Greek default could spread like Ebola. Subsequent to Greece, traders are beginning to be apprehensive of Spain as the unemployment rate in the first quarter topped 20.0 percent, while its fiscal deficit to GDP reached double digits. Furthermore, traders are speculating that Greece’s woes will spillover onto Portugal and Italy. Even though it is one of the smaller countries in the Euro-Zone, a default by Greece may lead France and Germany (two of the larger countries in the bloc) to enter a new recession as their banks have the largest exposure to the indebted nation.
Recently, European policy makers agreed to stress tests, which are expected to be released in July. However, these tests may do little to calm the knee jerk in the markets. Some economists fear that the outcome will not properly weigh the banks’ relative strengths. At the same time, there is a likelihood that the results may not include a sufficient amount of banks needed to get a clear picture of the health in the European markets. In 2009, the stress tests were not published as policy makers used a single standard with a scenario involving a 2.7 percent decline in economic activity in 2010 and a 12 percent unemployment rate scenario. As of late, it is unclear of what will happen to banks that “fail” these stress tests measures.
All in all, as uncertainty in the 16 member euro area lingers, we are likely to see the European Central Bank keep rates near zero for the rest of the year. Looking ahead, market participants are weighing in a zero percent chance that policy makers will hike borrowing costs twenty five basis points at its next rate decision meeting on July 8th, according to the Credit Suisse overnight index swaps.
The three month EURIBOR rate, one of the euro-zone’s principal money market indicators continues to hold near yearly highs on the back of credit risk conditions, rather than lack of ECB liquidity. The EURIBOR3MD is fixed at 0.761 percent, a high last seen since approximately October 2009.
The yield on Greek 10 year notes are up 67 basis points in the past 5 days, and have rallied 541 basis points to 10.44% in the past year, making Greece’s borrowing costs more expensive. Additionally, Portuguese and Spanish 10 year bonds have come under pressure this week, with the countries yield climbing 10 and 8 basis points respectively.
Credit default swaps on 10 year government bonds for “PIGS” have pushed higher from last week. Indeed, insurance against highly indebted countries in Western Europe is gaining momentum as market participants bet that Greece and its neighbors are heading towards default. Furthermore, Italy’s and Greece’s debt to GDP of approximately 115% in 2009 are additional concerns for investors as their bad debt will now have to be restructured. Comparatively to the U.S. where bad debt is in the private sector, for the Europeans, bad debt is in the public sector, and the nearly $1 trillion life line calls for passing on this debt onto the taxpayers of solvent states. One of the main problems with Europe is that peripheral states cannot keep up with the interest on the money that they borrow.
The euro looks to continue its southern descent against the U.S. dollar that began earlier this year amid the media frenzy surrounding the brewing sovereign debt crisis in Europe. From a technical standpoint, the pair has broken below an eight year rising trend which I noted earlier this month when the pair was trading at 1.32. As of today, the EUR/USD exchange rate stands at 1.22 and it looks apparent that the pair will rebound on the back of a much needed correction before pushing lower. It is also noteworthy that a break below the 20-day SMA, which has held up pretty modestly recently will expose the yearly low. Additionally, the Purchasing Power Parity now stands at 8.71%, down from its extreme level of 24.35% in the November, a signal that the euro may bottom out in the near term versus the U.S. dollar.
Weekly Glossary
Credit Default Swap A credit default swap (CDS) is a type of insurance that allows an investor to buy insurance against a bond issued by a country or a company. In detail, the buyer makes standard premium payments until the end of the contract as long as the borrower does not default. However, if the borrower defaults, the CDS holder is paid by the seller of the protection and the buyer then ceases to pay the payments. Market participants may use Credit Default Swaps for speculative purposes, betting against the solvency of the borrower, and in return receiving capital if it defaults. On the other hand, traders may use CDS contracts to hedge their investments.
MSCI World Stock Index
The MSCI Index is the collective of global companies which includes small, micro, mid, and large size companies.
Purchasing Power Parity (PPP)
One of the oldest and most basic fundamental approaches to determine the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. We compare values in PP to determine how much each currency is under – or over-valued against the U.S. dollar.
Chicago Board Options Exchange Volatility Index (VIX) The symbol for the Chicago Board Options Exchange Volatility index, the VIX is one of the most used measures of implied volatility of the S&P 500 index options. The objective of the VIX is to estimate the implied volatility of the S&P 500 over the next 30 days, on an annualized basis. Investors may use the index in tandem with recent fundamental developments in order speculate reverses or continuation of upward/downward trend.
(Reuters) - U.S. companies could face as much as $1 trillion in additional costs as a result of new laws designed to reduce risks in the $450 trillion, privately traded derivatives market, a derivatives trade group said on Tuesday.
U.S. lawmakers are close to finalizing legislation to overhaul the country's financial system, including moving most derivatives contracts to central clearinghouses, which stand between trading counterparties and guarantee trades.
Final rules will also require that companies that use derivatives to hedge their businesses, sometimes referred to as end-users, post margins to back the trades. Companies had argued they should be exempt from clearing and margining requirements because it would make hedging their business risk too costly.
"The margining requirements for corporate end-users as currently drafted in the bill runs the risk of imposing a significant cost on U.S. companies and could impede their ability to manage their business and financial risks," Conrad Voldstad, Chief Executive Officer at the International Swaps and Derivatives Association, said in a release.
ISDA estimates that companies would need to post about $400 billion of collateral with dealers to cover their current derivatives exposures as a result of new regulations, based on market surveys taken by the Office of the Comptroller of the Currency on derivatives use.
Companies would also need another $380 billion in additional credit capacity to cover the potential future exposures of their derivative positions, ISDA said.
If markets return to levels prevailing at the end of 2008, additional collateral needs would likely bring the total to $1 trillion, the trade group added.
Derivatives are based on foreign exchange, debt, equity or commodities or can be tied to changed in interest rates and are used to hedge financial risks or speculate on market movements.
(Reporting by Karen Brettell; Editing by Andrew Hay)
The euro appreciated vis-à-vis the U.S. dollar today as the single currency tested offers around the US$ 1.2395 level and was supported around the $1.2255 level. Concerns about stress tests on European banks eased during the North American session and this saw the common currency reverse course and move higher. The pair came close to gaining for the third consecutive week. Two-year U.S. swap spreads narrowed today, reflecting the lessening concerns about the Greek and European woes. Group of Twenty officials are convening this weekend in Toronto and it remains to be seen if policymakers can come to terms on a communiqué that addresses the differences between U.S. and European positions on economic growth and deficit spending. U.S. officials are said to favour higher deficit spending to stimulate economic growth while European officials are fostering a reduction in deficit spending at the expense of economic growth. Data released in the eurozone today saw German import prices up 0.6% m/m and 8.5% y/y while French Q1 GDP growth was unrevised at 0.1% q/q and 1.1% y/y. In U.S. news, data released today saw Q1 gross domestic product growth moderate to an annualized 2.7% q/q from the prior print of 3.0%, principally on account of lower personal consumption. The Q1 GDP price index ticked higher to 1.1% and core PCE was up 0.7% q/q from 0.6% q/q. Also, final June University of Michigan consumer sentiment ticked higher to 76.0 from the prior reading of 75.5. Data to be released on Monday include the May Chicago Fed national activity index, May personal income and spending, and the May PCE deflator. Euro offers are cited around the US$ 1.2570 level.
¥/ CNY
The yen appreciated vis-à-vis the U.S. dollar today as the greenback tested bids around the ¥89.35 level and was capped around the ¥89.75 level. Bank of Japan selected 66 financial institutions for its new lending program designed to stimulate bank lending in certain sectors of the Japanese economy. The U.S. dollar was lower across the board and this pressured the pair lower. Data released in Japan overnight reconfirmed that deflation remains a significant problem in the economy. It was reported that Tokyo-area June headline inflation was off 0.9% u/u while the ex-food and energy component came in at -1.4%. May nationwide headline consumer price inflation moderated to -0.9% from -1.2% in April and the ex-food and energy component printed at -1.6%. The government will likely continue to pressure the central bank to expand monetary policy. The Nikkei 225 stock index lost 1.92% to close at ¥9,737.48. U.S. dollar bids are cited around the ¥98.45 level. The euro moved lower vis-à-vis the yen as the single currency tested bids around the ¥109.75 level and was capped around the ¥110.80 level. The British pound moved lower vis-à-vis the yen as sterling tested bids around the ¥133.10 level while the Swiss franc moved lower vis-à-vis the yen and tested bids around the ¥81.10 level. In Chinese news, the U.S. dollar depreciated vis-à-vis the Chinese yuan as the greenback closed at CNY 6.7921 in the over-the-counter market, down from CNY 6.8001. Data released in China overnight saw the June MNI business conditions survey fall to 63.51 while the expectations survey moderated to 59.80. Also, May industrial profits growth moderated to 81.6% y/y. People’s Bank of China advisor Li Daokui said a major appreciation of the yuan is “impossible” and said the euro will move higher in the long-term. PBoC official Xie Due echoed Li’s comments on the yuan. China will likely not be pressured on the yuan at this weekend’s Group of Twenty meeting in Toronto.
£
The British pound appreciated vis-à-vis the U.S. dollar today as cable tested offers around the US$ 1.4970 level and was supported around the US$ 1.4855 level. Bank of England released a report that noted U.K. banks remain “vulnerable” to additional write-downs. Bank of England’s June Monetary Policy Committee meeting were released this week. They evidenced a 7-to-1 vote to keep the benchmark interest rate unchanged at 0.5%. MPC member Sentance favoured a 25bps tightening to 0.75%, noting that inflation has proven to be “resilient” since the end of the recession. In contrast to Sentance’s position, “other members thought that changes to the balance of risks were insufficient to warrant a change in the stance.” Cable bids are cited around the US$ 1.4620 level. The euro depreciated vis-à-vis the British pound as the single currency tested bids around the £0.8220 level and was capped around the £0.8270 level.
CHF
The Swiss franc appreciated vis-à-vis the U.S. dollar today as the greenback tested bids around the CHF 1.0975 level and was capped around the CHF 1.1045 level. Swiss National Bank released its quarterly bulletin today and noted the risk of deflation has largely disappeared. SNB added, however, that if risks materialized “via an appreciation of the Swiss franc, the SNB would take all the measures necessary to ensure price stability.” The Swiss government this week reduced its deficit projections for 2011-2013 and now sees a 2011 shortfall of CHF 600 million, considerably less than the deficit of CHF 4.1 billion that was predicted in August 2009. Data released in Switzerland this week saw the May trade balance decline sharply to CHF 820 million from the upwardly-revised April total of CHF 2.06 billion. This decline reflects the impact of the strong franc and the limited success Swiss National Bank has had in blunting the impact of the stronger franc through euro-buying intervention. SNB member Jordan this week said deflation risks have largely gone away and said there is currently no need for intervention. Swiss National Bank this week reported that its foreign currency investments rose to CHF 239 billion in May from CHF 153.6 billion in April, indicative of the significant amount of franc-selling intervention the central bank has been conducting to protect the Swiss export sector. U.S. dollar offers are cited around the CHF 1.1470 level. The euro depreciated vis-à-vis the Swiss franc as the single currency tested bids around the CHF 1.3505 level while the British pound moved lower vis-à-vis the Swiss franc and tested bids around the CHF 1.6380 level.
MORNING BRIEFING: Market’s negativity weighs on the markets today
What’s new: United States: Lawmakers seem to be close to approve new bank regulation G20: Summit ahead, some divergence seen on bank tax and speed of fiscal clean up Japan: CPI lower for the 15th consecutive month Asia: Asian equity started off negatively today
Today:
Rates in Asia and Indices: EURUSD: 1.2343 - 1.2297. USDCHF: 1.1047- 1.0999. GBPUSD: 1.4974 - 1.4916. EURJPY: 110.67 – 110.03. USDJPY: 89.71 – 89.41. DowJones: 10'152.80 -1.41% NASDAQ: 2'217.42 -1.63% S & P 500: 1'073.69 -1.68% Nikkei: 9’719.60 -2.10% Shanghai: 2'548.10 -0.73% Gold: $ 1'242.25 Crude Oil: $ 76.26
Comments: There seem to be a taste of pessimism today; the perceived riskier assets EUR, AUD and NZD found less support, Asian equities started off negatively early morning.
Growth prospects remain shaky on the continued mixed data we get from the United States and other economies. Even European debt is in the limelight again as Greek credit default swaps hit new record highs. Globally talks on increased bank regulation have given markets new concerns as late yesterday US lawmakers were agreeing to ways of limiting banks’ trading activity aimed at prohibiting risky trading activity.
Looking at the upcoming G20 summit due this weekend, it appears that countries are split on the need for a bank tax. Even when it comes to fiscal consolidation, though there seems to be agreement that targeting fiscal consolidation is a must – US cautions countries should not rush austerity measures and thus risk short term growth; while on the other hand in Europe: Germany, France and United Kingdom have set ambitious targets for reducing their debt levels aggressively. ECB’s Trichet is dismissing that austerity measures could trigger stagnation.
In Japan CPI data was down again for the 15th month. Analysts are starting to doubt Government’s goal ending deflation next year and BOJ’s forecast of a rise in CPI by 2012.
Looking at the EURUSD pair even though Euro maybe seen as losing steam it has at least managed to maintain the 1.22 level since 15th June. Market sentiment seems to favour a downside today, but since it has not yet breached the significant 1.2150 level upside cannot be ruled out completely. To the downside significant resistance seen at 1.2269 (the 23.60% Fibonacci retracement level ) below that 1.2245 and 1.2150 are the following key support levels. Possible targets for the upside are 1.2430/1.2450 as seen on the hourly and four hourly charts.
Today’s economic calendar is a light one, markets set to move on sentiment.
The euro appreciated vis-à-vis the U.S. dollar today as the single currency tested offers around the US$ 1.2385 level and was supported around the $1.2260 level. The common currency extended yesterday’s gains that began after the Federal Open Market Committee released a policy statement that was more dovish than expected. Two-year U.S. Treasury note yields are at or near lifetime lows, reflecting the expectation that U.S. official rates will be on hold for some time. The Fed yesterday reported it “anticipates that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.” There is a spirited ongoing debate as to whether the U.S. economy is likely to experience deflation or will maintain a low-inflation course for some time. Data released in the U.S. today saw May durable goods orders decline 1.1% y/y, a sharp reversal from the upwardly-revised April print of +3.0%, while the ex-transportation component was up 0.9%, up from April’s result of -0.8%. Also, weekly initial jobless claims fell to 457,000 and continuing jobless claims fell to 4.548 million. Data to be released tomorrow include Q1 gross domestic product, the GDP price index, core PCE, and final June University of Michigan consumer sentiment. The Fed will sell US$ 2 billion in term-deposits on 28 June to drain cash from the banking system. Traders will pay close attention to the Group of Twenty meetings that are beginning in Toronto. There is a perception that U.S. officials favour higher deficit spending while Europe favours reduced deficit spending. In eurozone news, there were renewed concerns today that Greece’s situation could worsen. Credit default swaps in Greek debt surged 145 bps to a record 1,077 today. Eurozone data released today saw April industrial new orders up 0.9% m/m and 22.1% y/y. German May import price data will be released tomorrow along with the Ifo June business climate survey. French data released today saw May consumer spending up 0.7% m/m and 1.9% y/y while May total jobseekers were higher by 22,600. Euro offers are cited around the US$ 1.2570 level.
¥/ CNY
The yen appreciated vis-à-vis the U.S. dollar today as the greenback tested bids around the ¥89.20 level and was capped around the ¥89.95 level. The pair lost ground even though Japanese economic data revealed the pace of economic growth may be moderating. It was reported that the total merchandise trade balance more than halved in May to ¥324.2 billion. Export growth cooled for the third consecutive month but shipments abroad were up 32.1% y/y. The 1.2% m/m decline is partially attributable to the ongoing strength of the yen and its impact on muting foreign demand for Japanese goods. Other data released in Japan overnight saw the May corporate service price index decline 0.8% y/y, an improvement from April’s decline of 1.1% y/y. Data to be released in Japan overnight include June Tokyo-area consumer price inflation and May nationwide consumer price inflation. The core ex-food and energy components are likely to remain in negative, deflationary territory. The Nikkei 225 stock index gained 0.04% to close at ¥9,928.34. The euro moved lower vis-à-vis the yen as the single currency tested bids around the ¥109.55 level and was capped around the ¥111.00 figure. The British pound moved lower vis-à-vis the yen as sterling tested bids around the ¥133.45 level while the Swiss franc moved lower vis-à-vis the yen and tested bids around the ¥80.75 level. In Chinese news, the U.S. dollar depreciated vis-à-vis the Chinese yuan as the greenback closed at CNY 6.8001 in the over-the-counter market, down from CNY 6.8140. Data to be released in China overnight include the June MNI business expectations survey and May industrial profits. The yuan has retained some of the gains it earned this week following People’s Bank of China’s decision to eventually end its two-year peg to the U.S. dollar and internationalize the yuan. China’s move to liberalize the yuan should help to counter inflationary pressures and cause China to rely less on foreign trade and focus more on domestic final private demand. Group of Twenty officials will meet with President Hu in Toronto this week.
£
The British pound depreciated vis-à-vis the U.S. dollar today as cable tested bids around the US$ 1.4915 level and was capped around the US$ 1.5010 level. Cable gave back some of yesterday’s gains that it scored when minutes from Bank of England’s June Monetary Policy Committee meeting were released. They evidenced a 7-to-1 vote to keep the benchmark interest rate unchanged at 0.5%. MPC member Sentance favoured a 25bps tightening to 0.75%, noting that inflation has proven to be “resilient” since the end of the recession. In contrast to Sentance’s position, “other members thought that changes to the balance of risks were insufficient to warrant a change in the stance.” Cable bids are cited around the US$ 1.4620 level. The euro appreciated vis-à-vis the British pound as the single currency tested offers around the £0.8270 level and was supported around the £0.8180 level.
CHF
The Swiss franc appreciated vis-à-vis the U.S. dollar today as the greenback tested bids around the CHF 1.0985 level and was capped around the CHF 1.1065 level. The Swiss government today reduced its deficit projections for 2011-2013 and now sees a 2011 shortfall of CHF 600 million, considerably less than the deficit of CHF 4.1 billion that was predicted in August 2009. Swiss National Bank will publish its quarterly bulletin tomorrow. Data released in Switzerland this week saw the May trade balance decline sharply to CHF 820 million from the upwardly-revised April total of CHF 2.06 billion. This decline reflects the impact of the strong franc and the limited success Swiss National Bank has had in blunting the impact of the stronger franc through euro-buying intervention. SNB member Jordan this week said deflation risks have largely gone away and said there is currently no need for intervention. Swiss National Bank this week reported that its foreign currency investments rose to CHF 239 billion in May from CHF 153.6 billion in April, indicative of the significant amount of franc-selling intervention the central bank has been conducting to protect the Swiss export sector. U.S. dollar offers are cited around the CHF 1.1470 level. The euro depreciated vis-à-vis the Swiss franc as the single currency tested bids around the CHF 1.3555 level while the British pound moved lower vis-à-vis the Swiss franc and tested bids around the CHF 1.6435 level.
(Reuters) - The Federal Reserve, which was criticized for failing to protect consumers in the run-up to the credit crisis, would be the home of a new financial consumer watchdog under an agreement announced on Monday.
House of Representatives Democrats said they have agreed to go along with a Senate proposal to put the watchdog inside the Fed, backing down from their earlier support for setting up a powerful new stand-alone agency.
The House's retreat on the issue resolves a lingering dispute and moves historic Wall Street reform legislation closer to completion. A Senate-House panel is slated to reconvene on Tuesday to work on finalizing the bill.
The legislation will be the biggest overhaul of financial regulation since the 1930s. Enactment would give President Barack Obama and the Democrats a major policy victory to add to healthcare reform going into November's general elections.
Under the latest agreement, the consumer watchdog would be housed in the Fed but it would be independent in many respects, with the power to both write rules and enforce them.
The new agency, which would consolidate consumer-related duties now dispersed across several agencies, would oversee mortgages, credit cards and other consumer financial products that critics say were poorly supervised in recent years.
House Democrats negotiating the legislation will also seek to subject payday lenders, check cashers and private student loan providers to the watchdog's supervision, said a statement from Representative Barney Frank, chairman of the panel.
The House said it wants to add certain exclusions to the watchdog proposal for auto dealers and pawnbrokers.
Frank also said the House has reached an agreement on a Senate proposal, drafted by Democratic Senator Richard Durbin, on curbing fees charged on debit card transactions.
Durbin said separately that the agreement makes minor, clarifying changes to his proposal, which was approved by the Senate. He said the changes would exempt from the rule prepaid and debit cards used in distribution of government benefits.
He also said the agreement would allow the Fed in some cases to adjust fee rates on cards for fraud prevention costs.
HOUSE TARGETS MORTGAGE PROVISION
In another aspect of the reform legislation, Frank said House Democrats want to strike from the bill a Senate proposal relating to risk retention requirements for commercial mortgage backed securities and add a provision to require consideration of collateralized instruments in credit risk retention rules.
The Senate-House conference committee aims to complete final legislation by Thursday. The panel is working to combine bills already approved by the two chambers. The finished product must win approval once more, then can go to Obama to sign. Democrats hope for that by July 4.
Lawmakers are still seeking compromise on proposals to force banks to spin off swap dealing desks, and to curb risky proprietary trading by banks unrelated to customers.
Groups likely to take the hardest profit hits from the proposed reforms, taken as a whole, include Goldman Sachs, Morgan Stanley, JPMorgan Chase, Bank of America and Citigroup, according to analysts.
The reforms are meant to prevent a repeat of the 2007-2009 credit crisis that tipped the economy into a deep recession, triggered massive taxpayer bailouts of big banks, and unleashed a wave of regulatory reform initiatives worldwide.
Tightening financial oversight in a coordinated way will be a key topic at a meeting of the Group of 20 economic powers in Canada next weekend.
The congressional conference committee last week concurred on widening audits of the Fed, but dropped a provision to make the head of the New York Fed a political appointee.
Lawmakers also reached full or partial agreement on measures dealing with credit rating agencies, private equity and hedge funds and raising bank capital standards.
(Additional reporting by Corbett Daly, Andy Sullivan, Karey Wutkowski and Tim Ahmann; Editing by Andrew Hay)
US dollar weakness and Swiss Franc strength translate into an interesting setup heading into the UK Budget, the FOMC and G20 summit next week, and is manifested in USD/G10 crosses approaching potential breakout territory and a rebound in volatility. GBP, NOK, SEK and the CHF all look set to test recent highs as equities negotiate one-month highs Underlying trading themes have not changed and should primarily continue to revolve around sovereign debt risk and the timing of a yuan reval, with US Q2 company results moving onto our radar. We stick to our longer-term bullish USD view but are pragmatic in a context where gold is hitting new highs and deteriorating US macro data and pressure from the G20 to curb public deficits have taken some wind out of the dollar's sails.
Recap
Gold rose to a new high above $1,260 and platinum also rallied as US dollar weakness returned, but unconfirmed sources report that China was behind the strategic purchases of the precious metals. However, the decoupling with copper is striking and tells us of potential divergence in view over the path for risk assets, also characterised by the sideways price action in major equity benchmarks. GBP experienced a mixed week, gaining ground vs the USD, but posted substantial losses vs the CHF (sharing the pain with the rest of the G10). GBP/CAD rose 0.9% and GBP/JPY firmed 0.7%. The CHF was the star performer after the SNB changed its position on deflationary risks and the strength of the Franc. The CHF gained 3.4% vs the USD, 1.9% vs GBP, and 1.4% vs the EUR.
UK CPI inflation slowed to 3.4% y/y in May from 3.7% y/y in April. RPI inflation eased to 5.1% y/y from 5.3% y/y. The core CPI rate dropped back below 3% to 2.9% y/y. Stronger than expected labour market stats for May reported a fall in total jobless claims back below the 1.5mln threshold, though the employment rate slipped and inactivity rate ticked higher. The RICS reported a bounce in its May house prices index to 22% from 19%, a 4- month high. In his annual Mansion House speech, BoE governor King said that a hike in Bank Rate would precede asset sales. The governor reiterated that inflation should ease back in the months ahead, but shared his concern and said is closely monitoring the rise in inflation expectations.
UK 5y swaps closed near the highs of the week at 2.61% after touching the upper limit of the 4-week range (2.63%). 3-mth Libor held steady at 0.73% for a 2nd successive week, causing the 3mth Libor/5y swaps curve to steepen up to 189bp. The 3mth Libor/Ois spread ended the week flat at 24bp. The 2y/10y swaps curve steepened to 204bp (+10bp), approaching resistance at 206bp. Strong auctions took place for the 2014 gilt (b/c 2.28). The 2017 IL mini-tender was covered 2.53 times. America Movil sold £650mln in 2030 paper (165bp over). G10 FX - GBP/USD at a Crossroads
GBP/USD has recently been flirting with a return to the 1.4784- 1.55 trading range observed between February and May. An improved technical picture and a rebound in correlations with equities and broader commodities from the early June lows suggest further upside may lie ahead in the short-term (1.54 topside) if the rally in risk asset remains intact and recent gains forces participants to cover short GBP positions. However, the downtrend in place since last November (see chart p2) still dominates and dictates a bearish profile for the medium-term, regardless of the Budget on June 22. A retracement below the 1.45 area cannot be ruled out if the cross fails to break through the 1.4900-50 resistance zone.
GBP/USD has been at a similar crossroads in mid to late April, only for the rally to fizzle out and reverse to the post-election May lows of 1.4231. The danger is that this scenario repeats itself if the rally up to the 1.4886 high on June 18 is not extended beyond trend line resistance situated in the 1.4950 area. The descending trendline in place since January 19 (1.6558 high) runs down to the April 24 high (1.5498). The trendline has not been tested since then and should dampen enthusiasm among those speculating that the cross can drift unchecked to 1.50-1.55, adding to the 1.9% gain in June. Though GBP is currently undervalued vs all its G10 peers (see table), PPP valuations have a very low predictive value when it comes to signalling short-term trend reversals. Speculative short GBP positioning vs the USD is still above historical norms and equally argues for a cautious set-up with tight stops.
The GBP/USD outlook depends on the following:
1/ Commodities, equities: the two asset classes have rallied off the Q2 lows and lifted GBP/USD to a one-month high due to a pickup in correlation (see chart). Short covering, equity buybacks and good EU peripheral auctions (at concessionary rates) may have contributed to a modest buying of risk, but equity benchmarks like the S&P remain 50% below the April high. US Q2 company earnings and guidance for the second half will be key in July for the direction in GBP/USD, provided that correlation with risk remains elevated. Also keep an eye on the CRB index. The index has to test and preferably break the May high (267) to confirm the rally from below 250 and underpin GBP/USD.
2/ Markets have been fairly agnostic to macro economic data recently. Is this about to change? A levelling off in US indicators could bring a second successive disappointing non-farm payrolls report on July 2. This would not go down well with risk assets (USD safe haven) and would add weight to talk that the Fed is discreetly discussing measures to counter a stagnating/ faltering recovery.
3/ Overseas investors have already been reassured that the Con/LD government is determined to cut the public deficit, so the upside for GBP/USD from an endorsement by the credit ratings agencies we think is likely to be minimal. By 2013/14, the OBR projects a reduction in the public deficit from £155bln in 2010/11 to below £100bln, and a fall in public debt from 10.5% in 2010/11 to 5% of GDP. Can the US administration and the USD continue to dodge market fixation with public deficits ahead of the November mid-term elections?
The euro depreciated vis-à-vis the U.S. dollar today as the single currency tested bids around the US$ 1.2255 level and was capped around the $1.2350 level. The common currency moved off of intraday lows during the North American session as U.S. equities reversed course and most of their intraday losses evaporated. European Central Bank member Quaden said the eurozone is unlikely to encounter a double-dip recession while Bank of Israel Governor Fischer suggested some countries may not remain in the eurozone. The Spanish government denied rumours that Spain requires assistance with external finance. ECB member Gonzalez-Paramo called for a revival of the securitization market in the eurozone and ECB member Ordonez said bank restructuring will be complete before summer. The ECB again failed to get any bids in a seven-day U.S. dollar term auction, the third consecutive time this has happened, and this underscores the comparative attractiveness of swap deals. The European Union today called on countries to reduce their deficits, adding a “cold shower” consolidation plan may be required in some instances. ECB member Noyer called for more exchange rate flexibility and Germany’s Bundesbank reported banks’ capital requirements are likely to increase significantly. Data released in the eurozone today saw May EMU-16 consumer price inflation increase 0.1% m/m and 1.6% y/y at the headline level and 0.8% y/y at the core level. The ECB will publish its June monthly report tomorrow. In U.S. news, data released today saw MBA mortgage applications climb 17.7% while May housing starts were off 10.0% to an annualized 593,000 units and building permits were off 5.9% m/m to an annualized 574,000 units. Also, May headline producer price inflation was off 0.3% m/m and 5.3% y/y and the ex-food-and-energy component was up 0.2% m/m and 1.3% y/y. Additonally, May industrial production was up 1.2% with capacity utilization stronger at 74.7%. May consumer price inflation data will be released tomorrow. There is speculation that Fed officials may reduce their forecasts for U.S. economic growth on account of European economic woes when policymakers convene next week. In April, Fed officials estimated the economy would expand between 3.2% and 3.7% in 2010. Euro offers are cited around the US$ 1.2460 level.
¥/ CNY
The yen appreciated vis-à-vis the U.S. dollar today as the greenback tested bids around the ¥91.10 level and was capped around the ¥91.80 level. Bank of Japan kept its economic assessment unchanged overnight after improving its assessment in May following better capital spending and foreign trade. The central bank reported Japan’s economy is evidencing a “moderate economy” and said the “degree of severity has eased somewhat” in employment and income conditions. The yen’s gains today were largely precipitated by renewed concerns over Europe’s sovereign debt struggles. Yesterday, BoJ unveiled details regarding a ¥3 trillion lending program to stimulate the economy and counter deflation. Data released in Japan overnight saw the April tertiary industry index improve to +2.1% from the revised prior reading of -2.7% while May machine tool orders were up 192.5% y/y. The Nikkei 225 stock index climbed 1.81% to close at ¥179.26. The euro moved lower vis-à-vis the yen as the single currency tested offers around the ¥111.70 level and was capped around the ¥113.30 level. The British pound moved lower vis-à-vis the yen as sterling tested bids around the ¥134.50 level while the Swiss franc moved higher vis-à-vis the yen and tested offers around the ¥81.30 level. In Chinese news, the U.S. dollar appreciated vis-à-vis the Chinese yuan as the greenback closed at CNY 6.8334 in the over-the-counter market, up from CNY 6.8333. It is being reported that China’s holdings of U.S. assets may now be at or near all-time highs.
£
The British pound depreciated vis-à-vis the U.S. dollar today as cable tested bids around the US$ 1.4745 level and was capped around the US$ 1.4830 level. New U.K. Chancellor of the Exchequer Osborne announced Bank of England will obtain new powers to prevent financial crisis and reduce credit risk. Osborne’s first “Mansion House” speech is scheduled for tonight and more information about the U.K. economy may be forthcoming. Osborne is expected to give the BoE more responsibility for macro prudential supervision. Former BoE Chief Economist Vickers will lead a new panel to review the U.K. banking sector. Data released in the U.K. today saw the May claimant count rate decline to 4.6% as the jobless claims were off 30,900. The April ILO unemployment rate ticked lower to 7.9%. The euro came off vis-à-vis the British pound as the single currency tested bids around the £0.8285 level and was capped around the £0.8335 level.
CHF
The Swiss franc appreciated vis-à-vis the U.S. dollar today as the greenback tested bids around the CHF 1.1275 level and was capped around the CHF 1.1340 level. Swiss national bank will released its interest rate decision tomorrow and is expected to keep its three-month Swiss franc Libor target rate at 0.25%. Data released today saw the June ZEW survey decline sharply to 17.5 from 40.5 and data to be released tomorrow include Q1 industrial production. U.S. dollar offers are cited around the CHF 1.1470 level. The euro came off vis-à-vis the Swiss franc as the single currency tested bids around the CHF 1.3870 level while the British pound moved lower vis-à-vis the Swiss franc and tested bids around the CHF 1.6685 level.
A rally in risk assets was accompanied by a fall in ST volatility this week, boosting demand for AUD, NZD and CAD. A rejection of key resistance targets and a lack of conviction in stocks leaves many participants pondering whether to further reduce risk exposure until clearer trends emerge. The performance of sovereign debt and talk of a yuan reval will dictate near-term direction, though Q2 corporate updates from the US will soon appear on the radar as we move into the second half of June. A more hawkish inflation message from the SNB next week or a decision to drain liquidity could cause selling of EUR/CHF to resume. We continue to treat rallies in EUR/G10 with suspicion and reiterate our mediumterm EUR/USD target of 1.15. Recap
The fx summary virtually reads like a copy of two weeks ago with the AUD outclassing the G10 table backed by a relief bounce in risk assets and a recovery from technically oversold conditions. The currency rallied 2.9% vs the USD through 0.84 and gained 2.6% vs the JPY and 2.5% vs GBP below 1.72. Supportive comments by China briefly lifted EUR/USD over 1.21 but the cross ran into profit taking on Friday. A poor overall performance for GBP resulted in sterling losing ground against all but two currencies of the G10, namely the USD and the JPY. GBP/USD hit a 1.4759 high on Friday but reversed sharply into the close to finish below 1.4550, near the middle of the 4-week trading range. EUR/GBP bounced off a 0.8211 low to close over 0.83.
The BoE left Bank Rate on hold at 0.50% and the asset purchase limit was also left unchanged, at £200bln. Inflation expectations accelerated to 3.3% from 2.5% according to the quarterly BoE survey, but proved no fillip to GBP or a concern to gilts as risk aversion drove yields lower. The UK global trade deficit narrowed to £7.27bln in April from £7.52bln in March. Input prices fell a smaller than forecast 0.6% m/m in May. Output prices rose 0.3% m/m (up 0.1% excluding energy). Manufacturing output fell 0.4% m/m in April, registering its first drop in three months. Confidence in economic recovery was buoyed by solid NIESR GDP data. Covering the three month period to May, GDP rose 0.6% q/q. Data for the quarter to April was revised up to 0.7% from 0.5%.
UK 5y swaps closed below 2.50% after running up to a high of 2.57%. 3mth Libor held steady at 0.73%, causing the 3mth Libor/5y swaps curve to flatten to 176bp. The 3mth Libor/ois spread widened a fraction to 24bp. The 2y/10y swaps curve flattened to 194bp, the lowest since last October. Profit taking after a solid new 10y auction pushed 10y gilts to 3.58% on Thursday, but buyers returned on Friday, squeezing yields back below 3.50%. National Express (225mln) and KFW (800mln) were the two issuers of sterling paper. G10 FX update - EUR/CHF - SNB meeting on June 17
Extreme levels of volatility in EUR/CHF have been observed and will in our view continue to characterise the short and medium-term outlook. After trading in a 1.46-1.48 range over the best part of Q1, the cross registered sharp swings to the downside punctuated by occasional relief rallies in March, May and June, taking out key technical levels at 1.46, 1.43 and 1.40. The pair hit a 1.3734 low on June 9. Intervention policies by the SNB and developments in Eastern European credit and mortgage markets are likely to be a key factor in the direction of EUR/CHF over the forecast horizon which we believe offers scope for additional depreciation in the short-term.
The volatility in EUR/CHF can be partially attributed to the EU sovereign debt crisis and SNB intervention to curb excessive appreciation of the Franc. The systematic intervention by the SNB is conducted through the purchase of foreign currency incl EUR denominated bonds. The SNB has been operating a de facto policy of quantitative easing since March last year, resulting in an extraordinary upswing of the Bank's currency reserves. Total currency reserves surged more than 50% last month alone to just over $260bln to stop EUR/CHF from grinding further below 1.38. Total reserves stood at just $52bln a year ago.
Though Swiss CPI inflation is still forecast to edge back up to 2% over the next two years, the SNB is worried that Franc strength vs the EUR, the currency of its main trading partner, could cause deflationary pressures to return. The safe haven status has also helped the Franc to strengthen as fears of debt and credit contagion from Greece spreads through the euro zone. How the EU debt crisis evolves and whether the 440bln euro Stability Mechanism is eventually triggered may play a prominent role over the direction of EUR/CHF as markets consider the implications of ambitious fiscal consolidation programmes on euro zone economies and the ability to service public debt. Wild swings in EUR/HUF on June 6 demonstrated that moves in EUR/CHF may also depend on economic and credit developments in Eastern Europe where EU banks carry a high exposure through Franc denominated mortgages.
With inflation in Switzerland running ahead of the March SNB projections and the economy and exports so far doing well to resist the stronger Franc, questions are now raised whether and how soon the SNB will end its ultra-loose monetary policy strategy. With interest rates pinned at 0.25% since March-08, the SNB may decide to start mopping up excess liquidity, with higher rates following later this or early next year. This is in contrast to the ECB where additional liquidity operations were decided this week to bolster inter-bank lending. We also expect the refi rate to stay on hold for longer.
