EMU inflation flash estimate (August): prices still falling
German adjusted unemployment (Aug): short-time work limiting rise again
ECB Council: no change in policy
German retail sales could have stabilised at least in July, as retailers' business assessment rebounded and consumer confidence rose. The Italian business confidence will probably have continued improving in August.
The Purchasing Managers' Indices for the German and EMU manufacturing sector in August are unlikely to be revised significantly. The same goes for EMU GDP in Q2.
Despite the severe recession, German adjusted unemployment surprisingly fell by 6k in July. The extensive use of short-time work schemes and statistical changes are still dampening the upward trend. We thus forecast that adjusted unemployment will have risen by a mere 5k in August. However, from autumn on, we expect unemployment to go up noticeably, as cost pressures will force companies to dismiss employees rather than to prolong their short-time work contracts.
Within a year, the harmonized EMU unemployment rate has risen from 7.5% to 9.4% by June. The regional differences are striking: while the German rate increased by a mere 0.4 percentage points, the Spanish rate jumped from 11.0% to 18.1% in the same period. We expect the upward trend in the EMU unemployment rate to continue for quite some time to come; the rate could have risen by 0.2 percentage points to 9.6% in July.
The Eurostat flash estimate is likely to show that euro area inflation became less negative in August. The inflation rate rose to -0.2% yoy, from -0.7% in July. This would correspond with a monthly increase in HICP of 0.3 % in unadjusted terms. The increase mainly reflects higher energy prices. Moreover, the base effect from falling energy prices in August 2008 is pushing the annual inflation rate higher.
The ECB Council is holding its regular monthly meeting on Thursday. The interest rate decision will be announced at 13:45hrs, the press conference is scheduled for 14:30hrs. Over the last few weeks, several ECB representatives have warned against excessive optimism. In addition, the ECB report on EU Banking Sector Stability underlines the substantial risk. We therefore expect the ECB policy stance to remain unchanged. The refinancing rate likely to be kept at 1.0%. However, the ECB staff projections will probably be revised higher. As growth in Q2 turned out to be better than expected and economic activity in Q3 seem to be more or less stable, growth forecasts for 2009 and 2010 are likely to be upgraded.
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Next week sees both month-end and a likely end to summertime trading conditions, both of which have the potential to generate heightened volatility. On Monday, Japanese election results (see below) will start the ball rolling, but liquidity will be hampered midday by the UK Summer Bank holiday which will see most of London absent. NY afternoons will likely remain thin as the US Labor Day holiday on Monday Sept. 7 leads to thinner interest than normal toward the end of the week. At the same time, summer will be ending for many asset managers and an increase in position adjustments may begin from Sept.1. Lastly, Friday will see the August US NFP report, always an important catalyst for volatility.
Is this as good as it gets?
As summer draws to a close, indications are increasing that the risk rebound has run its course and that markets are likely entering a more difficult phase of the global stabilisation/recovery story. On the technical side, in stocks, bearish divergences between price and momentum abound in major indexes like the S&P 500, FTSE, and the MSCI World. In currencies, the 'risk on' trade, long carry trades (e.g. long AUD/JPY, CAD/JPY, or EUR/JPY) and short USD, is also faltering and never corroborated the newest highs in stocks, which importantly came on weak volume.
On the fundamental side, upbeat economic data is increasingly being shrugged off, a la buy the rumor, sell the fact. August German IFO and Eurozone PMI's just made new highs for the year, but there was a palpable lack of response from European investors. Similarly, US consumer confidence for August just surprised with a stronger than expected reading, but shares were unable to sustain gains on the day. The same goes for August US housing data, which arguably provided the best case yet that the US housing market has reached a bottom. It could be a simple case of summertime lethargy, but more likely risk positioning has reached an apex and investors willing to pile in at current levels are increasingly scarce.
Perhaps nowhere is the divergence more apparent than in commodities, which might be seen as the closest barometer of growth expectations. If production is going to ramp up and personal consumption is expected to recover, commodities should be gaining ground. But the Reuters/Jeffries CRB index peaked on Aug. 6, posting another bearish divergence between price/momentum relative to its June 11 high, and has been declining since then. There's a built in circuit-breaker of sorts between commodity prices and other risk assets on either of two counts: 1) Higher commodity prices lead to higher final product prices, sapping disposable income and damping a consumer-led recovery, undermining corporate profitability; 2) If producers choose to eat higher input prices, corporate profits typically suffer and stock markets tend to underperform.
The greatest near-term risk emanates from China, which has recently announced efforts to rein in lending by state-owned banks to companies and to cut back on industrial production investment. Keep in mind, China and the rest of Asia were supposed to lead the rest of the world toward recovery. But with China's nearly $600 bln fiscal stimulus package exhausted earlier this summer, that source of further growth also looks to be fading. Interestingly, last week the July China Leading index gained to 103.24, just shy of highs of 103.96 seen in mid-2007 when global growth was at its peak. Does anyone seriously think the global economy is anywhere near to mid-2007 levels? In contrast, the Baltic Dry Index, a measure of commodity shipping demand, has been sliding lower since June and never recovered to anywhere near 2007 levels. The divergence between the two, which had been closely correlated until earlier this year, is striking and suggests potential for a significant cut-back in Chinese production, which would undermine global asset markets overall. If so, buckle up for a bumpy autumn and a relapse in risky assets. In FX, we will look to sell commodity currencies (AUD, CAD, and NZD) near to highs for the year in anticipation of weaker commodity demand going forward and an expected fresh erosion in risk appetites generally.
Japanese election this weekend
Japan will hold elections to the lower house of parliament (the Diet) on Sunday, August 30. Results will likely be known around noon on Sunday EDT/late afternoon Sunday GMT, but perhaps sooner if a strong trend develops. The most recent polls suggest that the DPJ (Democratic Party of Japan) may succeed in ousting the dominant ruling LDP (Liberal Democratic Party) from power for the first time since 1955, with one brief exception in 1993. The DPJ has been leading all along as popular discontent with the LDP and PM Aso simmers amid rising unemployment and a stagnant economy. Japanese stocks have advanced on the prospect for a DPJ victory, as its platform calls for enhanced consumer support and increased domestic spending. Japanese bonds have declined/yields have gained as increased DPJ fiscal spending is expected to lead to more borrowing and more JGB issuance, though the DPJ has indicated it would not necessarily borrow to fund its initiatives. The JPY has strengthened largely on the basis of higher yields, but is also likely supported by wavering risk sentiment.
We think a DPJ victory is largely priced-in to markets, and if so, the impact has been pretty minimal indeed. This raises the prospect of a 'buy the rumor, sell the fact' reaction, potentially leading to lower stocks, higher bonds and a marginally weaker JPY on a DPJ win. However, with 30% of respondents indicating 'undecided' in some recent polls, a surprise LDP victory may yet emerge, which could hurt stocks even more, resulting in further JPY strength. Overall, we think USD/JPY is likely to stay within 92/95 in the immediate aftermath of the election. We prefer to be buyers of USD/JPY on weakness in the 92.00/93.50 area on the basis that any resulting government will maintain the policy of limiting JPY strength. We will post an update on the election results and early market reaction on Sunday afternoon by 1600EDT/2000GMT; check The Week Ahead on the trading platform to see the update.
Details will matter in ECB and RBA rate meetings
The Reserve Bank of Australia is due to meet on rates this upcoming Tuesday and the market is unanimous looking for no change to the 3.0% target. Given that steady rates are pretty well baked in the cake, traders will be focused on the press statement. The bank is likely to note that economic conditions continue to improve as evidenced by that much better than expected employment number for July, which actually showed an addition of 32.2K while the market was forecasting another monthly decline. The key things to watch are whether the RBA discusses the Australian dollar strength and whether they hint that they will likely be one of the first central banks to raise rates. Rumors were a dime a dozen that the bank has been selling AUD in the past few months in an attempt to stem its gains, which hurt its export-oriented economy. Any hint that they are willing to intervene in the currency market further would be decidedly AUD negative. Should the committee focus instead on a timeline for rate hikes, AUD could see gains extend. Being one of the first to raise rates would give the market more confidence in the Australian economy and offer a nod to the bank's inflation fighting credentials - both positive for the currency.
The European Central Bank meeting is scheduled for Thursday and every strategist/economist surveyed is expecting no change to the current 1.0% rate. The focus will once again be on the press conference headed up by ECB President Trichet. He is likely to focus on the better economic outlook especially as indicated by major improvements in business and consumer confidence surveys of late. That jump to 95.0 in German IFO expectations in August from 90.4 the prior month did not go unnoticed. A rosier outlook for the eurozone is likely to get the EUR bulls revved up at least initially. The big question is whether Trichet will offer any details on potentially extending the ECB's covered bond purchase program. Comments coming out of the political arm of the eurozone have been focused on the lack of lending to businesses of late and we will see whether Trichet offers any insight on potentially increasing the current 60 billion euro bond purchase program to aid with this dilemma. Should the bank hint at expanding this program, EUR would undoubtedly take a spill. This would suggest that the eurozone credit space is perhaps in more trouble than most think and puts the economic recovery in peril.
Key data and events to watch next week
The US economic calendar is jam-packed with data. The Chicago PMI kicks off the action on Monday while Tuesday has ISM manufacturing, construction spending, pending home sales and motor vehicle sales on tap. Wednesday is also busy with the ADP employment report, factory orders, crude oil inventories and the minutes of the August FOMC meeting. ISM services highlight Thursday while Friday rounds out the week with the all-important August employment report.
It is also busy in the eurozone. Monday starts things off with the consumer price estimate. On Tuesday we see eurozone PMI manufacturing, eurozone employment, German retail sales and German employment. Wednesday brings eurozone GDP and eurozone producer prices while Thursday has eurozone PMI services, eurozone retail sales and the ECB rate meeting (more on this above). The European Commission releases its economic forecasts on Friday.
The UK sees a pretty typical week in terms of data. The Hometrack housing survey starts off the action on Sunday. Tuesday is the busiest day with net consumer credit, mortgage approvals and PMI manufacturing. The PMI services index closes out the week on Thursday.
The week in Japan starts early as the election results are expected Sunday (more on this above) along with PMI manufacturing, industrial production and retail sales. Housing starts are up on Monday while Thursday sees capital expenditures.
Canada has a characteristically light but important week ahead. GDP data is scheduled for Monday while Friday has the employment report and Ivey purchasing managers index on deck.
Most of the action down under is in Australia. New home sales are up Monday while Tuesday brings the current account, building approvals and the RBA rate meeting (more above). Tuesday has GDP and the performance of services index lined up while Thursday sees the trade balance. In New Zealand, only the business confidence indicator on Monday is noteworthy.
Brian Dolan, Chief Currency Strategist
Jacob Oubina, Currency Strategist
Forex.com
http://www.forex.com
DISCLAIMER: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
The Economy is Poised to Snap Back in the Second Half
Recent economic indicators point to a relatively robust bounce back in industrial activity during the second half of this year.
Stimulus programs are exaggerating the improvement in motor vehicle and home sales but recent gains will translate into stronger near-term GDP growth.
Bernanke's reappointment removes some of the uncertainty about the future monetary policy, while large budget deficits will constrain fiscal policy options.
Stronger Economic Gains Boost Recovery Hopes
This past week's reports on consumer confidence, durable goods orders and new home sales all came in well above expectations and point to a stronger snap back in economic activity during the third quarter. Revisions to second quarter GDP and the early read on consumer spending during the third quarter are also consistent with a strong bounce back in economic activity. Even the home price data look a little better. That said, we have repeatedly noted that stimulus programs such as the cash-for-clunkers, $8,000 tax-credit for first-time home buyers, and the Federal Reserve's purchase of mortgages, asset-backed debt, and Treasuries is lending a great deal of support to the financial markets and broader recovery. Regardless of how it got started, the recovery looks like it is here to stay, although the initial burst of activity we expect in the current quarter should gradually give way as stimulus programs end or simply lose their effectiveness.
Consumers clearly sense the economy is on the mend. The Consumer Confidence Index rose 6.7 points in August to 54.1. While most of the improvement continues to be in the expectations component, consumers are slightly less pessimistic about near-term employment and income prospects. The improvement likely reflects the winding down of large layoff announcements. Expectations are likely getting a lift from the recent strength in the stock market and better news on housing.
Do not read too much into the recent improvement in consumer confidence. The overall index remains exceptionally low and the current conditions component has barely risen off its lows. The consumer confidence index tends to track employment trends. Weekly first-time unemployment claims have clearly peaked, but the absolute level of claims remains relatively high, and there has also been a large increase in the number of people exhausting their unemployment insurance and filing for extended benefits. We expect consumer confidence to gradually grind higher, just like the rest of the economy.
The industrial side of the economy appears to be poised for a much stronger rebound. Production was slashed earlier this year and inventories were drawn down by $159.2 billion in the second quarter. That figure comes from the revised GDP figures and is $18 billion larger than first reported. A good portion of that inventory drop was likely in motor vehicles, where production was slashed during the period. Sales have rebounded more recently, with the cash-for-clunkers program helping fund the purchase of nearly 700,000 vehicles in July and August. The rise in sales will further reduce inventories in the current quarter but, with production rising, inventories should fall less, adding around 2 percentage points to third quarter real GDP.
Orders for durable goods jumped 4.9 percent in July, with orders for commercial aircraft soaring 107 percent. Orders also picked up for electrical equipment and steel. Part of that may still be tied to the ramp up of vehicle production but part also simply reflects a bounce back following and extended draw down in inventories. Either way production looks set to rebound.
U.S. Outlook
ISM Manufacturing • Tuesday
The Institute for Supply Management's headline manufacturing index rose for the seventh consecutive month in July reflecting notion that the prolonged contraction in the manufacturing sector is staged for recovery. Increased auto production should help continue to buoy the headline index. The consecutive gains toward the expansion/contraction threshold of 50 are consistent with the end of post-War recessions which reached the demarcation line two or three months after the recession ended (the only exception is the 1973-1975 recession). The forward-looking new orders index rose four out of five months, breaking 50 in May which suggests stabilization in orders. The re-opening of motor vehicle assembly plants will likely continue to boost the employment index. Several regional purchasing managers' indices have shown continued improvement in August, suggesting a boost to ISM manufacturing.
Previous: 48.9 Wells Fargo: 50.1
Consensus: 50.1
Vehicle Sales • Tuesday
Motor vehicle sales should ramp up significantly in August due the cash-for-clunkers program. The CARS program once again exhausted its funding far ahead of the expiration date with auto dealers applying for nearly all of the $3 billion supplementary appropriation. Manufacturer motor vehicle sales rose to an 11.2 million unit pace in July, but August sales should far surpass last month's figure likely jumping to a 14.2 million unit pace. This surge in motor vehicle sales is the highest since May 2008. The spike in auto production and sales can be seen across a whole host of economic indicators and should help boost GDP growth to around a 3.4 percent annual pace in the third quarter. Outside of the auto sector, however, the economy is simply getting less bad. While final demand is showing some improvement, income remains under pressure suggesting the third quarter rebound in production will probably not be sustainable. This will likely set the economy up for a sluggish recovery.
Nonfarm employment fell by 247,000 jobs in July producing a net loss of 6.7 million jobs since the recession began. Employment losses continue to be exceptionally broad based, but the biggest net declines remain in manufacturing and construction. Financial services and temporary staffing were also hit badly, but layoffs appear to have slowed. While the four-week moving average for initial jobless claims fell for the first time since the early auto plant shutdowns distorted figures, the recent decline is likely due to a slower pace in layoffs and the exhaustion of benefits. We expect nonfarm employment likely dropped by 306,000 jobs with the unemployment rate reaching 9.6 percent in August. Nonfarm employment is likely to continue declining into early 2010 and the unemployment rate will not likely top out until the middle of next year.
The Ifo index of German business sentiment rose in August to its highest level since last September, suggesting that industrial production in Germany continues to recover from the low that was hit this spring.
Most Asian economies grew on a sequential basis in the second quarter, and recent data suggest that the upturn has continued into the current quarter. Latin America appears to be lagging Asia, but there have been indications recently that the region is starting to turn around.
More Signs of Global Economic Stabilization
Incoming economic data continue to portray a global economy that is stabilizing and, probably, starting to grow again in the current quarter. For example, the Ifo index of German business sentiment rose for the fifth consecutive month in August (see chart on front page). Because the index is highly correlated with growth in industrial production (IP), the recent increase in the Ifo index suggests that IP is starting to recover.
The breakdown of German real GDP into its underlying demand components shows that macroeconomic stimulus was partially responsible for the 1.3 percent annualized growth rate that Germany was able to achieve in the second quarter (top chart). Real consumer spending rose nearly three percent, due in part to the country's “cash-for-clunkers” program, and government spending also provided a lift to GDP. Business spending on equipment continued to decline as did exports, although the rate of contraction in both components slowed significantly. That said, the significant liquidation of inventories that occurred in the second quarter lays the groundwork for further gains in GDP in the quarters ahead as the inventory cycle starts to swing the other way.
In Asia, news continues to pour in that shows bona fide recovery is underway in the region. For example, data released this week showed that real GDP growth in Malaysia, the Philippines and Thailand turned positive on a sequential basis in the second quarter. It appears that global trade, which was negatively impacted last year and earlier this year by the global credit crunch, is helping to lift real GDP in most Asian economies. Economic data thus far in the third quarter have generally been positive as well. Industrial production in Singapore jumped up 23 percent on a seasonally adjusted basis in July relative to the previous month. Although Singaporean IP tends to be very volatile on a monthly basis, even when the series is seasonally adjusted, the recent trend suggests that the economy continues to gather steam (middle chart). Moreover, the rise in IP is consistent with the increase in the purchasing managers' index since spring.
Recent data show that most Latin American countries are lagging behind Asia. For example, rates of economic contraction in Chile, Colombia and Peru all deepened in the second quarter, at least on a year-over-year basis. As we reported last week, Mexican real GDP tanked in the second quarter, plunging more than 10 percent in the second quarter on a year over year basis.
However, there are indications that the current quarter will be stronger than the second quarter for many Latin countries. The value of Chilean exports, which were up 14 percent in July relative to the previous month, rose to the highest level since last October. Brazil's exports have also trended higher recently, helping to lead to an increase in the country's trade surplus (bottom chart). In addition, Brazilian auto sales have recovered in recent months. Although most Latin economies are smaller today than they were last year at this time, growth in Latin America appears to be turning positive on a sequential basis.
Global Outlook
Japanese Industrial Production • Monday
Japanese industrial production tanked late last year and earlier this year as global trade imploded. Indeed, at its nadir in February, Japanese IP was down 35 percent on a year-over-year basis. However, Japanese IP has risen for four consecutive months and is now up 16 percent from its low. The consensus forecast anticipates that IP posted another solid gain in July.
Data on Japanese retail spending in July will also be released on Monday. Although industrial production has bounced since spring, the value of retail spending has trended slightly lower during that period. (The rebound in industrial production is due to stronger exports). Most investors look for a modest decline in retail spending in July. Data on housing starts will also print on Monday.
The Canadian economy contracted at the fastest pace since 1991 in the first quarter of this year. The decline in the first quarter was mostly attributable to a collapse in demand for Canadian exports, and a drop in business investment as business owners stopped all non-essential orders to survive the recession. The consensus looks for “less bad” numbers for economic growth for the second quarter which is scheduled for release on Monday. Government incentives in the United States to stimulate demand for autos may have contributed to some recovery in auto-exports from Canada, and business sentiment has improved since last winter.
On Friday of next week, the Canadian employment report for August will be released. These data have a tendency to be volatile but on trend, the pace of decline has been slowing in recent months and we expect that trend continued in August.
Previous: -5.4%
Consensus: -3.0%
U.K. Purchasing Managers' Indices
The U.K. economy has contracted for five consecutive quarters, but the recent rise of the manufacturing and service sector PMIs above the demarcation line that separates expansion from contraction suggests that real GDP growth may be turning positive again. Most analysts look for further increases when the PMIs for the manufacturing (Tuesday), construction (Wednesday) and service sectors (Thursday) for August print next week.
Like the United States, house prices in the United Kingdom fell sharply starting in 2007. However, most house price indices stabilized earlier this year, and are beginning to creep higher. The August reading for a widely followed index of house prices (the Halifax index) is slated to print next week.
This week's Congressional Budget Office (CBO) mid-year budget outlook highlights the problems inherent in conducting an “independent” monetary policy and an effective exit strategy in a subpar economic recovery. The CBO expects relatively weak real economic growth of 1.7 percent in 2010 and sees the unemployment rate reaching 10.2 percent. Their 10-year Treasury rate forecast is 4.10 percent compared to today's rate of 3.48 percent. The CBO estimates the federal deficit at $1.38 trillion for 2010. In this context, decision-makers will need to be vigilant in assessing how independent and how effective any exit strategy will be in the year ahead.
How likely is policy to be independent of both negative economic and political feedbacks? The Fed has indicated a commitment to reduce liquidity and exit the current accommodative stance. This presents a challenge to investors. Any Fed exit strategy will alter the relative returns for all instruments the Fed attempts to sell. This is particularly true for longer maturity instruments such as Treasuries, mortgages and ABS. As interest rates rise, the likely feedback is that the housing sector will witness weaker starts and a weaker recovery in prices. How independent of this feedback will the Federal Reserve be in its pursuit of price stability?
An effective exit strategy is also likely to coincide with a subpar economic recovery and large Treasury financing needs. Federal revenues will lag the economic recovery. The Fed's exit strategy will make Treasury auctions more difficult to place at the current low interest rates. The upward pressure on yields will likely be amplified. This week's CBO report brings into greater relief the fiscal/monetary policy conflict. Treasury debt will continue to be issued while the Fed will exit its easy policy and overall economic growth remains subpar. This all leaves us quite cautious on the Fed/Treasury being able to walk this tightrope. How will the Fed implement that exit strategy and be willing to accept the political criticism?
Consumer Credit Insights
Economics at the Community Level
This week we had the opportunity to speak at an Interagency Community Conference hosted by the FDIC in Washington, D.C. For communities and households in particular there are three key factors that determine economic success. First, economically diverse communities are more likely to succeed than undiversified economies over time. Being the world's capital in one business is great when that business is soaring but when that particular business is out of favor, then the downside is very difficult. We can see that today in Detroit.
Second, education achievement is critical for both individual and community success. Overtime, households and communities with a broader higher academic achievement levels tend to have higher average incomes and also bounce back from difficulties, (for example: Boston, San Francisco, Austin).
Finally, economic/financial education can be enhanced at the local level for many consumers by integrating the efforts of non-profits and private firms. Many non-profits, especially churches, that often have significant ties into communities that governments do not, can exercise outreach to offer job/financial counseling. The implementation of this three-pronged approach can foster community development that can turn around economically disadvantaged communities.
Topic of the Week
Manufacturing Activity Rebounds
Manufacturing is clearly one of the hardest hit sectors in this business cycle, with manufacturing employment down more than 12 percent over the past year. Recent national and regional manufacturing economic indicators, however, show that manufacturing activity appears to be turning around. The ISM manufacturing index rose to 48.9 in July, close to the “50” demarcation line. Additionally, manufacturing industrial production in July inched up 1.0 percent. Recent regional manufacturing surveys have also brought in positive numbers. The Richmond Fed and the Empire manufacturing index both signaled expansion for the last few months while the Philadelphia Fed index rose to 4.2, the first positive reading since September 2008. Most of the improvements were in new orders and shipments, indicating improvement on the demand side. The employment indices, however, are still low, consistent with continued declines in manufacturing employment.
A few factors can be attributed to the recent uptrend in manufacturing activity. Inventories were heavily liquidated in the first and second quarters, a total of $273.1 billion, as businesses endeavored to keep inventories in line with declining sales. This has set the stage for a comeback in production. Many auto plants restarted in July after significant headwinds in the auto industry caused early plant shutdowns. Also, the cash-for-clunkers program has significantly increased car sales, enabling auto makers to increase production in order to replenish depleted inventories. However, real domestic final sales have been weak and may indicate that the ramp up in production will not be sustainable in the next few quarters.
While production is rebounding, it may happen without solid employment gains as capital-intensive industries will likely fare better than the labor-intensive sector. Additionally, the economy has been progressively shifting to be more service-oriented, and it is becoming increasingly difficult to sustain high-cost industries.
Disclaimer: The information and opinions herein are for general information use only. Wachovia Corporation and its affiliates, including Wachovia Bank, N.A., do not guarantee their accuracy or completeness, nor does Wachovia Corporation or any of its affiliates, including Wachovia Bank, N.A., assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or any foreign exchange transaction, or as personalized investment advice. Securities and foreign exchange transactions are not FDIC-insured, are not bank-guaranteed, and may lose value.
The BEA's preliminary estimate of Q2 U.S. real GDP growth came in at -1.0% (annualized). A likely return to positive growth in Q3 makes the 2008-09 recession the longest in the post-war period at 18 months, as well as the deepest with a peak-to-trough decline in real GDP at 3.9%
U.S. new home sales rose by 9.6% in July and month's supply fell to 7.5 months (from 8.5 in June). S&P Case-Shiller shows first monthly gain in over three years, rising by 0.8%.
U.S. Personal spending data for July show a "cash-for-clunkers" boost. Real PCE up 0.2% (1.6% annualized) on a 1.2% rise in durable goods spending.
Canadian retail sales for June advance in both values (1.0% M/M) and volumes (0.4% M/M).
Canadian consumer confidence in August rises to highest level in past year.
Teranet-National Bank quality-adjusted home price index for June advances for second month (1.5% M/M)
Bank of Canada staff speak about monetary policy during the recovery, and markets over-react to Bank statements about the loonie's rise.
UNITED STATES - THIS TIME IT'S DIFFERENT?
With the release of the Bureau of Economic Analysis' preliminary estimate of the second quarter GDP growth and an increasing number of signs that growth will return to positive territory in the third quarter, it is an appropriate time for a "preliminary" post-mortem look at the U.S. Great Recession. The discussion can only be preliminary because the history books are still being written on the medium and long-run ramifications of the financial crises of 2007 and 2008 and subsequent global recession. At this point at least, we can say that the 2008-09 recession in the United States lasted 18 months - from January of 2008 to June 2009 and resulted in a 3.9% reduction in real GDP. While a number of elements of the recession were unique from previous recessions, in terms of its duration and depth this recession was only slightly worse than the 1973-75 recession, which lasted 16 months and saw a peak-to-trough decline in real GDP of 3.2%, and the recession of 1981-82, which also went 16 months and saw real GDP decline by 2.9% peak-to-trough.
The four most dangerous words in investing, according to Sir John Templeton are "this time it's different." You will often hear these words spoken in the formation of an asset bubble. Indeed, the notion that something is different about the current environment that justifies the run up in (take your pick) stock prices to earnings or home prices to income and rents, is what makes identifying an asset bubble ex-ante so hard to do. Unfortunately, it is all too easy to pick and choose some new phenomenon - the unbounded possibilities of the internet or innovations in housing finance, and claim that it justifies the dramatic move away from historical performance, especially when everyone around you is reaping the rewards.
Nonetheless, with the two most recent recessions at least proximately caused by bursting asset bubbles, the notion that central bankers should do more to lean against their formation, has once again picked up steam. This is precisely one of the questions that the newly reappointed Fed Chief Ben Bernanke will face as he heads into his second term. In that regard, the devastating impact of the housing bust challenges the consensus that central bankers goal of economic stability is best met by primarily focusing on low and stable inflation. As was noted at the recent Jackson Hole symposium, "price stability does not guarantee financial stability." Leaning against asset bubbles may in fact require straying from the target path for consumer price inflation for a certain period of time. How to do this while still maintaining the credibility of the central bank remains an open question.
In the next few weeks we will be updating formally our U.S. economic forecast. One of the key pieces of the forecast puzzle is how much near-term spending will be boosted by government stimulus and cash-for-clunkers. Data out this week on personal spending for July (the first month of the quarter) were encouraging. Real personal consumption expenditures (PCE) rose by 0.2% (2.6% annualized) led by a 1.8% rise in durable goods spending. Given the swiftness with which the cash-for-clunkers funds were exhausted, auto sales are likely to give an even larger boost to consumption in August, resulting in a fairly buoyant growth for overall PCE in the quarter. Positive PCE growth in addition to rebounding residential construction and a positive contribution from business inventory investment will likely lead to real GDP growth of something close to 3% (annualized) in the third quarter.
Beyond the third quarter, the longer term factors impacting the U.S. economy - continued deleveraging in the financial and household sectors, weak income growth, and the unwinding of monetary and fiscal stimulus - will make for a slow-go economic recovery. The impact of the U.S. Great Recession will continue to be felt for several years to come.
CANADA - THE SUN ALSO RISES
As economic data reveals the Canadian economy moving into rebound, the focus increasingly turns to how the recovery will unfold and how policy will be managed. The Canadian economy looks to be improving but levels of activity remain low. It is likely that June's GDP, due out Monday, showed a monthly advance - the first since September 2008. Although skewed upwards by gas sales, retail sales data for June were better-than-expected and, stripping away energy prices, the volume of retails sales advanced on the month. As well, the Canadian resale housing market appears on a tentative rebound with the Teranet-National Bank housing index (a quality-adjusted resale index) advancing in June for the second month and showing an improvement in its year-over-year decline.
Looking towards recovery, the Canadian economy still faces significant risks and these are largely external. Friday's report on Canada's current account balance for Q2/2009 (the tally of our net exports and net investment payments abroad) showed a record deficit of $11.2 bn, with our trade balance in goods posting a deficit for the first time since 1976. The era of twin deficits has clearly begun, and much focus will be on how policy-makers navigate these waters.
Two speeches this week from Bank of Canada officials provided insight on how the Bank will manage recovery over the medium- and longer-term. In Mark Carney's Jackson Hole speech on Sunday, the governor floated some balloons around a central bank's appropriate role in macro-prudential oversight. He observed that "the monetary and financial wings of our [central banks] have operated as two solitudes," and tentatively proposed a monetary policy framework that combined "leaning against the wind for financial stability" with price-level targeting (in contrast with the present inflation-targeting regime).
Regarding the Canadian economy beyond the recession, Deputy Governor Tim Lane spoke to the Canadian Association of Business Economists on Tuesday in an annual address. Hungry for juicy morsels on the Bank's view of the loonie, markets latched onto a paragraph flagging the risk from currency appreciation on the nascent economic recovery, pushing the loonie down three-quarters of a cent from noon to close. However, our view is that market participants misinterpreted and over-reacted to the speech. Firstly, the speech simply reiterated the Bank's stance in relation to a rising dollar that it had already articulated in its July Monetary Policy Report (MPR): The Bank observed the risk from a persistent appreciation and added the now standard boiler-plate that the Bank retains "considerable flexibility" in its conduct of policy. Secondly, the Bank only considers the exchange rate as relevant within the context of its price stability mandate. A fundamental-driven appreciation (such as driven by heightened commodity prices) would correspond with a positive shock to aggregate demand and currency appreciation offsets the resultant upward pressure on prices. This implies no need to adjust monetary policy for the appreciation. While the general weakening of the greenback may be placing upward pressure on the loonie, we regard the Canadian dollar's recent appreciation as primarily driven by economic fundamentals - these being rising commodity prices and financial inflows that will be used for new investments.
The bottom-line is that the Bank's commitment to a flexible exchange rate remains firm. Even in the unlikely event that the Bank opted to use "unconventional monetary policy instruments" it would be acting to maintain price stability, not to target a particular exchange rate. As such, the Bank would need to perceive that a currency movement would result in a substantial deterioration of inflation below the lower bound of its baseline forecast. While we regard the Bank's point forecast as optimistic, we believe that even an appreciation to parity would not result in a deterioration below their lower bound.
U.S.: UPCOMING KEY ECONOMIC RELEASES
U.S. ISM Manufacturing Report - August
Release Date: September 1/09
July Result: 48.9
TD Forecast: 51.0
Consensus: 50.1
The U.S. manufacturing sector has been hit hard over the course of the recession, though there is evidence to suggest that the siege is beginning to wane. Taking a look at the various regional PMI reports does suggest heightened manufacturing activity within various regions in the U.S. As such, we expect the upward momentum to continue for the eighth consecutive month, which we believe should take the ISM Manufacturing headline index above the 50-threshold for the first time since January 2008. The significance of this is that the production sub-index, which has sat above the 50-threshold for the past two months, should provide further upward support to the headline print. In addition, the new orders sub-index should also move higher, further buoying the headline number. In the coming months, we do expect the ISM headline index to rise further as aggregate demand picks up resulting in a manufacturing sector gradually returning to life.
U.S. Nonfarm Payrolls - August
Release Date: September 4/09
July Result: -247K; unemployment rate 9.4%
TD Forecast: -175K; unemployment rate 9.6%
Consensus: -225K; unemployment rate 9.5%
The improvement in U.S nonfarm payrolls last month is consistent with the secular downward trend in the pace of monthly job destruction. The monthly improvement is largely predicated on improvements coming from various labour market reports, including regional PMI measures and the weekly initial jobless claims data. As such, we are looking for nonfarm payrolls to ease to -175K in August, compared to the -247K drop reported in July, with a likely even split in the goods-producing and service-producing sectors. In terms of the unemployment rate, improving economic conditions and improving sentiment about the future likely enticed job seekers into the market, which should push the unemployment rate up to 9.6% after a temporary dip last month. Going forward, we fully expect further job destruction in the U.S., though not to the extreme depths we saw at the beginning of the year. In addition, while the pace of job destruction may moderate, the unemployment rate is likely to remain fairly elevated, and has not yet peaked.
CANADA: UPCOMING KEY ECONOMIC RELEASES
Canadian Real GDP - Q2/09
Release Date: August 31/09
Q1-09 Result: -5.4% Q/Q
TD Forecast: -3.3% Q/Q; Consensus: -3.0% Q/Q
This Global recession has been a head spinner for Canadian exports which shrank for a seventh consecutive quarter in the second quarter of 2009, with double digit declines for the last three quarters. As such, the bulk of the second quarter contraction came from a deterioration in net trade, which likely detracted 4 percentage points from economic growth. The sharp drop in sales over the last three quarters has left an inventory over hang as businesses couldn't scale back production fast enough to match the drop in demand. The much needed inventory contraction remains a wild card for the second quarter estimate, as it could detract anywhere from 1-3 percentage points from growth in the second quarter. Meanwhile, the domestic economy seems to have turned a corner. Fiscal stimulus spending has appeared to put a floor under nonresidential construction activity which remained flat in the quarter. Moreover, a steaming hot existing home market may have acted as a stimulus for renovation activity in Canada, Analyticswhich helped buoy residential construction in the wake of continued weakness in new homebuilding. Last but not least, consumer spending has been the rainbow after the economic storm, as recent strength in retail sales suggests that consumer spending posted its first gain in two quarters-- albeit a very modest gain.
Canadian Employment - August
Release Date: September 4/09
August Result: -44.5K; unemployment rate 8.6%
TD Forecast: -10.0K, unemployment rate 8.8%
Consensus: -20.0K; unemployment rate 8.8%
Despite the fact that the Canadian economic recession is on its last legs, there continues to be job destruction in the broader economy as businesses consolidate their workforces further to accommodate soft aggregate demand. However, to the degree that the economy has been showing signs of stabilization, we are looking for a modest decline of just 10.0K jobs in August. After the manufacturing sector shed its smallest amount of jobs since June 2008 in July, we expect the Canadian manufacturing sector to continue in this trend, especially as the economy continues to garner positive momentum. Further, the beleaguered accommodation and food services sector should start to moderate, suggesting a softer amount of job losses relative to July. In addition, there should actually be a positive boost coming from the student population, as in all likelihood there were fewer students hired at the beginning of the summer, would translate into fewer firings at the end of the summer, suggesting the seasonal factors should work in the report's favour. In terms of the unemployment rate, job losses continue to materialize while improving economic conditions likely enticed new entrants into the labour force. Taken together, we look for the unemployment rate to rise to 8.8% in August from 8.6% the prior month.
The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.
Equity trading was directionless this week, and US indices ended the week more or less where they began. The Administration confirmed that President Obama would nominate Fed Chairman Ben Bernanke for a second four-year term, a move that was praised from most quarters. Meanwhile, the White House's mid-year budget review trimmed estimates for the FY10 deficit to $1.58 trillion (mostly since money earmarked for bailing out banks is no longer required) but increased the deficit the ten-year deficit projection by $2T. The month-long "cash-for-clunkers" program ended, with 690K vehicles traded in at a cost of $2.9B in Federal funding. Housing data showed further improvement and the Conference Board's Consumer Confidence index rose to 54.1, blowing away estimates. For the week, the DJIA, S&P500, and Nasdaq were each up less than 0.5%.
Economic data out this week offered the strongest evidence yet that housing has turned a corner. The June S&P/CaseShiller Home Price Index rose on a sequential basis for the first time in three years, prompting some to say that housing has bottomed. The S&P/CS composite index showed home prices declined less than expected and improved a bit over May levels (a second consecutive gain) in the 20 leading metropolitan areas in the US; however, prices remain 16% lower than last year. The economists that developed the index, Karl Case and Robert Shiller, gave contrasting interpretations of the data. Case said "the boat has turned" for US housing while Schiller warned that less positive data should reverse this trend soon. The Commerce Department said July New Homes Sales rose nearly 10% sequentially, for their biggest month over month gain since early 2005. Some analysts cited a surge of first-time homebuyers cutting deals as the Federal tax credits for such first-time buyers are scheduled to expire in November. In another sign of housing normalization, the supply of new homes fell to 7.5 months from 8.5 months in June (about 6 months of supply is considered normal and healthy).
Quarterly numbers from homebuilder Toll Brothers also suggest that improvements are being seen in housing. While Toll Brothers lost far more than expected in Q3, the company saw another uptick in new contracts and, for the first time in three years, the number of homes in its backlog grew compared to the prior quarter (reversing a twelve-quarter trend). A wide selection of consumer names offered quarterly reports, although there was no clear trend in the data. Staples was in line with expectations and once again refrained from offering any forward-looking guidance. Burger King Holdings crushed EPS estimates and offered strong guidance for its FY10. High-end retailer Tiffany & Co. exceeded beaten-down expectations by wide margins. Dell gave some more hope to the consumer tech sector with a solid Q2 earnings report that garnered price target increases from several analysts.
The tech sector also got some good news out of Intel this week. The semiconductor maker raised guidance for revenue and gross margins on Friday, sending the stock up 4%. Another Dow component, Boeing, took flight on Thursday after issuing a new delivery schedule for its troubled new 787 Dreamliner jet, with first flight now expected by end of 2009 and first deliveries by Q4 2010. Management's apparent confidence that this would be the final revision of the flight schedule lifted the stock to an 11% gain on the week.
The FDIC reminded investors that the financial sector is a long, long way from normality in two separate moves this week. On Thursday FDIC released its Q2 quarterly report on the banking sector, increasing the number of "troubled" institutions on the list by about 25%, to 416 in Q2 from 305 in Q1. The FDIC fund for insuring deposits has dwindled to about $10B, its lowest level since the S&L crisis in the early 1990s. FDIC Chief Sheila Bair said she expects the number of problem banks and bank failures to remain elevated even as economy begins to recover. Rochdale analyst Dick Bove believes another 150-200 banks are set to fail in the US in the coming months, on top of the 106 banks that have collapsed over the last two years. The day before releasing the Q2 report, the board of the FDIC voted to lower capital ratio standards for investments made by private equity firms in failed banks to 10% from the 15% prior recommendation. The agency hopes to lessen the demands on its resources by allowing a wider pool of private investors to buy up failed banks more quickly.
Treasuries largely rallied in tandem with equities again this week, an anomaly only partially explained away by vacation-induced thin volumes. A larger-than-expected NY Fed coupon pass on Monday set the tone for the week, driving yields lower, a move reinforced by another round of successful 2-, 5- and 7-yr note auctions. The 10-yr note did move back above the psychological 3.50% level following personal income and spending data on Friday, but as equities continue to test their best levels of the year the US benchmark is still some distance below its August and 2009 highs.
Bernanke's reappointment was widely welcomed by a market longing for stability, with the notable exception of Morgan Stanley's Steven Roach, who criticized the Fed chairman for his well documented position on asset price bubbles. In any event, Bernanke is highly unlikely to depart from his existing blend of optimism and caution, nor is the "commitment to keeping rates low for an extended period" mantra likely to be adjusted any time soon. But with the appointment out of the way (pending Senate confirmation), the issue of exit strategies is likely to intensify. Note that within two weeks of a policy statement affirming the Fed "has decided to gradually slow the pace" of treasury purchases, the NY Fed's permanent coupon pass was almost double market expectations. Furthermore, the Fed Governor Lacker raised eyebrows on Thursday with hints that the Fed's $1.25T in agency MBS purchases would be reevaluated, in direct contrast to the official line.
In currencies, another round of improving economic data kept the greenback's price action within the prior week's range but did not managed to alter the dollar's inverse correlation to equity price movements. Official commentary about the sustainability of the recovery remained cautious, with the spotlight on Asia. Chinese PM Wen reiterated his cautious views and stressed that China would keep up its proactive fiscal policy and moderately loose monetary policy, cautioning markets not to be blindly optimistic. In Europe, the IFO data suggested that the German economy is on the mend, but European officials remained cautious regarding the sustainability of any recovery. Overall, EUR/USD held a 1.42 to 1.44 range with chatter indicating an Asian sovereign account had been bidding for euros for month-end commercial purposes at 1.4200. France's Sarkozy warned the euro should not suffer alone in FX adjustments. Meanwhile, Germany could face a wave of corporate restructurings and mass job cuts following next month's elections. Press reports speculated that German executives have deferred job cuts to ensure re-election of a business-friendly government, with an implicit "pact" ahead of the Sept 22nd ballot. Sterling maintained a heavy tone against the major pairs in continued selling associated with dovish BoE policy stance and high level of government and consumer indebtedness. Overall dealers speculating that the UK recovery will lag the Euro and US regions. GBP/USD dipped below the 1.63 handle while GBP/JPY tested below 100-day moving average at 153.33 area.
The dollar apparently decoupled from risk appetite sentiment this week, maintaining a steady tone in the early part of the week. Heaviness in the yen crosses had a negative influence on European-related pairs and indirectly aided the USD. The Yen seemed to be reacting to risk aversion growing out of comments from government officials, especially the comments from China cited above. Dealers also talked about a Japanese press report that an increasing number of firms plan to take advantage of tax exemptions on dividends from overseas units to repatriate funds ahead of the Japanese half-year point in September. The upcoming elections in Japan were also a focus, with numerous issues involved that could impact the yen, including currency reserves and bond strategy. DPJ leader Hatoyama commented that if his party wins the upcoming general election this Sunday (as is expected) it would not raise government bond issuance in the next fiscal year.
Gyrations on the Shanghai Composite have remained the focal point in Asia this week. Although the index is still above its multi-week lows from the prior week, extreme volatility coupled with a final session sell-off on Friday are making investors leery that the bounce from 2,750 low may not last. PBoC adviser Fan Gang attempted to infuse the uncertainty with a tone of optimism, suggesting that the recovery is progressing faster than expected and may build sufficient momentum to keep the economy growing above 8% in 2010. He also suggested that a firmer recovery in exports and corporate investment can replace the impact of the 4 trillion yuan stimulus going forward even as accommodative monetary conditions are removed. Conflicting forecasts from former PBoC member Yu Yongding painted a more dire scenario: Yu emphasized the threat of overcapacity leading to deflation as the direct result of over-stimulated investment in fixed asset infrastructure. Note that the Chinese Cabinet articulated plans later in the week to cap excessive investment in China's industrial sectors, especially in steel, cement and coal.
Markets in the Far East were also weighed down by ongoing tensions with Australia's miners. Early in the week, Rio Tinto noted that it may be looking into a bauxite and alumina cooperation with Chinalco, suggesting that the conflict from failed partnership with the state company may be in the past. However, that speculation was then refuted by Chinalco management, who said that although it remained open to cooperation with miners, no specific agreement was reached with Rio Tinto, and any subsequent offer would be under less favorable conditions than before.
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Sterling faced considerable selling pressure this week as expectations grew that the Bank of England may move to charge banks for reserves held via negative interest rates. A fall in short-term yields weighed heavily on sterling, with EUR/GBP closing the week at £0.8811, a 12 week high. GBP/USD closed the week lower, at $1.6307. Across markets, the USD index was unchanged on the week and the S&P500 could rally only 0.4% despite a plethora of strong economic data. Commodity currencies (Australian dollar, New Zealand dollar and the Norwegian krone) have remained firmly supported as economic data continue to improve globally. As such, these currencies remain close to their years high. US-Japan interest rate spreads moved in Japan’s favour, leaving the Japanese yen supported. USD/JPY closed the week at Y93.50, resulting in the yen being one of the strongest performing G-10 currency this week.
In the emerging markets, the performance of the USD has been mixed. Latin American currencies have underperformed with the Mexican peso and Brazilian real recording the largest losses over the week, falling 3.3% and 2.4% respectively. Much of the weakness in these currencies occurred in the first half of the week, triggered by the selling pressure in both soft and industrial commodities. Eastern European currencies have generally appreciated against the USD this week, with the Icelandic krona gaining the most (2%). The currency rallied aggressively, shortly after the release of an above consensus consumer price inflation report.
In the G-10 space, sterling is heading into month end with another disappointing week. Sterling fell against every single G-10 currency as the effects of the recently increased quantitative easing programme and concerns that the Bank of England may no longer pay interest on bank deposits it holds, continue to reverberate across financial markets. Signs of improvements in the UK housing market - Nationwide house price index rose by 1.6% in August and British Bankers’ Association data, for July, showed a further increase in the number of loans for house purchases – were unable to provide any support for sterling. On the flip side, business investment data showed investment spending fell by 10.4% in Q2, the most since the second quarter 1985, triggered another slide in sterling.
US data have continued to improve, with Case-Shiller house prices, consumer confidence, durable good orders and new home sales all surprising higher. The impact of the positive data on financial markets has been muted this week. The S&P500 rose by only 0.4% whilst the USD index was unchanged. This most likely reflects quiet trading and thin markets with many investors away during the summer. German data also showed an improvement this week. The Ifo business climate survey moved to its highest since September 2008, showing further improvement in August. This bodes well for the German economy which moved out of recession in the last quarter. Consumer price inflation rose by 0.4% in August, above market expectations. EUR/USD managed to garner some support from the data, eventually closing the week at $1.4370.
Interest rate market review - bonds, cash and swaps
UK government bond yields and swap rates posted sharp falls this week, leading 5y swaps to an intraweek low below 3.30% and 2y yields below 0.90%. Speculation that the BoE could impose negative interest rates on commercial bank deposits sparked a flurry of gilt buying and squeezed yields lower across the curve. UK 3-month libor fell below 0.70%, causing the spread over Bank rate to narrow to 19bp, the lowest level since February 2008.
There was no obvious trigger from economic data or central bank speeches to generate the solid display of buying interest in fixed income paper. With economic data, especially from the US, springing positive surprises and the FSTE-100 breaking above key resistance levels, yields stayed surprisingly soft. Yields were mostly guided by technical flows, month-end portfolio extensions and strong US auction participation, though some rotation out of bonds into equities took place on Friday.
UK economic data came in a tad stronger than forecast for the CBI distributive trades survey and the second estimate of Q2 gdp. The CBI survey for expected September sales rose to -14, the highest since July 2008. Consumer confidence held unchanged in August at -25 and Q2 gdp was revised up to -0.7% q/q, despite a sharp 10.4% contraction in business investment. Household consumption fell 0.7% and inventories dropped by a further £4.5bn. Government spending rose 0.8% and net trade improved due to a sharp fall in imports. The annual gdp deflator accelerated to 1.3% y/y from 1.0%, leaving a still very benign inflation backdrop.
A fall in UK wage inflation data for the May-July period was reported by the Income Data Services and helped to lower yields. A fall in 5y swaps below the 200-day moving average of 3.30% sparked a move to 3.27%, but rates bounced back on Friday to a close of 3.34%. This completes a near 50bps decline from the June top. A 3bp drop in UK 3-month libor caused the yield curve to flatten to 263bp. A fall in 10y swap spreads to 34bp, a near 4-week low, underscores the stronger appetite for riskier assets.
The US Treasury auctioned $109bn in 2y, 5y and 7y notes this week and managed to attract solid overseas demand, despite the fall in yields and rise in Treasury prices in recent weeks. This may have calmed market fears about a surge in government paper issuance in a week where the US Congressional Budget Office (CBO) revised up its public deficit forecast for 2009 to $1.6 trillion or 11.2% of gdp, the highest since World War 2. The CBO calculates that the total deficit could reach $7.4 trillion over the next decade. Yields also managed to shrug of stronger than expected reports of US August consumer confidence, July durable goods orders and house prices and new home sales. US house prices have now risen for the last two months and rising home sales have boosted hopes that supply will soon fall from still elevated levels. US 10y yields spent most of the week below 3.50% and closed 9bp lower on Friday at 3.44%. US 3-month libor fell to 0.35%, dropping below the Japanese libor rate. 5y swaps fell 13bp to 2.82%.
Stronger than expected German CPI data and a 5th successive rise inthe German IFO survey in August were equally unable to lift yields in the euro zone. The ECB is likely to revise up its 2010 gdp forecast next week but is not expected to change its bias on interest rates. EU-16 consumer and indutry confidence also improved, but the long end of the bund curve rallied on the report of a new record low in euro zone consumer price expectations. In contrast to the UK and the US, the 2y/10y bund curve steepened, led by the front-end. 5y swaps dropped 6bps to 2.78% and 3-month euro libor slipped to 0.80%.
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There is growing evidence that the H2 rebound in global growth could be quite robust. We are starting to see upside risk to our current (above-consensus) global growth forecast.
The corporate sector is leading the recovery. Revisions of US and German GDP data point to an even sharper inventory cycle, and a record strong rise in ifo expectations point to strong momentum in the German recovery.
Capital goods orders are starting to turn globally as also witnessed by a sharp rise in US durable goods orders.
Finally global housing indicators are improving fast with increases in both prices and sales.
Market movers ahead
We are heading for the big week in terms of data. US ISM and non-farm payrolls will provide important news on the pace of recovery. We look for a further rise in ISM but could see slight disappointment in payrolls.
In Euroland the ECB meeting will be the main event. We don't expect any changes to policy measures but a slight upward revision to their growth forecasts is on the cards.
It looks like a landslide victory for DPJ in the Japanese election. Chinese PMI data and Japanese industrial production should show continued strength.
Danish Currency reserve data should show a further strong inflow in August.
The Riksbank meeting will be main event in Sweden. We don't think the Riksbank will be as hawkish as the market expects.
Global update: Growing stronger
Global growth back above trend already in H2
The global recovery is currently getting stronger for each day passing. Over the past week the positive flow of data from the global economy has continued. The takeaway from the recent data is not only that most major countries are by now are out of recession, they are also seeing quite strong growth rates. Indeed there are now convincing signs that global economy will be returning to above trend growth during H2.
Signs of life in capex
The corporate sector continues to lead the recovery in an effort to close the huge gap between production and demand that opened up during the crisis. Indeed the case for a strong rebound in production during H2 was underpinned further by the revised Q2 national account data out of the US and Germany. The details pointed to even more inventory depletion than initially estimated and in the US demand growth was revised higher.
This suggests than the production backlog is even larger than we thought. Indeed this is the story behind the continued rise in global manufacturing indicators. In August the German Ifo posted one of its biggest monthly gains, reaching levels that point to solid expansion in the coming three to six months (see Flash Comment – Euroland: Ifo moves at super speed). In Japan the industry continues to recover. Japanese PMI headed higher into expansionary territory and Japanese exports rose further.
The sharp turnaround in industrial production already seems to be rubbing off at capital expenditures (capex), which was hit by the same negative factor as the rest of the economy. Now these strains are easing and with production being ramped up fast, an early recoil in capex seems increasingly evident. In fact the orders data released for Euroland and the US this week suggest that the businesses have already started to expand equipment spending. This is important as an early cyclical recovery in capex could make it up for some of the missing strength in consumer spending.
A turn in the housing market
In the housing market the signs of a turnaround are also piling up. The turnover of new and existing homes in the US continued up in July making it increasingly evident that residential construction need to be ramped up to meeting demand for new homes.
Also the price indices continues to send positive signs. In the UK nationwide prices are up about 6% since February and in the US prices have now stabilised by all the different measures. Some price indices have even begun to move higher. If the UK is any guide, home prices in the US could turn positive in the coming months, although we believe this is more likely to come next year. Nevertheless, the strong headwinds from the housing market on the US economy is now subsiding and will turn into a modest tailwind over the coming quarters (see Research US: Gauging the potential from a turn in housing)
US consumers less depressed – perhaps due to clunkers
Importantly, the US consumer confidence index resumed its ascendency in August following a couple of setbacks in recent months. Whether it is a temporary effect from the cash-for-clunkers incentive programme, or a return to the original trend of improvement is still difficult to tell. Despite massive stimulus the US consumer spending so far only managed to stabilise when excluding cars. Our hope is that the strong recovery in the corporate sector will stabilise the labour market by year-end, which should provide a much needed boost to confidence and spending by then.
Market movers ahead
Global
In the US positive news from the local business surveys suggests that another increase in the manufacturing ISM is on the cards for August. We see a risk that Friday's payrolls report could disappoint slightly. That said the trend will continue to be for a stabilisation in labour markets. Pending home sales for July will provide the freshest clue about the development in US housing markets. A continued rise would underpin the case for a turnaround in existing home sales. Finally, unit car sales will be in focus, as it will be interesting to see how much the cash-for-clunkers scheme has boosted August sales. Beside these key data events the FOMC minutes from the 12 August meeting will be important to follow.
The main event in Euroland will be the ECB meeting. It seems unlikely that ECB will make any changes to the policy stance, but an upward revision to its growth forecast seems inevitable. It will most likely be moderate though, for now as ECB has signalled a very cautious view on the recovery. German unemployment is also released but it is distorted at the moment by job sharing schemes and hence it is hard to interpret the underlying development in the labour market from these numbers.
In Asia focus will mainly be on the Lower House election in Japan on Sunday. It increasingly looks like a landslide victory for the opposition DPJ and the ruling LDP will be kicked out of power for only the second time since the end of the Second World War. Japan releases July industrial production, where we will pay attention to production plans for August and September to get an idea if the current strong growth can be maintained. In China NBS and CLSA manufacturing PMI released on Tuesday is expected to show continued improvement.
Scandi
In Denmark the currency reserve is expected to show a further increase.
The one event of any importance in Sweden the upcoming week is the Riksbank policy meeting. Obviously there will be no change of the rate, but the Riksbank might revise its rate forecast path. Although it is possible, we deem it unlikely that any change will be as hawkish as the market's expectation. PMI will also be released and should give further clues to the strength of the recovery.
In Norway focus turns to retail sales. We expect a sharp rise of 4.2% m/m. Shopping malls have reported very strong sales in July. The credit indicator and PMI will also be released.
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ECB Council likely to confirm expansive monetary policy stance
EUR-USD has remained within the trading range of the last few weeks, albeit mostly at the top end due to firm equity markets and upbeat economic data from the eurozone. At the end of the week, the euro is trading at around 1.4350 - slightly less than at the end of last week. The dollar has weakened somewhat against the yen too. Towards the close of the week, USD-JPY is just under 94.
The publication of the German GDP components has confirmed that economic activity picked up slightly in the second quarter. The ifo business climate has improved in August for the fifth month in a row. The EU Commission's economic sentiment indicator also shows a significant recovery in business confidence. The index rose from 76.0 to 80.6. Thus there appears to be little risk of an economic setback in the eurozone in Q3.
Data from the US were also positive for the most part. Consumer confidence rose sharply from 47.4 to 54.1, which is particularly striking, in our view. Expectations for the future are much more positive, and the assessment of the current situation, particularly in the labour market, is not seen as quite as gloomy as in July. Furthermore, new and existing home sales picked up again substantially. Durable goods orders, however, did not increase quite as much as hoped after the 4.9% increase the previous month. Volatile aircraft orders were the main reason for the sharp rise. Nevertheless, the figures indicate that investment in machinery and equipment could increase somewhat again in Q3 for the first time in six quarters.
The pound incurred larger losses. During the course of the week, EUR-GBP rose 1.7% to around 0.88. Disappointing growth in Q2 and the Bank of England's guarded assessment of the current situation evidently had an impact. Given the comparatively positive signals from the eurozone, concern is mounting in the UK that the economic recovery could turn out to be weaker there than on the Continent.
ECB Council: No change in monetary policy
Developments in the bond markets were not in line with the economic data and the strengthening euro. Despite the positive economic signals, short-term interest rates have fallen in the euro area. In the course of the past week, the yield on two-year Bunds has dropped 10 basis points to 1.27%. Largely as a result of this, the eurozone's interest rate advantage over the US has shrunk. Yields on two-year Bunds are now only 20 basis points higher than on equivalent US Treasuries. In the last few weeks, the difference had been about 30 basis points.
The fact that bond markets in the euro area have shown strength is likely to be connected to the upcoming meeting of the ECB Council. Leading central bankers have warned of too much growth optimism. The central bank did revise its growth forecast for 2009/10 slightly upwards last month, but it nevertheless expects the road to recovery to be bumpy. The ECB report on the stability of the EU banking system, published this Friday, emphasized that credit defaults are threatening to put pressure on banks and underlined the risk of negative feedback between the real economy and the financial system.
Thus the ECB made it quite clear that it is not planning to change its monetary policy in the foreseeable future - even if the new ECB staff projections turn out to be somewhat less unfavourable than in June. The market's expectation of a continuation of the current monetary policy in combination with the ample liquidity in the money market is putting pressure on interest rates, especially at the short end.
However, the flattening at the short end of the curve has gone very far. In our opinion there is a certain risk of profit taking in connection with the ECB Council meeting or the US labour market report, or the ISM survey results.
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German ZEW economic sentiment (August): set to rebound
PMI manufacturing indices Germany and EMU (August): up
The German ZEW economic sentiment is likely to have rebounded in August. The ifo business expectations and the US ISM manufacturing index have both improved. German yield spreads have widened somewhat, because long-term interest rates have increased slightly while short-term rates have decreased. The DAX has rallied too. However, the euro has appreciated and crude oil prices have gone up. The Purchasing Managers' Indices for the German and EMU manufacturing sector will probably have picked up further in August.
Following their usual seasonal pattern, the EMU trade balance and current account are expected to have improved in June, just like the corresponding German figures.
This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK Group") solely for the information of its clients.
The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results.
This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities.
Risky assets may come under increasing pressure, but...
That's what we've been waiting for
BoE minutes due Aug 19, not much room for surprises
German and France grow in Q2 but PMI still showing contraction
Key data and events to watch next week
Risky assets may come under increasing pressure, but...
The USD finished out this past week virtually unchanged from week-ago levels against most other currencies, excluding the JPY. To be sure, there was healthy intra-week volatility in most USD pairs, but the key take-away is probably that the USD rebound following last Friday's July NFP report was largely sustained, adding further weight to the idea that the USD has made a significant medium-term low. The other prominent result of the week is a more decisive turn lower in many of the so-called risky assets. USD/JPY most clearly surrendered all of its post NFP gains and continues to trade in near lock-step with US Treasury yields, which also gave back the bulk of their gains from last week. With the USD unchanged against most others, but down sharply against the JPY, the carry trades (JPY-crosses) have posted bearish engulfing patterns on the weekly candlestick charts, which typically warns of further losses ahead. Outside of FX, stocks continue to stall below key Fibonacci resistance at 1015/1020 in the S&P 500, while oil also looks to have more decisively given up on attempts to extend gains beyond the year's highs around $73.00/50. The recent strength in gold prices also looks to be losing steam after having topped out below key technical resistance in the $975/980/oz area. Overall, though, FX and many other assets remains trapped in recent ranges.
Some of the pullback in risk appetites is certainly due to exhaustion, with recent gains unable to extend without a more compelling case of an imminent rebound in economic activity. Increasingly, the view is spreading that all the good news is priced in, and as we've been suggesting over the past few weeks, valuations are getting rich. Faltering economic data, particularly on the consumer front (weaker retail sales, uptick in 4-week avg. of initial claims, and the drop in Univ. of Michigan Aug. sentiment), don't help the case for fresh near-term gains. On balance, the risks appear increasingly tilted toward a period of profit-taking, potentially leading toward a more serious set-back for risky assets. In FX, we think the USD has room to extend gains against all except the JPY, which will likely remain captive to fluctuations in Treasury yields. There, we continue to anticipate that yields will not see much lower than 3.40/45% in 10 year notes, and that suggests USD/JPY is unlikely to see much lower than about 93/94. In anticipation of higher rates in the months ahead, we continue to look for opportunities to buy USD/JPY on weakness in the 92/95 area. In other USD pairs, the USD is still trading in the lower half of recent ranges, and we think there is near-term potential for the buck to trade into the upper half of those ranges. That suggests potential for EUR/USD to drop under 1.40 and see to 1.37; GBP/USD under 1.65 toward 1.60; AUD/USD below 0.82 toward 0.78; and USD/CAD above 1.11 toward 1.15. S&P 500 below 970/980 would be the likely coincident catalyst for such a shift higher in the USD.
That's what we've been waiting for
Perhaps ironically, the seemingly impending risk relapse would come just as developments on the ground are about to get appreciably better. The risk here is that we underestimate the degree to which good news is already priced in, and therefore we might also underestimate the extent of the potential pullback. But for most of the summer we have been suggesting that the massive run-up in risk assets (stock, commodities, and JPY-crosses) was premature, and, as it wore on, increasingly overextended. We have consistently been expecting a more substantial improvement in economic activity in the late 3Q/early 4Q and were hopeful we might have a correction lower in risk assets before then to establish long positions at more advantageous levels. Unfortunately, markets have not cooperated with our view and the window of opportunity for a pullback is increasingly narrow. It may be that markets are indeed lagging, responding only now to faltering early 3Q data, and may relapse in time to get long risk before improving late 3Q/early 4Q data begins to hit, most likely initially only in late Sept./early October. From a longer-term strategic perspective, we will look to exploit such pullbacks to build long risk positions in anticipation of more sustainable economic improvement into the end of the year, which may only materialize in data reports in late Sept./early October at the earliest.
BoE minutes due Aug 19, not much room for surprises
The presentation of the Quarterly Inflation Report on Aug 12 has sapped the potential for surprises from the minutes of the BoE policy meeting. BoE Governor King has already made clear the Bank's view that the pace of the recovery remains highly uncertain with inflation more likely to be below the Bank's 2% target over the medium-term rather than above it. On this view of inflation, there would appear little chance of any adjustment in interest rates for many months to come. The release of July CPI on August 18 is expected to show a -0.3% m/m fall bring the headline rate to 1.5% y/y, this would be only the second consecutive month where inflation has been below target. Nevertheless, data in line with expectations would be in line with the Bank's prediction that prices pressures will fall significantly in the coming months. Rightmove housing market data and retail sales will be barometers of the general health of the economy and may show further signs of stabilization. By contrast, the July PSNCR data will give a reading on the poor condition of government finances in July. The latter is likely to sour the ability of sterling to benefit from an improvement on consumer related data.
German and France grow in Q2 but PMI still showing contraction
The EUR has benefitted from the news that both Germany and France managed to grow during Q2. The news is likely to heighten interest in forthcoming PMI data which to date have remained below the key 50 level for both manufacturing and services sectors in Germany, France and the Eurozone. Further improvement will be needed to sustain hopes for continued recovery in the latter half of the year. Also due is the German ZEW survey which can be expected to show an improvement on the recent better German economic data and following the recent rallies in stock indices. Eurozone trade data is unlikely to impact the market but signs of improving export performance could strengthen recovery hopes and the EUR. Barring a negative shock in the PMI, the EUR is likely to remain better bid. Given the contrasting performance of Q2 GDP data for the UK and Eurozone and barring any negative surprise from the Eurozone PMIs, EUR/GBP should maintain an upward bias near-term. Expect resistance in the 0.8680/90. A break above could see gains extend.
Key data and events to watch next week
It's a relatively light summer data week all around next week.
US data starts off on Monday with the NY Fed's Aug. Empire manufacturing index and the June TIC report in the morning followed by the Aug. NAHB housing market index in the afternoon. Tuesday sees July PPI and housing starts/building permits. Only weekly mortgage applications are out on Wednesday. Thursday sees weekly jobless claims, July leading indicators and the Aug. Philadelphia Fed index. Friday wraps up with July existing home sales.
Eurozone data begins with the EZ June trade balance due out on Monday. Tuesday sees the Aug. German and EZ ZEW sentiment surveys. Wednesday sees July German PPI and June EZ current account and construction output. Thursday has only Belgian Aug. consumer confidence of note. Friday concludes with Aug. preliminary EC PMI's for the manufacturing and service sectors in France, Germany, and the EZ as a whole.
UK data begins with Aug. Rightmove house prices at midnight Sunday local UK time. Tuesday sees July CPI/RPI reports. Wednesday has the release of the BOE MPC minutes and Aug. CBI industrial trends total orders. Thursday ends the UK data week with July retail sales and the July Public Sector Net Borrowing Requirement.
Japanese 2Q GDP data may be the highlight for the week on Monday morning in Tokyo. Tuesday afternoon sees the final June Leading index and July Dept. store sales. Wednesday will see the June All-Industry Activity Index and final July machine tool orders.
Canadian data starts on Tuesday with June international securities transactions data, followed by July CPI and leading indicators reports on Wednesday, and wraps up with June wholesale sales on Thursday.
Australian economic releases include the RBA minutes on Tuesday afternoon, followed by a speech from RBA Asst. Gov. Edey on Wednesday morning, and the June Westpac leading index that afternoon. NZ data starts with the July Performance of Services Index on Monday morning, 2Q Producer Prices on Wednesday morning and July Credit card spending on Friday.
Brian Dolan, Chief Currency Strategist
Jacob Oubina, Currency Strategist
Forex.com
http://www.forex.com
DISCLAIMER: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
