Monday, July 13, 2009

Weekly Focus: Hard Stuff

Global update

  • We start to see signs of life in Germany as both orders and production surprised strongly to the upside in the past week. This suggests we are on track for positive Euroland GDP growth in Q3.
  • Most focus, however, is on the US consumer. A sustained recovery in 2010 requires that US consumers start spending again. The data this week gave encouraging signs of US labour market improvement, which is key to get US spending back on track. The jury is still out, though, on whether tax cuts will be saved or spent.
  • IMF revised global growth higher during the past week - but not enough in our view. Expect more upward revisions in coming quarters.

Market movers ahead

  • Key focus the coming week will be US retail sales. Regional business surveys (Empire and Philly Fed) and US industrial production should give more information on the manufacturing recovery.
  • In Euroland the ZEW index is the only interesting number. We look for a small disappointment, despite our more positive long-term view.
  • Very quiet in Scandinavia. The result of the 12mth Swedish auction and Riksbank minutes are the main events.

Global update: Signs of German life

Hard data beating soft data

The real positive surprise this week was a sharp increase in both German factory orders as well as German industrial production (See Flash Comment - Euroland: German orders beat all expectations). Factory orders rose 4.4% in May reaching a total rise of 8.5% over the last three months. During the last 25 years this pace of increase has only been beaten twice - in 2000 and 1989. Industrial production numbers also surprised to the upside showing a rise of 3.7% m/m in May - the strongest in 16 years.

The data fit nicely with our view that Euroland will also be recovering and show positive GDP growth rates already in Q3. So what is going on? Basically we believe two main forces are driving Euroland's production higher: 1) A strong turnaround in Asia - and later in the US as well - is benefitting Euroland's exports. 20% of Euroland's exports go to Asia that has turned very briskly over the last 3-6 months. 2) The need for inventory reduction took industrial production to unsustainably low levels. Now that inventories are leaner and still being reduced at record pace production is starting to catch up with demand. Interestingly domestic capital goods orders also turned higher suggesting that investments may already be bottoming as well. If this is true it is happening sooner than expected, which would underpin the case for recovery even further. For an update on leading indicators see our update this week in the Global Business Cycle Monitor.

US jobless claims turning the corner - finally

Another positive surprise this week was the sharp move lower in US weekly jobless claims. Initial claims fell to 565k during last week from 617k the previous week. The closure of auto plants happened earlier this year and held up claims in previous weeks, which might have exaggerated last week's decline. However, the overall trend is clearly down, which is also needed to keep faith that the recovery can carry over to 2010 (see US section). ISM service also surprised positively with a new rise in the employment index. Hence surveys also provide evidence that the job market is moving in the right direction - despite the worse-than-expected payroll number last week.

IMF raising prospects for recovery - except for Euroland

Given the strong German data this week it was striking that Euroland was pretty much the only region which was not revised higher in IMF's global forecast update this week. IMF revised global growth up in 2010 to 2.5% from a previous estimate of 1.9%, but mainly due to higher prospects for US and Asian growth. Despite the upward revision, we still believe IMF is way too pessimistic. Especially in Euroland where they don't expect positive growth rates until early 2010. Of course IMF did not have the German data at hand when making the forecast but this is even more reason to expect an upward revision again soon. Interestingly ECB's forecast for Euroland is very similar to IMF - and hence we also expect an upward revision from ECB when the new projections are made in September.

The G8 meeting this week provided little news and showed a split world in their priorities regarding the crisis. While Germany wants to move talk to preparing exit strategies, the UK and France believe it is premature and favour looking at what can be done further to lift the global economy into a sustainable recovery. One positive thing coming out of the G8 meeting was a commitment to continue the Doha trade round in 2010 and finish it by the end of 2010. With new governments this year in both the US and India hopes are rising that the Doha Round can be completed. Disagreement between the US and India was one of the main obstacles for finalising the round last year.

Market movers ahead


  • The main mover next week will be the US retail sales report on Tuesday. The US consumer has become key in the markets and the report will be viewed as an indication whether the tax cuts are spurring consumption or not. We are broadly in line with consensus and expect a 0.5% rise in retail sales ex autos. In addition there will be some regional surveys from New York (Empire) and Philadelphia, which should show continued improvement in the manufacturing sector. Actual industrial production is out for June. Consensus is for another decline but after the rises seen in many Euroland countries we see some upside risk. A joker is the effect of the auto shutdowns. Finally there will be some focus on the housing market with NAHB housing index and housing starts.
  • In Euroland we expect to see a temporary setback in the ZEW expectations index. Since mid-June financial markets have increasingly questioned whether a recovery is taking place and the strength of it. We still think that the positive news outnumbers the negative news, but July's ZEW expectations are expected to reflect the more downbeat sentiment.
  • Important June data will be released in China next week, and especially GDP will attract attention. We expect Q2 GDP to show a significant acceleration to 7.5% y/y from 6.1% y/y in the previous quarter.
  • In Japan we expect the leading O/N target rate to be left unchanged at 0.1%. The new macroeconomic forecast from Board members is expected to be revised upwards. In addition BoJ might signal that it will extend most of its non-conventional easing initiatives past September. Finally, premier Aso this week might dissolve the lower house and call for a general election most likely in early August. Hence, political uncertainty will be back on the agenda.


  • In Sweden the market will focus on Riksbank activities in the coming week. On Monday the 100bn 12M SEK auction will take place and the market is keen to find out what kind of subscription level we will see and what possible ramification it may have for interbank rates. On Thursday the Riksbank will publish its minutes, which is likely to prove interesting as it really was an unconventional move by the Riksbank to cut rates all the way down to 0.25%.

Financial views


We maintain a positive view on equities in the medium term. To underpin further market recovery in the coming months, we are looking for (a) final demand pick-up, (b) coverage of underweight positions, (c) mid-cycle valuation focus, and (d) weaker deflationary impulses.

The short-term downward correction in global stock markets is a natural consequence of the need of a new market agenda in our view. We anticipate that the correction has a limited downside from current market prices, and that investors should exploit the situation to add risk, on a six-month horizon.

Fixed Income

Global: Bond yields have fallen back recently as recovery doubts have crept into the market. However, the medium-term trend in bond yields is expected to be up based on continued improving macro conditions, a rise in risk appetite and heavy supply.

Intra-Euro: We are neutral on peripherals (Italy, Greece and Spain) versus Germany. On longer maturities, we prefer France and Finland to Germany.

Scandi: We are underweight 10Y Danish government bonds against Euroland and swaps, but overweight 2Y Danish government bonds. We are overweight Swedish government bonds versus Germany in the 10Y area. For funded investors we recommend being long the 2yr bonds due to excellent carry with repo funding close to zero. We have an overweight on Danish 30Y callable mortgages bonds versus both swaps and government bonds. We remain underweight in non-callables versus government bonds apart from 4'10.


During the past months credit spreads have tightened significantly. Activity in the primary market continues to be record high. However, we question the pace and sustainability of the massive rally and sellers have re-emerged putting credit spreads under some pressure recently. The macro outlook is still challenging and defaults rising. For long we had an overweight on credits based on the large liquidity and risk premiums for credit. Both these premiums have been reduced substantially. We therefore recommend a neutral positioning.

FX Outlook

EUR/USD is set to adjust lower in the short run, but to continue upwards in the medium term. Important drivers for EUR/USD are equities as a proxy for risk and most recently oil prices. We see room for a further decline in EUR/GBP as financial conditions continue to improve and UK data get better. Carry can keep performing, while funding currencies will face headwinds.

Swedish krona and Norwegian krone both have solid potential against the euro. Low trading volume and thin liquidity are however not good for the Scandies and a dovish Riksbank and a soft oil price mean less support over summer. Hence, we might have to wait for the autumn or even later to see the Scandies exploit some of their potential. The Danish krone is attractive (e.g. against Swiss franc) due to sound carry.


The rally in commodities has run out of steam with WTI oil falling further below USD 60 a barrel. In the short term we could see more downside, but in six months' time, we expect a new leg up in prices when the different market balances are expected to tighten for real.

Foreign exchange: Summertime is here

Prospect of quiet summer markets but limited volatility

Summer is upon us, as is clear from the FX market where July has traditionally marked the beginning of a period of decreased liquidity. When markets are quiet, even small trades can trigger significant exchange rate movements, and so one might imagine that the summer period would bring relatively large fluctuations in the FX market and high implied volatility.

To test this hypothesis, in the latest edition of FX Crossroads we looked at daily fluctuations in G10 exchange rates from 1999 through to today and at changes in implied volatility (which reflects the prices of options and so expectations of future fluctuations). Looking at the futures market since 1999, we can see that EUR/USD and USD/JPY liquidity has decreased by an average of 13% in the first weeks of July. We therefore tested whether there are seasonal effects on FX volatility both during this period and during the rest of the year.

Our results indicate that there are clear seasonal effects in several currency crosses in terms of both implied volatility and actual daily fluctuations. We see a clear pattern in the USD/JPY, where implied volatility tends to rise in March, correct downwards in April and subsequently pick up in September. This can presumably be put down to the volatility resulting from the end of the fiscal year in March and the end of the first half of the fiscal year in September.

Both the magnitude of daily currency fluctuations and implied volatility fall in most G10 crosses over the summer and then rise again during the autumn when the market gets its rhythm back. Our results show that daily fluctuations in the EUR/SEK and EUR/NOK are significantly lower in July than in the rest of the year despite these currencies' limited liquidity. Note, however, that these results say something only about the size of the fluctuations and not about the direction the crosses take.

SEK and NOK tend to suffer in the heat

Historically the SEK and NOK have not performed particularly well during the summer, tending to depreciate. The likely reason for this is that commercial interests are greatly reduced in the summer months, with many companies winding down over the holiday period, and so non-speculative portfolio flows are smaller.

The SEK is currently vulnerable due to the Riksbank's latest rate cut and dovish tone, investors' uncertainty about Swedish banks' exposure to the Baltic States, and the global outlook, which is still not quite at a stage where recovery can officially be declared. We still think that the SEK is cheap at current levels and has real upside potential, but we do not anticipate any major appreciation over the summer.

It is somewhat surprising that the NOK is not trading higher. While oil prices have plummeted over the past fortnight, the NOK did not strengthen appreciably when oil prices more than doubled from mid-February to mid-June. Although Norges Bank lowered its key rate at its last meeting, indicating that a greater monetary policy stimulus was needed, it also revised up its interest rate path, indicating that the key rate could also rapidly be put up again. Our short-term model suggests immediate strengthening of the NOK (towards 0.85 from a current spot rate of 0.82), but this may well be delayed due to the quiet markets and low trading volumes of summer.

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Danske Bank


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