What to look for in the week ahead
The Week Ahead updated July 23, 2010
• 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 recapitalizing 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.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.