|Weekly Market analysis|
The Euro has continued to gain support from an easing structural risks and an improvement in yield considerations with some return of capital. There has also been further speculation that the Euro would gain be default given the aggressive monetary policies in the US and Japan. There will still be important vulnerability surrounding the Euro-zone, especially given the political considerations and risk conditions are liable to deteriorate again over the next few weeks with Asian unease also likely to increase.
Key events for the forthcoming week
The US GDP data has unsettled confidence given the unexpected contraction, but the economy overall is still likely to make solid progress. The PMI data has been generally favourable and there will be relief surrounding investment and housing trends. There will be some unease surrounding consumer spending trends. The Federal Reserve remains committed to aggressive quantitative easing in the short-term through monthly bond purchases, but there will be some pressure for the Fed to moderate policies later in the year. The Fed will also be subjected to international pressures given underlying currency tensions. The dollar will gain some defensive support if fears surrounding Asian growth increase again.
The dollar remained on the defensive against the Euro with losses to beyond 1.36, although the US currency was more resilient on a trade-weighted basis.
The headline US durable goods order data was stronger than expected with a 4.6% increase from 0.8% previously while there was a core 1.3% increase for underlying orders which triggered some boost in confidence surrounding investment levels despite the uncertainties surrounding future Boeing orders.
In contrast, the latest GDP data was weaker than expected with a contraction of 0.1% for the first quarter compared with expectations of around 1%. There was an increase in final demand and the data was undermined in part by a sharp drop in defence spending which suggested that the underlying data was stronger.
The Federal Reserve announced that it would continue its programme of bond purchases at US$85bn per month in the short-term. The Fed was slightly more confident surrounding the growth outlook with a modest labour-market improvement and the Fed also suggested that financial risks had declined. Kansas City President George dissented from the decision due to concerns that policy accommodation would increase longer-term inflation risks
The latest US ADP employment report was stronger than expected with a headline private-employment estimate of 192,000 from a downwardly revised 185,000 the previous month. There was an increase in US jobless claims to 368,000 in the latest week from 330,000 previously. Looking at the moving average, there were expectations of solid, but unspectacular employment growth in Friday’s payroll report. The Chicago PMI index was stronger than expected at 55.6 from 51.6.
Structural fears surrounding the Euro-zone will remain lower in the short-term and there has been a continuing decline in peripheral bond yields. The growth outlook in Germany has certainly improved, but conditions within the Euro-zone as a whole are still very difficult with peripheral recession continuing while the French economic conditions are continuing to deteriorate. There is also the threat of increasing political tensions within Spain and Italy. Overall confidence in the Euro could still falter quickly given the underlying growth vulnerability and there will be pressure for the ECB to relax policy conditions.
The Euro moved to 14-mnth highs against the dollar and advanced strongly for the week as a whole with a further shift in underlying positioning.
The latest Euro-zone money supply data recorded a slowdown in M3 growth to 3.3% from 3.8% the previous month while lending contracted for the eight successive month with a 0.7% annual decline. The data will reinforce unease surrounding monetary growth and the sharp drop in lending to non-financial institutions will be particularly alarming. There will be continuing fears that real economic damage be damaged and there will also be concerns over any further tightening of Euro-zone monetary policy through a stronger exchange rate or early LTRO loans repayments. The ECB data did not suggest that there had been a switch to shorter-term lending to replace the LTRO funds.
The troika will examine the Spanish banks to assess the burden of bad loans and there will be further unease surrounding the housing sector as transactions remain extremely low and prices continue to decline. There was also a very sharp decline in Spanish retail sales.
Following a much weaker than expected German retail sales report, underlying sentiment was boosted by the stronger than expected unemployment data with a seasonally-adjusted decline of 16,000 for December.
There were some fresh concerns surrounding the banking sector following weaker than expected Deutsche Bank earnings. There were also further concerns surrounding the Monte dei Paschi situation, especially given the potential impact on the Italian general election. There were also concerns that plans for monetary union, already facing hostility from within Germany, would suffer a further loss of support. There were also some concerns surrounding allegations of illegal payments surrounding Spain’s governing party, but financial flows still provided important net Euro support.
The Bank of Japan will maintain an aggressive monetary policy in the short-term with a 2% inflation target. The open-ended commitment to bond purchases is not due to come into effect until 2014 and there will be further concerns whether the central bank will actually deliver on the more aggressive policies. The appointment of new Bank of Japan governor will be watched extremely closely over the next few weeks and a dovish appointment would fuel expectations of a substantially weaker yen, although internal tensions would increase. The yen could still gain some support if global risk appetite deteriorates.
The US currency continued to gain significant underlying support from rising US Treasury bond yields with benchmark yields testing the 2% area. Underlying yen sentiment remained weak with solid interest in selling any significant rallies. Asian currency policies will also remain an important focus with countries such as South Korea likely to be increasingly uneasy over the implications of yen weakness.
There was underlying speculation over a dovish Bank of Japan Governor to replace Shirakawa in April which reinforced negative underlying yen sentiment. Current Deputy Governor Yamaguchi stated that it was not directly aiming to weaken the yen
The yen continued to be undermined by expectations of fresh easing by the Bank of Japan and a government commitment to drive the yen down in order to combat deflation even if a weaker exchange rate is not an official policy. There were major concerns surrounding the appointment of the next Bank of Japan governor. Extremely negative sentiment and a flow of funds back into the Euro pushed the yen sharply weaker again late in US trading with the dollar moving to fresh 30-month highs above 92.20 as the Euro rose above 125.50. The yen also failed to gain any respite following the weaker than expected Chinese PMI data.
There will be further concerns surrounding the UK growth outlook which will reinforce fears surrounding government finances. The PMI data will be watched very closely and another set of weak readings would reinforce growth-related fears. Markets will remain on alert for signs of further quantitative easing and will also be monitoring any possible switch to nominal GDP targeting as this could trigger an even more aggressive monetary policy. Defensive capital inflows are liable to weaken in the short-term which will maintain underlying Sterling vulnerability and the currency is liable to lose ground.
Underlying Sterling sentiment remained negative following Friday’s weaker than expected GDP report with fears over a triple-dip recession. The currency was also undermined further by comments from incoming Bank of England Governor Carney who hinted that monetary policy would remain extremely accommodative.
There were rumours of an imminent downgrading of the AAA credit rating and widespread expectations that it was only a matter of time before a downgrade was delivered which maintained the potential for further net capital outflows. There was also be further speculation that the Bank of England andgovernment might consider a change in mandate to nominal GDP targeting.
The latest consumer lending data was stronger than expected with overall lending rising to GBP1.7bn from GBP0.1bn previously. There was also a stronger reading for mortgage approvals and money supply growth which triggered some relief over underlying consumer spending trends. There was also a small improvement in the latest consumer confidence data.
There will be unease surrounding the growth outlook, especially in view of the KOF index deterioration. Given that the Swiss franc was a key beneficiary of defensive inflows during the Euro-zone crisis, there will be further speculation of a reversal in flows now that tensions have eased. There will be further debate over the merit of lifting the Euro minimum level, although the National Bank will continue to be very reluctant to engage in a policy of fine tuning through a small move in the minimum level.
The franc found support near 1.25 against the Euro as volatility remained higher. The dollar remained on the defensive and dipped to lows below the 0.91 level.
The latest KOF business confidence index was weaker than expected at 1.05 from a revised 1.29 previously which will tend to increase concerns surrounding the growth outlook and maintain pressure for franc gains to be resisted.
There was further speculation that the National Bank would covertly aim to push the currency weaker. There was no significant change in the latest central bank reserves data and there will be some expectations that the bank will look to lower the Euro proportion from close to 50%.
The Australian dollar was confined to relatively narrow ranges during the week with resistance on any move to the 1.05 area and it retreated to below1.04. There was evidence of selling against the Eurowhich tended to undermine the currency and there were some longer-term doubts surrounding the Australian and Asian economy.
The domestic economic data provided some support with gains in business confidence and housing sales which provided some degree of relief following a string of weak releases, but the manufacturing PMI data was weak.
The Australian dollar is likely to remain generally vulnerable on cross-related selling together with concerns surrounding the regional and domestic growth outlook.
The US dollar was unable to break above the 1.01 level against the Canadian dollar during the week and moved back to lows below the parity level late in the week with some degree of month-end Canadian dollar support.
The latest GDP data was stronger than expected with a 0.3% increase while there was a decline in producer prices.
The US currency should be broadly resilient on valuation grounds, especially with some increase in concerns surrounding the underlying Canadian fundamentals.