The US dollar began the week consolidating last week's losses after modest follow-through selling was seen in Asia. Soft UK house prices, anticipation of a dovish BOE quarterly inflation report midweek, and some cross-rate selling has seen the sterling under perform. The other major currencies are little changed and the greenback is slightly firmer against most of actively traded emerging market currencies.
Global equities liked the combination of ECB signals and stronger US jobs data, and the MSCI Emerging Markets Index rose to near a three-month high. Asia played a little catch-up, though Europe was managing to extend last week's gains. Meanwhile, European yields continued to fall. The market is anticipating both an ECB rate cut and bond buying and this is particularly evident in the short-end of peripheral curves.
We share four observations to start the new week.
1. The market risks making a fetish of ECB bond buying. Past SMP operations had limited impact on yields. The signal of Operation Reverse Half Twist sent short-term Spanish and Italian rates lower and this has removed the immediate pressure on Spain's Rajoy to satisfy the very pre-condition Draghi indicated for ECB purchases, namely that the "virtuous country" formally request EFSF support. Spain, nor Italy, have bond auctions scheduled for the remainder of the month and this removes some immediate pressure.
According to Bank of Spain figures, the government is paying an average yield of 3.43% to finance its debt in H1, down almost 50 bp from the same year-ago period. The EFSF itself, though, is preparing for a formal request. Before the weekend, reports indicated it was requesting the kind of facilities one would expect if the EFSF were to purchase sovereign bonds, including loan facilities and perhaps a repo facility. Recall that in late July, after Moody's cut the outlook for Germany, France and Luxembourg, it cut the outlook for the EFSF credit rating to negative from stable. Of course, on the one-year anniversary of the downgrade the US credit rating by S&P, one may rightly question the lasting significance.
2. The strongest US private sector non-farm payroll growth in five months will not dissuade market participants from expecting Fed action as early as next month. However, an August jobs report (Sept 7) of equal strength could steady the Fed's hand, while it completes Operation Twist. This week's data may not have the heft to move markets, but will nevertheless be interesting for investors and policy makers. Arguably, the most important report of the week for policy makers will be today's senior loan officer survey. The survey speaks directly on the availability of credit, something that the Fed is particularly sensitive to.
Since output increased faster than hours worked in Q2, there is little doubt that Wednesday's Q2 productivity report will show a clear recovery (~1.5%) after the 0.9% decline in Q1. The June trade balance will help economists fine-tune expectations for revisions of Q2 GDP. US exports have been holding up better than one might have expected, given the slowdown in the world economy. Imports have been fared better in Q2, but it appears that some of this went into inventories. Hence if inventories are drawn down in Q3, imports may diminish. Lastly at the end of the week, the US reports import prices. This report gives insight to the subsequent PPI (Aug14) figures.
3. Both the Reserve Bank of Australia and the Bank of Japan meet in the week ahead. The RBA decision is due early on August 7. Market expectations have swung away from a rate cut as recent string of data, including retail sales, building approvals, new home sales point suggest officials can continue to "wait and see". Given market positioning, the market may be sensitive to comments by the RBA about the Australian dollar's strength, which is tantamount to around 50 bp tightening.
After revising upward its outlook last month, there seems to be little chance that the BOJ will expand its JPY70 trillion asset purchase program at the August 8-9 meeting. The program could be tweaked, as operationally, it has become difficult for the BOJ to execute. Last week for the first time, the BOJ failed to draw sufficient offers for its 2-3 year bond buying program. Two new members of the BOJ board, Kiachi and Sato, are known to be sympathetic to more unconventional easing, but like the RBA, a "wait and see" stance by the BOJ is more likely now.
4. In a little noticed move, the ECB last week granted Bank of Greece's request to boost the cap on the amount of T-bills it can accept as collateral for emergency loans. Recall that the ECB decided on July 20 to stop accepting Greek government and guaranteed bonds as collateral. This will likely be sufficient to keep the deus ex machina working until the Troika makes is decision next month. In the larger scheme, however, the Greek banks do not have the loan book to allow continued borrowing, which requires acceptable and unencumbered collateral, much longer. Greece may be unique, but it may still offer insight into the future of others.