(Reuters) - A string of Europe's largest firms issued surprisingly upbeat profit reports on Thursday, bolstering an abrupt renewal of investor confidence in the region after months of debt turmoil and fears for the euro.
Broader economic data added to the theme, following some startlingly strong numbers last week -- euro zone economic sentiment rose strongly in July and German unemployment fell to its lowest level since November 2008.
Economists said the underlying performance in the region as a whole was never quite as bad as suggested by incessant news of debt default dangers in Greece and other southern European economies badly bruised by the recession of 2008-2009.
But they also cautioned that the abrupt swing toward a more positive mood did not change the fact that the region's economy is likely to heal only slowly with harsh government austerity measures poised to bite in the months ahead.
On the day, the upbeat news from some of Europe's biggest companies was nonetheless impressive and came on the heels of surveys last week which showed an unexpectedly high level of growth in both the manufacturing and services sectors in the region.
Publicis (PUBP.PA), the world's third-largest advertising group in terms of revenues, posted better-than-expected profit figures for the first half, declared its outlook better than previously envisaged, and the company's boss went as far as to declare the bad times over.
"We really have the feeling of being at the end of economic crisis, or even having put it completely behind us," Publicis CEO Maurice Levy told reporters.
His remarks were not isolated.
Dutch staffing firm Randstad (RAND.AS), second largest in the world in its field, said it was not seeing signs of a double dip in the economy, with companies continuing to hire more staff, notably in Germany and France.
"We are seeing growth everywhere. Even in Greece we are seeing the usual pattern. We are not seeing signs of a second dip," Randstad Chief Financial Officer Robert-Jan van de Kraats told Reuters.
Europe's debt market crisis spilled out of Greece late last year when markets took fright at the size of the country's deficit and ballooning debt, knocking the euro and European assets as investors started to fret about the risk of debt default in the region despite a Greek bailout.
Drugs and engineering giants gave good readouts too.
France's Sanofi-Aventis (SASY.PA) beat second-quarter earnings expectations, AstraZeneca (AZN.L) posted strong results and German chemicals maker BASF (BASF.DE) surpassed analysts' earnings expectations for the sixth straight quarter, bolstered by a rebound in the car and electronics industries.
German engineering conglomerate Siemens (SIEGn.DE) posted a better-than-expected 40 percent rise in fiscal third-quarter operating profit, helped by cost cuts and the export fillip from a weaker euro -- an exchange rate advantage ironically spawned by the debt crisis and investor fears that at some stages fueled questions about the common currency's very survival.
That debt market crisis propelled debt refinancing costs to record highs for governments in places such as Portugal, Ireland and Spain in May-June, but they have fallen back sharply in many cases in the last 10 days or so, suggesting investors sense the worst of the danger has passed.
The premium investors demand to hold the 10-year bonds of Ireland and Portugal instead of the equivalent debt of safe-bet Germany has fallen about 18 percent in less than two weeks and markedly too in Spain.
MOOD SWING
All that reflects a suddenly more positive take on Europe as the region additionally gains attractiveness in relative terms for global investors after a string of somewhat disappointing news on the U.S. front in recent weeks.
Investment bank UBS, where economists have long argued that investors were perhaps overly negative about the fiscal woes of the region, published a note that captured the shift in mood as far as they see it.
"Today our Global Strategy team upgraded Europe to Neutral (from Underweight) as they position their portfolio for a more positive tone," said the note.
"We continue to promote Europe on compelling valuations, economic data and relief for the banks to boot," UBS said, noting that Germany's Ifo index of business sentiment registered its biggest leap in 20 years in July, British second-quarter GDP was much stronger than expected and the fact that "stress tests" on banks across the region had proven mostly reassuring.
Other signals that the crisis was petering out include sharp drops in the price of credit default swaps (CDS), which provide protection against debt default and which soared in May.
The Markit iTraxx SovX index of Western European CDS prices is now at 114 bps, 54 basis points below its highest closing level of 168 basis points, seen on May 7.
In addition to a renewed focus on economic activity, signs are that investors are also encouraged by the existence of the 750-billion-euro standby lending facility euro zone governments have put in place to stem debt crisis contagion.
Despite some skepticism, investors also appear reassured by the fact that all but seven banks passed so-called stress tests of their financial resilience [ID:nLDE6661JE]. Bank shares in Europe, as measured by the STOXX Europe 600 bank index .SX7P, are up 7.4 percent since the stress test results emerged on July 23. and 25 percent up from the trough they hit in early June.
NOT SO FAST
At Deutsche Bank, however, economist Gilles Moec warned against getting carried away about the economy's recovery.
"There's no big change in terms of the underlying macro picture: we're in for slow growth," said Moec.
After poor first-quarter GDP figures in much of Europe, the second-quarter is expected to be stronger by definition more than as a result of any major upswing, and government stimulus deployed to combat the recession is still in place, with much of the post-recession austerity yet to come.
Economic growth is expected to be a modest 1.1 this year and 1.3 percent in 2011, according to a Reuters poll of 40 economists that was published in mid-July [ID:nLAG006340]. That follows a GDP drop of 4.1 percent in 2009.
"What is really impressive is the speed at which investors' focus has shifted away from hammering Europe to having a more sober look at the U.S.," said Moec.
A Reuters poll of 15 Europe-based asset managers showed on Thursday that European investors boosted fixed-income allocation to a 2010 high in July, although, as Mauro Ratto, head of Europe and Asia management at Pioneer Investments, put it:
"Concerns about the euro government debt crisis seem to be receding. However, most warning signs are still flashing red ... the prospect of budget tightening is unlikely to improve European growth rates."
(Additional reporting by William James and Jeremy Gaunt in London, Lionel Laurent in Paris and Reuters company news reporters across Europe; Editing by Mike Peacock and Stephen Nisbet)
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) - Unemployment rates fell in June from a year earlier in nearly half of the major U.S. metropolitan areas but more than a third had jobless rates of at least 10 percent, the Labor Department said on Wednesday.
Of the 372 metropolitan areas the government surveys, which encompass cities and counties, 185 said their jobless rates had dropped from a year before and 168 said they had risen. The rest said their rates were unchanged.
The number of areas with rates of 10 percent or more, 128, was lower than in June 2009. A dozen areas had rates of at least 15 percent, 10 of which were in California.
Bismark, North Dakota, registered the lowest unemployment rate in June of 3.8 percent, while the area of El Centro, California, again registered the highest rate of 27.6 percent.
Metropolitan areas' unemployment rates are not seasonally adjusted.
On Tuesday, associations representing municipal governments warned that they could lay off 500,000 workers over the next two years in order to balance their budgets in the face of collapsing tax revenues.
(Reporting by Lisa Lambert; Editing by James Dalgleish)
(Reuters) - State tax revenue is improving, but only slightly, and may not be enough to end steep spending cuts or replace the loss of assistance from the federal stimulus plan that expires in December, according to a report on Tuesday.
The National Conference of State Legislatures said states faced a collective budget gap of $83.9 billion when creating their budgets for fiscal 2011, which for most began on July 1.
Officials surveyed by the group, which represents state lawmakers, said revenue was beginning to pick up or at least slow its rate of decline. Nearly every state expects tax collections this fiscal year to surpass last year's.
"For the first time in a long time we're seeing some slight improvement in the state revenue situation," Corina Eckl, the NCSL's fiscal program director, said in a statement accompanying the report. "But glimmers of improvement are tarnished by looming problems."
Already, 33 states are forecasting budget gaps for fiscal 2012 and 23 anticipate shortfalls for fiscal 2013, highlighting the fragile state of their finances. Last year's collapse in state revenue -- one of the largest on record-- has shaken all parts of the U.S. economy.
Investors in the U.S. municipal bond market wonder about the future of debt issuance as state deficits swell.
Public employees see threats to their livelihoods and pensions as governments turn to layoffs. Citizens worry how the revenue crash will affect spending on schools and other services, and whether their tax bills will rise.
There are also concerns states will lead the country into a "double dip" recession. All except Vermont are required by law to balance their budgets.
Last week, Federal Reserve Chairman Ben Bernanke said state and local government budgets are reducing the speed of the recovery from the economic recession that began in 2007. He warned that in order to balance budgets, those governments would likely cut "several hundred thousand jobs."
White House Chair of the Council of Economic Advisers Christina Romer has said state budget shortfalls will be equal to about 1 percent of the country's gross domestic product.
The Center on Budget and Policy Priorities, a think tank that tracks state economic conditions, said earlier this month the recession had caused the steepest decline in state tax receipts on record and that more than 30 states raised taxes.
At least 46 states started fiscal 2011 addressing a shortfall. The Center estimated budget gaps for the fiscal year will total $121 billion, 44 percent higher than the forecast from the state legislatures.
The U.S. Census has also found state revenue is picking up, with state and local government tax revenue rising 0.82 percent in the first quarter of 2010. The Rockefeller Institute of Government, a New York-based research group, recently said overall state tax revenue rose 2.5 percent in the first quarter.
Still, those increases are not enough to push revenue back to pre-recession levels, the NCSL found.
"State lawmakers are going to need extra stamina to push through this next round of budget challenges," said William Pound, executive director of the NCSL. "It will be a long march before state revenues return to their pre-recession levels, not to mention other hurdles lawmakers have to clear."
The economic stimulus plan passed last year included the largest transfer of funds from the U.S. government to states, at $135 billion, but the aid runs out in less than six months.
Measures in Congress to extend some of that aid have stalled over fiscal conservatives' concerns about the deficit. Without the extension of Medicaid money, states will face new budget shortfalls topping $10 billion, the NCSL found.
Medicaid is the healthcare program for the poor, jointly administered by states and the U.S. government, which takes up 20 percent of state budgets. The stimulus boosted federal reimbursements for the program, freeing up money for other programs.
At least 25 states will have new budget gaps if the enhanced reimbursements are not continued for another six months, according to the NCSL, with 21 of those gaps greater than $100 million. Texas, North Carolina, New York and California risk having budget shortfalls of more than $1 billion.
(Reporting by Lisa Lambert; Editing by Dan Grebler)
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.
A decline in US 3-month libor below 0.50% coupled with solid Q2 company earnings have buoyed demand for carry trade strategies, driving high yielding and commodity currencies through key resistance levels vs the USD. It is debateable how long momentum can be sustained in a context of faltering momentum in the US. The idea that additional policy stimulus by the Fed could be required and would re-flate risk assets appears misplaced when elsewhere fiscal stimulus is withdrawn and liquidity is unwound. With the EU bank stress tests finally behind us, we look ahead to a G10 calendar next week dominated by the MPC testimony to the TSC and the first estimates of US Q2 GDP. Month-end implies currency and bond portfolio rebalancing. In five of the last six months, the re-weighting resulted in EUR/USD firming an average 0.5%. In contrast, GBP/USD only gained in month-end fixings in March and May.
Recap
The recap for fx this week reads very similar to that of two weeks ago. A rally in global equities propelled the AUD to the top of the G10 table, helping the currency to gains of 3.3% vs EUR, 2.6% vs USD and 2.5% vs GBP. A 1.1% q/q jump in UK Q2 GDP boosted GBP and helped the pound to record a 1.3% gain vs the JPY and 1.2% vs the EUR. GBP/USD ended the week above 1.5350, having traded as high as 1.5450. EUR/USD was equally unable to cling on to the best levels above 1.29 as profit taking emerged on the release of the EU bank stress tests following earlier bidding on a 3-year high for the German IFO.
UK Q2 GDP surpassed the most bullish estimates as the ONS reported a 1.1% q/q jump in output vs 0.3% in Q1. This still leaves the economy 4.7% below the starting pointof the recession in 2008, and will not tempt the MPC to change its view that the economy may weaken in the second half of 2010. The MPC minutes were remarkably more dovish on growth and members Posen and Dale did not hold back to warn of the dangers ahead. Retail sales also beat consensus estimates by climbing 1% in June. A marked decline in the retail deflator to 1.3% and a fall in inflation expectations back below 3% will comfort the MPC about the inflation outlook. Public finances recorded a bigger deficit in June, with borrowing reaching £14.5bln and data for May revised up to £17.0bln.
A good start to the week for UK rates reversed on Friday on the strong GDP release, causing yields to end the week on a high. 5y swaps climbed to 2.47%, up 6bp on the week. 10y yields rose above 3.40% to a 3.43% high. A deceleration in inflation pressures should keep yields capped going into August, with downside risk to the US macro data providing better levels to buy. The 3mth Libor/Ois spread widened one bp to 24bp. The 2y/10y swap spread widened 2bp to 198bp, and 10y swap spreads stayed flat at 2bp. A disappointing 2016 gilt sale drew lower than previous cover of 1.38x (1bp tail) .
G10 FX - GBP/USD, ST Trend Still Bullish
Back in June we noted that by flirting with a return to the 1.4784- 1.55 trading range in place between February and May, GBP/ USD had approached a crossroads, and how an improved technical picture and a rebound in correlations with equities and commodities pointed to further upside in the short-term (1.54 topside). This week we review our call and state that even though GBP/USD has posted impressive gains in July, there is no compelling case to drop the bullish near-term picture. Though the correlation of GBP/USD has eased back to statistically insignificant levels since the June comment (see chart), the divergence between UK and US macro indicators (see chart) brings the potential of further upside over the coming weeks before potential profit taking sets in ahead of the August MPC meeting and the Inflation Report on August 11.
The retreat of USD crosses since June has been led by a net change in speculative positioning and is marked by a net reduction in short JPY, EUR and GBP contracts. Disappointing US macro data since June has added downside USD pressure and is fuelling talk that the Fed may engage in a new round of policy stimulus in Q3/Q4 to prevent the economy from losing further steam. Though the jury is out whether the Q2 slowdown is a blip or start of a downtrend, a decline in US 3-mth libor below 0.50% and a rally in short-dated FF futures curve indicates that the market is taking a more pessimistic view. Additional US measures would threaten to drag the USD lower vs non-QE currencies or currencies where exceptional measures are gradually phased out.
Though strong UK Q2 GDP (+1.1% q/q) took the market off guard and lifted GBP/USD above 1.54, one cannot ignore the dovish observations by the MPC and individual comments by members Posen and Dale. This could lead investors to re-engage in accumulating GBP short positions into early August. To what extent the Budget will bear down on the Bank's growth and inflation forecasts will become clear in the next Inflation Report. Minutes from the July MPC meeting hint that growth prospects may be scaled back. Depending on whether inflation and inflation expectations also recede, talk of additional policy loosening (a greater than 50% probability accordng to MPC member Posen) would cloud the outlook for GBP vs other G10 currencies, especially those where performance is linked to positive interest rate spreads and elevated correlation with equities and commodities.
Based on our quantitative metrics, the correlation of GBP/USD with risk assets has receded markedly to the point that price action in stocks has become statistically insignificant for short term direction. Rate differentials between the US and the UK have also faded as a driver for GBP/USD, offering no clear sense of direction for the cross. Though we are tracking changes in correlations closely, this means is that markets are inclined to put more weight at present on corporate flows and a divergence between US and UK macro indicators, but with confidence about deficit reduction equally playing a part.
Technically, to sustain the upward short-term move GBP/USD has to overcome 1.5454, the July 15 high. Beyond 1.55 lies a cluster of resistance at 1.5524 and 1.5578. A breakout of the February- May range would bring 1.5814 into play.
* 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 British Pound extended the rally from the previous day and rallied to a fresh weekly high of 1.5412 during the European trade as the advanced 2Q GDP report for the U.K. reinforced an improved outlook for future growth, and the GBP/USD is likely to maintain the upward trending channel from the June low (1.4346) as the recovery gathers pace.
Talking Points • Japanese Yen: Weighed by Risk Appetite • Pound: 2Q GDP Exceeds Forecast • Euro: German Businesses Confidence Unexpectedly Improves • U.S. Dollar: European Bank Stress Test on Tap
However, a report by the British Bankers’ Association showed loans for home purchases unexpectedly slumped to 34.8K in June from a revised 36.4K in the previous month to mark the lowest reading since February, and the slack within the real economy may lead the Bank of England to maintain a dovish policy stance over the coming months as it aims to balance the downside risks for the region.
Economic activity in Britain expanded 1.1% in the second quarter, which exceeded forecasts for a 0.6% rise, while the growth rate increased an annualized pace of 1.6% to mark the first positive reading since 2008, and the larger-than-expected rise in economic activity could give the BoE scope to normalize monetary policy going into the following year as price growth continues to hold above the government’s 3% limit for inflation. The breakdown of the report showed manufacturing increased at the fastest pace in over a decade, with construction surging 6.6% to mark the largest advance since 1963, while service-based activity, which accounts for more than two-thirds of the economy, expanded 0.9% from the first three-months of 2010. However, as the new coalition in the U.K. targets the budget deficit and tightens fiscal policy, the central bank may look to support the economy throughout the remainder of the year as the outlook for future growth remains clouded with uncertainties.
The Euro crossed back above the 100-Day SMA (1.2878) and surged to a high of 1.2965 following an unexpected rise in business confidence, and the single-currency is likely to face increased volatility later today as the European Central Bank is scheduled to release the results of the commercial bank stress test at 16:00 GMT. The German IFO business confidence survey increased to 106.2 in July from 101.8 amid forecasts for a decline to 101.5, with the gauge for future expectations advancing to 105.5 from a revised 102.5 in June, and businesses may turn increasingly optimistic going forward as the region benefits from the rebound in global trade. Nevertheless, as the stress test takes center stage, dismal results is likely to weigh on the exchange rate, which could stoke a sharp selloff in the euro-dollar, but even a lackluster outcome may keep the single-currency above the 100-Day SMA as the economic outlook improves.
U.S. dollar price action was mixed overnight, while the USD/JPY advancing to a high of 87.22 as the Japanese Yen weakened against most of its major counterparts, and the reserve currency is likely to face increased volatility later today following the results of the European stress test as investors weigh the outlook for the global financial system. However, the major currencies could face choppy price action as market liquidity thins ahead of the weekend, but the rise in risk appetite is likely to dictate price action going into the North American trade as equity futures foreshadow a higher open for the U.S. market.
How Will The European Bank Stress Test Affect The Exchange Rate? Join us in the Forum
Related Articles:
US Dollar to Rise Against Yen, Decline vs Pound and Euro
To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com
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.
The euro appreciated vis-à-vis the U.S. dollar today as the single currency tested offers around the US$ 1.2930 level and was supported around the $1.2735 level. The common currency reversed yesterday’s intraday losses as risk appetite improved, driving some global equity markets higher. Data released in the U.S. today saw weekly initial jobless claims climb to 464,000 from a revised 427,000 while continuing jobless claims climbed to 4.487 million from 4.710 million. Also, June existing home sales were off 5.1% m/m to an annualized 5.37 million units while June leading indicators came off 0.2% from the previous tally of 0.5%. Also, the May house price index printed at +0.5% m/m, down from +0.9%. Federal Reserve Chairman Bernanke called for an extension of the Bush tax cuts and cited the elevated U.S. unemployment rate as the biggest problem in the U.S. economy. Bernanke also cited additional monetary easing options including reducing the rate paid on banks’ reserves held at the Fed and purchasing more securities. New York Fed President Dudley today said the “road to recovery is turning out to be a bit bumpy.” In contrast, former Fed Chairman Greenspan said the Bush tax cuts should not be continued and noted an end to cuts “would probably” slow economic growth. In eurozone news, eurozone data released today saw the July PMI composite improve to 56.7 from the prior reading of 56.0 while EMU-16 PMI services and manufacturing improved. Also, EMU-16 May industrial new orders were up 3.8% m/m and 22.7% y/y. Moreover, EMU-16 July consumer confidence improved to -14 from the revised reading of -17. German July PMI manufacturing and services improved and data to be released tomorrow include July Ifo business sentiment. French data released today saw July PMI manufacturing decline while PMI services moved higher. French July consumer confidence remained unchanged at -39. Results of stress tests on up to 91 European banks will be reduced tomorrow. Euro offers are cited around the US$ 1.2955 level.
¥/ CNY
The yen appreciated vis-à-vis the U.S. dollar today as the greenback tested bids around the ¥86.35 level and was capped around the ¥87.20 level. The pair continued to inch lower as traders tested 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 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 yesterday 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. Former BoJ Governor Fukui cited elevated global financial uncertainty. Data released in Japan overnight saw May all-industry activity index decline to +0.2% from the revised April print of +1.9%. The Nikkei 225 stock index lost 0.62% to close at ¥9,220.88. 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 ¥112.70 level and was supported around the ¥110.00 figure. The British pound moved lower vis-à-vis the yen as sterling tested offers around the ¥133.25 level while the Swiss franc moved higher vis-à-vis the yen and tested offers around the ¥83.75 level. In Chinese news, the U.S. dollar depreciated vis-à-vis the Chinese yuan as the greenback closed at CNY 6.7797 in the over-the-counter market, down from CNY 6.7767. Premier Wen said policy stability should be carried forth in the second half of the year. There are rumours the Chinese government could ease lending controls and Wen said China may “improve” stimulus measures to boost domestic consumption. Ratings agency S&P said Chinese banks are facing escalating credit risks and non-performing loan growth. PBoC also said it will seek to avoid major fluctuations in the yuan’s exchange rate.
£
The British pound appreciated vis-à-vis the U.S. dollar today as cable tested offers around the US$ 1.5295 level and was supported around the US$ 1.5150 level. Data released in the U.K. today saw June headline retail sales climb 0.7% m/m and 1.3% y/y while the ex-autos component was up 1.0% m/m and 3.1% y/y. Data to be released tomorrow include Q2 gross domestic product and June BBA loans for house purchases. Minutes from the July Bank of England Monetary Policy Committee meeting were released yesterday 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 appreciated vis-à-vis the British pound as the single currency tested offers around the £0.8465 level and was supported around the £0.8385 level.
CHF
The Swiss franc appreciated vis-à-vis the U.S. dollar today as the greenback tested bids around the CHF 1.0395 level and was capped around the CHF 1.0515 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 1.3460 level while the British pound moved lower vis-à-vis the Swiss franc and tested bids around the CHF 1.5850 level.
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.
(Reuters) - Increased housing commitments swelled U.S. taxpayers' total support for the financial system by $700 billion in the past year to around $3.7 trillion, a government watchdog said on Wednesday.
The Special Inspector General for the Troubled Asset Relief Program said the increase was due largely to the government's pledges to supply capital to Fannie Mae and Freddie Mac and to guarantee more mortgages to the support the housing market.
Increased guarantees for loans backed by the Federal Housing Administration, the Government National Mortgage Association and the Veterans administration increased the government's commitments by $512.4 billion alone in the year to June 30, according to the report.
"Indeed, the current outstanding balance of overall Federal support for the nation's financial system...has actually increased more than 23% over the past year, from approximately $3.0 trillion to $3.7 trillion -- the equivalent of a fully deployed TARP program -- largely without congressional action, even as the banking crisis has, by most measures, abated from its most acute phases," the TARP inspector general, Neil Barofsky, wrote in the report.
The total includes Federal Reserve programs and a myriad of asset guarantees, including Federal Deposit Insurance Corp. protection for bank deposits.
The increased government commitments more than offset about a $300 billion decline in the U.S. Treasury's TARP commitments in the past year as programs have closed and banks have repaid taxpayer funds.
HOUSING PROGRAMS CRITICIZED
Barofsky also in the report ramped up his criticism of the Treasury's housing relief efforts, saying that its program to reduce monthly mortgage payments for struggling homeowners was showing "anemic" participation numbers and had failed to "put an appreciable dent in foreclosure filings."
He said Treasury had refused his repeated recommendations to announce more effective goals and benchmarks for its mortgage modification program, which could reach up to $50 billion in TARP funds.
"Treasury's refusal to provide meaningful goals for this important program is a fundamental failure of transparency and accountability that makes it far more difficult for the American people and their representatives in Congress to assess whether the program's benefits are worth its very substantial cost," Barofsky wrote.
Among other recommendations repeated in the report, Barofsky called for the Treasury to consider making its voluntary mortgage principal reduction program mandatory, saying this would make it less likely for "underwater" homeowners to abandon their properties.
The Treasury has declined to adopt the recommendation, citing the prospect that mandatory principal reduction would cause mortgage servicing firms to opt out of the program and fairness issues in reducing principal for both responsible homeowners hit by value declines and homeowners who overleveraged their properties in refinancings.
U.S. Treasury officials defended the Home Affordable Modification Program, saying that it was still on track to reach its goal to keep 3 million to 4 million homeowners in their homes by the end of 2012 and was adapting to changing conditions by offering forbearance to unemployed people and extra funding for the hardest-hit markets.
Herbert Allison, Treasury assistant secretary for financial stability, said the Treasury often agrees with Barofsky's recommendations, "but once in a while, we differ on what type of policy will best carry out our mandate."
The report provoked swift criticism of Obama administration housing policies from U.S. Rep. Darrell Issa, a California Republican who has taken every opportunity to blast the Treasury's handling of financial bailout programs.
"The fact that the Obama administration is treating TARP like its own personal slush-fund is beyond egregious and a complete betrayal of what the American people were told would be then when their tax-dollars were used to bailout Wall Street," Issa said in a statement, adding that the housing efforts were "dumping good money after bad."
(Reporting by David Lawder; Editing by Kazunori Takada)
* German ifo business climate (July): unchanged * PMI manufacturing index EMU (July): unchanged
The ifo business climate for Germany could have remained unchanged at least in July. The German ZEW economic sentiment and the US ISM manufacturing index have both declined. German yield spreads have also gone down, as short-term interest rates have increased and long-term rates have been fluctuating. The DAX and crude oil prices have been fluctuating too and the euro has appreciated somewhat recently.
The Purchasing Managers' Index for the manufacturing sector in Germany and in the EMU and French business confidence could have remained more or less unchanged in July. However, Belgian business confidence might have continued deteriorating in July. The latter also applies to July consumer confidence in the EMU, in France and in Italy.
French consumer spending might have increased slightly in June, although French consumer confidence continued to deteriorate. EMU industrial new orders could have declined in May, just as the corresponding German figure did. Following its usual seasonal pattern, the EMU current account is likely to have gone down in May, in the same way as the EMU trade balance.
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.
Slower Growth, Low Inflation with Big Budget Deficits
* Retail sales and industrial production set the tone for the economic outlook as momentum has slowed to a three month pace of 4 percent compared to a 7 percent year-over-year gain. This slowdown outlook was reinforced by comments by the Federal Reserve. * Inflation, meanwhile, measured by the Consumer Price Index, is now up just 1.1 percent over the past year. Substantial slack in the economy will likely continue to put downward pressure on core CPI inflation. Slow growth and low inflation suggests big federal fiscal budgets persist for the outlook horizon. Moderate Paced Recovery with Low Inflation
A Dose of Reality from the Fed: Participants generally anticipated that, in light of the severity of the economic downturn, it would take some time for the economy to converge fully to its longer-run path as characterized by sustainable rates of output growth, unemployment, and inflation consistent with participants' interpretation of the Federal Reserve's dual objectives; most expected the convergence process to take no more than five to six years.
Recent data suggest economic momentum has slowed. Retail sales slowed to a three-month pace of 4 percent compared to a 7 percent year-over-year gain. This slowdown was reinforced by comments made by the Federal Reserve at the June meeting. The Fed suggested that the economic recovery was proceeding at a moderate pace in the second quarter but that the unemployment rate remained elevated. Yet, aggregate hours worked by employees on private nonfarm payrolls rose substantially through May suggesting continued forward momentum.
Reinforcing the Fed's view, industrial production figures this week indicated moderation over the past three months especially for consumer goods including autos. In contrast, business equipment production, including computer and electronic products, remains solid. Exports, business inventory rebuilding and the longer-run imperative of global competition have provided forward momentum to industrial production. Our July outlook is for 1-2 percent growth in GDP in the second half of 2012, with positive contributions from consumer spending, business equipment investment and government purchases. Inflation: CPI Moderation at a Low Level
On the inflation front, falling energy prices held down headline consumer prices in June, with overall CPI now at 1.1 percent year over year, while core consumer prices are at just 0.9 percent.
Fed: Nonetheless, the possibility that inflation expectations might start to decline in response to persistently low levels of actual inflation and the potential effects of continued weakness of the economy on price trends were seen by a few participants as posing some downside risks to the inflation outlook.
Clearly there is little pricing power for suppliers as it appears that keeping market share is the driving force. Our July outlook is for overall CPI to stay in the 1 percent range for the rest of this year. The Federal Budget Outlook and Our Foreign Friends The fiscal year-to-date deficit reached more than $1.0 trillion in June, and we estimate the deficit-to-GDP ratio will finish this year above 9 percent. The slight reduction of the deficits in recent months has been due to better economic growth so the recent slowdown in growth expectations is a negative signal for the deficit moving into the next fiscal year. Our outlook is for fiscal deficits to come in at $1.3 trillion on average for fiscal 2010 and 2011. Ominously, net foreign purchases of Treasury bonds and notes fell in May. Foreign official purchases of short-term securities also declined.
U.S. Outlook
Housing Starts • Tuesday
Housing starts are expected to remain within the range that has been maintained since the beginning of 2009. The market still has an oversupply of homes, and builders do not yet have a reason to add to it—demand is still soft, particularly in the wake of the first-time homebuyers' tax credit. The pullback seen in May could continue in June as sales have been extremely weak without government support, making builders exceptionally cautious.
The dismal labor market has also weighed on demand. Our expectation that the housing industry will be in the doldrums for some time was confirmed in May's reading of building permits, down 9.9 percent, and we anticipate weakness continued in June. Residential construction will likely detract from third quarter GDP growth.
Previous: 593K Wells Fargo: 580K Consensus: 581K
Existing Home Sales • Thursday
Existing home sales turned in a 2.2 percent decline in May, and we expect another weak result in June. The expiration of the first-time homebuyers' tax credit means that demand will be determined in the market without government influence for the first time in months. However, the effect of the tax credit was to pull demand forward for eligible buyers, so underlying demand is likely even lower than it otherwise would have been without the tax credit. The market will likely spend the summer finding its new sales pace, and our expectations are quite low.
Low mortgage rates are a bright spot for the housing market, which may entice certain buyers into the market; however, stricter lending standards limit the pool of qualified buyers.
Despite a steady string of positive readings since March 2009, it appears that the run has ended for the Leading Economic Index. We expect a slight drop to -0.1 percent, though the swing variable could very well be the building permits number, which prints on July 20 and is an important component of the index.
Slowing supplier deliveries, as seen in many recent surveys of the factory sector, as well as weakness in stocks in the month of June will detract from the index. The disappointing labor market, which has become a motif of late, will also weigh on the headline. While the leading index is paring its recent gains, we do not anticipate a double-dip recession; instead, a slower pace of growth in the second half is the most likely outcome.
* After a sharp rebound, the year-over-year rate of GDP growth in China slowed in the second quarter relative to the first quarter. The lending restrictions that the government directed banks to take a few months ago appear to have had their desired effects. * Although we look for further slowing in the quarters ahead, we do not look for a "hard landing" in China. Indeed, recent declines in equity and housing prices and benign inflation may cause the government to ease up on the brakes somewhat.
Chinese Economy Starts to Slow
Recent data show that real GDP growth in China slowed to 10.3 percent in the second quarter from 11.1 percent in the first quarter of 2010 (see graph on front page). Some of the slowdown in the year-over-year rate of economic growth reflects base effects. The first quarter of 2009 marked the nadir of the global downturn, making a strong year-over-year growth rate in the first quarter of this year easy to achieve. That said, it appears that economic growth slowed on a sequential basis as well in the second quarter due, at least in part, to a deliberate attempt by authorities to take some steam out of the economy.
In the midst of the global downturn, Chinese officials encouraged banks to ramp up lending in order to support the domestic economy. When it became apparent earlier this year that the global economy was on the mend, China no longer needed economic stimulation. Indeed, sharp rises in house prices in some cities indicated that tighter economic policies were appropriate. Therefore, the government directed banks to rein in lending and a sharp slowdown in loan growth ensued (top chart). The directives were largely targeted at excessive real estate investment, and the recent slowdown in fixed-investment spending suggests that the measures are having their desired effects (middle chart). In that regard, growth in the value of construction spending edged down in the second quarter and further deceleration seems likely.
Is the Chinese economy destined for a "hard landing"? Probably not. Outside of the construction sector there are few apparent signs of significant slowing, at least not yet. The year-over-year growth rate in retail spending continues to clip along around 18 percent, and export growth picked up to 40 percent in the second quarter from 30 percent in the first quarter. Although we expect export growth to slow in coming quarters, another downturn in exports seems unlikely unless the global economy falls back into a recession, which we do not expect.
Moreover, the recent behavior of prices, both in terms of assets and goods and services, means that the government may be able to somewhat ease up on the brakes. The stock market (as measured by the Shanghai Composite index) is off about 25 percent since mid-April, and the widely followed 70-city index of house prices edged down in June for the first time in more than a year. In addition, the year-over-year rate of CPI inflation declined to 2.9 percent in June from 3.2 percent in May (bottom chart). Although deceleration in food prices contributed to the decline in the overall rate of CPI inflation, non-food price inflation also edged lower in June. In other words, there is less evidence today to support the view that the Chinese economy is overheating than there was a few months ago.
Although the government may ease up on the brakes somewhat in terms of monetary policy, we expect its renewed willingness to allow some flexibility in the exchange rate to continue. The currency strategy group projects that the dollar will weaken about 5 percent versus the renminbi over the next 12 months or so.
Global Outlook
Bank of Canada Policy Meeting • Tuesday
At its policy meeting on June 1, the Bank of Canada (BoC) raised its target for the overnight lending rate to 0.50 percent from 0.25 percent, the first rate hike in nearly three years. In its statement announcing the rate hike, the BoC noted that "considerable monetary stimulus" is still in place. Given the recent strength in the labor market, we concur with the consensus forecast that the BoC will hike rates by another 25 bps.
Data on retail sales in May and CPI inflation in June will also be released next week, but the BoC probably won't have the luxury of seeing the data before its rate decision. Retail sales are expected to have bounced back in May from their unexpected decline in April, and CPI inflation should remain benign. That said, inflation could rise over the medium term if abnormally low interest rates excessively stimulate the economy.
It appears that industrial production (IP) in Germany strengthened considerably in the second quarter. Indeed, IP in the April/May period shot up nearly 5 percent relative to the first quarter, and the high level of the Ifo index in June suggests that IP remained solid during the final month of the second quarter. The Ifo index for July will offer investors some insights into the state of the German economy thus far in the third quarter.
Elsewhere in the Euro-zone, data on French consumer confidence and consumer spending are slated for release next week as well. Italy prints data on industrial orders and sales, consumer confidence, and retail sales. The "flash" estimates of the Euro-zone manufacturing and service sector PMIs are also on the docket next week.
Previous: 101.8 Consensus: 101.5
British GDP • Friday
Positive growth has returned to the U.K. economy, but the rate of recovery has been slow, at least through the first quarter. However, monthly indicators suggest that growth strengthened somewhat in the second quarter. For example, industrial production in the April/May period was up 1.1 percent relative to the first quarter. Therefore, most analysts, including us, look for an increase in the rate of GDP growth when the figures for the second quarter print on Friday.
Other data released earlier in the week will give investors further insights into the state of the British economy at present. A widely-followed business survey will shed some light on business sentiment, and retail sales data will show how consumer spending fared in June.
Like a good corporate investor relations head, the FOMC has given us guidance on interest rates and, like a good equity analyst, we pay attention.
The FOMC modestly lowered its projection for growth and inflation for the next two years. Growth in 2010 is now at 3.0-3.5 percent, which is slightly above our number. The FOMC cited tighter financial conditions resulting from spillover effects from Europe, while we would add that housing is not bouncing back as some expected after the first-time homebuyers' tax credit was discontinued. Unemployment also has been higher than the FOMC expected. We expect unemployment rates to stay in the 9.5 percent plus range this year. The FOMC also lowered its inflation outlook for core PCE prices for 2010 and 2011 as well.
Downside risk to the outlook for inflation was also discussed and the risk of deflation was cited by a few (more than one) participants. Given such guidance, our expectation is that the FOMC is unlikely to move the funds rate this year or through the first quarter of next year. Only some upside growth/inflation surprise is likely to get any movement.
Long Rates: Growth, Inflation, the Euro and Federal Deficits
Meanwhile our expectations are for five- and 10-year Treasury rates to remain around the 2 and 3 percent levels for the rest of this year. Two big positives for Treasury rates this year have been less than consensus expectations for both growth and inflation. Throw in a little flight-to-safety from the Euro and you get lower Treasury yields.
Risk remains in the large fiscal deficits and the dependence of the United States on foreign investors. As reported earlier this week, foreign demand for long-term U.S. assets fell in May as net purchases of Treasury bonds and notes fell significantly. Growth and inflation dominate but the delicate financing balance remains a concern.
Consumer Credit Insights An Increasingly Bifurcated Economy
This week, FICO reported that as of April, 25.5 percent of consumers now have a credit score of 599 or below, a significant jump from the pre-recession average of 15.0 percent. On the other hand, the share with a score of 800 or higher has risen to 17.9 percent versus a pre-recession average of 13.0 percent. The ranks of those with moderate credit scores between 650 and 699 have dropped to 11.9 percent from a pre-recession average of 15.0 percent. The reasons for the increase in the lower credit score range are numerous, including over-indebtedness, missed payments, job losses and foreclosures. But what accounts for the increase in the top score range? Those individuals who are lucky enough to have a job are likely putting more of their income toward paying down debt. Similarly, those who are lucky enough to still have equity in their homes are refinancing at record-low mortgage rates. Both of these actions can help to improve credit scores by either reducing debt or debt service burdens. This speaks to a bifurcated economy, one where those who are doing well are getting really good deals and shoring up their balance sheets, while those who are already going through difficult times are finding things getting even worse. With credit conditions tight across the economy, even those with good credit are still finding it challenging to get a loan, while those with bad credit are finding credit nearly impossible to obtain. This imbalance between supply and demand does not bode well for lenders.
Topic of the Week
States struggle to balance budgets
July 1 marked the beginning of fiscal-year 2011 for most states, and state officials are faced with tough decisions concerning their budgets. Slow economic growth coupled with the legal obligation to balance budgets forces states to continue to raise taxes and/or cut spending.
Record high unemployment levels have increased demand for state spending as more people qualify for assistance programs. States have projected total budget deficits of $127 billion in 2011. While less than the shortfalls of the past two years, this deficit will prove more difficult to close. Under the stimulus program enacted in 2009, the federal government was able to plug 30-40 percent of state budget shortfalls in 2009 and 2010. However, the funding will run out in December and Congress has yet to show any signs of extending assistance.
Two states facing significant financial woes, Arizona and California, show that states are looking to make considerable spending cuts. Arizona projects a structured shortfall of $1.69 billion. The budget solution consists of a 26 percent reduction in spending, cutting back on temporary cash assistance eligibility, as well as Medicaid services for more than 1 million Arizonans. The state imposed a 1.1 percent rise in the sales tax rate, creating the expectation of a 4.3 percent rise in base revenues. However, the boycotts some cities are calling against Arizona over its immigration laws may impact tourism and lead to lower-than-expected fiscal revenues.
Last year, California was able to close its budget gap of $60 billion, draining most of its rainy day fund, yet the state faces a $19.1 billion gap again this year. To help close the gap, California will reduce expenditures by $12.4 billion. Still facing unprecedented unemployment levels of 12.4 percent, California is looking at a rough road ahead. The cuts in state spending will continue to counterweight the federal stimulus and place a drag on the slow growing economy.
* Risk rally stalls, more downside likely * EU bank stress test results are keenly awaited * UK Inflation debate may be fuelled * Bank of Canada Rate hike expected * Key data and events to watch next week
Risk rally stalls, more downside likely
Risk assets (stocks, commodities, JPY-crosses) started out the past week on solid gains, but ultimately failed to overcome key resistance levels. In stocks, the fact that 20 out of 23 US earnings reports beat expectations and shares could not advance should be alarming. In reality, though, it should also have been expected--as the outlook for the US recovery continued to slide, the future outlook for stocks was undermined (and earnings are mostly backward looking indicators anyway). The market is still in the process of adjusting to a more sluggish 2H 2010, with US assets bearing the brunt at the moment, but we also think there is more to go in re-pricing for a slower global recovery.
In terms of price levels, the S&P 500 failed below the key 1100 psychological level and the bottom of the Daily Ichimoku Cloud around 1095, keeping the downside focus intact. A bearish engulfing line on the daily S&P candlesticks also highlights downside risk ahead. WTI crude oil prices never even managed to test the recent highs just below the $80/bbl area, and finished down on the week. EUR/USD topped out at the 61.8% retracement of the April-June decline, which came in at the psychologically significant 1.3000 level. The USD index extended losses below the daily cloud, but may have found a base above the key 82.00 level, just above the weekly cloud top at 81.90. AUD/JPY, the closest correlated FX pair to stocks, was rejected from the daily cloud up in the 77.30/78.30 area, mirroring the same S&P failure. Lastly, the commodity currencies have shown renewed signs of weakness against the USD, and they are frequently a leading indicator for broader USD-based moves, suggesting USD weakness may be set to reverse.
Over the course of the past week, several key correlations broke down in the short run, but other more meaningful correlations persisted. The major anomalies were in outsized EUR gains, followed closely by GBP, and extreme USD weakness. We look at EUR and GBP strength as mainly the result of another wave of short-covering, similar to what occurred in the middle of May. In this respect, we would note the outsized gains in EUR/AUD, EUR/CAD, GBP/AUD, and GBP/CAD. If it were a case of pure USD weakness, those crosses would not have seen such gains, reinforcing our view that this was a position-driven adjustment. Anecdotally, the break above the 1.2750/2800 area was heavily stop loss driven. Also, according to recent correlations, a weaker USD should have boosted stocks, oil and gold, but clearly that didn't happen either.
Taking a step back and looking at the bigger picture, US weakness undermines the prospects for the global recovery overall. From that view, many of the market moves in the past week make more sense: oil and stocks lower on slowing global outlooks; JPY-crosses lower on heightened risk aversion over the deteriorating outlook; and JPY and CHF strength on safe haven flows. We think the bulk of EUR and GBP short-covering has likely occurred and we are leery of chasing those currencies higher. Anticipating that increased risk aversion may eventually lead to the USD rebounding on safe haven demand, we would prefer to be sellers on remaining strength in EUR/USD between 1.3000-1.3150 and in GBP/USD between 1.5400/5530. The likely more reliable way to trade expected further risk pullbacks would be to sell JPY-crosses, especially AUD/JPY, CAD/JPY and NZD/JPY on remaining strength.
EU bank stress test results are keenly awaited
The first results of the EU bank stress tests are due on July 23. Credit analysts have been busy drawing up lists of which banks are likely to have failed; if the tests are to be perceived as credible then failures are considered to be inevitable. In contrast, the tone of many European officials has been confident. The Deputy Spanish Finance Minister Campa has said that Spain “can only win” from the publication of the tests, Bank of Italy Governor Draghi has stated that the stress tests will demonstrate that the capitalization of Italian banks is well above minimum levels and Bank of Ireland Governor Honohan has stated that Irish banks have already been through more severe tests. The IMF’s Strauss-Kahn has concluded that there will be some small institutions that will have to be refinanced. The official rhetoric along with a decent result to the Spanish bond auction and Greek bill sale this week has supported the EUR. Clearly the EUR may come under pressure if the stress tests bring many casualties. It could also be sold if the stress tests produce too few failures, as the tests will be seen as providing insufficient transparency to the interbank market. There could be a thin line where the results appear to be relatively agreeable and the EUR can derive support. However, having reached EUR/USD 1.300 already, upside potential for the EUR could be running dry.
UK Inflation debate may be fuelled
The debate on whether inflation pressures are building in the UK intensified a month ago when it was revealed that MPC member Sentance had voted for a rate hike at the June policy meeting. Since then Sentance has maintained his hawkish view although the CPI release has shown a fall in the headline rate and labour data has brought a moderation in the growth rate of earnings. The publication of the FOMC minutes this week re-opened the possibility that the Fed may ease policy again before it hikes. While this prospect cannot yet be dismissed in the UK, market expectations are favoring a policy tightening in the UK ahead of the US and this possibility has allowed for a better tone in cable in recent sessions. Sterling could find additional support on the back of the Q2 advance GDP report in the week ahead, which is expected to show relatively good growth. The impact, however, is likely to be short-lived given prevailing concerns that the UK growth rate will stutter in H2 on the back of the government’s austerity measures. The old range high of cable at USD.15525 is likely to offer decent resistance, a break below the USD1.5230 level may suggest additional losses are in store. Bank of Canada Rate hike expected
On Tuesday July 20, the Bank of Canada meets to decide on interest rates. We agree with the market consensus for a second consecutive rate hike of 25bps to 0.75% as recent economic data out of Canada supports policy tightening. A look at the jobs report underscores this as 93.2k jobs were added in June, more than 4 times analysts’ expectations. To put this in perspective, a proportionate number in the U.S. (whose economy is about 10 times larger) would be the creation of roughly 930,000 jobs. That is an impressive number and keep in mind that higher employment propels the economy forward. There has been some discussion that the BOC may tighten more aggressively, however we do not agree with this view. As inflation remains subdued there is no apparent need for more aggressive tightening. Year over year CPI is currently 1.4% which is below the 2% target inflation rate and the bank recently projected core inflation at or below 2% through 2012. In their forward looking guidance, policy makers are likely to take a cautious tone given the concerns over the Euro zone and slow down in global growth highlighted by a softening demand in commodities. More detailed thinking can be expected in Thursday’s Monetary Policy Report. Key data and events to watch next week
The calendar in the US is modestly light in the week ahead. Housing numbers kick off the week with the July NAHB Housing Market Index and continues into Tuesday with June Housing Starts and Building Permits. The data slate for Thursday sees weekly Jobless Claims, June Existing Home Sales, and June Leading Indicators. Fed Chairman Bernanke will deliver the semi-annual monetary policy out look to the Senate Banking Committee on Wednesday.
Eurozone data is relatively light but significant with a heavy emphasis on the aggregate EZ results of the bank stress tests on Friday. May Euro-Zone Current Account data is scheduled for Monday as is May Construction Output. No further data is scheduled until Thursday when PMI Composite, Services, and Manufacturing Output Indexes are to be released. Thursday wraps up eurozone data releases for the week with May Industrial New Orders and Euro-Zone Consumer Confidence. In Germany, Tuesday sees June Producer Prices with July PMI Manufacturing and PMI Services surveys to follow on Thursday. Friday closes out the data week with the July IFO Business Climate Index.
A moderate week of data lies ahead in the UK with June Public Sector Net Borrowing, June Mortgage Approvals, and the July CBI Optimism Index on Tuesday. Wednesday will have the Bank of England Minutes followed by June Retail Sales figures on Thursday. Friday wraps up the UK data session with the advance estimate for Q2 GDP.
Data out of Tokyo is light with May Leading and Coincident Indexes to be released on Tuesday. There is significant event risk though as BOJ intervention cannot be completely dismissed with USDJPY trading at current levels.
Canada begins a significant week of data with the Bank of Canada Rate announcement on Tuesday. Expectations are for an increase of +0.25% to 0.75%. Up next are May Wholesale Sales and May Retail Sales due out on Wednesday and Thursday. Friday wraps up the week with June CPI and Bank of Canada Core CPI set to be released.
The calendar down under begins with the release of the RBA minutes from the July meeting on Monday and continues with the Q2 NAB Business Confidence survey on Wednesday. Thursday wraps up the week with Q2 Import and Export Price Indexes.
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.
