FX

February 29th, 2016 6:44 am | by John Jansen |

Via Marc Chandler at Brown Brothers Harriman:

Baker’s Dozen – 13 Items that Should be on Your Radar Screen

– The year has begun on a tumultuous note, but three sources of stress have eased
– We identify 13 things that investors will be watching in the week ahead

Price action:  The dollar is mostly firmer against the majors.  The yen and the Aussie are outperforming, while the euro and the Swiss franc are underperforming.  The euro is trading lower around $1.09 after lower than expected CPI data, while sterling is trading lower around $1.3850.  Both are making new lows for the cycle.  Dollar/yen is trading back below 113.  EM currencies are mixed.  TRY, ZAR, and INR are outperforming while CZK, CNY, and PHP are underperforming.  MSCI Asia Pacific was down 0.4%, with the Nikkei falling 1%.  MSCI EM is down 0.5%, with the Shanghai Composite down 2.9% and the Shenzen Composite down 5.4%.  PBOC cut reserve requirements after Chinese markets closed.  While it was too late to help Chinese shares, the reserve cut helped European bourses recoup some earlier losses.  Near midday in London, the Dow Jones Stoxx 600 is off about 0.8%, led by a 1.1% drop in financials.  Banks and diversified financials are bearing the brunt.  The S&P 500 also recovered from earlier steeper losses.  The 10-year UST yield is down 2 bp at 1.74%, while European bond markets are firmer.  Commodity prices are mixed, with oil mixed, copper up slightly, and gold up nearly 1%.

The year has begun on a tumultuous note.  The Nikkei, DAX and S&P 500 all gapped lower the first day of the year.  However, heightened anxiety has calmed as the fire appears to have burnt itself out, and equities have moved higher over the past two week.  

Three sources of stress have eased.  First, investors are no longer taking their cues by what happens to Chinese stocks.  Second, the yuan has stabilized.  The onshore yuan is off 0.9% so far this year, while the offshore yuan is up 0.2%.  In February, the onshore yuan is up 0.4%, and the offshore is up 0.6%.  

A third source of anxiety has been the risk of a recession in the US after a dismal Q4 15.  However, growth was revised up to a 1.0% annualized pace, which, while disappointingly low, is not a harbinger of a recession.  To the contrary, most of the key real sector data, like the employment details, retail sales, manufacturing output and durable goods orders point to an economy that is rebounding in Q1 16.

Moreover, despite past decline in oil prices and dollar strength, both the core CPI and core PCE deflator have risen to new 2-3 year highs.  Fed hiked rates in December, but it did not knock the US economy into a recession as the doomsday talk suggested.  Meanwhile, between Brexit fears, and disappointing eurozone data (PMIs and preliminary February CPI), and new threat of stagnation and deflation in Japan, the contrasting macro picture seems distinctly dollar supportive.

We identify 13 things that investors will be watching in the week ahead:

1.  US employment:  Slack in the US labor market continues to be absorbed.  The consensus calls for a modest improvement from the 151k (158k private sector) increase in January.  The trend lower in weekly jobless claims favors another healthy report.  Earnings growth may rise 0.2% which is needed to keep the year-over-year rate steady at 2.5%.  The combination of continued improvement in the labor market and gradual increases in core inflation will likely support officials to continue to normalize monetary policy.  While the market turmoil and the decline in inflation expectations may keep the Fed steady in March, we anticipate a hike in Q2.  Separately, auto sales will be reported on March 1.  A sequential increase is expected, which may be picked up by the next retail sales report, and points to rebounding consumption, the single largest economic driver, in Q1.  

2.  Super Tuesday:  For many, the US presidential contest has thus far been an entertaining distraction.  However, things are about to become more serious.  On the Democratic side, Sanders may stay until the end, but after the primaries on March 1, Clinton will probably have secured almost 2/3 of the delegates needed to secure the nomination.  On the Republican-side, Trump is ahead in nearly every poll for the states that have primaries or caucuses on Super Tuesday.  Investors have yet to respond to the risk that Trump gets the Republican nomination.  While many are talking about who can stop Trump, in our experience, the hubris that is on display is often its own nemesis.  

3.  German politics:  Even if investors have not reacted to the prospects of a Trump victory, they are talking about it.  In contrast, there is a shift taking place in German politics that the event markets are implying about a one in three chance that Merkel is not in office at the end of the year.  In themselves, any one state election in Germany is not particularly significant.  However, the trend matters.  Municipal elections will be held in the Hesse on 6 March.  A week later, three states (Baden-Wurttemberg, Rhineland-Palatinate, and Saxony-Anhalt.  The AfP party that had been born as an anti-EU party has become among the most vocal critics of Merkel’s refugee stance.  It was not around to participate the last time the states had elections in 2011.  

4.  Spanish and Irish governments:  Spain’s elections were in December.  Finally, a minority coalition of the Socialists (PSOE) and the new centrists (Ciudadanos) will seek investiture by parliament.  The two parties together hold 130 of the 350 seats.  It needs to secure an absolute majority in the first round.   It will likely fail, and the markets may respond negatively.  However, it is the second round that is key, which likely would be held before the weekend.  Here only a simple majority is needed, so abstentions by the opposition could pave the way for a minority government.  Failure to secure parliamentary approval likely will force a new election.  

The results of the Irish election are not final.  It may take another day to two to sort it out.  Fine Gael likely remained the single biggest party but received a little more than a quarter of the voters.  Kenny ran a poor campaign and may not lead the next government.  Fien Gael’s traditional rival, Fianna Fail, appears to have gotten around 22% of the vote.  In Ireland’s electoral system, that would likely be sufficient to forge a majority.  However, what seems to be clear is that the most stable government between the two largest parties is politically awkward.  The current junior coalition member Labour looks to have done worse than expected.  It may have secured a little less than 8% of the vote.  Sinn Fein, new parties, and independents seem to have gained.  The anti-elitist pushback is evident even in Ireland, whose economy continues to be among the fastest growing in EMU.   Like Spain and Portugal before it, the electoral result of political fragmentation appears to be the second phase of the economic and financial crisis.

5.  RBA meeting:  The Reserve Bank of Australia is the first of several central banks that meet in March.  It will likely maintain the current record low cash rate of 2%.  None of the 27 respondents to the Bloomberg survey expect a change.  Governor Stevens has indicated a wait and watch mode.  The RBA has shaped expectations by noting that the low inflation gives the central bank the flexibility to ease policy if necessary.  Another poor labor market report (March 16) though could push the central bank into using that flexibility.  The Australian dollar has been trending higher since mid-January, appreciating about 6.5% against the US dollar.  However, the price action before the weekend was poor, with a one-day reversal pattern recorded, encouraged perhaps by the RBA’s Edwards expressing the desire of the Aussie to be nearer $0.6500.    

6.  China PMIs and NPC:  The market has taken on board that the Chinese economy has slowed. However, it does appear the economy may be stabilizing.  The PMIs are being looked upon for confirmation.  Chinese have made two points for global investors.  First that it is not seeking a large devaluation.  Some hedges might be pushing for it, but Chinese officials have spent several hundred billions of reserves to offset some of the pressure.  The main criticism levied against China was not about what it was doing, but the transparency of its operations and its communication.  The fourth session of the 12th National People’s Congress will open on March 5.  Although the role of China’s legislature still seems to be evolving, the concentration of power by President Xi warns against expecting fresh initiatives.  Still the event will offer an opportunity to the reiteration of some broadside economic, social and political goals.  

China hinted last week at scope for monetary and fiscal support and it wasted no time.  After local markets closed, the central bank announced a 0.5% cut in the required reserve ratio.  It now stands at 17%.  Further easing seems likely this year.  

7.  Swiss referendum:  The Swiss people go to the polls today, February 28 to vote on four initiatives.  There is only one that has potential direct impact on international investors.  It is the motion that would ban speculation in foodstuffs which could, if passed, impact producers such as Nestle.  Two other initiatives will be of interest.  The first is calls for the expulsion of foreign-born lawbreakers, and the second calls for enshrining the traditional definition of marriage.  The final initiative is about another tunnel through the Alps.  

8. Eurozone data:  The case for additional action by the ECB at the March 10 meeting is based on the poor economic outlook and the failure thus far to offset disinflationary forces.  The eurozone’s February inflation report disappointed and this weighed on the euro as it is seen adding to the likelihood that the ECB eases policy next week.  The headline rate tumbled to -0.2% from 0.3% in January.  This is the first negative price since last September, and matches the decline posted last February.   It is tempting to blame it on energy prices, and no doubt it played a role.  However, the core rate fell to 0.7% from 1.0%.  The PMIs may pick up additional softness in the periphery, and the price index and the forward-looking new orders components were already disappointing.

We have emphasized the divergence between the US and Europe.  It extends beyond monetary policy.  It includes the dealing with the non-performing loans at banks.  The divergence is also about labor.  Using comparable definitions, the eurozone will report a 10.4% unemployment rate in January.  Eurozone unemployment peaked at 12.1% in March and April 2013.  US unemployment peaked at 10% in October 2009.  In January, it stood at 4.9%.

The eurozone has also generated less aggregate demand.  This will be illustrated with the January retail sales report.  January sales are expected to have risen 0.1% for a 1.3% year-over-year pace, the slowest since November 2014.  On the back of such data, and ahead of the ECB meeting, it is difficult to see a compelling case for discretionary traders to increase euro exposure.    

9.  Non-EU Europe:   Two countries stand out.  The UK, where Brexit fears have given sterling a drubbing, and Sweden where the central bank is pursuing aggressive monetary policy despite strong economic activity and a large current account surplus.  The price action in sterling suggests the selling has not consumed itself.  It is not so much that investors we talk with anticipate the UK leaving the EU, but rather they are taking precautions.  Softer UK economic data, especially from the service and manufacturing PMIs, will do sterling few favors.  The Brexit debate has also been infused with anti-establishment flavor.  

The news stream is not all poor.  Sweden reported nearly twice the growth as the consensus forecast for Q4 15.  The 1.3% quarter-over-quarter pace compares with a 0.7% consensus call.  It was no fluke.  Growth in Q3 was revised to 1.0% from 0.8%.  The year-over-year pace accelerated to 4.5% from a revised 4.1%.  The krona strengthened on the news to its best level against the euro since the start of the month.  The euro is toying with the 61.8% retracement of this year’s advance that took it from SEK9.1220 on December 30 to SEK9.6130 on February 11.  That objective is found near SEK9.31.    Although Sweden is experiencing lowflation and the central bank is engaged in aggressive unorthodox policies (bond purchases as well as negative rates), the economic growth is among the strongest in Europe.  

10.  Canadian data:  Canada is continues to struggle with its terms of trade shock.  The economy is stagnant.  GDP may have risen by 0.1% in December, but Q4 growth was likely flat.  The central bank is signaling it is waiting for the new government’s budget, which may still be six weeks away. The recent strength of the Canadian dollar (~8% since mid-January on a trade-weighted basis) and backing up of interest rates (20 bp increase of the two-year yield since February 11) is a premature tightening of financial conditions.  

11.  G20:  It seemed that it was only after Asian equity markets fell did reports begin suggesting disappointment with the G20 meeting.  The narrative followed the price action rather than the other way around.  Before that at least one news wire claimed China was the winner of at the G20 meeting.   Its currency policy was not criticized.  Many, including US Treasury Secretary Lew, welcomed China’s clear communication and commitment to avoid a large depreciation of the yuan.  The final statement expressed interest in looking into the expansion of the SDR, a favorite hobby-horse of the PBOC.

However, this is to exaggerate expectations that the G20 were going to launch a new initiative.  Although the IMF seemed to call for some unspecified global coordinated effort, there was no political will for it, and that was obvious before the weekend.  Moreover, the key concern about China is about the divergence between what officials say and what they do.  The intentions of officials remain opaque.  Today’s is the fifth consecutive session that the yuan has fallen.  It closed at its weakest level since the markets closed for the Lunar New Year.

The G20 meeting seemed more concerned about yen weakness than yuan’s decline, and this despite the strong rise in February (~7.25%).  However, the discussion probably means that the bar is high for BOJ intervention, which it has confirm it did not conduct this month  (contrary to some market rumors) and for fresh monetary action at the BOJ meeting in mid-March.  However, Japan reported poor economic data.  It is true that January industrial output jumped 3.7% (consensus was 3.2% after 1.7% decline in December).  However, this seems to be a seasonal distortion. It was the strongest report since January 2015 when industrial production rose 4.1%.  Perhaps more telling is the 3.8% year-over-year decline, twice the pace in December.  Separately, Japan reported a 1.1% drop in January retail sales.  It was expected to have risen 0.1% after the 0.3% fall in December.  Despite the weakness in the economy and retail sales in particular, Prime Minister Abe has confirmed intentions on stick with the retail sales tax hike planned for April 2017.

12.  Iran election:   Iran appears to have supported what is seen as the moderate regime of President Rouhani who oversaw the nuclear negotiations.  A victory for the moderates is seen as favoring a new opening up of Iran to foreign investment.  The results may boost Rouhani’s chances to be re-elected in next year’s presidential contest.  Rouhani directed the strategic decision to accept a freeze of its nuclear ambitions for the lifting of the sanctions.  He cannot now offer to limit Iranian oil exports to participate in an effort to boost prices.  

13.  Brazil central bank:  The central bank meets March 2.  The concern about the deepening recession likely will more than offset the inflation worries.  The Selic rate is expected to remain steady at 14.25%.  The real is flat this month and off a little less than 1% year-to-date.  While this is better than most emerging market currencies, the political and economic climate is worrisome, and our proprietary model warns of further downgrade risks.      

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