FX

March 30th, 2015 7:50 am | by John Jansen |

Via Marc Chandler at Brown Brothers Harriman:

Drivers for the Week Ahead

– The calendar impacts the investment climate with reduced liquidity ahead
– Whether Greece remains in the monetary union remains an open question
– Varoufakis has failed to get other debtor countries like Spain, Italy, and France to defect from the consensus
– Recognizing the more constructive string of economic data, Draghi indicated that this was a cyclical recovery, not structural
– With the BOE clearly on hold for some time, the focus turns increasingly to the May 7 election

Price action:  The dollar is mostly stronger on the day.  The euro received some marginal support from signs of less disinflationary CPI figures for the region, but remains lower now at around $1.0850.  The pound is trading around $1.4855, within the same tight range over the last several sessions.  The Australian and New Zealand dollars are underperforming, falling to just under $0.7700 and $0.7530, respectively.  The US dollar made a clean break above the ¥119.0 level against the yen, but fell short of threatening ¥120.0.  On the EM front, currencies are mostly softer but in small ranges.  The main underperformer has been MYR, falling with lower oil prices.  Asian shares were higher across the board, with the Shanghai Composite up 2.6% on dovish comments by the PBOC governor and the Nikkei up 0.65%.  Euro Stoxx 600 is up nearly 1%, with the Dax back above the 12,000 level.  S&P futures are pointing to a higher open.

  • The calendar impacts the investment climate.  March 31 ends the month, quarter, and for several countries and companies, the fiscal year.  The Easter holiday is typically among the quietest in the capital markets, with many financial centers closed.  After April 1, full liquidity will not return until April 7.
  • At the same time, the dollar, bonds, stocks, oil, and commodity prices more broadly appear to have morphed from trending to consolidative/corrective markets.  There also has been an increase in uncertainty.  The consensus for the timing of the Fed’s lift-off has fragmented.  The ability of the ECB to buy 60 bln euros of assets a month is questioned; even the ECB’s Draghi has played down concerns about a shortage of willing sellers.
  • After nearly a decade of negotiations, an agreement with Iran on its nuclear program appears to have been reached.  It is not clear whether it will be sufficient to appease the skeptics in the US Congress.  Speculation of a deal may have contributed to the sell-off in oil prices ahead of the weekend.  At the same time, Russia appears to be fanning simmering Argentinian animosity toward Britain over the Falkland/Malvinas.  Saudi Arabia is leading a coalition to defend Yemen.
  • Despite the BOJ’s aggressive policy, inflation excluding food (core) and last year’s sales tax increase has drifted lower to zero.  The economy is not contracting as it did between April and September 2014, but the pace of activity is not very inspiring.  The UK election is a little over a month away, and while many recognize the era of single-party rule may be over, there are heightened fears that social divisions (e.g. Scotland, UKIP) will make it more difficult to have a stable coalition government.
  • Whether Greece remains in the monetary union remains an open question.  Recently, Soros suggested the risk was 50/50 but we still don’t think the odds of a Grexit are nearly as high.  Recall in 2010 when the Greek debt crisis emerged, indicative prices at book makers put the odds as high as 70% that Greece would leave.  Although Greek Finance Minister Varoufakis is reputed to be an expert in game theory, it seems that the Greek government knows only one game, and it is brinkmanship.  A brink is approaching as the Greek government runs out of cash.  Reports already indicate that it is conducting swaps with other government institutions to raise cash as a payment to creditors loom at the same time as the wage bill for civil servants and pensions are coming due.
  • Varoufakis has failed to get other debtor countries like Spain, Italy, and France to defect from the consensus.  His tactics have failed to isolate Germany.  His proposal to have tourists and/or students report on tax evasion insults the intelligence of his counterparts, which Varoufakis has also done.  No wonder that he appears to have been sidelined as the brink draws nears.  Rumors circulated before the weekend that Varoufakis, who is not a member of Syriza, resigned, but were officially denied (though we would not be surprised if this were to happen in the coming months).  It may be too late to suggest Dale Carnegie’s classic work “How to Win Friends and Influence People”.
  • The bar to freeing up aid money is not very high.  All the Greek government has to do is submit a list of a few reforms it will implement.  After a couple of false starts, the Tsipras government appears to have down this before the weekend and is being reviewed.  Fitch grew impatient and cut the country’s rating from B to CCC just before the reforms were submitted.
  • The list of reforms reportedly includes higher “sin taxes” on alcohol and tobacco.  The tax on high incomes may be increased.  There will be a greater effort to clamp down on tax evasion.  Reducing the associated penalty is reportedly generating some positive results.  News reports also indicate that Tsipras will also a primary budget surplus half of the 3% of GDP that the EU demanded.
  • Tomorrow, flash CPI readings for March for the entire eurozone will be reported.  A small uptick in prices is expected, rising from -0.3% y/y to -0.1%.  Regional figures out of Germany today and the Spain’s print at -0.7% y/y show diminished deflationary forces.  This will not change the ECB’s commitment to its recently announced asset purchase plan, which is less than a month old.  Insight into the debate about some of the purchases particulars will likely be generated by the account (minutes?) of the ECB’s March 5 meeting, which will be published on April 2.
  • Recognizing the more constructive string of economic data, Draghi indicated that this was a cyclical recovery, not structural.  Tuesday’s unemployment figures will likely bear this out. Despite the modest increase in the euro area economic activity, unemployment in the region is expected to be unchanged at 11.2%.  The depreciation of the euro as well as the decline in interest rates and oil prices will stimulate activity even without structural reforms.  These economic conditions benefit Germany the most, and after a soft patch, the economy re-accelerated at the end of last year and into this start of this year.
  • The IMF’s authoritative report on currency reserves (COFER) will be published at the end of the month.  It will be for Q4 2014.  We expect to see a continued decline in the euro’s share of reserves.  This trend should continue into this year as central banks and sovereign wealth funds are thought to be likely candidates to pare some of their euro bond holdings by selling them to the ECB.
  • The UK economy has been stronger than the eurozone’s but with no increase in consumer prices over the past year, the Bank of England is in no hurry to raise rates.  The implied yield on the December 2016 short sterling futures contract has fallen 50 bp over the past three weeks.  Growth in Q4 2014 is expected to be confirmed at 0.5%, and the January index of services and the three sectorial PMIs will likely underpin expectations for similar growth in the current quarter.
  • With the BOE clearly on hold for some time, the focus turns increasingly to the May 7 elections.  The one television debate that Prime Minister Cameron has agreed to will be held with six challengers on the evening on April 2.  The uncertainty of the election outcome is particularly acute, and this may deter market participation.  We note that the latest Commitment of Traders report for the week ending March 24 showed a sharp pullback by both bullish and bearish speculators.
  • Japan’s February industrial output figures were considerably worse than expected.  IP fell -3.4% m/m against expectations for a fall of only -1.9%, the lowest figure since June of last year. The report illustrates the struggle Japan that is having returning to a consistent growth path after last year’s sales tax increase.  Despite the weakness of the yen, Japanese exports (less than 15% of GDP) were only up 2.4% in February from a year ago.
  • Japan reports the March Tankan on April 1.  While there may be incremental change in sentiment, investors will be more focused on capital expenditure plans.  They are likely to be considerably weaker than the 8.9% pace of the December report.
  • US personal consumption and income data, including the PCE deflator, will be reported today.  A modest increase in income is expected, and after falling (0.2%) in December and January, spending is expected to have increased in February.  The core PCE deflator is expected to be flat at 1.3%.  If there is a surprise, it may come to the upside.  Core CPI has surprised two consecutive months to the upside, and gasoline prices firmed.
  • Separately, on April 1, the US auto sales figures for March will be published.  Industry estimates suggest that the three month declining trend has ended.  The consensus calls for a 16.9 mln unit annual pace, which would be the strongest since last November and better than all but three months last year.
  • On April 2, the US reports February trade figures.  Given the comments about how the dollar’s strength is eating into net exports, the trade balance will draw greater attention than is usually the case.  The US trade deficit averaged $42.3 bln in the twelve months through January 2015.  The monthly average for twelve months through January 2014 was $39.4 bln.  Given the drop in oil prices, the data indicates a significant deterioration in the non-oil trade balance.  
  • The US reports the March employment data at the end the week.  This is arguably the most important monthly economic report.  The market accepts that the Federal Reserve is looking at the labor market more broadly than just the unemployment rate, for which there is risk of a slippage to 5.4%.  Earnings are very much in focus, though Yellen was clear about this in her pre-weekend speech.  Wage growth is not necessary for her to be reasonably confident that the Fed’s mandates will be approached, but weakness could stay her hand:

“I have argued that a pickup in neither wage nor price inflation is indispensable for me to achieve reasonable confidence that inflation will move back to 2 percent over time.  That said, I would be uncomfortable raising the federal funds rate if readings on wage growth, core consumer prices, and other indicators of underlying inflation pressures were to weaken, if market-based measures of inflation compensation were to fall appreciably further, or if survey-based measures were to begin to decline noticeably.”

  • The ADP estimate on April 1 may steal some of the official report’s thunder.  We note that the 20 mln or so employees for which ADP has data are experiencing greater wage growth than employees are nationwide.  However, with an April hike ruled out, the March jobs data may not spark a swing back in the pendulum of market expectations.
  • Of note, Chinese shares rallied further.  The Shanghai Composite rose 2.6% and has gained in 13 of the past 14 sessions.  PBOC Governor Zhou hinted at additional stimulus and the central bank lowered the down payment required for some second home buyers.  After increasing the QFII quota for a large US asset manager last week, officials now indicate that money managers no longer need to be part of QFII program to invest in HK shares through the exchange link.    

 

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