Risk comes off and the USD still suffers
Last week we suggested that the strength of the global recovery remained very much in doubt despite the G8’s optimistic pronouncement and that risk assets (stocks and commodities) were set to weaken further, and that this would support the USD. Stocks and many key commodities did decline on the week (S&P 500 closed below the daily Ichimoku cloud bottom at 1305/1306; CRB commodity index potentially forming an ‘Abandoned Baby Top” bearish reversal pattern on daily candles), but the USD lost further ground anyway. USD weakness is clearly attributable to fresh US data disappointments that have rekindled talk of another round of Fed asset purchases (QE3).
We think QE3 is highly unlikely, but that won’t stop markets from speculating on it, which will keep pressure on the USD until we get some fresh indications from the Fed one way or the other (watch for Bernanke speaking on Tuesday). Also, Congress continues to dither on raising the US debt limit, which led Moody’s to warn of a potential downgrade to US ratings unless progress is made soon, adding further pressure to the greenback. Until a deal is reached, the political stalemate will also weigh on the buck.
But USD weakness was not equally distributed. In particular, we would note the buck was barely changed against the commodity currencies (AUD, CAD, and NZD), suggesting to us that commodity-related markets remain vulnerable. Indeed, USD weakness is typically associated with risk asset (stocks and commodities) price gains and that this did not happen reinforces our view that risk sentiment remains quite vulnerable. In this environment, our preference remains to look for opportunities to get short risk assets on remaining strength, potentially in select JPY-crosses (see the latest Weekly Strategy).
The star performer of the past week was clearly the EUR, which gained against all major currencies except ZAR. The resolution of the latest chapter in the Greek debt saga has given the EUR a healthy lift, but we will be watching closely to see if the pace of recent gains is sustained, or whether NFP-related excessiveness was too extreme. The ECB is meeting on Thursday and the expectation is that Trichet will signal a July rate hike using the ‘strong vigilance’ code words. The single currency seems most likely to remain supported in the run-up to the ECB meeting (barring any major peripheral turmoil over the weekend—see below), but if Trichet fails to signal a rate hike next month, EUR is likely to beat a hasty retreat a la the last meeting on May 5.
Greece passes its test – is the euro on its way to 1.5000?
After a month-long review the Greek Finance Ministry said that the EU/IMF and ECB had concluded “positively” on Friday. While there was little detail on what exactly was positive, it effectively means that Greece is likely to receive the next tranche of bailout funds at the end of this month and is also in the running to get a second bailout rather than return to the capital markets next year.
It is likely that Greece has signed up to even more austerity measures and asset sales to try to bring down its debts organically, rather than having to borrow more money. This makes the public workers strike scheduled for Saturday likely to be the first of many in the coming weeks.
But what is most important to Greece right now is the EU and how supportive it is of Athens. Three dates in June are crucial. On 20th June the Eurozone finance ministers meet and Greece is likely to be top of the agenda. On the 24th European leaders meet, where they are likely to agree to a second round of financial support for Athens; then on the 29th the IMF should release its next tranche of bailout funds.
It’s a crucial month for Athens, but after Friday’s announcement things have become much easier for the Southern European nation and its bond yields actually fell at the end of last week. This gave the euro the green light to rise above 1.4500 on Friday versus the greenback. Investors are rushing into the single currency after signs that the US economy is faltering as well as a cooling in financial pressure in the periphery.
The stage is set for EURUSD to make another stab towards 1.5000. A weekly close above 1.4500 is extremely constructive for the pair and we may see 1.4670 first and then the 1.4850 highs from early May.
But there is one large caveat to this. To start with Portugal holds a snap election on Sunday. Any sign that political turmoil will threaten its deficit reduction program may weigh on sentiment towards the single currency. Banking sector stress tests are also due for release this month (though there have been reports that the Eurozone bank regulator has requested banks to re-submit fresh data, suggesting a possible delay) and Spain has set a deadline of September for its troubled Caja banks to re-capitalize. So there are potential obstacles the euro has to climb to remain well supported. But as long as the prospect of QE3 in the US remains on the table then this should favor the euro over the greenback in our opinion.
Is the BOE getting more dovish?
Last week could end up being one of the most pivotal of the year for the Bank of England. Andrew Sentance, who had voted for 12 straight rate increases (and been voted down on each occasion) left the Committee as his term on the MPC expired.
In a television interview on the day he stepped down Sentance said the Bank risked its credibility by not raising interest rates and allowing inflation to reach 4.5 per cent. However, just as his words hit the airwaves there was further evidence that the economy is slowing and weak GDP in the first quarter is seeping into Q2.
Firstly there was the PMI manufacturing survey, which tumbled to its lowest level since September 2009. Additionally, the services sector survey, which represents the lion’s share of the UK economy, also fell in May to its lowest level since February. Cracks are starting to emerge in the UK’s growth picture and this makes a near-term rate hike extremely unlikely.
This was reinforced when one of the more dovish members of the BOE Paul Fisher said that he was open to the idea of extending the Bank’s asset purchase program if the economy was to contract sharply. He also reiterated his stance on rates, saying that it was too early to hike.
Of course Fisher is only one member of the Committee, but Sentance’s replacement Ben Broadbent, a former Goldman Sachs economist, seems to have a less hawkish bias than his predecessor.
Interest rate expectations for the rest of the year have fallen sharply since February and they remain back at October 2010 levels, when a rate hike was barely priced in for this year. We think that the outlook is too cloudy to pinpoint exactly when the Bank will normalize interest rates, but currently it looks like it may not be until the first quarter of 2012.
Low rates and weak economic data are weighing on the pound. While we think it will eventually grind lower against the dollar, we think it will experience a sharper move against the euro and the Swissie. Although the franc is at record highs versus the pound, we think it may move lower towards 1.3500. We also think that the pound looks more vulnerable than the euro right now, and this supports a move towards 0.9000, the highs last reached at the start of May.
Steady RBA cash rate…for now
Australia’s economy contracted -1.2% in the first quarter as the aftermath of Queensland flooding negatively impacted commodity export volumes. The drawdown in GDP alongside disappointing April employment numbers in the midst of a moderating global recovery will likely see the RBA hold its cash rate steady at 4.75% for the seventh consecutive month on Tuesday.
However, we expect the policy statement to contain hawkish undertones similar to those in the May 3rd minutes – ‘If economic conditions continued to evolve as expected, higher interest rates were likely required at some point if inflation was to remain consistent with the medium term target’ – as Q2 GDP looks set to rebound from firming domestic demand, business investment, and public consumption.
Additionally, a significant factor in Q1’s disappointing GDP print stems from the decline in net exports on the back of the tragic earthquake in Japan – Japan accounts for about 18% of Australian exports. The bulk of such export related losses are likely to remain confined to Q1 which may see external demand alongside domestic demand provide a substantial boost to second quarter growth. Accordingly, we think the RBA may begin tightening policy in July or August but we maintain a bias for an August hike as it would allow the RBA to take into consideration Q2 CPI readings.
RBNZ likely to remain on hold for an extended period
The RBNZ rate decision is set for release Wednesday with the official cash rate (OCR) almost certainly to be kept unchanged at 2.5%. Comfortable core inflation levels, downside economic impacts from the earthquakes, lower export volumes, and the elevated NZD are likely to be the determining factors in steady RBNZ monetary policy.
We think the RBNZ may signal higher rates for 2012 but the recent sharp ascent in NZD is likely to force the central bank’s hand to maintain a steady policy stance for the remainder of 2011. Further supporting the case for continued passive RBNZ policy is the elevated domestic currency – NZDUSD printed record highs this week. Sustained NZD strength at lofty levels would have substantial downside impacts on net exports. This may see the RBNZ attempt to rhetorically weaken the currency but such attempts may be of limited success considering the broader backdrop of USD weakness.
Key data and events to watch next week
- United States: Monday – Fed’s Plosser speaks on Central Banking, Geithner speaks to bankers in Atlanta, Fed’s Fisher speaks in NY; Tuesday - June IBD/TIPP Economic Optimism, April Consumer Credit, Fed’s Lockhart speaks on economy in North Carolina, Fed’s Bernanke speaks on economy in Atlanta; Wednesday –Fed’s Beige Book; Thursday – Weekly Jobless Claims, April Trade Balance, April Wholesale Inventories; Friday – May Import Price Index, May Monthly Budget Statement
- Eurozone: Monday – EZ April PPI, EZ June Sentix Investor Confidence Tuesday – EZ April Retail Sales, German April Factory Orders, EU Commission Assesses Euro-Area Budget Plans Wednesday – EZ 1Q P GDP, German April Current Account Thursday – ECB Rate Decision Friday – German May F CPI
- United Kingdom: Monday – May Halifax House Prices Thursday – BOE Announces Rates, April Trade Balance Friday – April Industrial Production, April Manufacturing Production, May PPI Input & Output, May NIESR GDP Estimate
- Japan: Monday – May Official Reserve Assets Tuesday – April P Coincident & Leading Index CI, May Japan Money Stock M2 & M3, May Bank Lending incl Trusts, April Current Account Total, April Trade Balance (BOP Basis) Wednesday – May Bankruptcies, 1Q F GDP Thursday – May Consumer Confidence, April Tertiary Industry Index, May Domestic CGPI
- Canada: Monday – April Building Permits, May Ivey PMI Wednesday – May Housing Starts Thursday – April International Merchandise Trade, April New Housing Price Index Friday – May Unemployment Rate, May Net Change in Employment
- Australia & New Zealand: Sunday – AU May TD Securities Inflation, AU May ANZ Job Advertisements Monday – AU May Foreign Reserves Tuesday – RBA Cash Target, AU Jun Westpac Consumer Confidence, AU April Home Loans, AU April Investment Lending, AU April Owner-Occupied Home Loans, NZ May QV House Prices Wednesday – AU May Employment Change, AU May Unemployment Rate, AU May Participation Rate, RBNZ Official Cash Rate Thursday to Saturday – NZ May REINZ House Sales
- China: Thursday – May Trade Balance 6/9-15 – May Actual FDI, May New Yuan Loans, May Money Supply M0, M1, M2