The deleveraging process continues and since credit has started to contract, we expect money holdings to follow that downward trend. Moreover, historically low short-term interest rates reduce the attractiveness of term deposits and other marketable instruments. We expect M3 growth to have fallen to 3.0% in June, down from 3.7%. The growth of loans to the private non-bank sector could have declined from 1.8% to 1.2% yoy in June.
The preliminary results for national German CPI for July are due to be released on Wednesday at the latest. We expect German consumer prices to have gone up by 0.3 % mom; the annual rate would then decrease into negative territory to -0.2 %. The monthly inflation will have been due mainly to significant price increases for package tours and accommodation services because of the summer holidays. On the other hand, price decreases for gasoline and heating oil are likely to have dampened inflation by about 0.2 percentage points. Clothing has probably had a dampening effect as well and food prices could have fallen again. Decreasing gas prices and increasing electricity prices could have more or less cancelled each other out. Year-on-year inflation is expected to stay in negative territory for some months.
The Eurostat flash estimate is likely to show that euro area inflation has become even more negative in July: We expect a rate of -0.4 % yoy. This would correspond with a monthly decrease in HICP of -0.4 % in unadjusted terms. Inflation rates yoy could remain negative until autumn this year, mainly due to energy price related base effects. But weak aggregate demand is having a dampening effect on consumer prices as well.
Due to the severity of the current recession, the increases in adjusted German unemployment are likely to have accelerated in July. Nevertheless, the extensive use of short-time work schemes and statistical changes are still dampening the upward trend.
The German GfK consumer confidence for August as well as the Italian business and consumer confidence and the EMU economic sentiment and industrial confidence in July probably have continued improving, just like the other national climate indicators.
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GBP softens, BoE QE risk sees some revival on weak data
Key data and events to watch next week
Stock markets continued to outpace gains in other risky assets, with shares breaking to new highs for the year on the back of a series of better-than-expected 2Q earnings reports. We are extremely skeptical of the sustainability of the current rally in stocks, based on both the fundamental outlook (see below) and the lack of confirmation seen in other risk asset markets. Among key markets failing to make new highs for the year, the CRB commodity index, oil, 10 year US Treasury yields, gold, and the Baltic Dry Index (a proxy for commodity demand) are all well below their highs for the year, and in most cases still below their most recent highs seen at the end of June. In FX, the USD approached lows for the year against most other currencies ex-JPY, but has failed to break down as stocks broke higher. Carry trades (e.g. long EUR/JPY, GBP/JPY, AUD/JPY, etc.), while following stocks higher over the last two weeks, have similarly failed to surpass their most recent highs from the end of June, much less their highs for the year.
Importantly, the lack of inter-market confirmation so far of the fresh highs in stocks is no guarantee that stocks will falter or that those other key asset markets will not play catch-up and move higher in the weeks ahead. But given the still weak fundamental outlook, it does suggest exercising extreme caution in regard to chasing stock market gains in other risky asset classes. Overall, however, given that it's stocks that are likely exceeding fundamentals based on 2Q earnings, we're more inclined to fade further gains in FX risky trades, selling JPY-crosses on strength and buying USD on weakness. There are still a few weeks left of earning reports yet to be delivered and the positive sentiment could run still further, so we won't hang on to counter-trend positions (short JPY-crosses/long USD) beyond the extremes seen at the end of June/start of July. But after the end of earnings data, what's left to drive stocks higher? Rising unemployment? Stagnating consumer demand? Incoming data will continue to drive short-term sentiment and we will remain alert for clearer technical signals of a more pronounced reversal to the downside. Of particular note in the JPY-crosses, a number of pairs have closed above the top of their Ichimoku clouds (EUR/JPY 134.22; GBP/JPY 155.80; AUD/JPY 76.66; NZD/JPY 60.45; CAD/JPY 85.67), which is generally a bullish signal. However, the lack of follow-through gains is troubling and potentially sets up a failure and subsequent drop back inside the cloud, which is typically a very bearish scenario. (GBP/JPY already looks set to finish out the week back inside its cloud.)
China-US talks to put USD back under scrutiny
Monday next week will see Chinese and US officials sit down for the latest round of the Strategic Economic Dialogue (SED) talks started under Tsy. Sec. Paulson. In recent months, Chinese officials have openly fretted over the value of the USD and its impact on the value of their vast FX reserves and US Treasury holdings. More recently, though, Chinese comments have become more USD supportive and we expect that tone to prevail at next week's meeting. The Chinese belatedly realized that questioning the reserve status of the USD is counter-productive to their asset holdings and they have even acknowledged that there are no alternatives to the USD as the global reserve currency in the foreseeable future. From the US side, Treasury Sec. Geithner will need to be seen to be doing the utmost to support the greenback, and we expect to hear the strong dollar mantra chanted yet again. Elsewhere, finance officials in Japan, Australia, Canada, and New Zealand have all voiced concern over excessive strength in their own currencies, suggesting there is a broad consensus that the USD should not weaken significantly further. Positive comments from Chinese officials on the USD or an additional public commitment to keep buying US Treasuries could see the dollar bottom out and begin to turn higher.
Risk rally really long in the tooth
Talk about irrational exuberance! The S&P 500 rallied 13% from the July lows, which coincidently were hit the day 2Q earnings season began on Jul 8. Now, earnings have beaten estimates broadly with about 75% of companies reported thus far posting a positive surprise and earnings coming in about 11% better than estimates. That said, the better bottom-line numbers are on the back of massive cost-cutting measure mainly at the expense of jobs - the unemployment rate isn't at 9.5% by accident. If one looks at what sales have done, they've actually come in about in line with the low-ball expectations.
Considering the state of the US consumer and the de-leveraging still needed before we get back to sustainable debt levels, driving that sales figure will become more and more challenging going forward. The consumer currently holds about 23% of annual disposable personal income in non-real estate debt and we think this number needs to creep closer to 18% to be sustainable. All else equal, this means an additional $525 billion in debt reduction, which will likely come at the expense of retail sales. The just released University of Michigan consumer sentiment index posted its first decline since February and the expectations component remained depressed. If the first half of 2009 is any indication, the consumer has clearly moved to a higher savings, lower debt and lower spending state of mind. While this is good in terms of building a better economic foundation for the future, corporate earnings will bear the brunt of this shift in behavior.
From a valuation standpoint, the rally looks extremely long in the tooth. The forward price-to-earnings ratio on the S&P 500, at just above 15 times, is the highest since October of last year. Historically the P/E ratio has been about 16.4 on average when we exclude the credit boom - an environment we will likely not revisit to anytime soon. If investors were to pay up for the next twelve month earnings at that rate, the S&P would trade at about 1072. The current economic landscape, however, is far from normal. Credit conditions remain extremely tight, the US consumer is in retrenchment mode and the employment situation is getting worse by the month. Not to mention another headwind from rising oil prices, which when translated to price increase at the pump will mean even less discretionary income. Throughout the last decade, every penny change in gasoline prices has had about a $1.2 billion impact on annual household balance sheets - not trivial when you consider we likely have another 25 cents of upside from last week's $2.50 pump price.
For anyone looking for solace in the so-called improved initial jobless claims numbers, we would just say that the recent weeks were skewed by seasonal adjustment difficulties surrounding the earlier than anticipated auto plant shutdowns in June. The potential for a snap back above 600K as the adjustment process normalizes is very real. And even if the shift in the reported numbers is for real, many continuing claims are merely shifting to extended federal programs that currently total a very non-trivial three million people.
So what does all of this mean for currencies? If past is prescient, we could very well be seeing some short-term tops in what have been deemed the risk trades. While it is true that the market can remain irrational longer than one can stay solvent, the sustainability of the recent gains is suspect. Despite stocks making fresh 2009 highs, EUR/USD has failed to take out its 1.4338 June highs. This level remains the upside risk for now, but the path of least resistance looks to be lower at this point. Should the risk rally reverse, the S&P could be at the 930 pivot in the blink of an eye. This would put EUR/USD closer to the 1.40/1.39 area. The squeeze would also have significant implications for the commodity complex, which has rallied nearly 9% from the July lows. This would help USD/CAD solidify support near the 1.08 area - where the Bank of Canada initially announced concern over CAD strength - and potentially elicit a move back towards the 1.11 zone. AUD/USD would also be vulnerable for a move back to 50-day sma support, which currently lurks at 0.7970. The clear winners become the USD and JPY, and so we would expect the price action in USD/JPY under this scenario to be limited.
GBP softens, BoE QE risk sees some revival on weak data
The discussion as to whether or not the Bank of England will announce an extension of its asset buying plan will undoubtedly get further airplay over the coming week. The minutes of the July MPC and comments from the BoE's Sentance have lowered the odds of further QE. Sentance noted that the Bank may pause if it were justified by forecasts while the minutes show that Bank in July saw not enough evidence to support an increase in QE. However, the release last week of the much worse than expected 0.8% q/q contraction in Q2 GDP will keep some speculation of further stimulation at the Aug 6 BoE policy meeting alive. While the GDP data show an improvement from the -2.4% q/q decline registered in Q1, the disappointing numbers illustrate that the economy is finding it tougher than expected to shake off the recession. These poor data put the upcoming release of the Bank's June lending data in the spotlight. May data highlighted continuing weakness in lending to individuals and in net lending secured on dwellings suggesting that QE had not then had a significant impact. June data due on Wednesday are expected to show moderate improvement.
In contrast to Friday's poor UK GDP data, German data brought an improvement in the Jul IFO to 87.3 (from 85.9 in Jun) and a rise in both its manufacturing and services PMIs. The contrast between the data was mirrored in the squeeze higher in EUR/GBP though sterling weakness was also evident vs. the USD and other crosses. In view of the sharp increase in the UK budget deficit (to 13.9% of GDP in 2009 using EIU forecasts), and concerns over fiscal restraint (reflected in warnings in recent months from the IMF and S&P) sterling is vulnerable. While EUR/GBP is still within a bear flag consolidation (suggesting that sterling's uptrend may not yet be over), it has broken up inside the cloud, on daily and weekly views which weakens the GBP outlook. Sterling will find support if the BoE steer away from QE on Aug 6. However, weak economic data in the week ahead could undermine the pound. A move above EUR/GBP0.8700 could trigger the start of a new weaker phase for the pound.
Key data and events to watch next week
The US data calendar is relatively busy and kicks off with new home sales on Monday. The Case-Shiller home price index and consumer confidence reports are up Tuesday while Wednesday brings the all-important durable goods report and the Fed Beige Book. Thursday sees the usual weekly initial jobless claims. Friday rounds out the week with the first cut of 2Q GDP and the Chicago purchasing managers index. The earnings season remains hot in the week ahead as well with about 150 S&P 500 companies slated to report.
It is a pretty typical week in the eurozone. Monday starts things off with French jobseekers data, German import prices and the German GfK consumer confidence survey. The highlight on Wednesday is the release of the ECB's bank lending survey and we also see French producer prices and German consumer prices that day. Thursday has the eurozone business climate survey, eurozone consumer confidence and German employment lined up. Friday has eurozone consumer prices and eurozone employment.
The UK calendar is on the light side. The Hometrack housing survey starts things off early on Sunday. Wednesday has net consumer credit and mortgage approvals on tap while Thursday ends the week with the GfK consumer confidence survey.
Japan's week is just modestly busy. Retail trade kicks things off on Tuesday while small business confidence and industrial production are due Wednesday. The highlight on Thursday is the employment report and we also have household spending and consumer prices slated for that day. Friday rounds things out with housing starts.
Canada sees an extremely slow week and industrial product prices on Thursday and GDP on Friday are the only noteworthy events.
The calendar down under is on busy side. New Zealand trade numbers kick it off on Monday and this will be followed by New Zealand building permits, Australian leading index and Australian business confidence on Tuesday. Wednesday sees New Zealand business confidence and the RBNZ interest rate decision. Australian building approvals are due up Thursday while Australian private sector credit rounds out the week 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.
Earnings continue to come in at or above expectations, with cost cutting producing more than enough savings to offset declining revenues. The better than expected earning news helped send the Dow above 9,000 on Thursday.
More folks are also buying into the notion that the recession is ending. The Leading Economic Index rose 0.7 percent in June, marking the third consecutive increase.
Existing home sales rose 3.6 percent in June, marking the third consecutive increase. Prices rose slightly and the months' supply of home on the market declined for the second straight month.
Slow But Steady Progress Is a Good Thing
Second quarter earnings announcements overshadowed this past week's relatively light schedule of economic reports. Earnings have generally beaten expectations, with cost cutting more than offsetting disappointing news on revenues. The emphasis on cost cutting is evident in the economic data but may be easing a bit. Layoffs have clearly slowed, as evidenced by the declines in both weekly first-time unemployment claims and continuing claims for unemployment insurance. In addition, mass layoff announcements tracked by the Bureau of Labor Statistics also show some tentative signs of topping out. While layoffs may have peaked, hiring shows no sign of picking up. We do not expect businesses to boost hiring until they see some evidence sales are growing again and order backlogs are rising.
One unambiguously positive bit of economic news this week was the 0.7 percent rise in the Leading Economic Index. The increase marks the third consecutive significant gain for LEI, which in the past has tended to signal a turn in the business cycle. The ratio of the coincident to lagging indicators, which is an alternative measure of business cycle turning points, also rose solidly in June, climbing 0.4 percent. The coincident to lagging index has risen 1.3 percentage points since bottoming in March. The breadth of the increase in the LEI adds credence to the notion that we are at a turning point in the business cycle. Seven of the ten leading economic indicators improved during each of the past three months.
Another clear, positive sign the economy is on the mend is the continued flow of better news on the housing sector. Sales of existing homes rose 3.6 percent in June to a 4.89 million unit pace, marking the third consecutive monthly increase. The National Association of Realtors reported that the foreclosures and short sales accounted for only 31 percent of sales in June, which may explain the improvement in average and median home prices. The supply of homes on the market declined slightly, falling to 9.4 months. While good news on the housing market is clearly welcome, there are concerns that a considerable backlog of foreclosed properties and homes likely headed for foreclosure will hit the market later this year and in 2010.
The federal minimum wage rose to $7.25 per hour today, marking the third installment of a 70 cents per hour increase enacted back in 2007. The increase in the minimum wage comes at a difficult time for many businesses, which have seen sales slump and orders decline. Businesses are much more focused on cost cutting right now rather than expanding operations or adding staff. This is particularly true of restaurants and retailers, where the vast majority of minimum wage workers are employed. The Bureau of Labor Statistics notes that roughly 2.5 percent of workers paid hourly earn the minimum wage or less. Among those earning the minimum wage, most tend to be young, with about half the workers below age 25 and about one-quarter being teenagers. Coincidently, the teenage unemployment rate has skyrocketed since the first phase of the most recent hike in the minimum wage took effect two years ago.
U.S. Outlook
Consumer Confidence • Tuesday
The Consumer Confidence Index fell 5.5 points to 49.3 in June after jumping nearly 14 points in both April and May. April and May's gains were due in large part to the expectations series which rose around 40 points in the two month period and was likely bolstered by "green shoot" sightings. Consumers likely removed their rose-colored glasses in June, with the labor market still under considerable stress and the unemployment rate reaching 9.5 percent. We expect the consumer confidence index fell for the second consecutive month in July to 47.8. The labor market has shed roughly 6.4 million jobs since the recession began and while layoffs have subsided, hiring has not picked up. We expect the unemployment rate will likely rise upwards of 10 percent in early to mid 2010.
Previous: 49.3 Wells Fargo: 47.8
Consensus: 48.7
Durable Goods • Wednesday
New orders for durable goods posted two consecutive increases of 1.8 percent in April and May with transportation and defense responsible for most of the gain. Recent declines in industrial production, the new orders component of the ISM manufacturing survey and manufacturing capacity utilization suggest the gains will be reversed in June. Driven by slowing business and consumer demand, orders for durable goods will likely fall 1.3 percent in June. Domestic demand in particular is being restrained by continued job losses, sluggish wage and salary growth and a massive loss of wealth. Nondefense capital goods shipments did not fall anywhere near as much as they did during the first quarter, which means business fixed investment fell at a less dramatic pace during the second quarter. It still dropped, however, and probably at a hefty double-digit pace.
Previous: 1.8% Wells Fargo: -1.3%
Consensus: 0.5%
GDP • Friday
Real GDP in the second quarter likely posted its fourth consecutive decline, but the pace of the decline is slowing. We expect real GDP likely fell at a 1.6 percent annual rate in the second quarter with the bulk of declines due to a continued drawdown in real inventories. Our forecast for the second quarter calls for inventories to drop by around $100 billion, which would subtract around 0.4 percentage points from second quarter real GDP. While personal consumption, business fixed investment and residential construction will likely also post declines, the pace of declines has slowed significantly suggesting the worst of the recession is behind us. With inventories at historic lows, production is now set to ramp up in the third quarter which should help to push GDP into positive territory. The economy may expand during the third quarter, but consumer demand is not improving.
Stronger data came out of Asia and North America this week. Large and frontloaded fiscal packages are a major factor here, as is the fact that the severe production cuts we saw in Q4 of last year are just not sustainable longer term. The inevitable bounce eventually ensues.
European data also surprised on the upside. Eurozone manufacturing and service PMIs for July both came in well above expectations, bolstering the case that the global recession is easing. Adding to the euphoria, U.K. retail sales surged in June and French business confidence strengthened again in July.
The Great Melt-Up?
The firmer tone in economic activity continued to build across the globe. We saw notably stronger economic data in Asia, North America and Europe this week. South Korea reported GDP in the second quarter jumped 2.3 percent. At a seasonally-adjusted annual rate, as GDP is often reported in the U.S., the increase becomes 9.7 percent, in line with the Bank of Korea's estimate at the beginning of the month. The GDP increase was broadbased, with private consumption clearly responding to stimulus measures, rising 3.3 percent quarter-over-quarter. Gross fixed investment jumped 2.9 percent and exports of goods and services expanded at an 11.2 percent pace.
In North America, Canadian retail sales for May surged 1.2 percent on the month, twice the consensus estimate prior to the release. This followed an upwardly revised decline in April of 0.6 percent. Auto sales paved the way with a healthy 2.4 percent gain, but seven of eight retail categories also registered sales increases on the month. Building and outdoor home supply store sales rose 1.0 percent on the month and have risen now for two consecutive months.
Even the United Kingdom reported stronger retail sales. June retail sales jumped 1.2 percent month-over-month compared to consensus expectations of a modest 0.4 percent gain. Retail sales in the United Kingdom have hardly lost a step in this recession so far. Year-on-year retail sales are up 2.9 percent. Analysts attributed the gain to a bout of warm weather and the impact of the temporary 2.5 percent cut in the VAT from 17.5 percent to 15.0 percent for stoking consumers' animal spirits and getting them to part with their cash. The VAT tax reduction has been in effect since December of last year and will remain in place until December of this year. The drop in energy prices is helping to boost real incomes and consumer discretionary spending power.
U.K. vehicle sales were strong, with a government car- scrapping scheme effectively propping up new car sales. Prime Minister Brown recently credited the car-scrapping scheme for boosting car sales by over 120K vehicles. However, the market has its doubts about the reliability of these data. U.K. consumer spending and retail sales data have been moving in opposite directions since Q4 2008. There have been changes to the methodology that are supposed to reduce the growth rate of the retail sales data. So far, this does not appear evident in the releases.
Eurozone PMIs for July confirmed the improving global economic outlook. The July manufacturing PMI jumped to 46.0 from 43.6. Consensus was looking for 44.1. This is the fifth increase in a row with gains seen in Germany and France. The service PMI increased to 45.6 from 44.7. Both indexes are still below the 50 level that would signal outright expansion, but at this point, we will take what we can get. In addition, Germany's Ifo index for July jumped to 87.3 in July from 85.9.
Global Outlook
Japan Total Retail Sales • Tuesday
The Japanese consumer appears to be slowly returning to the stores. Consumer confidence rose to an 18 month high in June to 37.6 from a record low 26.2 in December. Encouragingly, new vehicle sales are undergoing a broad-based recovery. Newly registered vehicle sales (ex-minis) improved to -13.5 percent year-over-year in June, boosted by government incentives. May total retail sales were roughly flat at -2.5 percent year-over-year. We expect further improvement in total retail sales in June.
Japan's real PCE in May jumped 2.2 percent on the month. Real Japanese PCE growth is now a positive 0.3 percent year-over-year. For working households, real PCE growth is even stronger, up 1.8 percent year-over-year.
Previous: -2.7% (Year-over-Year)
Consensus: -2.5%
German Unemployment • Thursday
Germany has begun to see some stabilization of employment losses from the steep declines seen in the first quarter of this year. The May data looked much better than expected partly due to changes to the official statistics, though the government's decision to extend the possibility for companies to shorten working hours has had a large positive effect as well. The risk is that when these policies expire, if demand has not materially improved, German job losses and unemployment could spike far higher. German June jobless numbers rose 31K with the unemployment rate rising one-tenth of one percent to 8.3 percent. We expect job losses to continue at a moderate pace in July, with the unemployment rate ticking higher.
Germany also reports July CPI and consumer confidence earlier in the week. CPI will be volatile month-over-month due to changing energy prices, but the risk of prolonged deflation is ebbing.
Previous: 8.3%
Consensus: 8.4%
S. Korean Industrial Production• Friday
South Korea, along with China, Japan and Taiwan are experiencing a healthy bounce off the January lows in exports and manufacturing production. We expect to get more encouraging news on this front on Friday when South Korea reports June industrial production. South Korea's industrial production rose 1.6 percent in May. It was the fifth straight monthly increase and the highest reading on industrial production since October. Industrial production was down 7.7 percent year over year in May, a marked improvement from the -25.5 percent record low in January.
June export orders for South Korea foreshadow another respectable gain in industrial production in June. June exports jumped 17.4 percent for the month. Export and manufacturing gains are now clearly visible in key South Korean sectors such as electronics and vehicle production.
Previous: 1.6% (Month-over-Month)
Point of View
Interest Rate Watch
Fed's Exit Strategy and Its Implications for Spreads
With his opinion piece in the Wall Street Journal prior to Tuesday's testimony Chairman Bernanke outlined an approach to the Fed's exit strategy from the "highly accommodative monetary policy" of the Fed that began two years ago. For some time we have spoken about this exit strategy with the explicit focus on the change in relative spreads such a strategy implies. In an earlier speech (June 15, 2009) Governor Duke presented some interesting views on the mortgage market and its "average" spread over Treasuries. There are three essential points about this exit strategy for fixed income markets.
First, Chairman Bernanke mentions several times that "these policies would help to raise short-term interest rates." This is the traditional approach to a monetary policy aimed at limiting liquidity. This policy aim clearly means a higher average level for all interest rates and a flatter yield curve. The spread between long and short rates will narrow and thereby impact bank profitability and the profitability of lending along the curve. Markets anticipate change and as the economy recovers the markets will anticipate a flatter yield curve.
Second, the Fed's attempts to reduce liquidity will impact the relative returns for all instruments it attempts to sell. Over the last several months Fed holdings of Treasury and especially Agency MBS have risen sharply. When the Fed attempts to sell these assets, relative asset prices will change sharply.
The final issue is not if there is a plan, but if it will be implemented in a timely manner. During the American Civil War General McClellan had the Army, yet refused to wield it, to Lincoln's consternation. Moreover, even when McClellan won at Antietam he failed to follow through and pursue Lee. We now know the Fed has a plan - but that's not the issue. Will they implement and follow-through?
Consumer Credit Insights
The Fundamentals
Consumer credit, in all its forms, reflects the fundamentals of both supply and demand. On the demand side we have witnessed changes in consumer incomes, their confidence level and their expectations of prices for goods/services that are often financed by credit. The decline in the use of credit is not an irrational reaction generated by panic but rather the rational response of consumers who see changing fundamentals.
Expectations drive behavior and household expectations for future income gains have downshifted to reflect the reality of a weakened labor market and future tax burdens. In our July outlook we estimated that real disposable income growth in 2009-2010 will average 1.7 percent compared to the pre-recession average of 3.2 percent in 2006-2007. This is accompanied by slower wage growth as well as significant downshifts in expected lifetime earnings in the manufacturing and finance sectors. Further, our expectations are for persistently high unemployment rates. Therefore, consumer optimism is down and household saving rates will be higher at any given income level. A more cautious, higher-saving consumer will give rise to more limited demand for credit over time. Finally, the expected future appreciation of assets that are frequently financed by credit has also diminished. This is certainly true of housing. Therefore, for any given interest rate, less financing of such assets is likely to occur.
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.
U.S. existing home sales up for the third straight month in June (+3.6%), signalling a trough in housing is forming.
Ben Bernanke delivers his semi-annual testimony to Congress, explaining the Fed exit-strategy and stressing the importance of Federal Reserve independence.
Bank of Canada (BoC) leaves overnight rate at 0.25% and reiterates its commitment, conditional on the inflation outlook, to stand pat until July 2010.
BoC upgrades real GDP outlook for 2009-10, and forecasts that inflation will return to the 2% target one quarter earlier (Q2-2011) than forecast in April.
Canadian wholesale (-0.3% M/M) and retail (+1.2% M/M) trade in May were significantly better than expected.
British Columbia to present a new Budget on Sept. 1, 2009 and move to harmonize sales tax (HST) on July 1, 2010.
In week fairly light on economic data, the U.S. existing home sales report made waves, giving one of the clearest signals yet that a trough is forming in the U.S. housing market. Existing home sales beat expectations and rose by 3.6% in June, the third straight month to see an increase. The year-over-year decline in sales is now only 0.2%, the best reading since 2005. In terms of leading indicators of recovery, rising existing home sales rank high, signaling that demand is returning to the housing market and helping to pull down inventories of unsold homes, key to limiting further price declines. Along with data on U.S. housing starts, this is as clear a sign as any that a recovery in the housing market and the economy may be close at hand.
The week was also marked by Federal Reserve Chairman Benjamin Bernanke's semiannual Policy Report to Congress. Bernanke's testimony to Congress comes at a pivotal time for the Fed chief, who has been under mounting pressure to explain both the Fed's exit-strategy as well as to defend the independence of the Federal Reserve in setting monetary policy. The Fed chief used his testimony to cover both bases. With regards to the exit strategy, Bernanke walked the tight rope of stressing that current economic conditions continue to warrant stimulative monetary policy "for an extended period", while at the same time explaining how - when the time comes - they will unwind the stimulus in an age of non-traditional monetary policy.
The main area of concern in terms of exit-strategy is the size of the Federal Reserve's balance sheet, which has grown by over 100% in the last year. In order to fund their liquidity injections and longer-term bond purchases, the Fed has effectively printed money by crediting the reserve accounts of banks. This has created the risk that as financial conditions normalize, banks sitting on piles of excess reserves will lend these out. But, if banks start lending out all these excess reserves it threatens to drastically overheat the economy and result in rampant inflation - the Fed needs a way to prevent this. Bernanke, in his testimony, explained that the Federal Reserve's ability to pay interest on excess reserves enables them to prevent the expanded balance sheet from causing rampant inflation. Put simply, since a payment by the Fed is risk free, it does not make sense to lend out money at below the rate the Fed is paying you to keep it in reserve. Therefore, if the Fed raises the rate it pays on excess reserves, its target rate should move up along with it.
The job of a Fed Chairman is never easy, least when an economic crisis such as the one we have experienced takes place. Equally important in Bernanke's testimony was his insistence that the Federal Reserve maintain its independence in setting monetary policy. A loss of Fed independence would most likely imply a much more volatile path both for inflation and interest rates in the future. Federal Reserve independence from the political sphere is necessary because controlling inflation requires actions that can be politically unpopular - raising interest rates when the unemployment rate is still historically high for example. As history shows, re-anchoring inflation expectations once they have become unhinged is a painful process that everyone would like to avoid.
The Fed chief also commented on policy initiatives aimed at avoiding crises in the future, indicating that a move towards macroprudential regulation that goes above and beyond individual institutions to focus on the stability of the entire financial system is essential to future regulatory efforts. Finally, Bernanke gave time to fiscal policy. While he has supported fiscal stimulus measures in the past, Bernanke stressed that government deficits, if not reigned in, are also a threat to economic stability. Sustained deficits imply higher-long term interest rates that crowd out private investment, which is the key driver of future prosperity growth.
CANADA - A SHORT BUT BRUTAL RECESSION FADES
Attention was squarely focused on the Bank of Canada's (BoC) words, rather than actions, this week. Consistent with a conditional commitment made in April, which was reiterated, the BoC left its overnight rate unchanged at 0.25%. A noticeably more upbeat tone was adopted in recent statements, however, from which we take away the following.
First, Quantitative/Credit Easing is all but dead and buried before it was ever born. To begin with, the BoC had set a high bar as to what cataclysm would need to happen - a new seizing up of credit markets, for instance - for this non-traditional form of monetary policy to be deployed. Thankfully, nothing of the sort has happened, and financial and credit conditions have been on the mend. At this point, the BoC is simply paying lip service to this option in reiterating that it is ready and available if need be.
On the plus side, stimulative monetary and fiscal policy, improved financial conditions, firmer commodity prices, and a rebound in business and consumer confidence will support more domestic growth than anticipated in its April MPR. In the minus column, a higher Canadian dollar and ongoing restructuring in key industries will weigh on growth. All said, the BoC thinks positive real GDP growth will resume in the current quarter (Q3), thereby technically ending the recession. If this unfolds, it will have been the shortest recession since 1957, albeit brutal nonetheless. Real GDP would still contract by 2.3% in 2009 - less than the 3.0% contraction forecast in April and similar to our forecast of a 2.4% contraction.
In early June, the BoC worried that "if the unprecedentedly rapid rise in the Canadian dollar [...] proves persistent, it could fully offset these positive factors". From late April to early June, the CAD had gained 12% against the USD. After retracing somewhat, the CAD remains 12% stronger than in April, so it remains unclear to us why a softer tone on the currency was adopted precisely when a risk noted in June is crystallizing. In 2010, the BoC expects a real GDP expansion of 3.0%, more than the 2.5% forecast in April. The gap between this forecast and our own (1.4%), as well as the private-sector consensus (2.1%) is wide. What the BoC sees as a downside risk, we build into our base-case scenario: we think the CAD will reach parity by year-end and its drag on growth into next year should not be downplayed. The BoC forecast implies an unprecedented performance of the Canadian economy vis-Ã -vis its trading partners. The Canadian economy has historically only outperformed the U.S. economy by this order of magnitude (1.5 percentage points or more) on four occasions over the last half-decade - each time in years entering a recession and never on the initial year of recovery after a recession. While the specific composition of assumed growth channels in the U.S. (e.g. industrial production, machinery & equipment, motor vehicles) might disproportionally favour our export performance, it would still constitute a remarkable feat for Canadian economy to grow by 3.0% while the U.S. and world economies crawl at respectively 1.4% and 2.3% growth.
On the data front, wholesale and retail trade figures for May came in significantly better than expected. Wholesale trade slipped by 0.3% M/M while markets expected a larger 2.0% M/M drop. Meanwhile, retail trade expanded at a brisker pace (1.2% M/M) than anticipated (0.5% M/M). Both data reports were fodder for recovery enthusiasts. The recent data is clearly showing that the recession is in its final stages, with growth resuming in either Q3 or Q4. But we would caution against getting too optimistic about the strength of the recovery. As the BoC acknowledged, it is early days and there remain strong headwinds.
U.S.: UPCOMING KEY ECONOMIC RELEASES
U.S. Durable Goods Orders - June
Release Date: July 29/09
May Result: total 1.8% M/M; ex-transportation 1.1% M/M
TD Forecast: total -1.0% M/M; ex-transportation 0.0% M/M
Consensus: total -0.5% M/M; ex-transportation -0.2% M/M
The recent flow of manufacturing sector reports has offered some hope that the sharp correction in the U.S. industrial complex may be nearing an end. Despite this, the lingering impact of sluggish global demand and weak domestic consumer spending will continue to push U.S. capital expenditures lower as businesses adjust their level of activity to the soft economic fundamentals. For June, we expect durable goods orders to decline for only the second time since January, with a 1.0% M/M drop. The sharp drop in Boeing aircraft and motor vehicle orders should be the key factors driving the headline number lower. As such, excluding transportation, durable goods order should be flat on the month. In the months ahead, Annualizedwe expect new orders to remain soft as the U.S. economic recession moves slowly into memory.
U.S. Real GDP - Q2/09
Release Date: July 31/09
Q1 Result: -5.5% Q/Q ann.
TD Forecast: -0.8% Q/Q
Consensus: -1.5% Q/Q
The U.S. economy likely shrunk in the second quarter of 2009 for the fourth straight quarter in a row. However, unlike the previous two quarters, the pace of decline is expected to have diminished significantly. The biggest source of downward pressure on U.S. GDP growth in the second quarter will likely be the drop in business inventories, in part due to the shut down of auto production, but also across other sectors as businesses adjusted their inventory levels to match the much slower pace of sales. Domestic demand should also continue to be a source of weakness to GDP, as both consumers and businesses cut back spending. Fiscal stimulus, in the way of social security transfers, gave support to personal income growth in the quarter but most of the checks ended up in savings and so had little impact on the level of spending. On a monthly basis real consumer spending troughed in December of 2008 and has moved pretty much sideways in the months since then. Government and net-trade were the two sectors that likely added to growth in the second quarter. In the case of government, a rebound in defense spending will be the main contributor to the gain, while on the net-export side the support will likely simply be a matter of imports falling by an even greater amount than exports - hardly something to cheer about.
CANADA: UPCOMING KEY ECONOMIC RELEASES
Canadian Real GDP - May
Release Date: July 31/09
April Result: -0.1% M/M
TD Forecast: -0.2% M/M
Consensus: -0.3% M/M
The combination of weak domestic consumer spending and slumping export demand have continued to hamstring the Canadian economy, resulting in the longest slump in economic activity in many decades. In fact, since July last year, Canadian economic activity has contracted in every month with the value of domestic output now at levels not seen since October 2006. The pattern of weakness is expected to continue into May. Indeed, during the month we expect Canadian GDP to contract a further 0.2% M/M. Slumping manufacturing sector activity (which have declined a staggering 5.8% M/M) and weak export demand (down 4.7% M/M) should be the key sources of drag on activity. Stronger retail sales and residential investment activity, however, should add favourably to the headline number, though they will only provide a partial offset. In the coming months, we expect Canadian economic activity to begin stabilising as the significant monetary and fiscal policy stimulus administered to the Canadian economy begins to gather traction.
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.
A powerful rally in equity markets and rising oil prices bolstered demand for commodity currencies and caused the dollar and the yen to weaken. The dollar index slipped close to the 2009 low as participants moved decisively into the C$, A$, NZ$ and sterling. The C$ was also underpinned by the decision by the Bank of Canada to reduce the duration of its liquidity operations from 12months to 9 months, and the Bank's statement that 'the recession is ending early'. Speculation that the BoE may draw a line under QE in August helped to bolster sterling and lifted £/$ to a 3-week high at 1.6586, though disappointing gdp figures sparked profit taking on Friday.
Stronger global economic data spurred hopes that the economy is recovering and helped equity markets to extend gains for a 2nd successive week. Key levels were breached to the upside in the S&P-500 and the FTSE- 100 and boosted positive momentum in commodity currencies and sterling. This caused currency volatility to fall further, especially in the shorter dates. The VIX index continued its decline and may test 20.0 if current trends prevail over the coming weeks. Demand for G10 currencies like the C$ and A$ surged as participants sought exposure to commodities. The South African rand and Colombian Peso were the best performers in emerging markets. The dollar was the principal causality during the rush for carry as participants increased exposure to risk. This led the dollar index to slump to 78.420, just 0.1% above the 2009 low of 78.334.
£/$ returned to the upper end of the 6-week trading range as the dollar fell. The BoE MPC minutes, comments by MPC member Sentance and strong UK retail sales data for June added positive impetus and helped £/$ to overcome resistance at 1.6550. Retail sales rose 1.2% in June and fuelled hopes of a positive surprise for Q2 gdp. The report on Friday of a 0.8% q/q contraction in Q2 gdp vs consensus of a 0.3% drop put paid to expectations of an imminent return to positive growth, but sterling selling was limited as participants concentrated on rising equities and mulled over the possibility that the BoE may not expand Quantitative Easing (QE) in August. The details of the MPC minutes and MPC member Sentance earlier in the week hinted that the Bank may decide against buying additional gilts or commercial paper. This helped to put a floor under £/$.
Stronger than expected data from the euro zone - the German IFO index rose to a 9-month high in June, caused the rally in £/€ to stall above 1.1656, but helped €/$ to close the week 0.59% higher at 1.4196, below Thursay's 6-week high of 1.4291. Stronger than expected French consumer spending and business confidence data underpinned optimism that the worst of the contraction in gdp has passed and may lead the ECB to adopt a cautiously more upbeat view about the prospects for recovery.
The Colombian peso and S. African rand gained 2.7% and 1.4%, respectively against the dollar, testifying to the inflow of investment flows in emerging markets as hopes grow of global economic recovery. Surprisingly, the Korean won failed to draw any strength on the report that the economy rebounded 2.4% q/q in Q2. $/ won ended the week flat at 1249.55
Interest rate market review - bonds, cash and swaps
Positive Q2 earnings surprises from a handful of US blue chip companies and stronger than expected economic data weighed on government bond prices this week and caused yields and swap rates to rise sharply. The decision by the Bank of Canada to reduce the term of liquidity operations and speculation that the BoE is moving closer to drawing a line under its £125bn QE programme compounded the squeeze upwards in yields. The shift in flows from bonds into equities was particularly painful for UK gilts where yields surged 16bps along the curve and 5y swaps rose above 3.70% to a one-month high. UK 3-month libor fell 3bps to 0.92%. Yields also edged up in the euro zone where stronger than expected outcomes for the German IFO survey and the euro zone PMIs buttressed confidence that the economy is on the mend.
Upward pressure on yields was relentless for most of the week until Friday when disappointing UK Q2 gdp data and profit taking in stocks helped yields and swaps to ease back. Market participants stepped up their purchase of equities, spurred by the report of a 3rd successive rise in US existing home sales in June (off a very low point) and enthusiasm over Q2 earnings. This pushed global equity indices to new 2009 highs and precipitated a sell-off in government bonds (higher yields and swaps, wider spreads), led by the UK where 2y and 10y yields shot up around 15bp.
UK June mortgage lending and retail sales data surprised to the upside and alongside the MPC minutes were important catalysts for the jump in gilt yields to the highest level since June 11. Mortgage loan approvals rose to 35,235 from 31,929, the highest since March 2008. Retail sales surged 1.2% on the month, lifting the annual growth rate to 2.9%, a 6-month high. Optimism about recovery quickly cooled on Friday, reinstating a bid in gilts (lowering yields) when the ONS reported a 0.8% q/q contraction in Q2 gdp, topping estimates for a 0.3% decrease. Annual gdp dropped to -5.6% from -4.9%. The 2016 gilt auction was covered only 1.70 times; not reflective of great investor support considering that this issue is part of the BoE's asset purchase programme (APF). Speculation about an end to the APF programme in August could dissuade some participants of bidding at auctions that precede the August MPC meeting, putting pressure on the DMO to offer the paper at a discount (higher yield). 5y swaps closed the week up 16 bps at 3.70%, leading to a steepening of the 3-month/5y swaps curve to 276bps.
US treasuries got a lift early in the week when Fed chairman Bernanke played down speculation that the Fed could soon implement an exit strategy from QE. Bernanke reiterated in his testimony to Congress on Tuesday and Wednesday that interest rates are likely to stay low and that inflation will stay subdued for some time. The Fed though later in the week decided to reduce the size of its auctions of cash to banks under the TAF to $125bn from $100bn. This is a consequence of a further improvement in funding conditions and is illustrated by a narrowing in the 3-month Libor/Ois spread to 30bps, the lowest since January last year. A 3rd consecutive gain in existing home sales and for the leading indicator in June supported the view that the economy is slowly improving. Participants are looking for a marked improvement in next week's release of Q2 vs Q1 gdp. 5y swaps fell 1bp to 2.98%.
Yields in the euro zone caught up with gilts and treasuries late in the week following a stronger than expected German IFO survey and euro zone PMIs for June. 5y swaps hit a 2.95% high. Euro zone 3- month libor fell 3bps to 0.92%, helping the libor/Ois spread to fall back below 50bps. Overnight deposits with the ECB remain stubbornly high and rose to 192bn euros on Friday.
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Bernanke: tentative optimism, exit still a long way off
Ifo recovers further
Forex markets have decoupled to some extent from stock markets: Only at the beginning of the week were they able to follow surging stocks. EUR-USD rose to 1.4277, but then ran out of steam even as the Dax scaled new highs in the second half of the week, reaching the highest level so far this year at 5300. The common currency on the other hand fell back to around 1.42 at the end of the week - a hurdle difficult to clear at the moment. USD-JPY more or less moved sideways too, closing this week the same as last at 94.50.
The DAX was fuelled mainly by strong corporate earnings. There were a few disappointments such as Morgan Stanley and Wells Fargo. The latter in particular - as some of its competitors - had to digest a massive increase in credit-loss provisions. But on the whole, expectations were exceeded. Companies such as Caterpillar were mainly able to post higher profits because of cost cutting measures. Sales, however, have declined sharply in the second quarter as expected.
Markets had hoped for a more upbeat message from Fed Governor Ben Bernanke before the Senate. Mr Bernanke did speak of signs of stabilization in the US economy, but at the same time he emphasized that unemployment would continue to rise strongly, which might be a drag on private consumption. Therefore the key interest rate would remain at its very low level for a considerable time. The Fed Governor said an exit from the very expansive monetary policy would depend on the labour market, capacity utilization and inflation expectations. Mainly because of the rather dismal outlook for the US labour market, a policy switch has thus apparently moved a long way into the future. Accordingly, bond markets gained strongly.
Subsequently, markets took little notice of Mr Bernanke's comments on an exit strategy. He was very detailed on the instruments with which the Fed is planning to mop up excess liquidity in a smooth and timely way once the economy recovers. The Fed Governor showed himself convinced that any inflationary risks were under control. To this, bond markets reacted with an upwards movement which proved to be temporary, however. Bond prices retreated again when the stock market rally continued in the second half of the week.
Macroeconomic data further confirmed an economic stabilization. German ifo business sentiment improved for the fourth consecutive time in June. For the first time the current situation was assessed to be significantly better, albeit mainly in the retail sector, which indicates that the economic stimulus programmes are having some effect. However, the ifo remains at a very low level and companies are still planning to reduce employment.
Next week the credit crunch debate is likely to be fuelled by the ECB's new Bank Lending Survey on 29 July. Moreover, the money supply data for the euro area are due on Monday. In the past months the growth rates of credit aggregates have been falling continuously. The latest figures showed that credit expansion has come to a halt or is in fact already declining slightly. If this trend continues, pressure on the ECB Council to take measures against a credit crunch will increase. The Council meets on 6 August. Calls from politicians for de-crunching measures are getting increasingly louder anyway. A credit crunch and banks' rising loss provisions are issues that could put the crisis to the front again. Therefore it looks unlikely that EUR-USD will break out of its current trading range of 1.37 to 1.43 next week.
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New Zealand data: trade, building consents, business survey.
US Fed : Bernanke, Beige book.
US data: Q2 GDP, durable goods, manufacturing & housing updates.
Key economic & financial forecasts
We have revised our growth forecasts. While the changes are not major they are significant in that we are no longer forecasting a technical recession.
We assess that the signals from the Australian economy in the last few months necessitate a less pessimistic growth forecast. We have identified the following factors that we expect will be instrumental in moderating the slowdown in the Australian economy. We summarise our changes in the attached charts. Note that we now expect year average growth in GDP in 2009 to be 0.2% compared to our previous forecast of minus 0.6%. For 2010 we expect growth of 1.8% compared to 1% in our previous forecast.
These might seem to be minimal changes but because GDP growth switches from positive to negative and our quarterly profile changes from three consecutive negative quarters (Q2; Q3; Q4) to only one (Q3) the technical recession label (two consecutive negative quarters) is no longer appropriate.
We do not believe that these changes are sufficiently material to change our rate or currency views.
Reasons behind our upward revisions are:
1) Critically, we saw a sharper than expected fall in export prices (21%) in the second quarter - we are aware of export values for April and May and our estimate for June values now suggests that export volumes for Q2 will increase by 1% rather than contract by 2%. We estimate that will mean that net exports will add 0.3% to growth rather than subtract 0.3% pushing our Q2 GDP estimate to 0.2% from minus 0.4%. The upward revision to net exports plays a significant part in our overall revision to growth in 2009. However, a word of caution - that was the biggest fall in export prices since the series began in 1974 (second largest decline was 6.5%) and therefore indicates extreme volatility in the net export/inventory/statistical discrepancy mix.
2) Both business and consumer Confidence have increased to their highest levels since December 2007. While these spectacular recoveries in Confidence are likely to prove fragile and can potentially partly retrace we expect that Confidence will establish higher base levels than we had feared earlier in the year.
We also believe that it is difficult to envisage events that could see Confidence plunging to levels prevailing earlier in the year. We remain very sceptical about the outlook for the major economies and anticipate ongoing problems with the financial systems of both US and Europe. But these developments will mainly affect the pace of growth in these economies rather than providing dramatic signals that would jolt Confidence in the way we saw earlier this year.
Households still have to negotiate the upcoming 6 month period in which nominal incomes will be contracting as hours worked fall; government handouts cease and interest rates are on hold rather than declining. However, we assess that households have been successful in saving a decent proportion of the cash handouts - one bank reports that 90% of those folks with owner occupier mortgages have opted to pay down debt rather than reduce interest payments.
We expect that as Confidence levels remain relatively high households will be prepared to reduce savings to maintain expenditure levels even as incomes contract. When Confidence is low households are likely to seek to maintain savings at the expense of spending - as we are seeing in the US but contrast the level of Australia's Consumer Sentiment Index (109) with the US (66). That observation has prompted an increase to our consumer spending profile increasing growth over 2009 from 1.3% to 1.6%. In 2010 we have raised spending growth from 2.0% to 2.3%.
Higher than expected Business Confidence will also moderate the downturn in business investment. That will mainly affect plant and equipment since we expect non-residential property and engineering investment will be largely driven by exogenous events (credit availability; external demand; government spending). We have revised the expected downturn in plant and equipment to minus 18% from minus 22% in 2009; and from minus 7% to minus 1% in 2010.
3) Finally, we have increased the strength of the recovery in housing construction. New lending for housing construction continues to surge - number of new loans for housing construction (owner occupied) is up 60%. That will eventually see strong positive prints on housing construction. We have raised the growth forecast for housing construction in Q4 from 2.5% to 4% and through the year growth in 2010 in housing construction to 23% from 19%.
While the "debate" about recession is occupying great coverage in media and official circles these forecast changes are significant in that they indicate that Australia may now avert a technical recession. That is our current best estimate but please respect the particularly challenging forecasting task stemming from unprecedented fluctuations in commodity prices; fiscal settings; monetary policy; global growth; and currencies.
Australia: Data Wrap
Q2 PPI
Q2 Final Stage PPI inflation was well below consensus at -0.8%qtr (consensus -0.1%, Westpac -1.2%), almost halving the annual rate to 2.1%yr from 4.0%, the lowest since 2004Q1.
Non-core elements subtracted slightly more from the PPI than expected, with weaker than expected food prices (fell 1.2%, subtracting 0.21ppts) but a larger than expected rise in petroleum refining prices (+4.9%, adding 0.11ppts), giving a net 0.10ppt subtraction from the quarterly PPI.
The 1.2% fall in food components builds on a 0.9% fall previously. While CPI food prices are not well correlated with PPI equivalents, the back to back falls in PPI food prices affirm our forecast of much tamer Q2 CPI food prices (our f/c is +0.3%qtr vs +2.2%qtr prev).
Ex-food and petroleum, the core PPI was very weak as we expected, courtesy of the stronger AUD cutting import prices. The core PPI was -0.9%qtr (weakest on record since 1998) slowing the annual rate to 3.4%yr (lowest since 2008Q1) from 5.2%yr previously.
With the AUD import weighted TWI up 10.2%qtr in Q2, the core imports PPI was -6.2%qtr.
Building construction prices continued to fall in aggregate (-0.5%) despite a bounce in house construction prices, weighing on the core PPI in addition to the import drag. Abstracting from these, domestic core pressures rebounded amidst firmer demand, but not enough to prevent a further fall in the annual rate. The domestic core PPI ex-construction & utilities was +0.7%qtr (vs -0.3% prev), slowing annual growth to 2.5%yr from 3.0%.
With improved new housing demand led by FHB's, house construction output prices rebounded 1.4%qtr (vs -0.5% prev).
Q2 CPI
Annual headline inflation falls below RBA target band courtesy of dropping out of strong 1.5%qtr from 2008Q2, and subdued 2009Q2 courtesy of pullbacks in food prices and further falls in bank interest rate margins (deposit and loan facilities -4.3%qtr vs -14.1%qtr prev).
Average RBA underlying CPI came in above consensus as we expected, at +0.8%qtr, allowing only a gradual slowing in annual underlying inflation to 3.9%yr from 4.2%yr previously.
Notably stronger than expected rebounds from New Year Sales discounted prices in several areas of discretionary retailing, reflecting recent strength in household demand, including clothing & footwear, furniture & furnishings, and household appliances, utensils & tools. This is acting to keep the slowing in annual underlying inflation very gradual.
We don't expect that these numbers will come as any surprise to the Reserve Bank. Their most recent forecast for underlying inflation to June 2009 is 3.75%yr and this number prints at 3.8%yr. Their forecast for headline inflation is 1.5%yr, the same as today's result.
However the stronger rhetoric from the Bank since on May 8 it released its somewhat controversial forecast that inflation will drop to 1.5% by June 2011 suggests a decent case for that forecast to be revised up to say 2% when we see the revised forecasts on August 7. With a less pessimistic forecast the obligation to consistently refer to cutting rates will be eliminated. Markets would be quite surprised if that terminology no longer appears in RBA rhetoric but we do not believe that it would mean the Bank is near to tightening.
Round-up of local data released last week
Date
Release
Previous
Latest
Mkt f/c
Mon 20
Q2 PPI
-0.4%
-0.8%
-0.1%
Tue 21
Jul RBA meeting minutes
-
-
-
Jun new motor vehicle sales
5.4%
5.7%
-
Wed 22
Q2 headline CPI
0.1%
0.5%
0.5%
Q2 avg RBA underlying CPI
1.1%
0.8%
0.75%
RBA Assistant Governor Debelle speaking
-
-
-
Thu 23
RBA Assistant Governor Debelle speaking
-
-
-
New Zealand: Week ahead & Data Wrap
Out of the frying pan
RBNZ Governor Bollard's speech on 14 July, simply titled "Economic Recovery", gives a clear indication of what to expect from next Thursday's OCR review.
Compared to the June Monetary Policy Statement, the RBNZ appears more confident that the global economy is stabilising and that New Zealand is entering the recovery phase; the main question now is what form the recovery will take. But with the prospect of recovery comes a growing concern that households could revert to their previous "borrow and spend' ways - and keeping interest rates too low for too long would clearly fuel that risk.
The change in the world growth outlook is perhaps the most significant factor for the RBNZ. Consensus Forecasts for growth in New Zealand's trading partners have been revised up in the last two months to -2.1% for 2009 and 2.2% for 2010, an increase of 0.2% for each year. That's a modest improvement so far, and still points to weak activity over the next couple of years. But it's increasingly likely that the "Depression Mark II' scenario that was feared earlier this year has been avoided.
In recent statements the RBNZ have made a point of undercutting Consensus forecasts, partly on the expectation that there would be further downward revisions closer to the date; their June projections assumed growth of -2.6% this year and 1.4% next year. But the gap versus Consensus is now widening, and the risk is that the RBNZ will need to make a significant leap to catch up. The tone of Dr Bollard's speech certainly suggests a more positive view on the world economy compared to June.
Locally, the data continues to suggest a gradual recovery. Consumer and business confidence have held their recent gains, retail spending has been a little stronger (though probably less so in terms of volumes), house sales are running at a stronger pace than a year ago and prices have stabilised. These factors have all been underpinned by low interest rates and stronger net inward migration. Notwithstanding the unknown impact of H1N1 influenza (which both we and the RBNZ assume will be small), we expect the economy to return to mildly positive growth in the current quarter.
On the downside, the New Zealand dollar remains at unhelpfully high levels. The trade-weighted index is tracking about 5% higher than the RBNZ's June projections, although the RBNZ did accept that there was likely to be some short-term strength, before the market began to focus again on New Zealand's large external financing requirements. And at the risk of reading too much into Dr Bollard's speech, the RBNZ's concern now seems to be that the stronger currency could cause the recovery to be lopsided, rather than stifling it altogether as suggested in earlier statements.
The RBNZ's view in June was that households will continue to borrow less and save more in order to strengthen their balance sheets. But they also offered an alternative scenario, in which households resume borrowing and spending, spurred on by rising house prices, while a stronger NZD depresses the export sector. In the longer term, international investors could demand higher interest rates in order to keep funding New Zealand's spending spree. The focus in Dr Bollard's speech on improving domestic savings behaviour suggests that this "alternative' scenario is increasingly becoming a central concern.
But there's an implicit assumption here: that households will have an incentive to return to their "borrow and spend' ways as the economy recovers. Renewed house price inflation and falling savings rates would be a sure sign that interest rates are too low - which is clearly something that the RBNZ could remedy. Indeed, we think that Dr Bollard's speech was the first step in preparing the market for the unpleasant fact that one way or another - whether it's through OCR hikes, greater use of prudential regulation, or market forces - interest rates are going to be higher in coming years.
But that's an issue for the longer term. For now, the RBNZ's focus is on supporting the economy through a period of weak activity, and with inflation pressures muted, there's no urgency to hike rates any time soon. But with the downside risks to the economy diminishing, we expect next week's statement to drop the line that "the OCR could still move modestly lower over the coming quarters" - no great sacrifice, since the RBNZ's 90-day rate projections in June already implied no further cuts as their central view, and market pricing implies only a 15% chance of another cut in this cycle.
That leaves the RBNZ's expectation that they will "keep the OCR at or below current levels until the latter part of 2010". If the pace of the global recovery continues to surprise the RBNZ in coming months, that expectation could soon become untenable. But we think they will retain this statement for now (without the "or below"), as they may be concerned that ditching it so soon could elicit a sharp jump in interest rates and the exchange rate.
The local data calendar gets busy ahead of Thursday's OCR review. We expect the June trade balance (Tues) to remain in surplus, though less impressively than in recent months, due to softer dairy export prices and a gradual pickup in import demand. Building consents (Wed) may be lower in June, due to the volatile apartment component, but we expect the trend to improve over this year as rising net migration exacerbates an emerging shortage of housing. Finally, business confidence (Wed) is expected to close to its recent highs, with most sectors (aside from agriculture) reporting early signs of stabilisation in recent months.
Round-up of local data released last week
Date
Release
Previous
Latest
Tue 21 Jul
Jun external migration ann.
11,200
12,500
Jun credit card transactions
-0.4%
0.2%
Data Previews
Aus Jun dwelling approvals
Jul 30, Last: -12.5%, WBC f/c: 9.0%
Mkt f/c: 8.0%, Range: 3.0% to 11.5%
May dwelling approvals were much weaker than expected, dropping 12.5% after a 21% recovery in the previous 3 months. Weakness was mainly in private units (incl apartments), which plunged 43.6%, the biggest fall on records back to 1983. Although this segment is famously volatile the scale of the pull back suggests funding difficulties are again influencing activity. The RBA also noted weakness ex capital cities attributed to weaker demand for holiday units (Gold Coast etc).
That said, demand for new housing is clearly rising strongly. Finance approvals for the construction & purchase of newly built dwellings are up 60% from mid-2008 lows. We expect this to overwhelm the effects of credit problems in June, with a 9% bounce in approvals forecast. Indeed, there is significant upside risk if the May figure turns out to be mostly a rogue.
Aus Jun private credit
Jul 31, Last: -0.1%, WBC f/c: flat%
Mkt f/c: 0.1%, Range: 0.0% to 0.4%
Private credit declined fractionally in May as business contracted for a fourth consecutive month and more than offset a 0.5% rise in housing credit.
The positive is that an upswing in housing finance (new lending) is supporting growth in the stock of housing credit. However, existing mortgage holders paying down debt more quickly is providing an offset.
Business credit (representing a little less than 40% of total credit) is contracting, declining by 2.3% over the last six months. The downturn has some way to go and we expect a further decline in June. That said, the recent rebound in business confidence is encouraging.
NZ Jun merchandise trade NZDm
Jul 28, Last: 859, WBC f/c: 200
The merchandise trade balance has moved aggressively into positive territory over the past few months. Expenditure on imports has plunged as demand for consumer durables, especially cars, has dried up. By contrast, export receipts have held up as commodity prices have ceased declining, and local production conditions have been solid.
We predict the first June surplus since 2002. The predicted surplus is not as strong as recent months, even after allowing for seasonal factors. Rising retail sales suggests consumer imports will be recovering, and car imports have lifted off their base.
On the export side, international dairy prices fell in June, and the higher exchange rate will have reduced NZD-denominated returns for many exporters.
NZ Jun building consents s.a.
Jul 29, Last: 3.5%, WBC f/c: -4.6%
Dwelling consents posted another solid gain in May, but with just over 1,200 consents being issued per month, the number of new homes being built is still well below that required to keep pace with population growth.
As such, we expect a solid lift in ex-apartment consents in June (+4.0%), and see risks to the upside. However, unless consents for the more volatile apartment component keep pace with May (at 275), the overall number of consents is likely to decline.
The trend in non-residential consents declined for the ninth consecutive month in May, although in unadjusted terms consents growth remains strong, up 35% on a year ago. Business confidence surveys continue to point to weakness in non-residential building over the remainder of this year, but it remains to be seen how much of the slack will be picked up by the government sector.
NZ Jul NBNZ business confidence
Jun 29, Last: 5.5%
Headline confidence improved further in June, reaching a seven-year high. Confidence in the agricultural sector fell on concerns about lower dairy payouts, but all other sectors moved into net positive territory.
We expect a similar outcome in the July survey. Recent commentary about the dairy industry will have done little to improve sentiment, but retail, manufacturing and services have each shown recent signs of stabilisation. Construction in particular is benefiting from increased housing demand and infrastructure spending.
The own-activity measure is a useful indicator for current quarter GDP. An unchanged read would be broadly consistent with our forecast of 0.2% growth in Q3.
The improving outlook for the global and domestic economies means the RBNZ will again leave the OCR unchanged at 2.50% next week.
The RBNZ is becoming more concerned about a return to debtdriven consumption as the economy recovers, which suggests that they no longer see further interest rate cuts as appropriate.
While the high NZ dollar remains a bugbear for the RBNZ, recent commentary suggests they now see the risk of a lopsided recovery rather than a stifled one.
US June new home sales
Jul 27, Last: -0.6%, WBC f/c: 6.0%
Across a range of indicators, the US housing market is showing signs of stirring, after four years of decline (new home sales peaked in July 2005!). The upswing in pending and finalised existing home sales is largely due to the distressed sale of foreclosed properties at knock-down prices, but homebuilder confidence and new housing starts and permits are also moving higher.
We are particularly impressed that single family home starts have not posted a monthly decline since January, and are up a cumulative 32% over the latest four months. Given the still large glut of unsold new and established dwellings, the risk is that this upswing won't be sustained, but in the short-term at least, it's likely that higher sales have been a driving factor.
Hence we expect new home sales to jump 6% in June.
US regional factory surveys for July
Jul 27, Dallas Fed: Last: -20, WBC f/c: -10
Jul 28, Richmond Fed: Last: 6, WBC f/c: -2
Jul 31, Chicago PMI: Last: 39.9, WBC f/c: 44.0
Jul 31, Milwaukee NAPM: Last: 50, WBC f/c: 48
These surveys have been a big part of the cliched "green shoots of recovery" story that first emerged in March. The Richmond Fed survey has been in positive territory (>50) for two months running, and the private sector Milwaukee NAPM improved dramatically in March-June, just touching 50. The others have lagged behind somewhat, but all are stronger in trend terms, consistent with a much slower pace of industrial contraction.
Thus far for July we have seen the New York Fed which rose from -9 to -1 and the Philly Fed which fell from -2 to -8 after soaring 20 pts back in June. These results suggest the other regionals should all keep trending higher, though the strongest two (Richmond and Milwaukee) may temporarily correct lower.
US June durable goods orders to correct lower
Jul 29, Last: 1.8%, WBC f/c: -1.5%
Durable orders posted back to back 1.8% gains in April-May, the first consecutive rises in orders since mid 2008, adding to the body of evidence pointing to a stabilising economy. Core capital goods orders (ie ex defence and aircraft) were especially strong, as were defence orders.
The prospect of a third straight orders gain in June is not strong, with both core capital goods orders and defence likely to correct lower. The orders component of the factory ISM switched from a gain in May to a fall in June, adding to the case for a correction lower. Also Boeing received 20 orders for new aircraft in both May and June, but those in May were of higher value, adding to the downside risk in the June report.
Putting all this together we expect June orders to fall 1.5% keeping the recent trend just barely positive.
US Q2 GDP advance: slower pace of contraction
Jul 31, Last: -5.5% annualised, WBC f/c: -2.0%
US GDP plunged at around a 6% annualised pace in Q4 and Q1, but a string of less weak survey and partial data since March has pointed to a much slower pace of contraction in Q2 and, looking ahead, modestly positive growth in Q3 is achievable if recent trends continue.
We expect a 2% annualised contraction in Q2, driven mainly by a renewed but modest fall in consumer spending; much less steep falls in both housing and business investment; continued inventory rundown (setting up a positive Q3 stocks contribution) but another positive contribution from net exports.
The Q2 report will also include historic revisions. As the data stand, prior to Q2 there were contractions in the three qtrs Q3 2008-Q1 2009, and also Q4 2007, but that profile could change substantially in these once a year revisions.
Extensive and perhaps over-excited media coverage of equity indices which rallied strongly for a second consecutive week (many for nine consecutive days) and some broke to new highs for the year. The best performers were Eastern European ones (Polish WIG +11.20% and Helsinki +7.0%) and Asian ones (Hang Seng +4.0%). Great excitement at the BBC World Service where the Dow Jones Industrial Average closing above 9,000 on Thursday made headline news. The US dollar lost ground against all currencies except the Yen, many trading close to their strongest levels this year, while the South African rand hit 7.6145 and its best level since August 2008. Yields backed up a little but remain well within the range of the last month. Most commodities are a bit higher, ICE Sugar at 18.48 cents per pound equalling the March 2006 high (and well above one standard deviation from the mean of the last thirty years), Nymex Crude Oil inched up to $67.68 per barrel, LME 3-month Aluminium $1,811 and Copper $5,575 per tonne, an increase of about 30% and 50% respectively from this year's lowest levels.
Political and Economic Developments
UK Q2 GDP dropped -0.8% Q/Q and -5.6% Y/Y, a record for a series going back to 1956 and a lot worse than the government and economists' forecasts. Meanwhile government debt ballooned again to a record £19B in June and net debt a whopping 55.6% of GDP. Typical of the British public, against this dire background they managed to push Retail Sales +1.2% M/M and +2.9% Y/Y due to unseasonably warm weather and early summer sales. Japanese Supermarket Sales -4.4% Y/Y, at the lower end of the range since 2000 as an increasingly desperate ruling LDP attacks the opposition Democratic Party, the election campaign heating up with headlines declaring: ‘The Future of Japan is in Danger'.
Brazil's central bank cut the key Selic rate by 50 basis points to a record low 8.75%.
Underlying Themes
While some banks reported good Q2 earnings on wider margins and successful trading, those lending to commercial real estate are suffering. Valued at $6,700B, 10% of US GDP, Moody's notes prices fell 7.6% in May and the sector as a whole had lost about 35% from its peak. Spanish residential rents are falling as properties that fail to sell (1.5 million so far and rising) flood the lettings sector - +55% to 3.3 million units over the last two years; Madrid and Barcelona down 8%, the first ever decline, to €12.6 per square metre. Hoteliers are getting reductions of up to 30% from landlords as they in turn see a sharp drop in guests especially at the business and luxury end. UK Commercial Property is struggling too, the British Retail Consortium estimates that one in eight town centre shops is empty. The beleaguered British Beer and Pub Association reports 52 pubs closing weekly this year against 39 last, the total still in business dropping to 53,446 from 58,600 in 2006, local ones rather than the high street especially hard hit. The Commercial Mortgage-Backed Securities Market is still pricing the very few deals done at eye-watering spreads - 145 basis points over ten-year Gilts for Land Securities' £360M on a site with a long-term government tenant in place.
What to watch for next week
Sunday 26th Ben Bernanke gives PBS TV an interview from the Federal Reserve Bank of Kansas City discussing the economy. Monday Japan June Corporate Services Prices, EZ16 Money Supply, US New Home Sales, UK July Hometrack Housing Survey, Nationwide House Prices from this day and German August GfK Consumer Confidence. Tuesday US May CaseShiller Home Prices, UK July CBI Distributive Trades and US Consumer Confidence. Wednesday Japan June Retail Trade, UK Net Consumer Credit, Money Supply and Mortgage Approvals, US Durable Goods Orders, the Fed's beige Book and July CPI for the different German states due from this day. Very late the Reserve Bank of New Zealand decides on rates (expected unchanged at 2.50%). Thursday Japan June Vehicle and Industrial Production, German Retail Sales and July Unemployment, EZ16 Business Climate Indicator and Confidence Surveys. Friday Japan June Jobless, Household Spending, Housing Starts, Construction Orders, National CPI, Tokyo July CPI, UK GfK Consumer Confidence, EZ16 CPI, Chicago Purchasing Managers, US Q2 GDP and Eurozone June Unemployment. Saturday is the 1st August.
Positioning and Technical Analysis
Rallies in equity indices are unlikely to see any follow-through next week so we shall allow for another two to four weeks of broadly sideways work. Those that posted new highs for this year we feel are in a process of establishing new wider trading bands. This should enable the Euro, pound and other major currencies to strengthen against the US dollar, causing another round of short-covering. Watch for strong weekly closes in these to confirm the start of the next leg in a long term trend. Commodities may benefit from this and perennial gold bugs will be tempted to buy more. Money market futures, especially Eurodollar interest rate ones, suddenly look vulnerable. If not next week then during August we expect a sharp sell-off, similar to the one in early June, as another round of jitters hit the banking sector. Fixed income yields should move sideways.
The information contained in this paper is based on or derived from information generally available to the public from sources believed to be reliable. No representation or warranty is made or implied that it is accurate or complete. Any opinions expressed in this paper are subject to change without notice. This paper has been prepared solely for information purposes and if so decided, for private circulation and does not constitute any solicitation to buy or sell any instrument, or to engage in any trading strategy.
