The Week Ahead updated April 24, 2009
• Risk appetites falter initially, but stage a comeback
• USD on its heels and gold may be set to advance
• Stress test preview proves anticlimactic and ambiguous
• What to expect from the Fed, RBNZ, and BoJ next week
• Key data and events to watch next week
Risk appetites falter initially, but stage a comeback
Markets overall continue to waver on signs that the global downturn is stabilizing, and after an initial bout of weakness, riskier assets have staged a mild comeback. The G7 draft communiqué explicitly noted that the global economy was showing signs of stabilization. On the week, stocks and JPY-crosses have declined slightly, but are well above the lows seen at the beginning of this past week. The USD, as measured by the US dollar index, is down more substantially on the week, which would seem inconsistent with only minor losses in risky assets, but makes sense given the heavy weighting of Europe in the index. European data this week carried the torch of improving sentiment, with Eurozone confidence gauges (ZEW, IFO and PMI's) all improving more than expected and bolstering the view that the worst is over.
On balance, though, in spite of some better data points and ostensibly improving outlooks, risky assets have failed to show significant upside progress, which is reminiscent of the prior week as well. As such, I can't shake the impression that the balance of risks remains biased toward a relapse in the current sentiment rebound. In the S&P 500, it also looks like a rounding top is forming and momentum (stochastics & MACD) continues to fade, while ADX readings remain well below trending levels.
USD on its heels and gold may be set to advance
In FX, EUR/USD staged a solid rebound from earlier losses that saw the pair drop below a key support zone at 1.3050/1.3100, only to regain that level and advance on the week. The ECB is likely to cut rates down to 1.00% when they next meet on May 7, and every indication is that they will also announce some form of quantitative easing, whether it's buying corporate debt or government debt. Those developments may restrain EUR strength, but further gains cannot be ruled out. EUR/USD has broken above the Ichimoku cloud and looks to have further upside potential while it holds above the cloud in the 1.3100-50 area. The Kijun line is at 1.3311 and a key trend line from the 1.3740 recent highs will be at 1.3350/60 and falling next week; strength above those levels could see EUR gains back toward 1.36/1.37.
USD/JPY also appears to have more potential toward USD weakness, as price fell below the 200-day moving average this past Monday, and subsequent weakness sent it below the Kijun line at 97.80, which opens up scope down to the cloud top at 95.80-96.20 initially. Weakness below there may see potential to the cloud bottom at 93.40. The combination of USD weakness and JPY strength may lead to another fitful week of trading in the JPY-crosses.
Gold prices seem to be having the best of both worlds, benefiting from USD weakness as well as a rebound in risk appetites. News that China has been accumulating gold in its reserves over the last 7 years helped fuel further gains on Friday, however, I would actually look at that as more of a sell-signal than a buy signal, since China would be unlikely to reveal its actions while it's still accumulating gold. Still, spot gold has closed inside its Ichimoku cloud, with the cloud base at 904.45 needing to hold on a daily closing basis. The Kijun line is at 916.07 and a trend line from the Feb highs will be at about 918 and falling next week, presenting a formidable resistance zone. Strength above those levels may see gains to the cloud top at 935 initially. Alternatively, weakness below the Tenkan line at 890.60 and rising may suggest a false break higher and a return to recent lows near 864/865.
Stress test preview proves anticlimactic and ambiguous
The Fed’s Stress Test White Paper and accompanying headlines proved ambiguous at best. While it noted that “most” banks have more capital than needed, it also said banks will be told to hold a “buffer” for losses into 2011. Just what “most” means is anyone’s guess and ditto for what size “buffer” is needed. The assumptions themselves left much to be desired. The most striking was the 2009 unemployment rate, which is assumed at no worse than 8.9% for the year. Given the recent rate of job losses and the fact that we are already sitting at 8.5%, we could take out this so-called worst case scenario by next month. The doomsday scenario for 2010 unemployment in the Fed’s mind is 10.3%, a far cry from a truly adverse situation of somewhere upwards of 11%.
The other fly in the ointment was the line that the banks’ estimates are “not necessarily consistent” with that of regulators. This begs the question, whose estimates are worse? Ultimately, the release adds more confusion with regards to the state of affairs in the financial industry and we will have to wait until May 4 when the official stress test report cards come out. The equity market didn’t know what to do with the whole thing, with stocks dipping initially on the news and rebounding sharply thereafter. If the market decides to err on the side of caution, given the puzzling nature of the report, we would expect stocks to head lower in the near-term.
What to expect from the Fed, RBNZ, and BoJ next week
The Fed will release its statement on Wednesday at 1815GMT/1415ET. The target rate will remain the 0.00-0.25% range and the Fed will likely note that they will continue to engage in quantitative easing via the purchases of Treasury securities. Two important things to look for in the statement will be 1) whether the Fed decides that more aggressive Treasury purchases are necessary as yields have ground significantly higher since the first QE announcement (witness the 10-year now flirting with the 3.0% level once again) and 2) whether the word “stabilization” will be used when describing the economy. Indeed, the theme from the recent Beige Book – a resource which the Fed uses extensively in its meeting – was that while economic growth remains extremely subdued there were some signs of “stabilization” emerging. We would think that a more upbeat assessment on the US economy, coupled with a more aggressive plan for Treasury purchases would see “risk trades” become better bid and hurt the US dollar. This in turn would be constructive for EUR, the yen crosses, and the commodity currencies.
The Reserve Bank of New Zealand announcement is scheduled for Wednesday at 2100GMT/1700ET. The consensus is that the bank will slash rates by -50 basis points to 2.50%. There are, however, a few economists/strategists looking for a more modest -25 bps reduction. While a cut looks warranted given still weak economic data and slowing inflation, we think the likelihood of the smaller -25 bps reduction is very high. Economic data remain weak but continue to show signs of life. Retail sales improved 0.2% in February after a sharp -1.2% contraction the prior month. Meanwhile, the more forward-looking business PMI jumped to 40.7 in March from 38.9 and the trade deficit is expected to narrow for the third consecutive month to NZ$4.89 billion from NZ$5.16 billion. Inflation remains on the decline and the latest consumer price report showed the annual rate slipping to 3.0% in 1Q from 3.4% prior.
One of the better arguments as to why the bank will not cut by the more aggressive -50 bps, however, is that they said as much themselves. In their last communiqué the RBNZ noted that “any future cuts will be much smaller than observed recently.” We think that given the market’s overwhelming expectation for a -50 bps cut, the reaction in NZD from a less aggressive reduction will be positive. In deciding to cut by less, the bank will likely justify this with an overall rosier picture for the economy. This will also mean that New Zealand will enjoy a much bigger interest rate differential, thus allowing it to attract more investment from abroad. Kiwi weakness would likely emerge from a -50 bps cut coupled with dovish musings on the economy.
The Bank of Japan communiqué is expected sometime Thursday evening and they will also remain on hold at the inconsequential 0.10% rate. BoJ Governor Shirakawa said just this month that “the current benchmark rate of 0.1 percent is the most appropriate policy now”, so we expect no change on this front. The economic outlook is likely to resemble that of Japan’s Cabinet Office which said in their April assessment that the “economy is worsening rapidly while in a severe situation” – no change from the prior two months. On the “non-standard measures” front, we expect the BoJ to reaffirm its commitment to purchase more commercial paper, corporate bonds, and government bonds. In sum, we expect little in the way of earth-shattering news from the BoJ. The yen crosses should continue to trade commensurately with risk assets.
Key data and events to watch next week
The US economic calendar is on the busy side next week and the action kicks off with the S&P/CaseShiller home price index and consumer confidence on Tuesday.
Wednesday is the highlight with the first take on 1Q GDP, the Fed rate decision/statement (more on this above) and the weekly crude oil inventory report. Thursday has personal income/spending, initial jobless claims and the Chicago PMI on deck. Friday closes out the week with University of Michigan sentiment index, ISM manufacturing, factory orders and vehicle sales.
The eurozone calendar is lighter and starts off on Monday with the German GfK consumer confidence survey. Tuesday will see German consumer prices while Wednesday has eurozone business climate indicator and consumer confidence lined up. Thursday closes out the week with the eurozone consumer price estimate, unemployment and French producer prices. There are a couple of ECB speakers as well, with Mersch presenting the Financial Stability Report on Wednesday.
It isn’t very busy in the UK either. The Hometrack housing survey is due to be released over the weekend and the CBI distributive trades report is the highlight on Tuesday. Wednesday has GfK consumer confidence due up while Friday ends the week with mortgage approvals and the PMI manufacturing report.
There is slightly more action in Japan and it starts with retail trade numbers on Monday. Tuesday sees small business confidence while Wednesday has PMI manufacturing and industrial production on deck. The BoJ will meet on interest rates Thursday (more above) and we also get housing starts, employment and consumer price data.
It is ultra-light in Canada and all of the noteworthy data is due up on Thursday. That day has industrial product prices and monthly GDP due up. BoC Deputy Chief Wilkins is also expected to speak and is likely to highlight the more upbeat assessment for the Canadian economy.
Last but not least, it is a characteristically light week down under. NZ trade kicks it off on Tuesday while NZ business confidence, building permits and the RBNZ rate decision are Wednesday (analysis above). AU business confidence and performance of manufacturing index close out the action on Thursday.