• Credit concerns dominate headlines, but growth is the story
• BoE due to release Inflation Report
• Cable suffering the impact of reduced liquidity
• Spain, Portugal, Greece to remain in the headlines
• Irish stocks less hard hit this year
• Key data and events to watch next week
Credit concerns in the headlines, but growth is the story
As we suggested in last week's report, risky assets swooned further this past week, with stocks, commodities, gold, oil and carry trades (JPY-crosses like AUD/JPY, EUR/JPY, and CAD/JPY) all seeing steep losses, while the USD surged higher as traders sought refuge. But a sharp rebound on Friday in those markets strongly suggests a medium-term bottom has been found. The price action on Friday generated 'hammers' on many of those markets daily candlestick charts (a bullish reversal signal after a decline), and price declines had clearly become excessive. We look to see risk trades recover next week on bargain hunting and optimists re-loading for the much awaited global recovery, but ultimately we favor using corrections in risk trades as a selling opportunity.
Eurozone credit/deficit concerns continue to dominate headlines, but the fears are likely overblown in the near-term. Sovereign credit default swaps (CDS), a measure of the risk of default, made new highs this past week, but tellingly failed to finish out on those highs, similar to the rebound in risk assets. The risk of default is minimal and unlikely in the year ahead, but the drama of the 'fiscal crisis' is likely to drag on for many more months at the minimum. The contagion is not limited to national governments and is now spreading to the European financial sector, with cross-border lending exposures to the troubled peripheral economies being scrutinized. For example, Spanish real estate developers owe some EUR 325 bio to lenders throughout Europe, suggesting European banking losses are likely to become another source of market angst in the weeks ahead.
But while credit/deficit funding concerns make news, the real story is the faltering global economic recovery. We trace this back to China announcing bank lending restrictions about a month ago in an effort to slow a potentially overheating economy. The moves threatened to undermine demand from Chinese firms and undercut one of the key pillars of the global recovery. In the past week alone, we have received numerous reminders of the fragility of the global rebound and the bumpy road still ahead: NZ reported higher 4Q unemployment, the US continued to shed jobs in January, Australian Dec. retail sales declined, the RBA held steady, and Eurozone retail sales fell in December, as did Eurozone industrial production. The speculative unwind of long risk positions started with the Chinese cuts to bank lending and has since accelerated. We think there is still more room to run, after some correction/consolidation, and we would look to Eurozone GDP reports next Friday as one of the next likely reminders of overall weak global prospects.
With this view in mind, we'll be looking to re-sell EUR/USD in the 1.3800/50 area, GBP/USD in the 1.5850/5900 area, AUD/USD around 0.8780/0.8830, gold in the 1085/1095 zone. In the carry trades, we also favour re-selling on a bounce: EUR/JPY 123.50/124.00, AUD/JPY 78.80/79.30, NZD/JPY 62.70/63.20, and GBP/JPY 142.50/143.00. In terms of further risk downside triggers, we would note in particular that AUD/USD bounced off its 200-day mov. avg. exactly at 0.8578, while the USD index looks to have stalled below its 200-week moving average at 80.53. We are also mindful that EUR/USD has reached down to the 1.35 handle, which is likely to see heightened option and psychological support. We'll also be watching closely to see if USD/JPY is able to continue holding above the base of its daily Ichimoku cloud, which will be between 89.00/30 next week. A drop below could signal another leg down in the JPY-crosses.
BoE due to release Inflation Report
The Bank of England is due to release its Quarterly Inflation Report on February 10. The Bank has already made it clear that January CPI is set to rise further from the surprisingly high 2.9% y/y December level. On first sight this is a worry. The BoE's inflation target is 2% and a level at 3% or above will force Governor King to write a letter of explanation to the government. However, the Bank has been stressing for some time that this rise is a short-lived base effect brought about by last year's temporary reduction in VAT and by last autumn's in oil prices. There is a caveat to this, however. Last year the Bank was correct in estimating the CPI would fall sharply. However, CPI did not fall to the lows that the Bank had originally been predicting. This suggests that CPI may have a modest upward bias relative to the Bank's predictions. Insofar as the Bank predicted after the Feb MPC meeting that inflation will 'fall below target for a period' and that the pace of growth this year will be 'gradual', there seems little risk that the Inflation Report will change expectations that there will be no BoE rate hike before Q3. The Jan CPI release is due on Feb 16.
Cable suffering the impact of reduced liquidity
Cable has been the subject of some volatile action over the past week or two. Lessened liquidity on the back of the recent ending of the BoE's gilt purchasing plan (QE) and reduced USD liquidity following contagion prompted by fears of rising sovereign default have both played a part in driving cable's price action. By contrast, EUR/GBP has remained range driven over the past week with the market reluctant to buy sterling as a haven against the EUR's woes following the pound's 7.5% rally vs. the EUR since Oct, concerns about the UK's budget deficit in addition to uncertainties pertaining to the forthcoming general election. That said, a continuation of downside pressure on the EUR is likely to see EUR/GBP testing the bottom of its range and head back down towards 0.8600.
Spain, Portugal, Greece to remain in the headlines
The markets will be closely watching for any reaction by the European Commission to the Spanish budget in the week ahead. While it may rap Spain on the knuckles for allowing its budget to get out of hand and while some amendments may be recommended, the Commission will almost certainly have to approve Spain's plan. Not to endorse the budget plans of Spain, Portugal or Greece would encourage uncertainty in the markets, shift bond yields higher and effectively raise the risk that the structure of EMU as we know it would have to be altered. Once the Commission has approved all these budgets, the markets will have to shift its focus to the degree of success the governments have in implementing austerity measures and also the appetite of investors to keep buying the debt of these nations. It may be months before the risk of a bailout from either the ECB or the IMF can be ruled out. In the meantime the EUR will likely remain vulnerable and further downside in EUR/USD remains on the cards.
Irish stocks less hard hit this year
Irish stocks have been performing far better than Spanish shares this year. While Ireland and its banks are not out of the woods, the risks are perceived to have declined. The Irish budget which was announced before the end of last year was bitterly austere. Its presentation did not, however, result in social unrest. Like the Swedes after their 1994 bond market crisis and the Canadians during the 1990s, it seems that the Irish electorate recognize the need to get their house in order. Not just that, but the Irish budget crisis resulted from the bursting of the Irish property bubble which prompted the need to transfer debts generated by the private sector from the banks into the public sector. While fiscal policy should have been tighter during the boom years to offset the impact of monetary policy with was inappropriately loose for the Irish economy, arguably the Irish did not sidestep budgetary reform in a way that Greece and some other countries have done in 'good' years. In 2007, ahead of the bursting of the property bubble, the Irish debt was around 25% of GDP, well below the 60% of GDP target offered by the Maastricht Treaty. The Irish still have a long way to go, but the situation is currently less uncertain than in Greece, Spain or Portugal.
Key data and events to watch next week
The US economic calendar lightens up a touch in the week ahead. Tuesday has the NFIB small business survey and wholesale inventories due up. Wednesday is busy with international trade, crude oil inventories and the monthly budget statement. Thursday sees the important retail sales report, jobless claims and business inventories. The University of Michigan sentiment index closes out the week on Friday.
The Eurozone calendar is not terribly busy either. Bank of France sentiment kicks things off on Monday while German trade and German consumer prices are due on Tuesday. French industrial production is the only thing of note on Wednesday. Friday rounds out the week with industrial production, French nonfarm payrolls and German and most other Eurozone 4Q GDP reports.
The UK opens with the BRC retail sales monitor, home prices and the trade balance on Tuesday. Wednesday closes things out with industrial production, the NIESR GDP estimate and the Bank of England quarterly inflation report.
Japan is characteristically light and starts off early with the current account and trade balance on Sunday. The Economy Watchers survey is due Monday while machine tool orders and housing loans are up Tuesday. Consumer confidence ends it on Friday.
Canada is super-light and housing starts on Monday, international trade on Wednesday and new home prices on Thursday are the only noteworthy releases.
The calendar down under is modestly busy. Australia has consumer confidence on Tuesday and the employment report on Thursday. New Zealand sees home prices on Sunday, credit card spending on Tuesday, business PMI on Wednesday and retail sales on Thursday.
Next week also brings some important China data that could move markets. Trade is due on Tuesday, PPI and CPI are up Wednesday while money supply and loan data are scheduled to be released between Tuesday and Thursday.