The US dollar is firm ahead of what promises to be an eventful North American session. The ADP steals much of the thunder once reserved from the monthly non-farm payrolls report. The US created a net 1.4 mln jobs in H1, and the streak of 200k+ monthly gains in non-farm payrolls is expected to continue into July's report.
The first estimate of Q2 GDP is expected to completely reverse the 2.9% contraction in Q1. It appears that momentum softened late in Q2, suggesting the risks are on the downside. That said, the jump in consumer confidence to seven-year highs, reported yesterday, and the upbeat regional Fed surveys suggest momentum returned at the start of Q3.
The FOMC meeting is likely to be close to a non-event. The action is universally anticipated: another $10 bln in tapering. The economy has proceeded along lines the Fed expected, and this means that its assessment is likely to be simply tweaked. The housing market remains disappointing, and the Fed may acknowledge this.
The other wrinkle may be in a hawkish dissent by Dallas Fed Fisher, whose op-ed piece in the Wall Street Journal, earlier in the week, and during the traditional quiet period ahead of an FOMC meeting, seemed to have tipped his hand. Moreover, there has been reports indicating that he will likely step down next spring and is being considered for a position as Chancellor of the University of Texas. Lastly, in this period, we suspect the FOMC minutes may be more interesting as surely the Fed will be discussing the post-taper period.
There have been a few developments to note. First, the recent string of Japanese economic data suggest the toll of the sales tax increase may be greater than officials anticipated. This includes the June industrial production figures released earlier today. The preliminary estimate indicates a 3.3% decline, nearly three times worse than the market expected, and the worst since March 2011. Industrial output fell a cumulative 6.8% in the April-June period. Estimates for July have been revised up (2.5% from 1.5%), but such estimates have shown a clear optimistic bias.
Second, the ECB's bank lending survey was a positive surprise. The survey found that "credit standards for all loan categories eased in net terms" in Q2 and that net loan demand "continued to be positive for all loan categories." Net demand for business loans increased to 4% from 2% in Q1. The net demand for consumer credit increased markedly to 17% from 4%.
There seems to be some disconnect between the economic performance, which appeared to have softened, and the increased demand for credit. This disconnect will likely be seen by officials as a reflection of their policy initiatives, though in fairness, some of the trends, like improvement in lending to households, may have begun before the June rate cuts. Draghi had noted this at his press conferences following ECB meetings.
On the margins, one might suppose that improvement in credit conditions would reduce the pressure for more action, i.e., QE. However, the key here is inflation or deflation. And today's news on that front is not particularly encouraging. Spain reported its harmonized measure at -0.3% year-over-year CPI. It was flat in June, and the consensus was for a -0.1% reading. This is the deepest deflation Spain has experienced since 2009.
The fact that Spain's 10-year yield is at record lows has captured much attention as it slips below US rates. However, as we have noted, we are more concerned about the high real rates. With the -0.3% inflation rate, the real yield is 2.75%. The US is about 50 bp, using the same methodology of subtracting current inflation from the nominal yield. One implication of the high real rate is that it raises questions about the sustainability of the recovery, which the preliminary estimate of Q2 GDP came in at 0.6% (quarter-over-quarter) for a year-over-year rate of 1.2%. Spain is poised to be the fastest growing large EMU member.
German states have reported their July inflation figures as well, and the national estimate is due shortly. The harmoninzed CPI measure is likely to slip below June's 1%. It would be particularly worrisome if it below May's 0.9% pace, which matched the lowest since early 2010.
Lastly, we note that the poor data from Sweden as stopped the krona in its tracks. It is off about 0.5% against the dollar today and a little less against the euro. It was not so much the softer consumer confidence report (99.9 vs 101.3 in June, and 102.2 expected), but the preliminary Q2 GDP of 0.2% was disappointing. It was a third of what the market expected. Recall the euro had raced to almost SEK9.40 on the back of the unexpected 50 bp rate cut in early July. These gains were generally unwound with the euro returned to SEK9.1460 at the start of this week. It has now rebounded above SEK9.24. Technically, the krona appears poised to weaken further, even though the policy implications are minor. Inflation or deflation is thought to be more significant.
Geopolitical tensions continue to run high in both the Middle East and Ukraine. Full details of the new sanctions have not yet been announced, but it is clear that 1) Europe and the US are moving more in sync presently as Europe denies state-owned Russian banks, oil companies and munitions makers the ability to sell news bonds and stocks in Europe. Russian bonds are a bit firmer, and the dollar's gains that had carried it to almost RUB36.0 have been pared. Russian shares up a little more than 2%, recouping much of the ground lost over the past week.
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