We are getting more and more signs that the global economy is starting to improve. As expected, indicators in Asia and the US are showing the strongest signs of healing. In particular, surveys of new orders have risen in both areas recently. This is in line with our expectation that the US and Asia will be the first regions to start a recovery phase (see Global Scenarios). Apart from survey data, other indicators are also pointing to improvement: US retail sales have started to rise after a period of strong decline, car sales globally have improved recently and housing data has improved. In Asia, exports and industrial production is starting to increase. Japanese companies, which have taken the biggest blow to production, are now planning to increase production in March and April. For more leading indicators, see our Global Business Cycle Monitor out today. Risks to growth forecasts are changing at the moment from strong focus on downside risks to upside potential; that the recovery comes faster and stronger. Remember that the fiscal stimulus is only starting to hit the global economy and will provide a strong boost in coming quarters.
We still see plenty of bad news and this is likely to be part of the picture for a long time. In this context it is important to distinguish between leading and lagging indicators. Global unemployment is likely to rise sharply for the rest of the year. But job losses normally come with a lag and hence the rise in unemployment is partly an effect of the weakness we have behind us and does not say much about the future. If that were the case we should never have experienced any recoveries because unemployment always rises strongly during recessions. Other lagging indicators are bankruptcies. We expect to continue to see a sharp rise in bankruptcies over the coming year. Rising unemployment and bankruptcies leave the economy fragile and vulnerable to new shocks and setbacks. But it is normally not a hindrance for a recovery to take off.
Euroland: Disappointing 25bp rate cut from ECB
It was widely expected that the ECB would cut the refi rate by 50bp on Thursday. However, it disappointed the markets with a modest 25bp cut in both the refi rate and the deposit rate. In addition, Trichet did not announce that the ECB will embark on quantitative easing as some market spectators had hoped for.
On a positive note, however, Trichet did say that the refi rate is not at its lowest limit and that the ECB could cut further in a measured way. We expect another 25bp cut in the refi rate in May or June. This would take it to 1.0% and would probably mark the end of this cutting cycle. Improvements in macroeconomic data will close the window for further cuts in late summer. Trichet also said that the ECB does not expect to cut the deposit rate further than the current 0.25%. The ECB just does not like zero interest rates.
Another positive message from Trichet was that he announced that the ECB will provide information about its decision on new non-standard measures at the next meeting. He also said that it will do everything possible to revive money markets. We assume that the ECB is finalising a package of non-standard measures to be implemented - possibly with several measures including the introduction of a 12-month auction (the longest is currently six months) and buying of credit paper (commercial paper and/or credit bonds). If it just wanted to lengthen the maturity on the auction, it could have done so immediately, so we assume that it is preparing something ‘bigger', which requires more planning. Nevertheless, if macroeconomic data improves substantially before the next meeting, it is possible that the ECB might decide not to introduce any new measures at all.
Key events of the week ahead
- 6 April: Retail sales in February are expected to show a modest decline month on month.
- 8 April: German manufacturing orders have been in near freefall, and we now look for signs of stabilisation.
- 9 April: Industrial production data from several countries including Germany is expected to show further decline.
- 16 April: Euroland inflation and industrial production.
Switzerland: Labour market, Hildebrand and the CHF
The coming week brings unemployment figures for March, which are expected to confirm the upward trend of recent months. The OECD predicts that this year Switzerland will have the biggest negative output gap for 13 years, and the Swiss National Bank expects the decrease in overall growth to be the biggest for more than 30 years. The question, though, is how fast unemployment will rise as a result of the slowdown. The outlook certainly looks bleak: the Swiss economy is heavily dependent on the European economy, which is deep in recession itself; a large proportion of Swiss goods exports are investment goods and so particularly cyclically sensitive; and Switzerland has a large financial sector, which has already been responsible for significant job losses. Taken together, this will exert strong upward pressure on unemployment, which we expect to hit its highest level for more than 60 years. In recent times the record for unemployment was set in 1997 when it peaked around 5.4%, which has to be seen as very low by international standards. One significant unknown, however, is the degree to which the dynamics of the Swiss labour market have changed as a result of the structural measures introduced to increase labour mobility, especially in relation to the EU countries.
SNB vice-chairman Philipp Hildebrand demonstrated once again during the week how effective verbal intervention can be when it comes from a credible central bank. He reiterated previous statements from the SNB that an existing risk of deflation still demands highly expansionary monetary policy, and mentioned intervention in the currency market as a complementary tool in a situation where interest rates are close to zero. The market reaction was immediate, and the CHF weakened by around 0.4%, taking the EUR/CHF back above 1.52. He also repeated that the SNB's intervention in the currency market should not be seen as a desire to pass the buck in the form of an artificially gained competitive edge over Switzerland's trading partners, but as an insurance policy to ensure that the continued financial uncertainty does not lead to renewed appreciation of the CHF, as this would undermine the favourable effects of the SNB's interest rate cuts. So far there have been no international protests against the SNB's intervention in the currency market, which should probably also be seen in the light of the fact that a stronger CHF would merely exacerbate the financial risk in Central and Eastern Europe where CHF loans are particularly widespread.
Key events of the week ahead
- The coming week brings unemployment figures for March. The consensus in the market is a rise in the seasonally adjusted rate to 3.3%.
- SNB chairman Jean-Pierre Roth is due to speak in Berne at 10:00 CET on Friday 17 April. It will be interesting to see if he echoes Hildebrand's comments concerning a continued focus on avoiding appreciation of the CHF.
UK: More signs of improvement
The data flow has continued to improve over the past week with better data for both manufacturing and housing. A picture of gradual recovery is starting to emerge and risks are becoming more balanced from being primarily on the downside.
Manufacturing: PMI showed an upward surprise this week rising to 39.1 in March from 34.7 in February. The index still points to falling production but the decline seems to be tapering off faster than expected. Housing: For the first time in 16 months, Nationwide house prices recorded a rise in March. Other price statistics from Halifax and Rightmove have pointed to stabilisation in house prices but we have been reluctant to put too much weight on them given the continued decline in Nationwide house prices which tend to be much more stable. It does seem, though, that house prices are indeed stabilising sooner than expected. The effect from lower rates looks to be having a very strong impact in stabilising the housing market. Mortgage approvals have also increased recently after a steep decline. The buyers' enquiry index in the RICS housing survey is also close to the highs from the boom in 2006. This index tends to have a good lead on house prices and hence has also pointed to improvement in the pipeline.
Credit conditions: This week the Bank of England released the quarterly Credit Conditions Survey for Q1. It showed that credit was still being tightened for households in Q1 but standards for the corporate sector credit were actually eased - contrary to expectations in the banks three months ago. And for the first time since Q3 07 credit availability to households is expected to be eased in the coming quarter. This was quite surprising but suggests that some easing of credit standards is in the pipeline.
With the signs of improvement we expect Bank of England to abstain from taking further measures to boost the economy. As this has been a key driver for GBP weakness we believe GBP should start to gain versus EUR. Given the strength of EUR versus GBP, the recovery in Euroland is expected to be much slower. And the ECB is likely to announce new non-standard measures at the next meeting, moving the weakening pressure to EUR. At the same time, GBP is one of the most undervalued currencies and also tends to be a very cyclical currency. All this points to a strengthening of the GBP going forward. Bond yields are expected to rise from here as the support from quantitative easing will start to fade and a further improvement in the economy could trigger inflationary worries and more talk about the exit strategy.
Key events of the week ahead
- Monday: New car registrations.
- Tuesday: Industrial production still likely to fall as it is February data. Improvement should come later.
- Wednesday: Nationwide consumer confidence. May be in bottoming phase.
- Thursday: Bank of England meeting. We do not expect any changes.
USA: More signs of life in the US economy
Although the recession in the US economy continues to rage, incoming economic data have surprised on the upside in recent weeks. These signs of life support our view that the economy is in the early stages of stabilisation and will return to positive growth in H2. There is even a risk of the recovery turning out to be stronger and faster than we - and not least the market - anticipate.
Most importantly, there are now signs of a turnaround in US private consumption. Despite record-low consumer confidence, spending has actually been stable since October and there have even been tentative signs of recovery in recent months. Given the rise in auto sales in March and further healthy figures for underlying retail sales, there is the prospect of another strong retail sales report for March. Our provisional estimates indicate an increase in retail sales of 1.2% m/m overall and 0.6% m/m ex autos. This would mean an increase in real private consumption of more than 2% q/q AR in Q1 and a strong start to Q2. With the prospect of tax cuts and increased access to credit via the Fed's TALF facility, the outlook for Q2 would then be pretty rosy.
At the same time, there are signs that the inventory correction in the US economy is now very advanced. The ISM index, which is the earliest indicator of US industrial activity, climbed in March but is still at a low level consistent with deeply negative growth. That said, the figures for March did contain strong indications that the index will rise more rapidly in the coming months. Given the prospect of private consumption picking up during H1, there is a good chance of industrial production stabilising in the coming quarters. In other words, the stage is set for a sharp rise in the ISM index over the next three to six months.
Finally, housing market data have surprised on the upside. Although we are more uncertain about whether this marks the beginning of lasting stabilisation of the housing market, we do not believe that the latest data should be rejected out of hand. All in all, we believe that the seeds have been sown for the US economy to surprise on the upside in Q2.
Key events of the week ahead
- Wednesday 8 April: FOMC minutes.
- Wednesday 15 April: Consumer prices, retail sales, NAHB housing index and Fed's Beige Book.
- Thursday 16 April: Housing starts, building permits and Philadelphia Fed business survey.
- Friday 17 April: Ben Bernanke due to speak.
Asia: Things continuing to brighten in Asia
Although the closely followed Tankan survey of business confidence in Japan fell to record-low levels in March, the overall outlook for Asia is still beginning to brighten. In Japan, the Tankan confirms that GDP will probably fall sharply once again in Q1, but the expectations side of the report suggests that the economy may begin to stabilise in Q2 (see Flash Comment - Japan: Tankan plunges to the lowest level ever in Q1). As recent data have indicated some stabilisation in the global economy, there will for once be less pressure on the Bank of Japan to pull new rabbits out of the hat in the form of further unconventional easing of monetary policy at the coming week's meeting. It will probably therefore be a relatively undramatic meeting, with interest rates naturally being left unchanged and no new quantitative easing being announced.
Manufacturing PMIs in all Asian countries are pointing upward, and it appears that both world trade and global industrial activity are on the way up again, and that the turnaround in Asia may be relatively strong compared with the rest of the global economy. Right now the indicators suggest a return to positive growth in most Asian countries if not in Q2 then certainly in Q3. In China, the downside risks to the economy are currently receding, and we may very well have seen the last rate cut from the People's Bank. There has also been a shift in the FX market's expectations of the yuan (CNY). Having previously discounted CNY weakening against the US dollar, the NDF market now expects the CNY to strengthen against the dollar over the next year. We also believe that China will restart the gradual appreciation of the yuan against the dollar in H2.
Key events of the week ahead
- In Japan, the main focus will be on the monetary policy meeting at the Bank of Japan on Tuesday 7 April.
- In China, interest will centre on the release of GDP figures and most other key data, such as industrial production and consumer prices on 16 April.
Foreign exchange: G20 agree to avoid competitive devaluation and issue SDR
It could not happen - and it did not happen. In the end the G20 summit was not the fiasco that had prompted the world's press for a few nail-biting days beforehand to draw parallels with the catastrophic meeting in London in 1933, when the world was also in deep crisis. In the final statement, the G20 leaders agreed to continue their ongoing fiscal expansion, which will amount to USD5,000bn or 4% of global output by the end of 2010. They also decided to treble the resources available to the IMF to USD750bn, which is a clear acknowledgement that the fund is to play a very important role in rebuilding the global economy.
Imbalances in FX markets were not on the agenda but there was still a very important paragraph, which could prove very significant going forward, on a topic that we broached in last week's Weekly Focus, namely competitive devaluation: "We will conduct all our economic policies cooperatively and responsibly with regard to the impact on other countries and will refrain from competitive devaluation of our currencies and promote a stable and well-functioning international monetary system". If the US, Canada, the UK, Japan and Switzerland really mean this, it may mean that we no longer need to worry about the depreciation of these countries' currencies as a result of them actively seeking to devalue their currencies by printing more money.
It was announced beforehand that discussion of a new global reserve currency would not be on the agenda, and so expectations of major FX implications were limited. However, it is important to note the plans to issue USD250bn worth of special drawing rights (SDRs), the IMF's artificial currency basket, possibly following pressure from China, which has been unhappy with the US strategy of monetarising its debt. There will still be too few SDRs in the world to create a real alternative to the US dollar as the preferred reserve currency of central banks. And this does not mean that central banks will now start selling off their US dollar-denominated assets because they would rather hold SDRs. But in the longer term it may mean that some of the growth in reserves will be in the form of SDRs. So it may eventually result in demand for the dollar decreasing on a relative scale, given that the dollar makes up "just" 44% of the SDR basket. However, it is important to note here that the euro with a weight of 34% will still "only" be the second most popular currency globally.
In the short term there are two main factors driving exchange rates at the moment. First, investors are sensing better times ahead, perhaps on the back of better figures for the housing market, manufacturing and credit conditions. Second, the sharp decline in share prices seems to have been replaced with an upward trend. The tendency is for bad news not to spark any notable market reaction, as the market has already discounted a true economic nightmare scenario, while good news is triggering relatively large movements. Since most data are still woeful, this may perhaps be something of a false dawn, but in our view the huge upside potential weighs up this risk, and we now recommend increasing FX-related risk exposure a little. The pro-cyclical pound still looks cheap, and the Bank of England's comments that it will probably not be necessary to continue so aggressively with quantitative easing have significantly limited the downside risk to sterling. We reckon that GBP/DKK could climb from its current 8.15 to more than 9.00 on a 12M view. The Swiss franc is no longer being underpinned by a deleveraging equity market, and we believe that the SNB's block on further appreciation will be an effective safeguard against much higher levels for the CHF/DKK. Despite greater risk appetite, our analyses suggest that it is still too early to be tempted by the Swedish krona, which carries a relatively large risk premium given the prospect of Swedish interest rates of close to zero and Swedish banks' exposure to the Baltic States. SEK/DKK may therefore remain subdued for the next month, after which it will presumably trend upward.
Fixed income: ECB let-down sends yields up
The ECB confounded expectations both here and in the market by choosing to cut the refi rate by just 25 basis points to 1.25% (see also Euroland article). The deposit rate was also lowered by 25bp and now stands at 0.25%, which the ECB indicated is as low as it will go. This sent both 2Y and 10Y German yields up 8-10bp, which also fed through to US yields. Although we expect the ECB to lower the refi rate by another 25bp before going on hold, we believe that a floor is forming underneath German yields. Gradual improvement in global economic indicators in the coming months will close the window for further rate cuts, and we expect yields to continue to climb on a 3-6M view.
Back home in Denmark, the Nationalbank also disappointed by failing to narrow the policy rate spread in respect of Euroland, lowering its key rate by 25bp instead of the anticipated 75bp. The bank clearly wants to further build up its already record-large currency reserves rather than narrow the policy rate spread, although we do not believe that an independent Danish rate cut can be far away. The closing of the gap between market interest rates such as money market rates and short swap and government rates will therefore be a little slower than anticipated, but we still expect Dano-German yield spreads to narrow in the coming months.
Despite being let down by the ECB, risk appetite in the market picked up toward the end of the week, boosted by a series of better-than-expected economic data. We expect this upbeat mood to persist over the coming fortnight, the most important incoming data being strong retail sales in the US. How US yields react will depend partly on the minutes of the latest FOMC meeting released on Wednesday. Here the focus will be on the discussion of the Treasury buyback programme: if the minutes reveal strong disagreement on the decision and do not suggest that the Fed is prepared to make further purchases if necessary, positive surprises from incoming data may cause the market to test the upper end of the 2.5-3% band in which 10Y yields are trading. This would also feed through to German yields.
Disclaimer
This publication has been prepared by Danske Markets for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Markets' research analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for private customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S, which is regulated by FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange.