• MPC unlikely to provide support for sterling any time soon
• UK data could stay gloomy
• Waiting for a UK election date
• Greece issue will run and run
• Key data and events to watch next week
Risk sentiment may take a plunge
The global recovery trade (aka the reflation trade) took a serious stumble this past week as a spate of disappointing US data suggested the US recovery is in greater jeopardy than previously thought. As the largest national economy, the US setbacks undermine the global outlook, which was already under pressure as China moved to restrict lending and stimulus programs wind down in other major economies. We think market positioning is still heavily biased toward risk being on (investors holding long positions in stocks, commodities, and long JPY-crosses, like AUD/JPY and CAD/JPY based on a positive growth outlook), so the risk is quite high that a position-driven exodus out of those risk assets sends them sharply lower in coming weeks. For the time being, recent range/psychological lows have held in many key markets (e.g. Gold 1090/95, EUR/JPY 120, EUR/USD 1.3450/3500, and USD/JPY 88.50). We would also note that the major US stock indexes tested the base of the daily Ichimoku cloud, and a daily close below could trigger a much sharper decline. Until those key supports break, we still have the potential to sell riskier assets at higher levels and our focus will be on using corrective bounces as selling opportunities.
For the EUR in particular, a short squeeze higher (those who sold EUR/USD are forced to buy back higher) seems especially likely in the short-term. Sentiment on the European single currency is universally bearish and positioning reflects that. Recent news that Germany's KfW Bank (the state-owned reconstruction bank) would be a last ditch buyer of Greek debt in an emergency suggests official support will extend beyond rhetoric, reducing the chances of a debt default. As well, the EUR is likely being seen as potentially under speculative assault by the ECB and other EU institutions, raising the prospect of verbal/actual intervention. Meanwhile, the 1.3450/3500 level has held on several tests in recent weeks, potentially setting up a short-term reversal higher as speculative shorts cover or get squeezed out. We still hope for the opportunity to re-sell EUR/USD somewhere in the 1.3850/3950 area in coming weeks.
USD/JPY continues to follow US Treasury yields, which topped out at recent range highs at 3.80/85% in the 10 year, and moved lower on Bernanke's pledge to keep rates low for an extended period of time, along with the slew of disappointing US data. USD/JPY has closed the week below its daily Ichimoku cloud (base at 89.30) and the bias remains lower while below that price. However, the market is rife with talk of semi-official Japanese buying interest in USD/JPY at the 88.50/80 area, and this may limit the decline. This sets up the prospect that if the JPY-crosses are to move lower on risky asset selling, the bulk of the declines may occur in the non-JPY dollar pairs, like AUD/USD, GBP/USD, and EUR/USD. Should USD/JPY see below 88.50, a sharper decline to the 85.00/50 area may be unfolding.
Ominous US data point to uneven recovery
The US economic data this week dealt a major blow to expectations of a speedy economic recovery and suggests that, if anything, the rebound will be quite uneven and very bumpy. Contemporaneous reports such as consumer confidence, durable goods, new/existing home sales, and jobless claims were all ominous and not at all constructive for the outlook going forward.
The consumer confidence metric for the month of February sank to 46.0 from 56.5 the prior month. The breadth of the report was extremely poor as both the current and expectations components declined sharply. Moreover, the labor differential which measures jobs plentiful minus jobs hard to get plunged to -44.1 from -42.1 previously. This coupled with the squeeze higher in jobless claims to 496K from 474K suggests that perhaps the drop in the unemployment rate in January to 9.7% from 10.0% could have been a statistical anomaly and that we could be heading back to a double-digit jobless rate in the near-term.
If the problems on the consumer front weren't enough to concern the growth bulls, they got plenty of bad news from the housing and capital spending spaces as well. New and existing home sales plummeted in January by -8.5% and -7.2%, respectively. Indeed, the annual rate of new home sales fell to a record low 309K and this number isn't even adjusted for population growth. The declines come in the face of still artificially depressed mortgage rates (Fed MBS buying the culprit) and despite the new homebuyer tax credit which benefits even more folks than the initial first-time buyer only plan did. The Fed's MBS purchases are set to end in late March and this is expected to elicit a squeeze higher in mortgage rates. If the housing data look ugly now, watch out if rates shoot up 50-100 basis points. If you expect the stimulus to offset rate increases, our advice would be to not hold your breath.
On the capital expenditure front, the durable goods report this week sent shockwaves through the economic models forecasting 1Q GDP. While the headline printed a robust 3.0% monthly gain, the details painted a very different picture. The core number that feeds into GDP (non-defense capital goods excluding aircraft) sank -2.9% on the month in the largest decline since April 2009. This is a horrendous hand-off for 1Q and points to much lower growth than what the consensus currently anticipates.
While the US data have looked bleak, their impact on the US dollar has been marginal if non-existent. The buck is practically unchanged on the week in broad (trade-weighted) terms. This is due to the fact that the US dollar is still viewed as a safe-haven asset in times of economic uncertainty. Certainly we would not expect the global investment community to park their money in Euros at a time when the peripheral Eurozone economies face daunting debt problems.
The flight to USD-denominated assets was clear in the very well received US Treasury auctions. Bid/cover ratios were extremely constructive in all three auctions this week and it is thus no surprise that the yield on the most widely traded maturity (the US 10-year note) sank about -20 basis points on the week - denoting higher prices. Furthermore any slowdown in the US economy is likely to trickle through to the rest of the globe and put further pressure on those markets. Bottom line, weaker US data will not necessarily prove to be a net negative for the greenback, with the exception being against the JPY.
MPC unlikely to provide support for sterling any time soon
The March Bank of England meeting was never meant to be very exciting. The February meeting, due to its coincident timing with the Quarterly Inflation Report was the meeting that promised to bring the decision as to whether or not quantitative easing would be extended or not. In the event QE was paused, and since the meeting various BoE officials have fallen over themselves to drive home the point that a pause means a pause and the door to QE is still open. This makes the March (and April) MPC meetings a little more interesting. It is still likely that any major decisions with respect to QE will coincide with Quarterly Inflation Reports given the new information that these afford the MPC. However, a discussion on the topic by the MPC is possible in March and April. Given the dovish views presented by Governor King and other MPC members during the week and a run of mostly weak data for January it seems unlikely that cable will find much support from the Bank any time soon.
UK data could stay gloomy
The headline revision to UK Q4 GDP was better than expected at +0.3% q/q but the breakdown showed that this was largely due to government spending which rose 1.2% q/q. Insofar as fiscal stimulus is set to go into reverse this year, the strength of this component underpins the question over whether the recovery can yet sustain itself. Clearly the risk of double dip recession has not yet been fully averted. Even with the support of government spending, Q4 consumer spending rose a moderate +0.4% q/q in Q4, investment fell a worrying 3.1% q/q. These data highlight the ongoing argument over the risk of a double dip recession in the UK if too much austerity is introduced after the general election and the opposing view that a potential funding crisis could result if no austerity is announced. The week ahead may bring an improved picture; but the market is expecting only a modest uptick in UK Feb PMI services and a slight contraction in PMI manufacturing, while M4 is likely to continue hinting at the weakness of the real economy.
Waiting for a UK election date
General election jitters are rising in the UK. Rumors have been suggesting that an announcement regarding the date may be imminent. May the 6 is currently favored though there has been talk that the PM may be inclined to go for an earlier date to capture Labor's improved performance in the opinion polls. Given that polls are still highlighting the likelihood of a hung parliament, sterling is likely to trade poorly into the election. We continue to view upticks in cable as sterling selling opportunities. A break below GBP/USD1.4855 may see down towards USD1.4680.
Greece issue will run and run
It is difficult to imagine that Greece has anything up its sleeve that could alleviate market skepticism. Insofar as structural reform can take years to bear fruit, Greece is going to struggle to keep its budget in line for years. While the EU may eventually come up with a scheme that tides Greece over and keeps EMU intact, the market will be well aware of the budgetary cracks that exist. Until there is solid progress on budget reform in certain EMU members the EUR could stay under pressure. The planned 10 yr Greek issuance, if it goes ahead soon, will be an interesting litmus test. Like the previous sale it may go better than expected and bring some short-term comfort. However, there is no getting away from the fact that the elevated yields needed to attract investors is also adding to the pressures on the budget. The long-term average of EUR/USD is 1.18, so at current levels the EUR is still a strong currency. The EUR is currently looking oversold and this may force a corrective move higher. That said this would present fresh EUR selling opportunities. EUR/USD may fall towards USD1.20/1.18 in a 6 mth view, with the possibility that it could then see lower.
Key data and events to watch next week
The global recovery trade will get another pulse check to start the week when Chinese PMI manufacturing is released on Sunday evening.
The US economic calendar heats up again next week with plenty of top-tier data to chew on. Personal income/spending, ISM manufacturing and construction spending all kick off the action on Monday. Motor vehicle sales are the only thing up on Tuesday while Wednesday brings ADP employment, ISM services, crude oil inventories and the Fed's Beige Book. Productivity/labor costs, initial jobless claims, factory orders and pending home sales make for a busy Thursday. The main event is on Friday with the employment report on deck. Multiple Fed speakers are also scheduled throughout the week.
It is a big week in the Eurozone as well. PMI manufacturing, the employment report and German import prices kick off the week on Monday. Consumer prices are due Tuesday while PMI services and retail sales highlight Wednesday. GDP and the ECB rate announcement/press conference are up on Thursday and Friday rounds out the week with German factory orders.
The UK has important news on deck as well. Monday starts things off in busy fashion with the housing survey, consumer credit and PMI manufacturing. Consumer confidence is due on Wednesday while all eyes will be on the BOE rate decision (and quantitative easing) on Thursday. The week closes out with producer prices on Friday.
Japan has a characteristically light week ahead. Household spending and the employment report are due Monday while capital spending closes things out on Wednesday.
Canada sees a typical week as well. Industrial product prices and monthly GDP are up on Monday. The highlight comes Tuesday with the Bank of Canada rate decision/press statement (market expects no change to 0.25% target). Building permits and the all-important Ivey PMI close out the week on Thursday.
The data down under is solely out of Australia. New home sales are up on Monday while Tuesday is key with retail sales and the RBA rate decision (market expects a 25 basis point increase to 4.0%). GDP is due Wednesday while the trade balance closes things out on Thursday.