Week of May 29, 2011
G8 optimism on global growth seems wishful thinking
The past week ended on an upbeat note for risk assets (stocks and commodities) and a weaker USD ostensibly on the pronouncement from the G8 that the global recovery is “gaining strength and is becoming more self-sustained.” However, incoming economic data suggest the opposite, namely that growth in major developed economies is showing signs of slippage. Just in the past week, key Eurozone PMI’s and business confidence indexes posted larger than expected declines, while in the US durable goods orders and the Richmond Fed index also fell more than forecast. Coming up next week, key US data points include May’s Chicago PMI and national ISM indexes, all of which are expected to post declines from the prior month. And to finish out the week will be the May US employment report, which is also expected to show a moderation in job gains, though still moderately healthy at +184K consensus forecast (prior +244K).
Then there is the Eurozone debt crisis, which continues to drag on like an epic Nordic saga (though no Scandinavians are in trouble). The latest is political opposition from Greece’s minority parties to additional austerity measures and the potential that the IMF may not be able to disburse its share of the next tranche of aid due to Greece at the end of June due to its own internal rules. The political debate on how to shore up Greek finances shows no sign of being resolved, while Greek public opposition to austerity continues to run the risk of major social unrest. We think some form of Greek debt restructuring remains extremely likely, with only the timing open to question. As such, and with European data continuing to indicate a slowing ahead, we think the EUR and risk sentiment in general remain vulnerable.
We’re viewing this past week’s rebounds in commodities and major currencies against the USD as a correction in a larger risk-off movement, but we are also keenly aware that many in the market are more optimistic on the risk outlook. We would note that most indicators of risk aversion, with the notable exception of the USD, support our ‘risk-off’ view: US Treasuries (and other solid government debt issues) are at recent highs; gold and silver are stronger, CHF is at record strength, and JPY-crosses are consolidating nearer to recent lows in most cases. This suggests to us that markets remain exceptionally cautious and are prone to another relapse in risk sentiment. In currencies, then, we favor using current USD weakness as a buying opportunity, especially against some of the commodity currencies (e.g. selling NZD/USD near all-time highs of 0.8210/20). Still, in many of the USD pairs we have reached significant technical pivot levels, which if surpassed would likely signal a renewed bout of USD weakness ahead, so we won’t be married to our outlook. In concrete terms, EUR/USD above 1.4350/70, GBP/USD above 1.6520/50, USD/JPY below 80.00/30, and the USD index below 74.55 would all be problematic for our USD-positive outlook. Next week will see the usual month-end silliness (i.e. inexplicable volatility), along with a US holiday on Monday, so we expect many of those USD levels to be tested at the minimum.
June’s event risks are make-or-break for the Eurozone
As we reach month-end it is worth taking stock of what lies ahead of us especially since June is set to be a critical month for the currency bloc.
Firstly the results of the latest round of stress tests on Europe’s banks are set to be released. This is expected to be the most stringent yet (we’ve heard that before) and are designed to reveal the true depth of Europe’s banking crisis so that capital bases can be re-built and investors can have confidence to invest in Europe’s financial institutions once more.
The major risk from the stress tests is Spain. If its troubled domestic lenders – the Caja banks – have more bad debts than expected then the government will be under pressure to underwrite the capital short-fall akin to what Ireland did that eventually forced it into a bailout.
Currently analysts estimate that losses for Spain’s banking sector could be as high as EUR120bn, which is almost 10 times the Spanish Central Bank’s projection. Massive loans to property developers are the bulk of the toxic assets on the Caja balance sheets. These may top EUR300bn as Spain’s property market remains in deep trouble.
A bailout of Spain is too big for the current EFSF fund to manage and would therefore threaten the stability of the Eurozone. Nerves are likely to be on edge prior to the release of the tests. The exact date the results are due is not yet known, but some in the market predict they will come out in June or July, so watch out.
Also due are the results of the IMF’s audit of Greece’s compliance with deficit reduction targets, which is expected sometime before the end of June and possibly as soon as next week. There are concerns that Athens will not have complied with the terms of its bailout loan so the world’s lender of last resort will cut its support to the nation. This would make a default of Greece extremely likely and could see another wave of panic wash over the financial markets.
This is likely to keep the euro capped in a range until these “unknowns” are finally known. So watch out for some sharp moves especially if Spain’s banking crisis is worse than first thought. Below 1.4040 EURUSD is in a technical downtrend.
There’s more than meets the eye to the Swissie
The Swiss franc had a storming week and broke fresh highs versus the euro and is on the cusp of all-time highs against sterling. It’s no surprise that the Swissie was stronger last week as the markets remained jittery about developments in the sovereign debt crisis and the prospect that the IMF may not extend more bailout funds to Greece next month.
But as risky assets came more into favor at the end of last week, the Swissie remained in demand. This suggests that there are more than just safe haven flows driving the franc. Of course investors remain nervous about the sovereign debt crisis, which should keep the Swissie well supported, but at the same time a raft of strong economic data along with its own warning from the IMF suggest domestic fundamentals could be a key driver of the currency going forward.
At the end of last week the IMF explicitly called for the Swiss National Bank (SNB) to hike interest rates in the “near-term” in a report. It called the current policy of remaining on hold “unsustainable” and said that fears a strong franc would cause deflation or weigh on exports were unjustified. The latter point was backed up by exports data for April, which showed a 7.9 per cent increase, easily reversing the 3.1 per cent decline in March, suggesting a high franc hasn’t yet dampened demand for Swiss goods.
This wasn’t the only bit of good economic news. The KOF survey, a popular leading economic indicator, also remained at an elevated level in May.
So now the pressure is being heaped on the SNB to change its policy stance, which has consisted of keeping rates on hold and talking down the currency. The IMF said that intervention in the markets (verbal or direct) should only occur if there is excessive volatility, which isn’t the case right now.
So the SNB may have no choice but to hike rates in order to retain their credibility. The next policy meeting is 16 June and so far the markets still think that rates will remain on hold at 0.25 per cent. But GDP released on 31/05 could make this position untenable. Although inflation is not currently a problem, in April it was a mere 0.3 per cent on an annualized basis, high levels of growth – the markets expect a 3 per cent YoY rate – could lead to inflation pressures building up in the future.
This is likely to keep upward pressure on the Swissie for the time being, and there is a chance that EURCHF could see 1.2000 before staging a pullback. On a technical basis the pair doesn’t look oversold, which suggests there could be more steam in this record-breaking move higher.
The Loonie’s flight path facing some turbulence
The greenback declined against every G10 currency in the past week with the exception of one – the loonie. Canadian dollar weakness was jumpstarted last Friday by weaker than expected April CPI (+0.3% vs. expected +0.5%) and disappointing March Retail Sales which declined -0.5% from the prior month vs. expectations of a +0.9% print. Real retail sales also fell by -0.8% in March, its lowest levels since August ‘10, suggesting slowing domestic demand as Canadian consumers tighten their pockets.
Negative U.S. data surprises have also contributed to recent CAD weakness – weekly Jobless claims are back above +400k, pending home sales fell by a whopping -11.6% in April, and the Richmond Fed Manufacturing Index printed -6 vs. expectations of +9 in May. More significant, however, is evidence of moderating U.S. Industrial Production - accounts for almost 75% of Canada’s foreign sales - which swooned -0.8% from March to April suggesting downside implications for Canada 2Q GDP.
The Bank of Canada rate decision is set for release Tuesday with the target rate expected to be held steady at +1.00%. The U.S. fiscal situation, Eurozone sovereign debt concerns, moderating domestic demand, and a still firm Canadian dollar’s negative impacts on external demand are likely to be the deciding factors for continued passive BoC monetary policy.
Prior to the BoC rate decision, GDP figures are on tap Monday with Bloomberg surveys expecting a 1Q annualized rise of +4.0% and a March increase of +0.2%. Our estimates are in line with consensus expectations as the GDP release is likely to confirm a strong start of the year for the Canadian economy. However, we think that fading loonie strength on the back of a firm GDP print may be appropriate for two main reasons – the unlikelihood for the BoC to adopt a tightening bias due to the above-mentioned reasons and the technical breakout above the key 100-day SMA which had rejected upside attempts on numerous occasions since September ‘10. Accordingly, we think the short term bias in USD/CAD is higher with the key moving average likely to serve as immediate support in the week ahead.
Key data and events to watch next week
United States: Tuesday – Mar. S&P/CaseShiller Home Price Index, May Chicago PMI, Consumer Confidence, NAPM-Milwaukee, Dallas Fed Manf. Activity Wednesday – May ADP Employment Change, Apr. Construction Spending, May ISM Manufacturing, Treasury Secretary Geithner Testifies, Fed’s Pianalto Speaks, May Total Vehicle Sales Thursday – Weekly Jobless Claims, 1Q Final Nonfarm Productivity, Unit Labor Costs, Apr. Factory Orders Friday – May Employment Report, ISM Non-Manufacturing Composite, Fed’s Tarullo Speaks
Eurozone: Tuesday – German Apr. Retail Sales, May Unemployment data, EZ May CPI, EZ Apr. Unemployment Rate Wednesday – German and EZ May Final Manufacturing PMI, ECB President Trichet Speaks Thursday – ECB President Trichet Speaks Friday – German and EZ May Services PMI, ECB’s Gonzalez-Paramo Speaks
United Kingdom: Monday – May Hometrack Housing Survey Wednesday – May Manufacturing PMI, Apr. Consumer Credit, Lending, Mortgage Approvals, BOE’s Paul Tucker Speaks Thursday – May Construction PMI Friday – May Services PMI
Japan: Tuesday – Apr. Employment Data, Apr. Preliminary Industrial Production, Apr. Construction Orders, Housing Starts, Vehicle Production Wednesday – May Vehicle Sales Thursday – 1Q Capital Spending, BOJ’s Nakamura Speaks
Canada: Monday – 1Q GDP and Current Account, Mar. GDP Tuesday – Apr. Industrial Product Price, Raw Materials Price Index, Bank of Canada Interest Rate Announcement
Australia & New Zealand: Monday – NZ Apr. Trade Balance Figures, AU 1Q Operating Profits & Inventories, NZ Prime Minister Key Speaks Tuesday – NZ Finance Minister English Speaks, May NBNZ Business Confidence, AU 1Q Current Account, Net Exports, AU Apr. Private Sector Credit Wednesday – 1Q NZ Terms of Trade, NZ May Commodity Price Index, AU 1Q GDP, May RBA Commodity Price Index Thursday – AU Apr. Trade Balance, Retail Sales Friday – NZ Apr. Building Permits, AU May AiG Performance of Service Index
China: Wednesday – May Manufacturing PMI Friday – May non-manufacturing PMI