MORNING BRIEFING: Beige Book shows some districts slowing economy
What’s new: United States: Financial state of emergency in California United States: Beige book report shows some districts slowing economy Euro zone: Tougher lending rules for banks from ECB United Kingdom: No tacit agreement to keep low rate China: IMF board split on China’s exchange rate debate Japan: BOJ’s Kamezaki says won’t base policy on forex New Zealand: RBNZ raises interest rates by 25bps to 3.00%
Today:
Rates in Asia and Indices: EURUSD: 1.3045 - 1.2978. USDCHF: 1.0581 - 1.0517. GBPUSD: 1.5631- 1.5584. EURJPY: 113.97 – 113.18. USDJPY: 87.52 – 87.10. DowJones: 10'497.88 -0.38% NASDAQ: 2'264.56 -1.04% S & P 500: 1'106.13 -0.69% Nikkei: 9'696.02 -0.59% Shanghai: 2'648.60 +0.57% Gold: $ 1'167.20 Crude Oil: $ 77.22
Comments: In an interview, British finance minister George Osborne declared ‘There is no tacit agreement with Bank of England Governor Mervyn King on keeping interets rates low. He is absolutely independent, as is his Monetary Policy Committee.'
New Zealand’s Central bank lifted interest rates by 25bps to 3.0%, but scaled back its plans for further move. The New Zealand Dollar fell sharply after the Reserve Bank of New Zealand signalled the pace of further interest rate hikes would be less than earlier thought. The kiwi fell to a low near $0.7202, from about $0.7287 before the announcement.
The Beige Book, released yesterday at 2000 CET, reports on conditions in all 12 districts that are part of the Federal Reserve system. The report, based on information before July 19, said activity "continued to increase, on balance" though Cleveland and Kansas City said business held steady. "Among those districts reporting improvements in economic activity, a number of them noted that the increases were modest, and two districts, Atlanta and Chicago, said the pace of economic activity had slowed recently," the Fed said.
The Euro is still hovering near an 11-week high against the US Dollar reached earlier this week. EURUSD is up to 1.3045 today, just shy of the recent high reached 27th of July. Against the Yen, the single currency dipped on high selling by Japanese exporters. Traders are expecting more offers to emerge if the Euro rises to above 115 Yen.
(Reuters) - The euro struck a two-month high against the yen and stayed within reach of an 11-week high against the dollar on Wednesday, as markets stayed in risk-on mode on robust European bank earnings and solid economic data.
The Australian dollar bucked the trend, after weaker-than-forecast Australian inflation dented rate hike expectations.
Risk sentiment had been boosted on Tuesday as European shares hit a five-week closing high. Two of Europe's top banks, UBS AG (UBSN.VX)(UBS.N) and Deutsche Bank AG (DBKGn.DE)(DB.N), posted results that reassured investors following last week's regulatory stress tests.
A rise in Germany's GfK consumer sentiment indicator on Wednesday to its highest level since November has also boosted hopes that the economic outlook in Europe is improving.
Asian equity markets tracked the positive tone, as Japan's Nikkei 225 Index .N225 and China's Shanghai Stock Exchange .SSEC both jumped more than 2 percent on Wednesday.
"Clearly there's a risk-on situation as the market is starting to believe there's a European recovery in place, but there is thin liquidity behind it," said Neil Mellor, currency strategist at Bank of New York Mellon.
At 3:24 a.m. ET, the euro was trading up around 0.3 percent versus the yen at 114.50, close to a two-month high hit in early European dealing at 114.74 on trading platform EBS.
Technical analysts said the picture was becoming bullish, as euro/yen continued to make gains within its Ichimoku cloud. The top of the cloud was seen as key resistance at 117.86.
The euro stayed within touching distance of an 11-week high against the dollar at $1.3045 hit the previous day. Traders said an option barrier at $1.3050 would need to be taken out for a move toward Fibonacci resistance at $1.3125, which is a 38.2 percent retracement of the December-June move.
Large option expiries were reported by traders at $1.3000 and $1.2850, potentially slowing the euro's gains on the day.
Focus for the morning was the ECB's three-month liquidity operation, with the result due around 5:20 a.m. ET.
"The tenders have shown there are a still a large number of European banks which are clearly hooked on ECB funding, which isn't a good situation," said BNYM's Mellor.
Results of a Portuguese bond auction were also keenly awaited, set for release around 0930 GMT.
AUSSIE SLIDES ON CPI DATA
The Australian dollar slid 0.7 percent to $0.8949, having dropped from a 11-week high of $0.9069 reached the previous day.
Australian consumer prices rose much less than expected last quarter and core inflation slowed to its lowest in more than three years, ruling out the need for a rate rise next week and possibly the rest of the year.
"The Aussie has given back some of its recent gains as CPI data prompted investors to push back expectations for higher rates," said Ayako Sera, a market strategist at Sumitomo Trust & Banking.
"But the Aussie is likely to keep drawing support from Australian interest rates, which are still the highest among industrialized countries."
The dollar index .DXY was down 0.2 percent at 82.011, staying close to a 12-week low hit on Tuesday at 81.824.
(Additional reporting by Rika Otsuka; Editing by Susan Fenton)
€ The euro depreciated vis-à-vis the U.S. dollar today as the single currency tested bids around the US$ 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.
€ The euro appreciated vis-à-vis the U.S. dollar today as the single currency tested offers around the US$ 1.3005 level and was supported around the $1.2875 level. The common currency briefly traded above the US$ 1.3000 figure before settling back during the North American session. Dealers continued to chase the pair higher following the release of Friday’s stress test results on 91 eurozone banks, the details of which were better than expected. Data released in the U.S. today saw the June Chicago Fed national activity index decline to -0.63 from the revised prior reading of +0.31 while the July Dallas Fed manufacturing activity index fell sharply. Also, June new home sales evidenced a surprising 23.6% m/m increase to an annualized 330,000 units. May CaseShilller home prices data will be released tomorrow along with July consumer confidence data and and the July Richmond Fed manufacturing index. Philadelphia Fed President Plosser reported “there is underlying strength that is still there,” adding there is not much of a role for additional Fed action in the near term but conceded Fed policymakers “have ammunition to act if we want to.” San Francisco Fed President Yellen, the presumed next Vice Chairman of the Fed, reported it would be “risky” to adopt a long-run inflation goal of 4% and said regulation and supervision are the “first line of defense” against financial risks. In eurozone news, June M3 money supply data will be released tomorrow followed by the ECB’s bank lending survey on Wednesday. European Central Bank President Trichet reported the stress test on the banks was a “very important transparency exercise” while ECB member Ordonez said the tests “for sure have been enough to restore investor confidence.” Eurogroup chaiman Juncker said the stress tests evidence a “robust” European banking industry. Euro offers are cited around the US$ 1.3265 level.
¥/ CNY The yen appreciated vis-à-vis the U.S. dollar today as the greenback tested bids around the ¥86.80 level and was capped around the ¥87.70 level. New political party “Your Party” called on the government to weaken the yen and undertake a more expansionary fiscal policy to stimulate the domestic economy and counter deflation. Nomura, Japan’s largest brokerage, downgraded its assessment of Japanese equities to “neutral,” citing a bleaker profit outlook and decelerating economic growth prospects. Nomura expects economic growth of 2.6% this fiscal year and 1.5% next fiscal year. Data released in Japan today saw the June merchandise trade balance increase to ¥687 billion from the revised previous tally of ¥320.9 billion. The June corporate services price index will be released overnight. The Nikkei 225 stock index climbed 0.77% to close at ¥9,503.66. 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 ¥112.20 level and was capped around the ¥113.45 level. The British pound moved higher vis-à-vis the yen as sterling tested offers around the ¥135.55 level while the Swiss franc moved lower vis-à-vis the yen and tested bids around the ¥82.50 level. In Chinese news, the U.S. dollar depreciated vis-à-vis the Chinese yuan as the greenback closed at CNY 6.7790 in the over-the-counter market, down from CNY 6.7799. The June leading index will be released this week along with the July MNI business conditions survey and July PMI manufacturing. People’s Bank of China Deputy Governor Hu Xiaolian reported the “fixed” yuan exchange rate system caused excess liquidity that may cause “heightened inflation expectations and speculation in assets.”
£ The British pound appreciated vis-à-vis the U.S. dollar today as cable tested offers around the US$ 1.5515 level and was supported around the US$ 1.5405 level. Data to be released in the U.K. tomorrow include CBI July reported sales data followed by July Nationwide house prices data on Thursday and other mortgage and consumer credit numbers. Bank of England announced its new Financial Policy Committee will have eleven members and be in place by the autumn. The key functions of the Financial Services Authority will be relegated to the BoE. CEBR reported BoE will not need to raised rates for eighteen months. Chief Economist Dale has warned of lower economic growth, higher inflation, and rising unemployment. There is talk of a possible three-way split on the MPC this year if one or more policymakers voted to expand policy accommodation. Some believe the MPC may resort to increasing its asset purchase program. Cable bids are cited around the US$ 1.5140 level. The euro depreciated vis-à-vis the British pound as the single currency tested bids around the £0.8325 level and was capped around the £0.8380 level.
CHF The Swiss franc appreciated vis-à-vis the U.S. dollar today as the greenback tested bids around the CHF 1.0490 level and was capped around the CHF 1.0555 level. The June UBS consumption indicator will be released tomorrow followed by the July KOF Swiss leading indicator on Friday. U.S. dollar offers are cited around the CHF 1.0980 level. The euro depreciated vis-à-vis the Swiss franc as the single currency tested bids around the CHF 1.3565 level while the British pound moved higher vis-à-vis the Swiss franc and tested offers around the CHF 1.6345 level.
In the absence of any notable European economic data on Monday, the regional day has been dominated by the performance of equity indexes in the aftermath of the release of the bank stress tests on Friday.
European equities are currently mixed. The German DAX stock index was recently lower by 0.2% at 6,156 after falling as low as 6,141. Meanwhile, the Eurostoxx 50 is 0.1% higher at 2,721 versus a high of 2,741 and a low of 2,711.
Earlier on Monday, regional markets heard from a couple of European central bankers. In an op-ed written in Frankfurter Allegemeine Zeitung, ECB Executive Board member Lorenzo Bini Smaghi said the EU-IMF loans package is the “best route” to make sure Greece achieves fiscal consolidation.
He added that decisions made by Athens in recent weeks indicate that the Mediterranean country will be able to reduce its budget deficit to manageable levels.
In an interview with Spanish radio station Cadena Ser, ECB Executive Board member Jose Manuel Gonzalez-Paramo said that the European stress tests indicate the strength of the regional banking sector.
Noting that they were very demanding, the central banker added that he was satisfied with the tests’ results.
Against this backdrop, the euro is slightly weaker against the U.S. dollar. However, the three Scandinavian currencies are all underperforming the euro.
Outperforming is the pound sterling after UK Treasury Minister Mark Hoban told an audience in London that the government will create a consumer protection and markets agency.
He added that prudential regulation will be overseen by the Bank of England. Hoban also said that the central bank unit, whose members will be from banks, will also regulate clearing houses and is scheduled to meet four times a year.
The remainder of Monday will focus on the U.S. June new home sales report.
After last week's MPC minutes, retail sales and GDP reports, the UK data calendar thins out considerably this week. The latest CBI Distributive Trades and housing/lending surveys provide the main focus in a week of second tier data. The CBI is expected to report that retail sentiment picked up slightly in July, boosted by the hot weather and sales of seasonal clothes lines. We expect the net balance of retailers reporting a rise in sales to have risen from -5% to +3% this month. In keeping with signs that the UK housing market may be starting to soften again, the Nationwide house price index is forecast to have dropped by 0.4% in July; mortgage lending and approvals in June are also expected to have softened.
By contrast, after Friday's EU bank 'stress tests', this week sees a variety of releases across the euro-zone, including euro M3 money supply, the latest European Commission surveys, preliminary July CPI data and July German unemployment figures. Euro area monetary statistics are of particular interest as financial market volatility has a direct bearing on bank funding costs. Surprisingly, bank lending growth to the euro-zone private sector picked up modestly in May, despite extreme market volatility. But it is not clear this trend will continue uninterrupted going forward. Meanwhile, we look for a modest improvement in the Commission's economic sentiment index to 99.0 from 98.7, amid continued healthy demand from emerging Asian economies for euro-zone exports. On inflation, the "flash" estimate of euro-zone annual CPI is predicted to register 1.7% in July, from 1.4% previously. At July's ECB press conference, Jean-Claude Trichet noted that some pick-up in price pressures was likely in the short term.
In the US, the advance estimate of Q2 GDP on Friday provides the data highlight of the week, although before then other more timely releases will also draw strong interest. We look for annualised GDP growth from 2.7% in Q1 to 2.8% in Q2, underpinned by rising business investment. This release will also contain annual revisions to GDP growth for the past three years. The Fed's Beige Book, on Thursday, is likely to underline the dovish tone of the June FOMC minutes and Fed chairman Bernanke's testimony last week. Together with a likely softer reading for July consumer confidence earlier in the week, it raises the possibility that GDP growth may remain relatively subdued in the current quarter. The economic slowdown appears to be weighing heavily on the housing market, although the latest data also reflect the expiration of key government initiatives. While we look for a small rise in June new home sales on Monday, this comes after a record 33% drop to an alltime low of 300,000 in May. In other events, the Treasury will auction $104bn of notes this week.
Elsewhere, key Australian price data are out this week. CPI inflation is forecast to rise from 2.9% to 3.3% in Q2, largely reflecting a 25% increase in tobacco excise taxes, as well as higher interest rates and health costs. While this is likely to take inflation above the upper end of the RBA's 2-0%-3.0% target range, the detail of the inflation report, rather than the headline number, is likely be more influential in determining whether the RBA follow up with a rate rise at its next meeting in August.
Elsewhere in the region, the South Korean economy is expected to have expanded by a strong 1.2%q/q in Q2, a rise of 6.8% on the year. Although slightly slower than the 2.1% quarterly growth registered in Q1, this would still represent a strong outturn and justify interest rate increases to contain building inflationary pressures.
The pound sterling is much higher after UK second quarter advanced GDP easily beat expectations, growing at 1.1% annualized pace compared to +0.6% expected; year-over-year GDP rises 1.6% compared to 1.1% expected. Cable has rallied as high as 1.5450 but has since pulled back and appears to be retracing.
The other data point in European trading was the German IFO business climate survey. It crushed expectations as it rose to 106.2 in July compared to 101.5 expected and 101.8 prior. Europe continues to put out better-than-expected economic data. ECB executive board member Jose Manuel Gonzalez-Paramo said recent data reduces the risk of a double-dip recession, which effectively reflects the market sentiment (or even understates it).
The major event in North American trading will be the noon ET (5 p.m. in London) results of the European stress tests. 91 banks were tested by 20 different regulators so there is a considerable amount of uncertainty. Today, Goldman Sachs released a survey that indicated that the consensus of banks that will fail stress tests is 10.
Leaks are possible in the hours leading to the results and it’s likely that some market participants already have inside knowledge of what has transpired. Spanish newspaper El Pais reports that several Spanish banks have failed the stress tests. Gonzalez-Paramo said he has “no doubt” the impact of the tests will be “very positive” for markets. Similarly, ECB executive board member Gertrude Tumpel-Gugerell said the stress test results will send a “clear message” about the resilience of Europe’s financial system. Given all the leaks and the prevailing sentiment, it’s highly unlikely that there will be some sort of negative shock in the results.
Outside of Europe, there is a focus on yen levels. In Asia-Pacific trading, Japanese Cabinet Office official Keisuke Tsumura says yen has been “a bit too high.” We suspect further verbal intervention if USD/JPY falls to 85.00 with actual intervention only coming if the pair falls close to 80.00.
Thursday’s main economic news included more testimony from Fed Chairman Ben Bernanke, some better-than-expected U.S. housing data, and a surprise rise in euro zone consumer confidence.
In his annual testimony to the House panel on Capitol Hill, Bernanke said, “Unemployment is the most important problem we have right now.”
He added that the Fed is prepared to take action if the economy “doesn’t continue to improve, if we don’t see the kind of improvements in the labor market that we are hoping for and expecting”.
Bernanke listed possible actions the central bank may undertake: signaling the path of interest rates, cutting payments on excess reserves and engaging in further quantitative easing.
Also in the U.S., some above-consensus housing data was released. Existing home sales fell to a 5.37 million pace in June, better than expectations for a drop to 5.10 million from 5.66 million in May.
Meanwhile, sales slipped by 5.5% on the month, above calls for a 9.9% decline to follow the 2.2% fall in May
The surprise in the data was followed by a rally in the U.S. S&P 500 stock index, which helped risk currencies.
Ultimately, the S&P 500 closed 2.3% higher and at its strongest level since last Thursday.
Investor sentiment was also supported by better-than-expected Q2 earnings from Caterpillar and 3M.
Caterpillar announced Q2 earnings per share (EPS) of $1.09, exceeding calls for $0.84, while 3M revealed EPS of $1.54 versus the Street’s estimate of $1.47.
Against strong risk appetite in U.S. stocks, all G10 currencies advanced against the U.S. dollar. The Australian and New Zealand dollars outperformed.
Aside from the yen, the pound sterling made the smallest gains against the U.S. dollar, though its advance (by around 100 pips) was nonetheless impressive.
Aside from risk appetite, the euro, which rose above $1.2900USD once again on Thursday, was supported by an upside surprise in euro zone consumer confidence. It surprised expectations for it to remain at -17 in July by rising to a -14 print.
With no major Asia-Pacific releases scheduled for Friday, market participants’ attention now turns to the German IFO survey, UK Q2 GDP and Canadian consumer prices data.
* Stress test results are in--Yawn * Sterling bolstered as some of the economic gloom lifts * German recovery becoming difficult to ignore * JPY-strength becoming an issue in Tokyo * Key data and events to watch next week
Stress test results are in--Yawn
The long-awaited results of the Eurozone banking sector stress tests were delivered on Friday and markets greeted them with a collective yawn. Earlier leaks led markets to conclude the adverse scenarios would not be especially stringent, causing most to discount the results. To re-cap, only 7 of the 91 banks tested failed, requiring a total of only EUR 3.5 bio to be raised in new capital. To put that number in perspective, some analysts reckon Spanish banks alone need to raise EUR 40 bio to be adequately capitalized. The stress tests also excluded the potential for a sovereign debt default and focused only on securities held in banks' short-term trading books, and not the 90% of banks' government bond holdings that are classified 'hold to maturity.' But the basis of the European debt crisis was exactly that--banks holding large amounts of Euro-area government debt were vulnerable in the event of a sovereign default. The lack of credibility of the stress tests raises the risk that market concerns over Euro-area financial sector stability will resurface, leading to another round of speculation that the EUR is a doomed currency.
The one potential bright spot to emerge from the stress tests are disclosures of individual bank's holdings of government debt of Greece, Spain and Portugal, but those numbers were not available on Friday. They are expected to be divulged over the next two weeks. Revealing which institutions hold what amounts of troubled government debt will allow banks to more accurately determine which of their counterparties are most risky, and potentially improve credit market functioning and overall stability. Another possibility is that revealing government debt will lead to a two-tiered lending environment, with those holding significant exposures being forced to pay up or rely further on the ECB. We will be watching closely to see how European inter-bank lending rates move to start next week as the decisive measure of the market's acceptance of the stress test results. Going into the stress test results on Friday, with all that was known about the tests beforehand, 3-month Euribor rates were at the highest levels for the year, suggesting that credit markets remain on edge.
Against this backdrop, risk assets performed reasonably well in the past week, with stocks rebounding and making new gains, JPY-crosses at their highs (but still below recent highs), and the USD nearer to its lows against most others. Continued positive corporate earnings reports appear to be holding sway, but the overall environment remains extremely fragile and of low conviction. At the close of the week, risk looks like it may test higher next week, just as it looked set to extend losses at the end of last week. The passing of the stress test 'event risk' may propel risk higher in the near-term, but with more questions raised than answered, we think gains in risky assets are likely to prove unsustainable. As well, recent positive data surprises obscure the risks from a pending US slowdown into year-end, which is likely to echo around to other major economies. In this environment, we would suggest maintaining an extremely short-term trading bias and remaining alert for sharp intra-day reversals. Sterling bolstered as some of the economic gloom lifts
There is a broad consensus that the second half of this year will be difficult for the UK economy as it struggles in the face of budget reform. The news that Q2 GDP was far stronger than expected (+1.1% q/q) doesn't change this impression but it significantly reduces the chance that the UK economy will fall back into double dip recession on the back of austerity measures. The additional growth should soften the government's budget projections and should help heal the deficit a little faster than previously expected. Since UK growth in Q2 was quicker than expected it follows that inflation potential may also be a little firmer. Recent economic data does not support this view with headline CPI slipping back and average earnings moderating. That said there is sufficient fodder in price data for the UK inflation hawks to remain on edge. The impact of the GDP report was thus to send sterling sharply higher. EUR/GBP pushed below the 0.8390 technical support following the data release. A fall below 0.8310/20 could suggest another leg lower. Cable has broken above the USD1.5330 level which has strengthened the technical outlook. A break above USD1.5450 may see towards 1.5525.
German recovery becoming difficult to ignore
The German July IFO survey surged to 106.2 in July, outpacing both the market consensus and the June data by a generous margin. The release comes on the heels of stronger than expected German PMI data and provides more evidence that Germany's economic recovery continues to gather pace despite the loss of momentum in the US economy. Both the current and expectations components of the IFO surprised on the upside. Recent German surveys have shown some hesitancy in the expectations components, so the IFO's result suggests that the impact of the sovereign debt fears may have peaked. The current disparity between US and German economic data provides an interesting backdrop for the continued move higher in Euribor; though the ECB have attributed this to market forces. While there is little risk that the ECB will hike the refi rate at least before the middle of next year, the firmer Euribor is likely to offer EUR/USD decent near-term support. Medium-term the EUR remains susceptible to difficulties that some European banks may have in recapitalising themselves. Near-term, the USD1.2700 support continues to hold solid and risk is for another run at the USD1.3000 level.
JPY-strength becoming an issue in Tokyo
Japanese officials have stepped up their verbal rhetoric against continuing JPY strength, with comments coming from senior leaders at the BOJ and the MOF. Most highlighted the risk of a stronger yen being a significant danger to future growth in the Japanese economy. This week's Q2 earnings reports, as well as the highly awaited announcement of the European stress tests were major sources of pessimism over the past few weeks. The fact that both came and went without much fanfare has calmed the markets and reassured investor sentiment. Thus, the Yen has weakened against every major currency in the G10 this week; of note: USD/JPY (86.50 to 87.40), EUR/JPY (111.60 to 112.90) and AUD/JPY (75.25 to 78.30) rose over 4% this week alone.
The BOJ will continue to monitor market activity closely as increased global risk aversion is still on the forefront and could lead to fresh JPY-strength. There have been rumors of semi-official interest to buy USD/JPY down around 86.20/30 in the short term and we're likely to see further verbal intervention if it reaches 85.00. However, it is rather unlikely the BOJ will take further measures on additional strength unless it rapidly appreciates towards the 80.00 level, then the odds of actual intervention would become highly probable.
Key data and events to watch next week
The calendar in the US is moderately busy in the week ahead. Housing numbers kick off the week with June New Home Sales on Monday and the May S&P/CaseSchiller Home Price Index to follow on Tuesday. Also on tap for Tuesday are the Richmond Fed Manufacturing Index and the Consumer Board's Confidence Index for July. The data slate for Wednesday sees Durable Goods Orders for June followed by the Fed's Beige Book in the NY afternoon. Weekly Jobless Claims are scheduled for its regular release on Thursday. Friday's data sees Q2 GDP, Q2 Personal Consumption, Q2 GDP Price Index, and Q2 Employment Cost Index. Data for the week wraps up with Chicago PMI and University of Michigan Survey of Consumer Confidence Sentiment for July.
In the Eurozone, Wednesday sees the release of the Business Climate Indicator, Consumer Confidence, and Industrial Confidence numbers for July. Friday closes out the week with June Euro-zone Unemployment Rate and July CPI Estimate. In Germany, Tuesday sees the August GfK Consumer Confidence Survey and June Import Price Index. The data session comes to a close on Thursday with July Consumer Price Index and July CPI - EU Harmonized. In addition to the upcoming data releases, there will be top tier Q2 and first half earnings releases, kicking off with Deutsche Bank on Tuesday.
A light week of data in the UK starts with July Nationwide House prices, June Net Consumer Credit, and June Mortgage Approvals on Tuesday. There is no significant data due out until Friday, however the BOE's King, Bean, Fisher, and Sentance will be testifying on the May Inflation Report at Parliament's Treasury Committee on Thursday. Friday closes out the week with the July GfK Consumer Confidence Survey.
Data out of Tokyo is moderate, starting with June Retail Trade and Large Retailers' Sales on Wednesday. Thursday sees June Unemployment Rate, July Tokyo CPI, June National CPI, and June Industrial Production. Friday wraps up the week with June Housing Starts.
Canada begins a light week of data with Industrial Product Prices and Raw Materials Price Index for June on Thursday. The data session comes to a close with May Gross Domestic Product MoM on Friday.
A light calendar down under begins with Q2 PPI and CPI due out on Sunday and Tuesday. The week wraps up with June Private Sector Credit on Thursday. New Zealand begins the week with July NBNZ Business Confidence on Tuesday. Wednesday will have the RBNZ rate decision with expectations for a 25 basis point hike to 3%. Data continues on Wednesday with June Trade Balance and wraps up on Friday with June Building Permits.
Weekly Economic and Financial Commentary U.S. Review
Home Is Where the Economy's Heart Is
* Housing starts and existing home sales declined in June, reflecting the winding down of homebuyer tax credits. * Building confidence fell to 14 in July, and June's numbers were revised down slightly. * The effect from the unwinding of various economic stimulus programs is evident in other data, with the leading indicators declining 0.2 percent and weekly firsttime unemployment claims bouncing back to 464,000. * Bernanke's midyear report to Congress outlined possible future steps the Fed may take to boost economic growth.
We Have Got to Get in Shape
If the state of the nation's housing market is at the center of the economy's near-term prospects, then we have got to get in shape. Nearly all of the major housing indicators reported this past week showed more weakness than was widely expected, suggesting that the payback from the homebuyer tax credit program will be a bit deeper and longer lasting than many had hoped. One of the most disconcerting pieces of news was housing starts, which fell 5 percent in June, following a downwardly revised 14.9 percent drop in May. A slight 2.1 percent rise in building permits initially took some of the sting out of the headline number, but all of that gain was in the volatile multi-family unit series. Permits for new single-family homes fell 3.4 percent, following 10.3 percent drops in both May and April
Single-family permits are now running at just a 421,000-unit pace, well below the recent trend in starts. When you couple this with July's decline in the Wells Fargo/NAHB homebuilders' index, there is no reason to expect housing starts to increase in July, and we may not see a gain in August either. With demand flat and credit for homebuilders still extremely tight, there is no incentive for builders to get out ahead of demand.
Existing home sales actually fell less that expected, but the trend remains unfavorable. Existing home sales have been harder to read because of the extension of the closing deadline for homebuyer tax credits from June 30 to September 30. The net effect of the deadline extension will be to moderate the slide in existing home sales over the new few months.
The latest data from the National Association of Realtors (NAR) shows that first-time homebuyers accounted for 43 percent of home sales, about the same as the prior month. Distressed transactions, which include foreclosures and short sales, accounted for 32 percent of existing home sales in June, and investor purchases accounted for 13 percent. One of the more worrisome aspects of the report is that the number of homes on the market increased in June and remains relatively high. There is currently a 10.6-month supply of condominiums on the market and 8.7-month supply of single-family homes.
There were also a couple of pieces of encouraging news. The median price of an existing home rose 1.0 percent from last June to $183,700. The NAR also noted that home prices rose in 10 of the 19 MSAs that report monthly, and sales increased in 12 of those 19 areas. In addition, mortgage applications for the purchase of a home rose 3.4 percent, as the lowest mortgage rates on record are beginning to pull some buyers back into the market.
Fed Chairman Bernanke delivered his midyear report to Congress this week and basically reiterated the forecast released in the minutes of the June FOMC meeting. The markets were initially bewildered that the Fed chairman did not focus more on the deterioration in economic activity and growth prospects that has occurred since that forecast was put together. He redeemed himself, however, by focusing on what steps the Fed could take to further stimulate economic activity.
U.S. Outlook
New Home Sales • Monday
Giving back two months of solid gains, new home sales plummeted 32.7 percent in May to a 300,000-unit pace, the lowest level on record. Demand for new homes was pulled forward due to the homebuyers' tax credit, which required buyers to sign a contract by April 30. With mortgage applications for purchase declining 14.8 percent in June, we expect at least one more month of payback. New home sales will likely fall 3.3 percent in June to a 290,000- unit pace, setting a new record low. Moreover, the downward trend in other indicators such as builder sentiment, permits, and starts continue to suggest weakness in the housing market. With new home sales at such depressed levels, a modest recovery in sales could be imminent following the tax credit payback, but any rebound in housing will likely be painfully slow.
Previous: 300K Wells Fargo: 290K Consensus: 320K
Durable Goods • Wednesday
Advance orders for durable goods fell 1.1 percent in May, driven largely by a 29.6 percent drop in nondefense aircraft orders. The decline in aircraft bookings was mostly payback from a 215.7 percent surge in April. The underlying components of the report were far more sanguine than the headline suggested, with machinery, primary metals and computers and electronics bookings all increasing on the month. New orders excluding the volatile transportation sector were up 0.9 percent in May and will likely continue to improve in coming months, but at a modest pace. Moderating its positive momentum, the ISM manufacturing index pulled back for the second consecutive month in June, likely suggesting slower manufacturing activity in the second half of the year. We expect headline durable goods to increase 1.2 percent in June, with orders excluding transportation rising 0.8 percent.
Previous: -1.1% Wells Fargo: 1.2% Consensus: 0.8%
GDP • Friday
The economic recovery that likely began a little more than a year ago is beginning to lose momentum. Much of the slowdown can be attributed to the fading of fiscal stimulus programs and the ending of the inventory cycle. Moreover, recently released economic data on retail sales and foreign trade also suggest the economic recovery is moderating. Core retail sales, which excludes auto dealers, gasoline stations and building material stores, rose only 0.2 percent in June and posted negative readings in April and May. This component of retail sales closely parallels personal consumption and suggests another quarter of weak consumer demand. International trade could also weigh down economic growth. The trade deficit widened in May and may shave 1.0 percentage point from second quarter GDP growth. Consequently, we expect real GDP likely grew at a 2.4 percent pace in the second quarter.
Previous: 2.7% Wells Fargo: 2.4% Consensus: 2.5%
Global Review
U.K. Economy Breaks into a Sprint, but Will It Last?
* The U.K. became the first major economy to report GDP growth for the second quarter. Expectations were blown away as growth expanded at the fastest clip in nearly a decade. But, given the fiscal deficit problems and upcoming cuts in government spending, does the U.K. economy really have the legs to keep up this pace? * Fiscal tightening is not the only concern in the United Kingdom. The overall rate of CPI inflation is well above the Bank of England's target of 2 percent, and the January increase in the value-added tax complicates the outlook for inflation.
Strong Growth Will Face Headwinds in the U.K.
During the global recession, the U.K. economy was among the hardest hit in terms of major developed economies, with real GDP falling more than 6 percent. Since then, a tepid recovery has taken hold and, until very recently, sequential economic growth has been weak even with the benefit of low base effects. But developments in the United Kingdom this week including a decent retail sales report and a stellar GDP print for the second quarter might seem to suggest something different. Is the U.K. economy finally catching the wind in its sails? Unfortunately, we suspect the sequential growth rate in the second quarter will likely be the high-water mark for the next several quarters and the expansion will slow somewhat as fiscal tightening and deficit reduction programs sap economic growth in coming quarters.
The Bank of England's (BoE) Monetary Policy Committee (MPC) on Wednesday released the minutes from its meeting earlier this month. As was widely expected, the MPC left rates at the very stimulative present level of 0.50 percent. There is clearly a divergence among the members of the MPC as to the timing of dialing back stimulus from the U.K. economy. Even as one member voted for a hike in the target benchmark rate, the minutes revealed that the "committee considered arguments in favour of a modest easing in the stance of monetary policy." While the recovery appears to be building up steam, the overall rate of CPI inflation is well above the Bank of England's target of 2 percent at present. Adding to inflation concerns, the MPC agreed that, in the near term, "inflation was likely to be higher." Our view is that fiscal tightening will exert headwinds on growth over the next few quarters, and there seems to be support for that position among the MPC members. That is why we are not forecasting a rate hike until the second half of 2011. The valueadded tax hike in January may keep the overall rate of CPI inflation elevated, but underlying inflationary pressures should remain benign.
Thursday's retail sales report for June showed that sales climbed 0.7 percent in the month and, excluding the volatile auto fuel component, sales climbed 1.0 percent. Month-to-month changes in retail sales are notoriously choppy, and it should be noted that retail sales have been tepid so far in this recovery; the jump in June may also reflect a temporary boost in spending related to England's participation in the World Cup.
Finally, at the end of the week, the United Kingdom became the first major developed economy to report second quarter GDP. U.K. GDP grew at a 4.5 percent pace in the second quarter after increasing at a mere 1.3 percent pace in the previous quarter. We do not yet have a breakdown of GDP into its various components, but preliminary details suggest a jump in construction sector spending. There was also an increase in government services output, an area where support will likely be absent in coming quarters as government spending is scaled back. Going forward, we do not expect the U.K. economy to match this pace of growth as it struggles to overcome headwinds from fiscal tightening.
Global Outlook
Japanese Retail Sales • Tuesday
The Japanese economy has expanded in each of the past four quarters, and total real GDP has retraced roughly half of the ground lost in the recession. Part of the recovery story in Japan has had to do with surprising strength in domestic demand. Indeed, retail sales climbed steadily in every month of the year through April before falling 2.0 percent in May. This moderation is consistent with our outlook for slower growth in the second half of the year. On Tuesday, retail sales data for June will become available. The June measure of consumer confidence surged to its highest level since 2007, which may suggest shoppers in Japan returned to the stores in June, but we do not expect strong consumer spending to last. Also out next week in Japan are data on housing starts and construction orders on Friday, which will shed light on the housing situation.
Previous: 2.8% Consensus: 3.2%
German CPI • Wednesday
As the largest economy in the Euro-zone, economic trends in Germany can influence decisions made by the European Central Bank (ECB). In ordinary times, the ECB targets an inflation rate of just under 2 percent. The year-over-year harmonized inflation rate for Germany slipped to 0.8 percent in June. A July CPI figure is expected on Wednesday of next week. A modest recovery in oil prices during the month could help lift the year-over-year rate somewhat, but inflation pressures will likely remain benign for the near future. This gives the ECB cover to keep its target rate at 1.00 percent, and to continue its other unconventional methods of stimulating the economy such as providing a nearly limitless supply of credit to banks. In addition to usual concerns like balancing growth and inflation, the ECB has the additional consideration of keeping the sovereign debt situation from spinning out of control.
Previous: 0.8% Consensus: 1.1%
Euro-zone Unemployment Rate • Friday
The unemployment rate in the Euro-zone held steady at 10 percent in May - the highest level of joblessness in more than 11 years. When the ECB recently dialed back its growth outlook for the second half of the year, ECB President Jean-Claude Trichet noted "weak labor market prospects" as one of the bank's primary worries.
The June unemployment number will hit the wire on Friday and will give financial markets a sense of whether hiring is picking up. We suspect employers across the Euro-zone will be sitting on their hands, holding back on big expansions or mass hiring until they become convinced that the sovereign debt situation is under control and until they get a better sense of how growth will be shaping up in the second half of the year.
Previous: 10.0% Consensus: 10.0%
Point of View
Interest Rate Watch
The Fed Still Has Some Bullets Left
Fed Chairman Ben Bernanke broke precious little new ground in his midyear report to Congress and essentially reiterated the forecast issued in the minutes of the June FOMC meeting. The problem with that is economic conditions have clearly deteriorated since the Fed last met, and many forecasts for second quarter growth have been scaled back by a full percentage point or more. With conditions widely thought to have deteriorated further, many of the questions the Fed chairman faced were whether the Fed had any bullets left if the recovery should falter.
Bernanke outlined the steps the Fed could take to provide more stimulus if conditions warranted. He stated the Fed could change its policy statement to indicate that shortterm interest rates would remain near zero for an even longer period. The Fed could also reduce the interest rate it pays on excess reserves. In addition, it could reinvest the proceeds of maturing mortgage backed securities or buy more securities.
While Bernanke's reasoning is perfectly sound, the first option already appears to have been played out. The financial markets have already pushed the first Fed tightening all the way out into late 2011. Announcing that the extended period had been extended further would seem anticlimactic at this point.
We believe the Fed is putting on a brave front. While he stood by the Fed's forecast, Bernanke also noted there are downside risks to the forecast and also spent considerable time lamenting the problems with persistently high unemployment. We expect the Fed to reduce its forecast later this year.
A second round of quantitative easing was always a long shot unless we saw severe deterioration in the economic outlook or some sort of exogenous shock. That said, the Fed would be wise to keep its powder dry. There are still huge unresolved issues with the sovereign debt crisis in Europe and municipal finances in the U.S.
Consumer Credit Insights
A New Credit Paradigm
Consumer spending as a share of real gross domestic product (GDP) has risen from 60 percent in the early 1950s to 70 percent today. These were the heydays of American consumer might. These were the days when if you wanted something, you bought it, with little thought to if you could afford it. This was fueled by a post-war economy that continued to innovate, expand and grow. More recently, this was accompanied by a severe lack of concern for the credit quality of borrowers, which led to a credit explosion. Even the Great Recession didn't stop this trend, as the peak of consumers' share of real GDP was reached in the third quarter of 2009. But the U.S. economy is going through a structural shift, characterized by a new credit paradigm.
With the passage of the Financial Regulation (FINREG) Bill, as the banks warned, credit is likely to be more scarce than it already is. The new rules will force banks to hold more capital, which could restrain loan growth. In addition, due to the reduction in interchange fees and other stipulations in the bill, banks will need to find new sources of revenue. All of this will likely lead to less reliance on credit, a more frugal consumer and a smaller consumer contribution to GDP. But maybe this isn't such a bad thing. After all, diversification is a good thing, right? Maybe it's time to focus more on trade. Increasing exports would support economic growth, likely create more jobs and would help to reduce the current account deficit. Topic of the Week
A Glimmer of Hope in the Construction Outlook
The Architectural Billings Index (ABI) is a monthly diffusion index that can serve as a leading economic indicator for nonresidential construction spending. The American Institute of Architects surveys around 300 architecture firms across the country where participants are asked whether their billings increased, decreased, or stayed the same. In June, the ABI posted a reading of 46.0, remaining below the breakeven of 50 for nearly two and a half years. The score continues to suggest further weakness ahead for nonresidential outlays.
All is not doom and gloom, however. The ABI, although still below the threshold of 50, has risen significantly since reaching its record low of 33.9 in January 2009. Despite May's subpar reading, a closer look at its components sheds some light on the future of the nonresidential construction industry. Billings for architecture firms with a commercial/industrial specialization posted a score of 50.6 in June, putting the sub-index in expansionary territory for a second consecutive month. Commercial and industrial construction spending can lag the commercial/industrial sub-index up to 11 months, which suggests better times could be less than a year away in this sector.
The ISM Manufacturing Index, which also closely parallels the commercial/industrial sub-index, has been in expansionary territory for nearly a year and could also portend future growth in the commercial and industrial sector.
It is still too early to predict what will come of the sector and nonresidential construction spending overall, however. Sure, the commercial/industrial sub-index surpassed the breakeven of 50, but two months in positive territory is not nearly enough evidence to prove a recovery. Moreover, while the index provides valuable insight, it is a diffusion index, which can only accurately portray the breadth and not the depth of the industry's strength. We expect nonresidential construction outlays will continue to fall well into 2010.
* Bernanke expecting slow recovery, but also preparing for double dip * Ifo improves markedly in July, growth in Germany set to remain robust in Q3 * Inflation rates pick up in eurozone
German Economy in a Party Mood
After flirting with 1.30 at the beginning of the week, EUR-USD weakened somewhat as the week progressed. The US reporting season delivered a mixed bag of disappointing results and (for the most part) positive surprises, causing some volatility in equity and currency markets.
Fed chairman Ben Bernanke's monetary policy testimony before the respective committees of the Senate and the House of Representatives confirmed the more cautious monetary policy stance, thus echoing the minutes of the last FOMC meeting. Mr Bernanke told the members of Congress that, in the event of a significant slowdown in the recovery, the Fed was basically prepared to take further policy actions to boost the economy. However, the Fed continues to see the US economy expanding at a moderate pace.
Speculation about the possibility of the Fed implementing further easing measures was probably one reason why US Treasury yields hit new lows. During the course of the week, the yield on 2- year Treasuries fell to an all-time low of 0.55%, and the yield on 10-year T-notes dropped to just under 3%. In the forex market, however, the Fed's dovish rhetoric helped to strengthen the dollar. The dollar's rebound could also reflect fears of a global economic slowdown, as even though the short end of the US curve is still extremely firm, the interest rate advantage of 2-year Bunds over the equivalent US bonds narrowed by nearly 10 to 15 basis points during the course of the week.
This continued until Friday, when the preliminary ifo business climate results were released. They revealed a further significant improvement in the business climate in Germany in July; the index rose from 101.8 to 106.2 - its biggest increase since German reunification. At 106.8, the current assessment is now nearing its top level; only during reunification and the boom of 2006- 2008 has it been higher. It is also remarkable that, despite this positive assessment, the business expectations for the next six months have risen by a further three points to 105.5. What is more, all sectors - manufacturing, wholesaling, retailing and construction - are unanimous in their positive assessment of the business situation.
The business climate data are the first concrete signal that German and European robust economic growth will continue in the third quarter. At around 1.5% quarter-on-quarter, Q2 German GDP growth is set to overstate the trend. However, the business climate bodes well for Q3 too - in spite of the sovereign debt crisis in southern Europe and the austerity measures.
In the short to medium term, the majority of economic data from Europe are likely to be upbeat. In addition to the purchasing managers indices and the ifo business climate, Q2 GDP figures from the UK - with a sharper-than-expected quarter-on-quarter increase of 1.1% - give a foretaste of what is to come.
This could also ease the sovereign debt problem to some extent. At this point of time, we cannot say what risks the European banking stress tests, which are due to be published on Friday evening, will reveal. In our view, however, the fact that the risks are now more transparent will have a soothing impact. Any problem cases which may emerge will doubtless be taken in hand by the relevant regulatory authorities.
Against this backdrop, ECB policymakers are not likely to contemplate further easing measures as the Fed has done. Given the consumer price developments in the eurozone, the ECB could even strike a more hawkish tone. The inflation rate will probably rise by about half a percentage point to 1.9% in July - the flash estimate will be published on Friday. The inflation rate is set to remain at around this level for the rest of 2010. All in all, therefore, we are assuming that the ECB has welcomed the return of liquidity in the money market and the subsequent increase in money market rates. In view of this and the relatively favourable economic environment, the interest rate advantage on the European side could well widen.
From a European perspective, therefore, there are several factors in the euro's favour at present. However, uncertainty on the US side is halting this momentum. During the next few weeks, a series of important US indicators are on the agenda, including GDP data for the second quarter and, in the first week of August, the ISM indices and the labour market report. The FOMC meeting will then be held on 10 August. Should the data turn out to be worse than expected, the euro's chances would diminish significantly.
A week spent speculating which banks might fail their 'stress tests', and whether these were worth doing at all, indices alternating between fairly large up and down days to end the week in positive territory. Jakarta, Mumbai and Thailand set new highs for 2010. The Japanese stock market closed near the lowest levels in two years, pressured by a strong yen (86.27) and dragged down by the banks index. The US dollar has lost ground against all major currencies this week, the Australian dollar leading at $0.8972 (a ten-week high) and the Swiss franc at 1.0400, best this year. The Hungarian forint weakened to 292.00 per Euro because of new PM Viktor Orban's refusal to implement IMF-suggested austerity measures. Top-quality Treasuries remain well bid, those of weaker Eurozone countries still all too close to their records over Bunds. US asset-backed securities the first casualty of new financial regulation, so the SEC has had to allow a 6-month grace period for implementation. [Rating agencies can now be sued for fraud and reckless behaviour so they are not allowing their ratings to be published in prospectuses]. ICE Sugar rallied to 18.66 cents per pound, its most expensive since March though a fraction of February's unsustainable 30.40 peak. Most Baltic Freight rates are at their lowest in a year or more. Political and Economic Developments
The Bank of Canada raised it key rate by 25 basis points to 0.75%; Brazil raised its Selic rate 50 basis points to 10.75%, slightly less than expected on negative inflation in June.
UK Q2 GDP came in a better than expected +1.1% Q/Q taking Y/Y growth to +1.6%, helped in part by June Retail Sales which rose by 1.0% M/M and +3.1% Y/Y excluding auto-fuel. No doubt the football World Cup had an effect, but this keeps it at the average of the last decade. With June Core CPI also running at +3.1% Y/Y (RPI +5.0% Y/Y and among the highest in two decades) yet Gilts maturing within 9 years yielding under 3.00%, real interest rates are decidedly negative. Pity then that National Savings and Investments was forced to withdraw its index-linked securities (RPI +1.00% per annum) to all new investors, the first time in their 35-year history, because of huge inflows. Hometrack has annual house prices rising by under 3.00% or shrinking since December 2007, Rightmove suggests +3.7% Y/Y, though the Halifax and Nationwide calculate 6.3% and 8.7% respectively. Gains on main homes tax free.
German and Eurozone Purchasing Managers' Indices, IFO and Consumer Confidence Surveys all upbeat versus June's.
Underlying Themes
For several weeks now politicians and central bankers have been suggesting we shouldn't be so gloomy, that in fact the economy was growing and banks were sound, many giving lengthy TV interviews on these subjects. Mercifully chairman Bernanke in his semi-annual testimony to the Senate Banking Committee spared us the usual drivel. Saying the number one concern for small businesses was a lack of demand not access to credit and that funding was not a constraint on large firms, that state and local governments were under fiscal stress, plus the worrisome structural problems of high unemployment, were all drags on economic recovery; above all the 'economic outlook remains unusually uncertain'. Perhaps they have at last grasped the enormity of the problem; perhaps they now know there are no more tools in the box; perhaps they now understand that deleveraging and rebuilding overstretched balance sheets takes a very long time. Perhaps the Bank of England's MPC is also adopting a more realistic approach. After predicting UK CPI would be back at target by the end of this year (their usual mañana mentality) chief economist Spencer Dale suggested this might now not happen until the end of 2011, and that the country would not get back to normal 'for an awfully long time'.
What to watch for next week
Monday Japan June Trade Balance, German Import Prices due from this day, US New Home Sales and UK July Hometrack Survey. Tuesday Japan June Corporate Service Prices, EZ16 M3 Money Supply, UK CBI July Distributive Trades, US Consumer Confidence, German August GfK Consumer Confidence and US May CaseShiller House Prices. Wednesday Japan July Small Business Confidence, ECB Bank Lending Survey, July CPI for the various German states due and US June Durable Goods Orders. Thursday Japan June Retail Trade, Large Retailers' Sales, UK Net Consumer Credit, Mortgage Approvals, German July Business Confidence, Unemployment, EZ16 Business Climate and Confidence and the Fed's Beige Book. Friday Japan June Unemployment, Household Spending, CPI, Industrial and Vehicle Production, Housing Starts, Construction Orders and Tokyo July CPI. Then EZ16 June Unemployment, CPI, US Q2 GDP, July Chicago Purchasing Managers and final University of Michigan Confidence Survey. Monday 2nd August holidays in Canada and Iceland.
Positioning and Technical Analysis
The last week of another thin summer month and many markets are tottering at fairly pivotal levels. August will probably see trends develop and more chaotic conditions predominate. Watch FX weekly closes for important breaks; another round of generalised US dollar selling is due, something which should prop up commodity prices. Top-notch Treasuries and Corporate bonds should remain well bid maintaining the pressure on credit spreads. Stock markets will probably be subject to increasingly violent intra-day swings.
€ The euro appreciated vis-à-vis the U.S. dollar today as the single currency tested offers around the US$ 1.2965 level and was supported around the $1.2790 level. Results of stress tests on the largest European banks were released today and they confirmed most financial institutions have sufficient capital to absorb soverign debt-related problems. Some dealers doubted the reliability of the exams. European Central Bank member Nowotny reported the tests conducted on 91 banks revealed the European banking system is in a “stable and promising” position. ECB policymakers revealed seven of 91 banks failed the European Union’s stress tests and noted today’s results should increase confidence in the eurozone. Data released in the eurozone today saw the July PMI composite improve to 56.7 from the prior reading of 56.0 while EMU-16 PMI services and manufacturing improved. Also, EMU-16 May industrial new orders were up 3.8% m/m and 22.7% y/y. Moreover, EMU-16 July consumer confidence improved to -14 from the revised reading of -17. German July PMI manufacturing and services improved and data to be released tomorrow include July Ifo business sentiment. French data released today saw July PMI manufacturing decline while PMI services moved higher. French July consumer confidence remained unchanged at -39. In U.S. news, data released in the U.S. this week saw weekly initial jobless claims climb to 464,000 from a revised 427,000 while continuing jobless claims climbed to 4.487 million from 4.710 million. Also, June existing home sales were off 5.1% m/m to an annualized 5.37 million units while June leading indicators came off 0.2% from the previous tally of 0.5%. Also, the May house price index printed at +0.5% m/m, down from +0.9%. Federal Reserve Chairman Bernanke this week called for an extension of the Bush tax cuts and cited the elevated U.S. unemployment rate as the biggest problem in the U.S. economy. Bernanke also cited additional monetary easing options including reducing the rate paid on banks’ reserves held at the Fed and purchasing more securities. New York Fed President Dudley reported said the “road to recovery is turning out to be a bit bumpy.” 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 ¥87.50 level and was supported around the ¥86.75 level. Bank of Japan issued a report that noted emerging market economies need to begin tightening monetary policy to avert overheating. The pair moved higher on an improvement in asset prices including equities as risk appetite bettered. Traders may have steered away of testing the resolve of the Japanese government to intervene in a bid to stop the yen’s appreciation. The government has not officially intervened for several years but there are increasing whispers that Japanese monetary authorities will try to protect the ¥85 level. Bank of Japan Deputy Governor Yamaguchi this week suggested the central bank is considering other policy options, noting “Ways to strengthen the foundations for economic growth are not necessarily limited to the measure the bank has introduced. We will continue to make sufficient considerations while exploring various possibilities.” Minutes from the June BoJ Policy Board were released this week in which policymakers said the central bank should consider additional policy options other than the ¥3 trillion loan scheme recently announced. Vice finance minister Ikeda said the government “wants to avoid excessive gains in the yen” while trade minister Naoshima said the yen’s gains pose a threat to economic growth. The government’s ability to provide additional fiscal stimulus is limited by its commitment to cap annual fiscal spending at ¥71 trillion. The Nikkei 225 stock index climbed 2.28% to close at ¥9,430.96. 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 ¥113.00 figure and was supported around the ¥111.55 level. The British pound moved higher vis-à-vis the yen as sterling tested offers around the ¥135.00 figure while the Swiss franc moved lower vis-à-vis the yen and tested bids around the ¥82.65 level. In Chinese news, the U.S. dollar appreciated vis-à-vis the Chinese yuan as the greenback closed at CNY 6.7799 in the over-the-counter market, up from CNY 6.7797. A Chinese source reported Chinese banks may struggle to recover approximately 23% of the CNY 7.7 trillion in loans to local government infrastructure projects. People’s Bank of China set its daily fixing rate at the strongest level this week and yesterday said it may begin to publish the yuan’s exchange rate against a basket of currency and not just the U.S. dollar. PBoC also warned Chinese home prices may fall sharply.
£
The British pound appreciated vis-à-vis the U.S. dollar today as cable tested offers around the US$ 1.5450 level and was supported around the US$ 1.5250 level. Data released in the U.K. today saw Q2 gross domestic product climb 1.1% q/q and 1.6% y/y while June BBA loans for house purchases moved higher and the May index of services improved. Minutes from the July Bank of England Monetary Policy Committee meeting were released this week in which policymakers voted 7-to-1 to keep the Bank rate unchanged at 0.5%. The minutes read “On balance, most members thought that it was appropriate to leave the stance of monetary policy unchanged. The committee considered arguments in favour of a modest easing in the stance of monetary policy. The softening in the medium-term outlook for GDP growth over recent months would put further downwards pressure on inflation, once the impact of temporary factors had waned.” MPC member Sentance voted again to raise interest rates. There is talk of a possible three-way split on the MPC this year if one or more policymakers voted to expand policy accommodation. Some believe the MPC may resort to increasing its asset purchase program. Cable bids are cited around the US$ 1.5140 level. The euro depreciated vis-à-vis the British pound as the single currency tested bids around the £0.8315 level and was capped around the £0.8450 level.
CHF
The Swiss franc depreciated vis-à-vis the U.S. dollar today as the greenback tested offers around the CHF 1.0565 level and was supported around the CHF 1.0405 level. Data to be released in Switzerland on 27 July include the June UBS consumption indicator. UBS reported the Swiss National Bank may intervene again if the euro/ franc rate falls “sharply.” SNB reported its euro holdings doubled in the second quarter on intervention. Most dealers believe SNB has been forced to intervene less on account of all of the euro-denominated assets on its balance sheet but some note the SNB will likely continue to intervene at opportune levels. 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 1.3605 level while the British pound moved higher vis-à-vis the Swiss franc and tested offers around the CHF 1.6270 level.
The amount of nervous energy in today’s FX market has already translated into some choppy, range-bound trading. The source is obviously the impending release of the EU bank stress test due to be issued at 16:00 GMT.
Today, German IFO data came in much stronger than expected spiking the EURUSD 40 pips rallying up to 1.2965. In the back of our minds, we remember that torrent of support risk-correlated trades gained on the release of the US stress test despite the market’s criticism then. Nevertheless, we remain unconvinced that today’s risk appetite will receive the same boost.
The EU stress test lacks the rigor of the US test and has lost enormous credibility based on the handling of the assignment. Swiss regulators highlighted this fact when the FT reported that they had conducted their own bank stress tests which were twice as stringent. The FT reported that the Swiss regulators conducted 13 different mega-risk scenarios including the collapse of the credit market and a drastic fall in GDP. I would suspect that investors will look at the Swiss test and feel kind of slighted when the actual EU tests & methodology are released.
As we have yet to see the actual report, the assumptions we’re making are based solely off official statements and newswires, thus we may be proved incorrect. The most important factors for the release will be the credibility of the results, the transparency of information and the explanation of all assumptions made during the research.
According to the most recent reports, all vital banks (read: too big to fail) will pass including Germany’s Landesbanken and all Greek banks. If all Greek banks are set to pass this test, something must be awry somewhere. To create the illusion of authenticity, the EU may throw a few minor banks under the bus. There are still significant EURUSD shorts lingering in the market and if the report is truly first-rate, we could see some heavy short covering and quickly.
In the UK this morning, the Office for National Statistics released their first estimate for Q2 GDP. The numbers came in much stronger than expected at +1.6%, exceeding the +1.1% consensus among economists and a -0.2% previous reading. The surprise number significantly decreases the probability of further QE by the BoE. Although an entire strategy cannot be based off one data point, the BoE’s MPC will most likely focus more on inflation and less on growth in future meetings. Perhaps Mr. Sentence, the lone dissenter in the last meeting, may not have been too far off base after all.
Finally, the ECB’s Trichet suggested that fiscal tighten was necessary around the globe and should not be delayed. The comment is in direct contrast to the Fed’s view that some level of stimulus was still required, a point just reiterated by Bernanke this week. We don’t expect any reaction in the USD, but it will be interesting to monitor because strict fiscal policy compounded by loose monetary policy should be extremely supportive for the underlying currency.
Today's Key Issues (time in GMT): 07:30 EUR ITA Jul consumer confidence index, 103.9 exp; last 104.4. 08:00 EUR GER Jul Ifo sentiment index, 101.6 exp; last 101.8. 08:00 EUR GER Jul Ifo current conditions index, 101.7 exp; last 101.1. 08:00 EUR GER Jul Ifo expectations index, 101.6 exp; last 102.4. 08:00 EUR ITA May retail sales; last -0.3% m/m, -0.5% y/y. 08:30 GBP Q2 GDP - prelim, +0.6% q/q, +1.1% y/y exp; last +0.3%, -0.2%. 08:30 GBP Jun BBA mortgage lending data 16:00 EUR Stress Test results for individual banks expected start 17:00 EUR CEBS press conference regarding Stress Test results
EurUsd We may have written EURUSD off prematurely yesterday as our short trade at 1.2790 was thwarted by the bulls managing to break back within the 4-week uptrend channel. Fortunately, leaving a tight stop just above the trendline around 1.2830 shielded us from being dragged all the way back up to 1.2933 highs, but it has somewhat dented conviction in our short-term bearish view (the medium-term bearish view still prevails). Not only does the break back inside the uptrend signal that the bulls are not quite done, but there is also a bullish engulfing candlestick on the daily chart which also suggests the bears are lacking the energy to do much about it at the moment. We are currently toying with the 100-day moving average at 1.2881 but next resistance levels on the topside are expected at 1.2933 (yesterday’s peak), 1.3028 (20 Jul high) and 1.3093 (10 May high). The lower edge of the 4-week uptrend now comes in at 1.2830, but should there be another break below there we would once again attempt a short with a view to re-visiting 1.2733 (yesterday’s low), and 1.2683 (14 Jul low) in extension.
GbpUsd Yet another currency pair to give us the head-fake this week, GBPUSD’s break below its 6-week uptrend touched a low of 1.5125 before rebounding sharply back up towards 1.5350 resistance (19 Jul high). This 1.5350 level still poses a difficult challenge for the bulls to overcome, especially as 1-week downtrend channel resistance comes in just ahead of there at 1.5340; but should they manage to push it higher then look for next resistance up at 1.5472 (last Thursday’s high), and 1.5525 (15 Apr high). Next support is that lower edge of the 6-week uptrend at 1.5250; but if the trend breaks lower once more then first stop on the downside will be 1.5125 (Wednesday’s low), followed by 1.5080. Should we managed to conquer those supports, there is a much clearer path towards the next downside targets of 1.4992 (100-day moving average), then the 12 Jul low 1.4949.
UsdJpy Yesterday we outlined the two possible scenarios in play for USDJPY –the first being a potentially bullish symmetrical triangle pattern with a target at 88.15, and the second one a larger bearish flag pattern which had not yet been activated. That latter pattern now looks to have become activated by the sell-off through trendline support at 87.00-05, and with that we now feel that the smaller symmetrical triangle pattern is as good as dead in the water. The classically defined target on the downside for this new flag pattern is 84.30 with supports ahead of there eyed at 86.27 (16 Jul low) and Nov 2009 lows of 84.83; but as we have mentioned a couple of times recently, down at those levels we would be playing Russian roulette with possible BoJ intervention so anything below 85.50 seems an ambitious enough take profit level for our fear/greed ratio. Any rallies from here are likely to meet fresh sellers around 87.15-20 (back side of the flag) where those who missed the break-out first time around will want to jump in, then further resistance seen at 87.57 (this week’s high from 20 Jul), 88.00 (former pivot), 89.15 (12 Jul high) and 89.50 (28-29 Jun high).
UsdChf The 3-week downtrend channel has been violated a number of times in the past few sessions, but the bulls failed to capitalize on the upside break and the pair is has since tumbled back towards major support at 1.0400. Until we get a decisive break out one way or another –either below 1.0400 or above the downtrend resistance 1.0470 –we are likely to be confined to achingly tight ranges. Those who favour buying on dips should only do so around 1.0400, as the landscape below 1.0400 is dotted only with stale support levels at 1.0365 and 1.0230. Sellers are likely to step in back up towards 1.0450 former pivot, aforementioned downtrend channel resistance at 1.0470, then 1.0560 (19 Jul ) highs.
Markets gained a temporary sense of optimism as FX risk-correlated trades recover from yesterday’s sell off and equity markets rally in Asia. Yesterday we saw a sharp reversal - especially in the EURUSD as leveraged players cut their long positions after the pair lost momentum and seemed to run into resistance. EU officials are on the wires talking up the bank stress test due to be released this Friday.
As we’ve already stated this week, we suspected that EU officials would throw a few sick banks under the bus in an effort to create the illusion of rigor. Greek, Spanish and now French officials have all been vocal affirming that the vast majority of their banks will pass the test. French Economic Minister Christine Lagarde stated she was "confident" about the results of the stress test for French banks, but failed to provide any details as to why.
The show boating is making us a bit concerned about the “stressfulness” of their methodology. Our best guess is that the test will measure the two major types of bond portfolios within banks. One bond type is used for trading which the ECB can apply a haircut to, the second is your traditional hold-to-maturity bonds which are going to be mark-to-market and potentially deemed immaterial. EU offical move in this direction since they are concerned with a "trading shock" more then a default. However, we hearing rumors that there’s been a fascinating migration of tradable bonds into the hold-to-maturity classification as of late.
The EU structured safe haven for these bonds and not looking at the full picture concerns us as it is a convenient place to hide bad assets and tell half the story. We don’t believe that this stress test will provide the confidence the market is searching for and certainly not be as successful as the US stress test. We suspect that the EUR will continue to come under selling pressure and we are watching for a test of the 1.2750 lvl.
In Japan, the BoJ minutes released this morning asserted the central bank’s commitment to "continues to aim at maintaining the extremely accommodative financial environment” and that the BoJ’s new scheme to encourage commercial lending to growth industries would be initiated in August. Perhaps the most intriguing aspect is that officials continue to make comments on the recent Yen strength while BoJ Deputy Governor Yamaguchi reiterated that they are watching forex moves very carefully.
While we don’t expect US yields to reverse their current direction, which would provide a great catalyst for a JPY sell-off, we do believe that Japanese comments and potential intervention around the 85 lvl will provide some ample USDJPY buying opportunities in the near-to-mid term.
Today’s focus will be on the BoE’s MPC minutes release & Chairman Bernanke’s testimony to Congress. MPC member Sentance voted for a rate hike at the June meeting and his recent public comments continue to be hawkish. However, dovish MPC member Posen maintained to Dow Jones that there was more than a 50% probability that the next BoE move would be a policy loosening, not tightening. Sterling has been very jumpy as of late as traders try to anticipate the BoE’s next move. Without any clear guidance, this is a currency we would avoid for the time being.
Today's Key Issues (time in GMT): 08:30 GBP retail sales, +0.5% m/m, +1.0% y/y eyed; last +0.6%, +2.2%. 08:30 GBP BoE MPC minutes, vote 7-1 prior 09:30 EUR German FinMin Schaeuble, French FinMin Lagarde meeting in Paris. 10:00 EUR Germany E4.0 bln 3.25% 2042 Bund auction. 00:00 EUR Portugal E1.25 bln 12-month Treasury bill auction. 10:15 EUR Schaeuble-Lagarde, Franco-German Econ-Fin"l Council press conference. 18:00 USD FOMC Chair Bernanke semi-annual Senate testimony
EurUsd Just as we suspected in yesterday’s report, the brief visit above 1.3000 (1.3028 the high) soon attracted the attention of bears who re-emerged in numbers and drove the pair all the way back down to lows of 1.2839. We feel that at these lofty levels, a short bias seems the most attractive in terms of risk-reward (recall that the rally to 1.3028 represented a 9.5% appreciation in the space of just 6 weeks), and significant resistance level appear to cap the upside to 1.3095-1.3125. That zone of anticipated selling interest includes the triple whammy of 10 May high (1.3095), the 4-week uptrend channel resistance at 1.3115, and also the 38.2% fibonacci retracement of the entire sell-off from 1.5145 to 1.1876 which comes in at 1.3125. The tricky part here is selecting favourable entry levels and a small enough position size to tolerate a wide stop; 1.2950 would be the ideal area for us to re-load shorts, with the view that the pair should at the very least re-visit the lower edge of this 4-week uptrend channel in the coming days (currently seen at 1.2745). We still expect some buyers to lie around 1.2780 (a former pivot) and 1.2683 (last Wednesday’s low).
GbpUsd The fickle short-term trends in GBPUSD are making trading conditions difficult, and indeed the 1-week downtrend channel we highlighted yesterday morning has already broken its originally defined ceiling –a development made all the more frustrating by the fact it came very shortly after the pair had broken through 1.5230 support (which would have suggested in our minds that the next significant leg of this move would be to the downside). Given this whipsaw action, we prefer to steer clear of fresh trade entry for the time being, and should the bulls clear the next significant resistance at 1.5350 (19 Jul high), we could be induced to consider longs once more. Above there the likely targets are 1.5472 (last Thursday’s high), and 1.5525 (15 Apr high). Should the pair opt to go lower instead, yesterday’s low was 1.5154, and next supports are seen at 1.5080 former neckline, 100-day moving average 1.4992, then the 12 Jul low 1.4949.
UsdJpy A very interesting picture for USDJPY at the moment with the possibility of both a bullish triangle pattern and a bearish flag pattern currently on the table. Yesterday we highlighted an ascending triangle pattern on the hourly chart with a target at 88.15 which looks to have been activated by the move up through 87.22; but having assessed the subsequent price action, it looks more accurately like this was in fact a symmetrical triangle. The consequences of this shift in definition is a mere 5 pips (the target now 88.20), so our view of the topside prospects remain unaltered;resistance is seen around 88.00 (i.e. might use discretion on taking profit a little earlier than the pattern’s defined target), and further supply remains at 89.15 (12 Jul high) and 89.50 (28-29 Jun high). What is intriguing however about the current picture is that there is also the possibility of a bearish flag coming into play in the coming sessions, and which currently suggests a break below 86.95 (lower edge of the flag) would be a good trigger for short entry –implying a target of 84.20 below. This bearish scenario does tie in nicely with the recent break of 86.97 (1 Jul low) which opened up the possibility of another plunge towards Nov 2009 lows of 84.83; but once again we should remain cautious that such a bearish target would almost certainly catch the attention of the BoJ in which case intervention may be a very real and ruthless threat.
UsdChf The 3-week downtrend channel continues to direct price action in the short term, but trendline resistance has already been under threat this morning around 1.0515. Given that the bears looked unable to muster a decent assault on 1.0400 at the end of last week, they are likely to capitulate soon enough in defending this trendline too. Having said that, it doesn’t look like the bulls are all that feisty for a move higher either, so perhaps we will be confined to ranges for the time being. If that’s the case, we think that current levels (1.0530) actually look pretty attractive for short entry given the previous price action around 1.0550-60. We’d be satisfied using 1.0580 as our stop, and set a first target on the downside of 1.0450 (Monday’s low), with 1.0400 (double bottom seen last week) as a possible extended target. Some bulls may favour buying on the dips towards, 1.0400, but should they be wrong the landscape below 1.0400 is only dotted with stale support levels at 1.0365, 1.0315 (trendline support), then 1.0230 –could be a nasty plunge with few buyers to slow the descent.
Will the First Estimate of UK GDP Surprise again in Q2?
The UK calendar remains busy over the coming week with the release of retail sales, the first estimate of Q2 GDP and the Bank of England MPC Minutes set to hold the market's attention. Although economic recovery in the UK appears to have gained some momentum over the course of the past several months, the household sector looks to have lagged behind. Growth in retail sales in particular has been mixed, with consumers remaining wary of spending on big-ticket items while also having their buying power squeezed by high inflation. In June, we expect a 0.5% monthly gain in retail sales volumes, taking the year on year rate below 1% (sales volumes rose 1.7% last June). But due to the positive base effects related to Q1, for Q2 as a whole sales volumes will probably have increased by around 1.8% and implies a fairly sizeable contribution to Q2 GDP growth. Combined with upbeat industrial production numbers it should mean that GDP in Q2 rose by around 0.6% - the strongest reading since 2007 (data out on Friday). Earlier in the week, on Wednesday, the Bank of England publishes the Minutes from its July MPC meeting. Last month saw the first member to dissent since September 2008, with Andrew Sentance voting for a 25bp rate increase. Given his recent comments, it is almost certain he would have done the same again in July. We think though that yet again he was probably alone in arguing for higher rates and expect to see another 7- 1 vote in favour of unchanged interest rates.
Amid continuing uncertainty in financial markets, this week sees the long-awaited publication (on Friday) of the EU-wide bank stress tests. The tests will be conducted on a bank-by-bank basis with the objective of assessing the overall resilience of the EU banking sector. Specifically, they will examine banks' ability to absorb further possible 'shocks' on credit and market risks (including sovereign risks) and to assess any dependence on public support measures. A 'baseline' and 'adverse' scenario will be used, with the latter assuming a 3 percentage point deviation in GDP relative to the European Commission's forecasts over a 2-year time period. This scenario will also incorporate a 'shock' to interest rates to capture a rise in risk premia linked to a worsening of the euro-zone sovereign debt crisis. The tests have been welcomed by the ECB on the grounds of greater transparency. But for us, given that the tests include the German Landesbanken along with a good number of the Spanish cajas, the risks of igniting market fears about capital adequacy could still outweigh the perceived benefits of transparency. Beyond this, key euro-zone economic data this week include July's German Ifo business climate index where we look for a pull-back to 101.3. Similarly, we anticipate a weaker pace of growth in July's preliminary PMI surveys for the euro-zone, due on Thursday.
In the US, the semi-annual Monetary Policy report will be presented by Fed Chairman Bernanke to the Senate on Wednesday, providing a detailed update on the economy and policy outlook. Last week's inflation data underlined that price pressures remain subdued, raising renewed concerns about the lingering risk of deflation. It is a relatively quiet week for US economic releases, with the focus on the housing market. We look for housing starts and building permits to show a further fall in June as the expiration of government initiatives weighs on the market. Existing home sales could show a particularly sharp fall.
In other events, the Bank of Canada is forecast to raise interest rates for the second successive month to 0.75% on Tuesday. The Brazilian central bank on Wednesday is likely to lift the selic rate by 0.75% for the third straight meeting to contain inflation.
* US growth slower; retail trade and manufacturing sector weaker * Fed sees growth risks return, puts exit discussion on hold * Money market rates in eurozone climb further, liquidity withdrawal continues
US Growth Doubts Weigh on Dollar
This week the euro continued its rally against the US dollar and against most commodity and emerging market currencies. The majority of European currencies have managed to hold their ground versus the euro - some (such as the pound Sterling and the Scandinavian currencies) more than others (e.g. the Czech koruna, the Hungarian forint and the Swiss franc). The yen, like the latter, has slipped somewhat against the euro.
The euro gained over 3 cents versus the dollar and is currently approaching 1.30. Its sharp rebound is partly due to thin trading. The holiday season is starting to have an impact on sales volumes and exchange rate movements. The unwinding of short euro positions, which had been built up at the height of the debt crisis, also boosted the euro. The main reason for the euro's recovery, however, was probably a shift in market focus. For weeks on end, the spotlight had been solely on the credit risks of European countries and banks. The implementation of a rescue package for countries potentially at risk of default at the eurozone level and austerity packages at the national level has restored investors' confidence to some extent. Markets are now focusing more on the relative growth outlook for the major economies and monetary policy stance.
Thus the forex markets' reaction pattern is changing. Up till recently, the dollar has served as a safe haven currency, when equity markets, economic data or credit spreads have sent out crisis signals. The risk on/risk off mechanism seems to be becoming less significant, and the more traditional correlation between growth and interest rate differentials and the exchange rate is gaining importance. And here the US have fallen behind the eurozone.
Eurozone: Confidence is slowly returning
Compared to the crisis scenarios acted out in the markets over the last few weeks, the European economy is doing quite well so far. Second quarter data are expected to be strong, and according to the economic indicators, an end of the expansion is not yet in sight. The German economy, the eurozone's main growth driver, seems to be in quite good shape.
At the same time, money market rates in the eurozone are climbing. Even though the ECB claims not to have changed its monetary policy stance, the withdrawal of liquidity, which had started at the beginning of July when the €442bn one-year tender matured, is continuing. This week too, a good €15bn of central bank loans were not renewed. The Eonia overnight rate has now risen to almost 0.50%, the 3-month Euribor stands at 0.86%. The more liquidity the ECB drains from the system, the more money market rates are determined by the main refinancing rate, which, at 1%, is quite high compared to that of other countries. Simultaneously, 2-year Bund yields have risen from 0.55% at the beginning of the month to 0.80% currently.
USA: Hopes are dashed
The situation in the US is exactly the other way round: after production had picked up, employment had started to rise and even the housing market had shown signs of improvement, markets had begun to hope that the upswing was gathering pace. These hopes have been dashed, however, by the latest data. After the expiration of the homebuyer tax credit, the housing market plummeted; excluding temporary Census-related hiring, the number of new jobs created is so small that the unemployment rate is still almost at its peak. The latest economic data published this week were also disappointing: retails sales declined again in June; industrial production fell in June, and the first regional surveys show that the weak trend is set to continue in July; furthermore, the trade balance deteriorated again in June.
The Fed is more downbeat too. The minutes of the FOMC meeting of 23 June state that the economic outlook has deteriorated somewhat; a number of committee members see an increase of downside risks. The changes in the outlook are "relatively modest", however, and do not warrant any additional monetary policy accommodation.
That sounds relatively harmless at first, just like a confirmation of the present monetary policy stance. It should be borne in mind, however, that the discussions in the central bank have completely changed direction. Up until a few weeks ago, the debate had focused on identifying the right time to embark on an exit from the extremely expansive monetary policy. Now, all of a sudden, the question whether the central bank should implement further monetary easing measures, to prevent the recovery from faltering, has taken centre stage.
The change in discussion is reflected in the development of interest rates. On Thursday, 2-year T-note yields fell for a time to their lowest level ever, 0.58%, and now stand at 0.60% - the same level as at the beginning of the month. In a comparison between Treasury and Bund yields, within the space of a mere six weeks, spreads have altered from a significant interest rate advantage of around 30 points for the US bond to a disadvantage of 20 points.
We are expecting the situation responsible for these developments - weakness in the US, relatively robust economy with tendency for higher money market rates in the eurozone - to continue over the next few weeks. Against this backdrop, the euro should remain well supported. However, beyond 1.30, the air will get thinner for EURUSD.
Stocks tried to rally for a second consecutive week, subsequently giving up those small gains, to end unchanged (though the Nikkei and Shanghai Composite lost 1.85%). Rather than the usual 'risk on/risk off' knee-jerk reaction investors seem to have become a little more savvy; they continue buying top-quality bonds, so that US benchmark two-year TNote set a record low yield at 0.58%, UK five-year Gilts matched 2009's record low 1.985%, while ten-year BBB+ rated Mexican ones set a new record low at 6.64% as did Brazil's BBB- at 4.34%. Peripheral Eurozone Treasuries remain under pressure trading at or close to record spreads with the ECB's reluctant quantative easing in place. While buying yen, taking it to 86.50 per USD, they sold dollars against most currencies taking the Euro to $1.3008 and Cable $1.5473, an increase of 2.5% in five days leaving consensus opinion (for a stronger greenback) head-scratching calling this a 'technical short-covering rally'; previous 'darlings' are lagging well behind. CBOT Wheat rallied strongly again for a third consecutive week, caused by the heat wave in Europe and parts of North America, reaching 598.5 cents per bushel and its most expensive in a year, dragging Corn up to 397 cents.
Political and Economic Developments
The Bank of Thailand raised it key rate by 25 basis points from a record low 1.25%. Moody's downgraded Portugal's sovereign rating to A1. UK inflation remains stubbornly high, CPI +3.2% Y/Y to June and RPI +5.00% (the higher figure which no longer will be used for index-linking payouts) though no rate hikes are currently in sight. US CPI far more benign, +1.1% Y/Y to June, Core +0.9% almost as low as 1961's record low +0.7%.
Minutes from the Fed's FOMC meeting saw 2010's GDP forecast trimmed to 3.0%-3.5% saying it might need to 'consider whether further policy stimulus might become appropriate'. Sentiment surveys from New York, Philadelphia and Michigan were rather downbeat this month and nationwide Retail Sales dropped 0.5% after May's 1.1% decline.
Underlying Themes
US Congress voted 60 to 39 to pass a new financial regulation bill aimed at preventing 2008's 'too big to fail' fiasco. How exactly and when this will be implemented remains to be seen, its subsequent implications for the industry too numerous to consider here. One thing looks certain though: credit will be more constrained and banking less profitable. Yesterday heads of the UK's top five banks were hauled in to the Treasury where the Con-Dem's George Osborne and Vince Cable were in 'listening' mode for talks forming the basis of a green paper to be published in about a fortnight - aimed at increasing lending to small and medium-sized enterprises. All banks face unspecified hikes in capital requirements (with or without Basel III), UK ones seeing a sharp drop in the growth of household deposits these last two months, trying to re-build balance sheets while facing high levels of bad debt. No mean feat. At least the Fed's Janet Yellen had the decency to say, 'we have learned a harsh lesson about the dire consequences a financial crisis has for ordinary Americans... (because) weak bank regulation contributed to excess' at yesterday's Senate hearing, while nominee Raskin bemoaned the fact that government reforms had not addressed the problem of GSE home-lenders. What to watch for next week
Monday the 19th a Marine Day holiday in Japan, Eurozone May Current Account, Construction Output, UK July Rightmove House Prices and US NAHB Housing Market Index while top US financial regulators meet for the first of four public hearings on updating rules. Tuesday German June PPI, UK Public Finances, Money Supply and Mortgage Approvals, US Housing Starts and Building Permits while the Bank of Canada decides on rates (many expect a 25 basis point increase to 0.75%). Wednesday just Bank of England July 7th/8th MPC Minutes and the Fed's Bernanke delivers his semi-annual report to the Senate Banking Committee. Thursday Japan May All Industry Activity Index, EZ16 Industrial New Orders, UK June Retail Sales, US Existing Home Sales, Leading Indicators, May House Price Index, July Manufacturing PMI's for various European countries and Eurozone Consumer Confidence. Friday German July IFO, UK May Index of Services, June BBA Mortgages and Q2 GDP plus more interestingly the results of Europe's bank 'stress tests'.
Positioning and Technical Analysis
Markets are nearly always thin in July and early August, exacerbating price swings; volumes are usually poor so that often bankers question their job prospects. Watch FX weekly closes for important breaks, 87.00 for dollar/yen and $1.3000 on the Euro. Another round of generalised US dollar selling is likely if not next week then next month, something which should prop up commodity prices. Top-notch Treasuries and Corporate bonds should remain well bid maintaining the pressure on credit spreads. The merest hint of an end to policies propping these up could send them into a tailspin. Stock markets will probably be subject to increasingly violent intra-day swings.
EURUSD traded above 1.2700 but lacked the momentum to drive above the 1.2800 level. Part of the reason for the restrained market activity may be the EU Bank Stress test results expected to be released next Friday. While some say the release will be good for risk-correlated trades due to the high level of transparency – we believe this may only be the case if the anticipated cost of recapitalizing about-to-fail banks is manageable.
We suspect that much of the optimism surrounding the report has already been priced in while the risk of a negative surprise is comparatively higher. Further, just because European officials have been able to take a single snapshot of the banking sector doesn’t means a bailout solution isn’t necessary nor that further erosion of banks’ balance sheets can be halted. The European Financial Stability Fund’s Regling reiterated that if an EU government were to formally apply for financial support, it could take 3-4 weeks for the cash to become available. Regling believes the fund will be operational by the end of July and receive a credit rating by mid-August. Good indicators for the Euro were recent bond auctions in Germany, Italy, Greece and Portugal – all of which went off without a hitch, even with Moody’s recent double-downgrade of Portugal. Interestingly, today CNBC speculates that eleven banks will fail the EU stress.
In Asia, we had suspected Chinese growth & inflation would continue to surge causing officials to tighten monetary policy, which in turn might prompt a serious return of risk aversion. If market risk aversion sets in again, it most likely would serve as the catalyst for our expected EURUSD reversal. However, real Chinese GDP came in below expectations at 10.3% from a 10.5% consensus. Industrial production fell as well and CPI eased to 2.9% y/y from a 3.1% consensus.
Asian regional indexes sold off due to the slowdown in growth even though the greater concern should be that Chinese officials might end the free lending of cheap money necessary for the global recovery. Concerns over the curtailing of Chinese lending seems less immediate to market participants, but should be noted. We could see a delayed reaction to the Chinese report especially when you consider the weak US retail sales, the FOMC forecast and German ZEW survey data.
Yesterday’s FOMC minutes predicated slower growth, a considerable fall in inflation and a slower-than-expected decline in unemployment. The FOMC affirmed that it "didn't see the need for additional policy accommodation" at this time. All yesterday’s figures could serve as indicators for some and/or passive evidence for the “double dip” theorists. Lots of Tier 1 US data is set to be released today which should provide some clarity into this cloudy market view. Lastly, the US Senate is due to hold hearings on the nominations of San Francisco Fed President Yellen, and Sarah Raskin to the Board of Governors of the Fed.
Today's Key Issues (time in GMT): 09:00 CHF Jul ZEW investor sentiment index; last 17.5. 08:00 EUR ECB monthly bulletin. 12:30 USD Jul Empire St mfg index, 19.00 eyed; last 19.57. 12:30 USD Jun PPI, 12:30 USD Jun PPI - core 13:15 USD Jun industrial production -0.5% m/m eyed; last +1.3%. 13:15 USD Jun capacity utilization, 73.8% eyed; last 74.1%. 14:00 USD Jul Philly Fed survey sentiment index, 10.0 eyed; last 8.0. 23:15 USD Richmond Fed President Lacker (FOMC non-voter) speaks
EurUsd Yesterday’s better than expected Greek debt sale and ensuing risk rally was the kiss of death for our short EURUSD positions, and after ripping through our stop just above the Monday night highs of 1.2615, the pair then went on to take out the week’s high of 1.2650 and then to a peak of 1.2739. Yesterday’s risk rally managed to push EURUSD up through the top of our potential bullish flag pattern (around 1.2735) on the hourly chart, and went on to hit a high of 1.2778. We are therefore long with a stop just below 1.2700 and have our sights set on a target of 1.2950, but the follow-through has thus far been uninspiring. The problematic 1.2750 area is managing to suppress further upside for the time being, but should that level give way, the skies above are very clear for a move higher, with ony the 100-day moving average 1.2923 standing in the way of a return to 1.3000 levels. Should the bulls fail to get a leg up beyond 1.2750; next supports are seen at 1.2710 overnight lows, 1.2683 (yesterday’s low), 1.2600 and 1.2522.
GbpUsd GBPUSD has continued to roar higher in the past day, and after conclusively breaking above 1.5230 resistance, the pair has gone on to touch a high of 1.5322. This price action has now taken us back within the former 1-month uptrend channel, and 1.5230 now represents a very nice pivot level which we would use as a guide to buy on dips. From here the topside looks very accommodating, with sparse resistance at 1.5390 (30 Apr high), 1.5525 (15 Apr high) and 1.5585 (200-day moving average). Our bullish bias will only be threatened by a fresh break below 1.5230, in which event we would expect next supports at the 1.5080 former neckline, then the 12 Jul low 1.4949.
UsdJpy We’re still long USDJPY from the double bottom break-out that took place around 88.20, but there has been frustratingly slow progress since Monday morning’s promising JPY weakness. The high this week remains 89.15 (a mere 25 pips from our 89.40 target), but the pair has been meandering between 88.00 –89.00 for much of the last few sessions. As we foresaw on Monday, the delay in reaching our target at 89.40 has now allowed the 5-week downtrend to creep onto the horizon, and as of this morning the latest slump in equities markets is putting pressure on the critical support 88.00.Should that support give way, nearest supports expected at 87.30 former downtrend support, then 86.97 lows from 1 Jul. Should the move reverse and head back higher, downtrend resistance comes into play at 89.10, backed up by further pockets of supply at 89.50 (28-29 Jun high), 90.40 (50-day moving average), and 90.75 (25 Jun highs and 200-day moving average).
UsdChf Our cautiously bullish bias is certainly under threat this morning as another day of heavy USD trading has already caused USDCHF to puncture its critical 1.0480 (8-9 Jul lows) support once, touching a reaction low of 1.0474. The move is however rather uncompelling at this stage, as the bears have not managed to keep the downward momentum going at all, and the pair has since bounced straight back out of the former 2-week downtrend. On an hourly close below 1.0480 we would flip to a short bias and expect a quick visit to the 1 April low 1.0434. Until that point buying on dips towards 1.0480 still looks like a decent trade for the braver bulls, with resistance likely to come in at 1.0550 intraday resistance, 1.0650 (Tuesday’s high) and once again at the 1.0676 week’s high.
The euro weakened today s the Spanish lenders borrowed the record amount form the European Central Bank and after the region’s industrial production expanded less than predicted.
Spain’s financial institutions borrowed the record €126.3 billion from the ECB last month as the investors avoided the local banks. The seasonally adjusted industrial production grew by 0.9 percent in May compared with April in the Eurozone. The median forecast was the growth by 1.2 percent.
EUR/USD traded at 1.2700 as of 12:06 GMT today after it opened at 1.2722. EUR/JPY dropped to 112.46 from its opening level of 112.87.
MORNING BRIEFING: Markets increasing appetite for risk
What’s new: Asia: Equity Indices start in the Green United States: Intel reports profits and a surge in Sales EURO: Defends its gains this morning GBP: Consolidates further gains on the back of increased expectations for employment figures today ECB: Lower values seen in Securities Market Program interventions – indicative of improving debt markets United States: Trade Deficit rises to an 18-month high
Today:
Rates in Asia and Indices: EURUSD: 1.2734 - 1.2691. USDCHF: 1.0617- 1.0540. GBPUSD: 1.5252- 1.5173. EURJPY: 113.28 – 112.79. USDJPY: 89.11 – 88.64. DowJones: 10’36.02 +1.44% NASDAQ: 2'242.03 +1.99% S & P 500: 1'095.34 +1.54% Nikkei: 9’783.66 +2.58% Shanghai: 2'476.10 +1.05% Gold: $ 1'210.90 Crude Oil: $ 76.27
Comments: Asian markets started off positively today as investors are being relieved by a good start for the Q2 US corporate earnings season, and the Euro Zone debt problems appear to be under control. Intel, the micro chip giant reported a second quarter profit and a noticeable increase in sales yesterday this continued to fuel a rally in major indices worldwide.
EUR/USD has hit highs of 1.2734 up to this morning. RTFX TraderTip indicates Resistances of 1.2800/1.2877 to the upside and 1.2584/1.2446 to the downside.
Important data today coming out today; from the United Kingdom employment data, and from the Euro Zone inflation data is expected. Some analysts are raising expectations of a fall in UK jobless claims and in unemployment rate – which might explain the support for the British Pound this morning and earlier this week. Even Euro was defending well the gains made yesterday mostly on the back of the positively concluded Greek treasury bill auction. It was reported that last week the ECB settled only EUR1Bln worth of Euro Zone bonds, this reduced intervention probably signals an improving situation for the debt markets.
Meanwhile the release for trade balance reported yesterday revealed a 18-month high trade deficit for the United States rising to USD42.3Bln in May from a previous USD40.3bln in April. Imports outstripped exports with most of the blame attributed to demand for imported cars, computers, and clothing.
