Sunday, July 5, 2009

Weekly Focus: Is It Strong Enough?

Global update

  • Market doubts about the sustainability of the US recovery were fuelled by disappointing US non-farm payrolls and US consumer confidence.
  • It was not all bad news, though. There are more signs of global housing stabilisation and the Asian recovery is proving very strong.
  • We continue to look for a stronger-than-expected rebound in global growth in H2 09 as the inventory cycle will likely prove stronger than generally anticipated. The job market is expected to improve as the economy recovers.
  • The ECB meeting did not provide much news and ECB will be sidelined for a long time now. The Riksbank on the other hand still knows how to surprise. With a repo rate cut to 0.25% and the introduction of a negative deposit rate of -0.25% the Riksbank broke new ground.

Market movers ahead

  • A very quiet week is ahead of us with the G8 meeting starting Thursday as the most exciting event. China will try to push the agenda with talks about a new global reserve currency.
  • In US the ISM non-manufacturing is expected to rise further, but consumer confidence from University of Michigan could disappoint as higher oil prices and weaker equity markets could lead to a temporary setback in confidence.
  • In Europe German factory orders and industrial production for May are likely to show a further decline before recovering later in the year. The Bank of England meeting is not expected to give any surprises.
  • Focus in Scandinavia will be on inflation data.

Global update: Sustainability doubts

Is it strong enough?

The data picture over the past week was a bit of a mixed bag and overall disappointed markets. Equity markets slipped and bond yields fell further.

Although there were no very negative numbers and the trend is still for improvement, most data were slightly below consensus expectations and market doubts about the sustainability of the recovery have been reinforced. US non-farm payrolls fell 467k in June vs. expectations of a decline of 365k. While it is still some way from the bottom of -741k in January, job cuts of 0.5m per month are not a recipe for a consumer recovery. As we like to emphasise though, the labour market is a lagging indicator and the improvement in ISM for example should soon translate into fewer job cuts (see chart).

Speaking of ISM the release this week showed further improvement from 42.8 in May to 44.8 in June. But again, it was slightly below consensus of 44.9 and the new orders index, which is the most leading part of ISM, slipped a bit.

Another disappointment to the market was a decline in US consumer confidence from 54.8 in May to 49.3 in June. Consumer confidence is still very low. Our models had suggested we could see a weaker number due to the rise in the oil price. A rise in the oil price is one of the things that could spoil the recovery and we got a small warning this week. The news of weaker confidence was a blow to a market that is impatient about getting information that may suggest the recovery is sustainable into 2010 when the inventory cycle has run its course. Fortunately oil prices reversed some of the decline this week and if sustained it could underpin confidence in coming months. Also remember that the most important factor for the trend in consumer confidence is the labour market. As job cuts taper off we expect to see a clear improvement in consumer confidence over the next 6-12 months.

Overall the data were not quite as good as expected in the past week, but the deviations from consensus were not huge. We are still confident that growth rates will surprise to the upside in H2 09 as the inventory cycle is very forceful and stimulus is strong (see also Research – Global: A historic inventory cycle to boost growth released today).

Not all bad news: Auto sector and housing market improving

On other fronts things were more encouraging. Announcements from car makers suggested the worse is behind us in the auto industry. Ford for example raised its production target for Q3 from +10 y/y to +16% y/y and GM stated it saw the bottom in H1 09 (see WSJ article for more). The “cash-for-clunkers” incentive on car sales starts in July with the biggest effect probably in Aug/Sep. Hence after stabilisation in car sales over the last 3-4 months we are likely to see it revive from the bottom in Q3.

Also on the positive side global housing data continued to improve. US pending home sales rose stronger than expected and now point to a clear stabilisation in home sales. Case/Shiller house prices showed the smallest decline in 1½ years. And in UK Nationwide house prices rose 0.9% m/m in June. With increases in three out of the last four months there is no longer much doubt that UK house prices are stabilising. This is much sooner than expected and is quite positive for both consumers and banks.

Asia keeps booming - Japan turning fast

Asian production is seeing an incredible comeback, which is much stronger than anyone expected. Japanese industrial production rose 5.9% m/m in May taking the cumulated increase to 14% from the bottom in February! In Taiwan industrial production data is now up 33.3% from the bottom reached in January. The Tankan report in Japan was a bit mixed but the forward-looking parts were better than expected. Asian PMI also rose further. Being 25% of the world economy the turnaround in Asia should soon have positive spill-over on other regions.

Market movers ahead


  • It will be a very quiet week in the US. ISM non-manufacturing will be released on Monday. We look for an increase from 44.0 in May to 48.0 in June reflecting the rise we have seen in other indicators. On Friday consumer confidence for July from University of Michigan should attract attention as the market is increasingly focused on the consumer to gauge if the recovery can follow through in 2010. We look for a small disappointment in terms of a decline from 70.8 to 70.6 (consensus 71). Higher oil prices and lower equities are a short-term headwind to consumer confidence. Weekly jobless claims is also interesting at the moment as a measure of how fast the labour market is improving. The pace of decline in claims has disappointed slightly recently.
  • The G8 meeting on Thursday in Italy should receive some attention in FX markets. China will participate on the second day of the G8 meeting when it will try to push the agenda for a new global reserve currency. If that happens it could put the USD under pressure. However, we don't think China will succeed in setting the agenda and the support to the dollar from other leaders will be unchanged.
  • The main attraction in Europe this week is German factory orders and industrial production. Orders have shown some signs of bottoming recently, which is in line with PMI data rising. We believe orders will fall slightly by 0.2% m/m and that production will fall a bit further by 0.6% m/m. The meeting in Bank of England is expected to be a non-event without major news.
  • The calendar will be very light next week in Asia. South Korea is expected to leave its leading interest rate unchanged at 2% on Friday in light of the remarkable strong recovery in industrial production and exports in recent months. On Thursday the IMF board will discuss the latest assessment of the Chinese economy. It is uncertain when the assessment will be made public, but according to press reports IMF will soften its criticism of the Chinese exchange rate policy and adjust its 2009 GDP forecast up to 7.5% from earlier 6.5%.


  • In Norway and Sweden focus will be on inflation data for June. However, inflation is not a big market mover at the moment. With high excess capacity inflation fears are not present. The fear of deflation is also limited given the substantial depreciation of the currencies in the past year.

Financial views


We maintain a positive view on equities in the medium term. Risk appetite has returned and our five point trigger list (from February 2009) for a stock market recovery has almost been completed, which means we are looking for new triggers. 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 correction in the global stock market is in our view a natural consequence of the need of a new market agenda. Already in May we expressed our concerns that the market recovery came too fast to avoid a sanity check in especially cyclical stocks. Still, we anticipate that the correction holds a limited downside from current market prices, and that investors should exploit the situation to add risk, if they have a six-month horizon.

Fixed income

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

Intra-Euro: We are neutral in peripherals (Italy, Greece and Spain) versus Germany. On longer maturities, we still 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 has enjoyed a strong spell across sectors and capital structure. Spreads have tightened significantly. Activity in the primary market continues to be record high as companies turn to the capital markets instead of banks for funding.

We question the pace and sustainability of the massive rally and in recent weeks sellers have re-emerged putting credit spreads under some pressure. The macroeconomic outlook is still challenging and defaults are rising. For long we had an overweight on credits based on the large liquidity and risk premiums for credit. Both these premiums have now been reduced substantially. We therefore recommend a neutral positioning.


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. EUR/GBP has lost some of its downward momentum, but we still see further GBP performance supported by recovery signals and normalisation of financial conditions. Carry can keep performing, while funding currencies will face headwinds.

Swedish krona and Norwegian krone both have solid potential against the euro. However, after the bold move from the Riksbank this week SEK once again got hammered, and the risk of a Latvian devaluation is still looming on the horizon. Hence, we might have to wait until 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 seems to have run out of steam with WTI oil below USD 67 a barrel. We think the risk of a further short-term correction is evident. In our view, the market is neglecting near-term weakness such as weak oil demand and huge stocks in base metals. However, 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: China requests USD debate at G8 meeting

G8 meeting to set agenda for USD (perhaps)

A G8 meeting will take place in Italy next week (Wednesday to Friday), and interest in the FX market is centring on the Chinese delegation led by President Hu Jintao. In the past week the financial media have reported that China wants a discussion about the USD's role as reserve currency. Understandably the Chinese are worried about what the US imbalances will mean for the USD in the long term, especially considering that the bulk of China's FX reserves are invested in USD assets.

The same channels have also reported that there could even be references to the topic in the final G8 communiqué. Remember here that the People's Bank of China said back in March that the world's central banks should consider making more use of the IMF's Special Drawing Right (SDR) as a reserve currency, and the Russian finance minister has aired similar thoughts. SDR is an artificial currency created by the IMF based on a basket of USD, EUR, GBP and JPY.

However, we reckon that this is mostly a case of hollow threats. As ever, China's problem is that it has no alternative to buying USD assets if it wishes to pursue its current FX policy. Nor is there anything in the available data to suggest that the Chinese (or other countries for that matter) have seriously lost their appetite for USD assets in their FX reserves. If China pushes to get the topic onto the agenda, we expect that the USD will be backed by the IMF and other world leaders as was the case in March. The general view will be that it is too early to embark on such a discussion – the last thing the global economy needs right now is a USD crisis. It is worth remembering that China is not formally part of the G8: the Chinese are only in Italy because it was decided to invite the so-called G5 countries (Brazil, China, India, Mexico and South Africa). If the Chinese kick up too much of a fuss, this will attract attention to their blatant manipulation of their own currency. But the debate is there in either case, and if it does make it onto the agenda (which we doubt), it will definitely put temporary pressure on USD. Remember that if the USD's role as reserve currency changes, this will be a very long-term process.

Central banks continue to set the agenda

During the week the Riksbank in Sweden announced a surprise reduction in its benchmark rate to just 0.25% and offered the bank sector SEK 100bn in one-year loans at a fixed rate of just 0.4%. The combination of very low interest rates in Sweden, which reflect the depth of the recession in the country's economy, and the fact that we are moving into the summer period, which traditionally brings low levels of liquidity in Scandinavian FX markets, means that caution is advised with long SEK positions. SEK has previously shown a tendency to weaken during the summer, and this year the situation in the Baltic States presents an extraordinary risk. However, there was also some good news in Sweden during the week when the PMI climbed to 50.5, indicating a return to growth in the manufacturing sector. -SEK is highly pro-cyclical, and this is one of the reasons why we anticipate strengthening of SEK in the medium and long term despite the Riksbank's aggressive monetary policy.

In the coming week we will be keeping an eye on the monetary policy meeting at the Bank of England, but we do not expect any big surprises in the form of rate changes. GBP came under pressure during the week when Q1 growth turned out surprisingly weak, but these figures are by their very nature historical, and recent forward-looking data paint a brighter picture. We therefore still see masses of potential in the GBP.

Key events of the week ahead

  • G8 meeting in Italy, with possible focus on the USD's future role as reserve currency (Wednesday to Friday)
  • Bank of England rate-setting meeting (Thursday)
  • Inflation figures in Sweden (Thursday) and Norway (Friday)

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