For stock investors, the current focus should be the trend in the US stock market. Nothing means more for absolute returns in 2009 than the trend in the world's largest stock market. And here a new bear market rally has started, which is likely to lead to a rise in US stocks by another 7-10% or up to the 825-850 range for S&P500 in the short term.
Our year-end 2009 target is 950 or around 25% from today's levels. Investors' risk aversion has obviously risen after the outbreak of the credit crisis and ex-ante risk premia are at least one percentage point higher than normal. We anticipate this unusually high risk aversion to gradually ease off, when investors start to see through the losses in the banking industry and as funding markets continue towards normalisation.
For the stock market to show sustainable gains, more key factors have to show recovery signs. On our five point recovery list, the only recovery signal available now at the end of Q1 09 is the global industrial cycle. Easing of negative earnings revisions for 2009/10 could be next. US housing, the credit market as well as investor/consumer confidence all need to heal for a market recovery to be sustainable.
Still, there is a risk that the bear market will continue for most of 2009. Our distress case could bring stocks to around 625, and taking into consideration recent history we cannot preclude this short-to-medium-term outcome. However, to experience a 20% correction from the already inexpensive stock market levels, the crisis should be brought to ‘the next level' through clear signs of deflation and hence prolonged ‘depression-like' economic development for the US and global economy.
Euroland: Not many signs of dawn, yet
There are not many signs of dawn breaking in Euroland. One is the German ZEW economic expectations index, which improved to -3.5 in March from -5.8 in February, and now has advanced for five consecutive months from a low of -63 in October 2008. Note though that the index is still below its mean (+26) and even below zero, which indicates that there are still more financial market experts that believe that the economic situation will be worse in six months than there are experts who believe things will improve.
The ZEW current situation index has continued to fall, although it now seems to be stabilising. But it is doing so at an awful record low -89.4 reading in March. The very negative view on the current situation is confirmed by industrial orders which were still in free fall in January (-8 % m/m in Germany), which indicates that production may well fall throughout Q1. The current level of PMI is also signalling that we should expect to see a decline in GDP of at least 1 % q/q in Q1. Thus things might be better in half a year, but right now the economic situation is really bleak.
Next week we might get more hints of dawn as we get flash PMI for Euroland and the German Ifo index. Composite PMI fell slightly in February, but we think this could be a turning point and look for a small increase in March. The Ifo business expectations index improved in both January and February and we expect to see a further improvement in expectations in March - in line with the ZEW indicator. The Ifo current situation index is still in almost free fall and is expected to fall further, though a stabilisation should soon materialise.
Key events of the week ahead
- Tuesday we receive flash PMIs. We look for a small increase in Euroland composite PMI.
- Tuesday we also get industrial new orders for Euroland. We expect a bleak reading dragged down by the 8% decline in German orders.
- Wednesday the German Ifo index is published. We expect a further improvement in expectations while the current situation index will fall, although starting to stabilize, in line with ZEW developments.
Switzerland: The week after
With few economic data released during the week, the focus has remained on the previous week's rate-setting meeting where the Swiss National Bank commenced quantitative easing and intervened in the FX markets to weaken the CHF. That said, the week did see the release of industrial production figures for Q4, which revealed a drop of 5.9% y/y, and the government's latest economic forecast, which suggests a decrease in real GDP of 2.2% in 2009. Although this is a sharp drop in economic activity, it is still slightly more optimistic than the SNB's forecast, which indicates contraction of 2.5-3.0%.
Since the SNB intervened in the FX market on Thursday, 12 March, the CHF has fallen further against the EUR with the continuing resurgence in the stock market (the S&P 500 has now climbed almost 20% since bottoming out on 6 March) and the Federal Reserve's decision to turn up the printing presses, which has put not only the USD under pressure but also other currencies where the central bank has begun quantitative easing, namely the CHF, GBP and JPY. Thus EUR/CHF has risen well above 1.52, its highest level since December, and there has been speculation in the market that the SNB has been intervening in the market again even at current levels.
SNB governor Jean-Pierre Roth was also out reminding the market during the week that the bank will not hesitate to intervene again in the FX market if the CHF strengthens too much against the EUR. With good reason, he did not say just how far the SNB will allow the EUR/CHF to fall, but the market seems to have concluded for now that a level of around 1.52-1.53 would bring the SNB into action. We expect the SNB to remain very active in communicating that it will counter appreciation of the CHF and that it still has plenty of scope to ease monetary policy. We therefore still expect the SNB to succeed in capping the CHF, and our forecast is for the EUR/CHF to rise towards 1.58 on a 12-month view.
Key events of the week ahead
- Monday, 08.15 CET: M3 money supply for February.
- Tuesday, 18.15 CET: SNB governor Jean-Pierre Roth speaks in St. Gallen.
- Wednesday, 11.00 CET: SNB publishes its monetary policy report.
- Friday, 11.30 CET: KOF leading indicator for March.
UK: More bad data - but mostly lagging indicators
We have just been through a week of more bad data. Most notable was the biggest rise in unemployment since the data series started in 1972. Unemployment rose 138.4k from January to February taking the unemployment rate up to 4.3% in February from 3.9% in January. As usual the labour market reacts with a lag and the rise in unemployment is an effect of the extremely weak GDP in Q4. The CBI industrial survey was also released during the past week and showed a decline in orders to the lowest level since 1992. The indicator has been lagging PMI data, though, and basically doesn't add much new information.
The massive rise in unemployment is adding pressure on consumers who are also being hit by falling wealth from lower house and equity prices. This is a picture seen everywhere - to varying degrees. A steep decline in inflation, however, is giving support currently as it gives a boost to purchasing power. We have actually seen a little stabilisation in retail sales lately. It has risen by a cumulative 2.4% from November to January. But there is a need for more support for consumers if consumption is to be kept afloat. And this is why Bank of England has slashed rates massively and started to print money to buy credit bonds and government bonds. Looking ahead we expect growth to continue in very negative territory in Q1 and Q2 but then to recovery gradually as the stimulus starts to work its way through the economy. Exports should also gain a bit from a slight improvement in the US economy.
The weak data and bold moves from Bank of England have put further pressure on the GBP and we have seen EUR/GBP rise to close to 95. As long as data is very weak, pressure will be on the GBP since Bank of England is showing a greater willingness to use unconventional measures than ECB. It also supports further outperformance of UK bonds versus Germany. In the longer run, though, the GBP is undervalued and as the global economy recovers during 2009, GBP should gain versus EUR again.
Key events of the week ahead
- Tuesday: CPI data to show further decline in inflation - and low core inflation
- Wednesday: CBI distributive trades report out. Has improved a bit lately - can it last?
- Thursday: Retail sales data likely to slip back a bit after rising for two months
- Friday: Final GDP numbers - not likely to reveal much new. Advanced GDP showed a decline of 1.5% q/q in Q408
US: Fed's bold move supports a gradual recovery in the US economy
The Federal Open Market Committee (FOMC) made yet another aggressive move at its meeting this week in an attempt to re-inflate the economy. The Fed committed to purchase up to USD 300bn in longer-term Treasury securities over the next six months. In addition the Fed will expand its mortgage backed security purchase programme by USD 750bn to a total of USD 1250bn and increase its purchase of agency debt by up to USD 100bn. The Fed also scaled up on the rhetoric on the interest rate stating that the Fed funds rate would be held exceptionally low for an “extended period” compared to “for some time” at the January meeting. The move took markets by surprise and led to a significant decline in US yields and the USD weakened substantially. The Fed has now taken all the measures that Bernanke listed in his famous “helicopter speech” in 2002.
The Fed thus sent a strong signal to markets that it will not accept a surge in Treasury yields as long as the financial system remains in severe stress and economic weakness is substantial. The increase in the MBS purchase programme is large and these purchases have already helped to reduce mortgage rates and will likely work to reduce them further. This will lend important support to the housing market and US home-owners who can refinance into lower rates. Overall these actions should help to ease financial conditions further and we view the aggressive response as overall positive to US growth.
Going forward we expect the Federal Reserve to hold rates at close-to-zero for a long time. The output gap in the US economy is significant and so is the amount of slack in labour markets which implies that underlying wage and price pressures should be absent for the foreseeable future. Rate hikes will not come on the agenda before the economy returns to trend and unemployment has peaked.
Key events of the week ahead
- Monday - Existing home sales
- Wednesday - Durable goods orders likely continued to decline in February
- Wednesday - We expect new home sales to increase by 1.9% m/m to 315K
- Friday - Personal spending likely remained stable in February. Core PCE to show an 0.2% m/m increase
- Several Fed members will speak during the week. Geithner will testify on financial regulation Thursday
Asia: Hesitant Bank of Japan in stark contrast to Federal Reserve
As expected, the Bank of Japan expanded its programme of quantitative easing at the week's monetary policy meeting (see Flash Comment - Japan: BoJ steps up quantitative easing). The bank increased the target for its monthly purchases of government bonds from JPY 1.4trn to JPY 1.8trn and also raised the possibility of supplying JPY 1.0trn of subordinated loan capital to the banks. At the ensuing press conference, BoJ governor Masaaki Shirakawa dampened expectations of further quantitative easing by saying that there is only a limited chance of the bank further increasing its buy-backs of government bonds. The BoJ's new quantitative easing measures did therefore not have any notable impact on long-term bond yields in Japan. Paradoxically, long Japanese yields actually fell during the week, due primarily to the strong quantitative easing delivered by the Fed later in the week. The bill for the BoJ's more hesitant approach arrived promptly in the form of marked JPY strengthening to below 94 against the USD. This is highly unwelcome given the current parlous state of the Japanese economy. The pressure is therefore back on the BoJ to deliver more aggressive quantitative easing.
In the week ahead, we will be looking forward particularly to the publication of Japanese foreign trade statistics for February, where it will be interesting to see how exports fared. Based on export data for Asia in February already released, there are signs that the decline in exports has at the very least slowed and possibly even bottomed out (see chart), while provisional export data for Japan based on the first 20 days of February suggest that exports fell further in February, albeit at what appears to be a decreasing rate.
Key events of the week ahead
- In Japan, Monday sees the minutes of the BoJ's monetary policy meeting in February, Wednesday offers trade figures for February, and Friday brings consumer prices and retail sales.
- In China, no major releases are due during the week.
FX: FED goes Xerox!
This week the Federal Reserve surprised financial markets by stepping up the scale of its quantitative easing (QE). The reaction in the FX market was profound and the dollar weakened on a broad base. Short term we expect the USD to slide further, at least as long as risk appetite remains in the market, and we see a high probability that EUR/USD will break above 1.40. However, from a short-term technical perspective EUR/USD looks overbought, and the risk of a consolidation is high.
The explanation for the strong reaction in the FX market is straightforward. The US is effectively monetizing its fiscal deficit and the supply of US dollars is increasing, which theoretically will lead both to a weaker currency and eventually inflation. But there is more to the story. The Fed is pushing US interest rates lower, which, all else being equal, erodes the attractiveness of the USD. The move also abruptly changed sentiment towards the dollar. Market commentators broadly agree on being dollar negative, some even calling the day of QE ‘the day the dollar died'. The move from the FED also added to a further improvement in market risk sentiment. The broad move against the USD was furthermore exaggerated by a market generally being long the dollar - that is at least the message we get from the weekly IMM positions. Finally, there is currently a perception in the market that the move will help bolster the US economy and henceforth the global economy. One could argue that such a development would be dollar-negative as the current dollar repatriation and deleveraging will come to an end.
However, as we have argued several times, there are two sides to the story. Both Euroland and the Japanese economy look very fragile. Who is talking about EUR strength? Remember in that respect, that the ECB is also expected to slash rates in the coming week - bringing the policy rate to 1.0%. Furthermore, there is still a lack of dollar liquidity in global markets. Finally, it can be argued that the aggressive move from the FED will facilitate an earlier trough in the US business cycle than elsewhere, eventually benefiting the otherwise battered USD. That said we do believe that the bold move from the Fed yesterday is, in the short term, dollar negative on balance, and we will consider revising our USD forecast accordingly this week.
With four of the main central banks (BoE, BoJ, FED and SNB) having already adopted QE, the obvious question is who is next? In our view, the most likely candidate to follow suit is the Riksbank. However, we will have to wait for the 21 April rate decision to get further clarity - the Riksbank is expected to slash rates to 0.25% (practically zero) and discuss QE as the way forward. Considering how the USD, CHF and the GBP have reacted to QE, the event risk around the Riksbank meeting for the SEK is exceptionally high. However, for the immediate future the SEK might still get a boost from the higher risk appetite in financial markets.
Given the economic situation, the pressure is also on the ECB and the Bank of Canada to adopt unconventional monetary policy instruments to revive their economies. However, the prospect of the ECB adopting QE is still remote. Trichet has certainly not been a proponent of QE, and it is hardly a surprise that the influential Bundesbank does not favour policies that could eventually fuel inflation.
Basically, we argue that, with regards to QE, the right answer would be to short the currencies backed by aggressive central banks, i.e. to remain short USD, GBP, CHF and JPY. Meanwhile, support remains for those currencies backed by central banks least likely to turn to QE, implying continued support to especially NOK and AUD - and for the time being also EUR. Both NOK and AUD are also going to benefit from any surge in commodity prices in the aftermath of a weaker USD and an improved global growth outlook. Not least the NOK stands out. Norges Bank might in fact this week flag a somewhat more positive tone at the monetary policy meeting, repeating that NOK-rates will not drop significantly below 2%. Such a move would be in stark contrast to a Riksbank expected to push rates to practically zero and discuss QE.
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