PCE core deflator (Apr): still close to the upper limit of the Fed's comfort zone
ISM indices (May): increasing but still indicating contraction
Non-farm payrolls (May): another decline of more than half a million jobs
Personal income is likely to have fallen by 0.3% mom again in April, as average hourly earnings only rose modestly and aggregate working hours declined by 0.6%. Given the decline in retail sales, we forecast that personal spending will have decreased by 0.2% mom in April. We expect the PCE core deflator to have increased by a good 0.2% mom in April, slightly less than core CPI. The annual rate could thus have remained at 1.8%, which would still be close to the upper limit of the Fed's comfort zone. In its projection update, the FOMC raised the range for the core PCE deflator slightly to 1.0 to 1.5% for this year, but, due to the weak labour market and a record amount of idle production capacity, the committee expects the core PCE deflator to 0 range from 0.7% to 1.6% in the next two years.
Since January, the ISM manufacturing index has improved for four consecutive months, albeit remaining well within the contraction zone. In May, the Philadelphia Fed index and the New York Empire manufacturing index in particular rose to much less negative levels, and the Richmond Fed index even entered positive territory. In contrast, the Chicago PMI fell back sharply from 40.1 to 34.9. All in all, we forecast that the ISM manufacturing index will have increased slightly to about 41.0 at best in May. The automotive shutdowns could have prevented a larger improvement.
The ISM non-manufacturing, which had fallen in March, recovered noticeably in April. We expect it to have gone up again, albeit more moderately, to 44.5 in May. Thus both ISM indices would still have remained well below the expansion threshold.
Construction spending increased unexpectedly in March, as public and nonresidential private construction spending in particular rose sharply and the decline in residential construction spending slowed somewhat. Public spending might have risen again in April, but we expect a noticeable downward correction in commercial spending and a continued decline in residential spending. Therefore total construction spending could have fallen by about 2% mom in April.
Pending home sales went up in February and March, and due to increased housing affordability, tax incentives and low mortgage rates, we forecast that pending home sales will have risen again by about 0.5% mom in April. Factory orders are likely to have gone up by 1.2% mom in April, as durable goods orders rebounded because of defense and transportation orders, and non-durable goods orders could also have increased because of higher gasoline prices in particular. However, the April rise will not fully compensate for the March decrease, which could be revised from -0.9% to about -1.5% mom.
Initial jobless claims fell by 13k in the week ending 23 May, and the 4-week moving average declined for the second consecutive week too. We expect initial jobless claims to have remained stable at their current elevated level in the week ending 30 May.
Given that Q1 business output declined by 7.6% instead of 8.2% as initially announced, the rise in nonfarm productivity is likely be revised up from 0.8% to 1.4% qoq annualised, whereas the increase in unit labour costs could be lowered from 3.3% to 2.7%.
The ADP report showed a decline of 491k private jobs in April, much less than in March (-708k) - probably related to the decline in jobless claims in the 2nd week of April, as ADP uses these data for its estimate of the change in payrolls. However, jobless claims were significantly higher again in the relevant week in May, and thus ADP private payrolls could have declined by about 560k.
Non-farm payrolls decreased by 539k in April, compared to -699k in March. Temporary government jobs related to the 2010 census were the main reason why the decline was not as sharp. We therefore expect the government to have made a positive impact again, but otherwise the labour market situation remains extremely unfavourable and we predict that non-farm payrolls will have fallen again by about 540k in May. The unemployment rate, which has risen by 2.6 percentage points in the last six months alone, could have gone up from 8.9% to 9.2%. But average hourly earnings might have increased by a mere 0.1% mom again, lowering the annual rate from 3.2% to 3.0%.
BHF-BANK http://www.bhf-bank.com This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK Group") solely for the information of its clients. The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities.
The US dollar remained under selling pressure this week, as data raised hopes of a global economic recovery. Equities and commodities rallied higher, with crude oil pushing above $65 for the first time in six months and gold breaking through $975. This saw commodity currencies head higher, with the New Zealand, Canadian and Australian dollars posting the biggest gains against the US$ in the G10 this week. NZD/$, AUD/$ and CAD/$ all set fresh 2009 highs, with momentum still appearing strong behind them. The UK pound was buoyed by data showing the second rise in house prices in the last 3 months according to the Nationwide, helping £/$ climb to 1.6183 on Friday, the highest since November. £/$ closed the week up 1.6% at 1.6156. The news that euro zone inflation had fallen to zero for the first time in May failed to prevent €/$ from pushing above 1.41 on Friday for the first time in 2009. It ended the week 0.9% higher at 1.4135. However, €/£ closed lower for the third successive week at 0.875. The yen and Swedish krona were the only G10 currencies to close lower against the $ this week.
In emerging markets, the high-yielding South African rand and Icelandic krona posted the biggest gains against the US$ this week. $/rand eased below 8 for the first time since September, in spite of the central bank cutting interest rates to a three year low of 7.5%. Concerns about regional instability, following the testing of nuclear missiles by North Korea, led Asian currencies to post the largest falls against the US$ this week.
Although it was a relatively quiet week for major data and events in the UK, the pound appeared to benefit from their overall positive tone. First, the BBA reported that mortgage approvals had picked up in April, then later the Nationwide reported house prices jumped by 1.2% in May, easing the annual decline to 11.3% from 15% in April. The Gfk consumer confidence index was steady at -27 in May, however that still matched the highest reading for 11 months. After a surprisingly strong bounce last month, probably boosted by Easter sales, the CBI distributive trades survey headline index fell back to -17 in May, from +3 in April. However this was still well above the -44 outcome in March, while the quarterly index of retailers' optimism improved to the highest since November 2007.
Although starting the week on a firmer footing, after fears about nuclear missile tests in North Korea, the dollar came under renewed selling pressure towards its close. However, US economic data this week were largely supportive of a possible return to GDP growth in the third quarter. The Conference Board's consumer confidence index posted another strong rise in May, hitting an 8-month high of 54.9, up from just 26.9 in March. Durable goods orders rose by a solid 1.9% in April, while both existing and new home sales posted modest rises. The second estimate of US Q1 GDP showed the economy contracted by an annualised 5.7%, up from a fall of 6.1% in the preliminary estimate. There was also grounds for optimism in the euro zone this week, after the German IFO survey posted its second consecutive rise in May and the euro zone economic confidence index rose to a 6-month high
Interest rate market review - bonds, cash and swaps
US 10-year treasury yields hit a 6-month high of 3.75%, despite decent demand in the auctions and talk of further asset purchases by the Fed. Five-year swaps surpassed 3% for the first time since November. Instead, increasing concerns about the rising fiscal deficit weighed on treasuries, despite Moody's affirmation that the country's AAA rating is stable. Reports of MBS-related selling also exacerbated the rise in yields. Further out on the curve, 30-year treasury yields hit a 9-month high of 4.65%, raising concerns about the impact of higher mortgage rates on any potential recovery in the housing market, while 30-year swap spreads were the least negative for four months. Case-Shiller figures showed US house prices continued to fall sharply by 18.7% on the year, while new home sales in April were weaker than expected and Q1 mortgage delinquencies rose to 9.12%, including a rise in subprime delinquencies to nearly 25%.
At the short end of the US curve, 2-year treasury yields rose and touched 1% for the first time in three weeks, but the 2s/10s spread nevertheless continued to rise. Other US data showed an upward revision to Q1 GDP to a quarterly annualised contraction of 5.7%, compared with the 6.1% fall in the advance estimate. The surprisingly strong rise in the Conference Board consumer confidence index to 54.9 in May earlier in the week helped pull treasury yields off their lows and set the stage for the sell-off later in the week. Strongerthan- expected durable goods orders data also weighed on treasuries. Ahead of next week's release of labour market data, initial jobless claims remained above 600k, though the 4-week average has edged down slightly, which may signal that the pace of decline in non-farm payrolls eased in May. However, further Fed asset purchases and a lack of supply next week may support treasuries. Dollar 3m libor fell again this week, but only marginally to 0.656% from 0.660%.
In the euro zone, German 10-year bond yields rose to a 6-month high of 3.69%, pulled higher by US treasury yields. Yields at the short end also increased, despite a smaller-than-expected rise in the German IFO business survey, a fall in euro zone annual May CPI to 0% and decent bid/cover for the inaugural 2-year schatz. Moreover, M3 money supply and private sector credit growth continued to moderate. That said, the German unemployment rate fell unexpectedly to 8.2% in May. Over the week, 5-year swaps rose above 2.90% and ended the week up 9bps at 2.84%, while euro 3m libor edged up for the second consecutive week to 1.27%.
Gilt markets were driven largely by developments overseas, as 10-year yields rose to 3.84%, the highest level since February, while 30-year yields stayed around recent highs. Sterling 3m libor fell further to 1.28%, while 5-year swaps recovered from a low of 3.08% to end the week at 3.28%. Departing MPC member Blanchflower said that the economic recovery is likely to be slow and that there may be many 'false dawns', as unemployment is set to still rise significantly. Nationwide reported an unexpected rise in house prices in May, which was the second monthly rise in three months, while figures from the BBA showed a small rise in the number of mortgage approvals. Although housing market conditions have improved recently, it is could be too early to see this translating into a sustained period of rising house prices. The Halifax measure, due next week, has been notably weaker in recent months. Other figures showed the GfK consumer confidence index stayed at a weak level of - 27, while the CBI distributive trades survey indicated that retail activity deteriorated in May, though the recent monthly trend had improved.
The Bank of England and ECB are expected to keep respective benchmark interest rates on hold at 0.5% and 1% next week. The BoE is not expected to make any new announcements on the asset purchase facility, which was recently expanded to £125bn, but the ECB is expected to provide details of its plan to purchase €60bn of covered bonds. Elsewhere, the RBA and BoC are also expected to leave interest rates unchanged at 3% and 0.25%, respectively.
Full Report in PDF Lloyds TSB Bank http://www.lloydstsbfinancialmarkets.com Disclaimer: Any documentation, reports, correspondence or other material or information in whatever form be it electronic, textual or otherwise is based on sources believed to be reliable, however neither the Bank nor its directors, officers or employees warrant accuracy, completeness or otherwise, or accept responsibility for any error, omission or other inaccuracy, or for any consequences arising from any reliance upon such information. The facts and data contained are not, and should under no circumstances be treated as an offer or solicitation to offer, to buy or sell any product, nor are they intended to be a substitute for commercial judgement or professional or legal advice, and you should not act in reliance upon any of the facts and data contained, without first obtaining professional advice relevant to your circumstances. Expressions of opinion may be subject to change without notice. Although warrants and/or derivative instruments can be utilised for the management of investment risk, some of these products are unsuitable for many investors. The facts and data contained are therefore not intended for the use of private customers (as defined by the FSA Handbook) of Lloyds TSB Bank plc. Lloyds TSB Bank plc is authorised and regulated by the Financial Services Authority and is a signatory to the Banking Codes, and represents only the Scottish Widows and Lloyds TSB Marketing Group for life assurance, pension and investment business.
A busy week for central banks; the ECB may steal the limelight
Key data and events to watch next week
USD weakness nearing extreme levels
The US dollar consolidated for much of this past week, only to relapse into fresh weakness on the last trading day of the week/month. Healthy demand at US Treasury debt auctions and affirmations of US credit ratings by two rating agencies failed to stem the exodus from the USD, as fears that US deficits will inevitably lead to a weaker USD continue to dominate investor sentiment. The weakness in the USD has evolved into a full-blown downtrend, with commodity prices rallying sharply and gold prices finally surmounting the sticky 965/967 level. A vicious cycle of dollar weakness/commodity strength will eventually short-circuit itself, as higher commodity prices would undermine consumer spending and de-rail economic recovery, but not before potentially running further. While we continue to view the medium-term (multi-month) outlook for a sharp rebound in economic activity (see below) as highly premature, the investor stampede to own risk appears similarly highly resilient. Even the looming bankruptcy of the largest US automaker has left recovery sentiment apparently unfazed, but probably only because it has been expected for months now.
One important element of the flight from the USD has been a synchronous exit out of longer-dated US Treasury securities. While we see no technical indications of an imminent rebound in the USD, the rally and subsequent collapse in 10-year Treasury yields this week suggest that the heaviest selling there may be done, potentially providing the USD with some support. We would note that US deficit funding fears seem overblown in the wake of this past week's $101 bio 3/5/7 year debt issuance, with foreign participation remaining healthy, but showing a preference for shorter maturities. Looking ahead, it seems unlikely that there will be a single catalyst that turns sentiment more bearish. More likely, a slow trickle of more negative economic data in coming weeks may provide investors with reasons to re-think current optimism. In this vein, the US experienced several negative data surprises this past week (Chicago PMI, mortgage delinquencies, and weak housing data), but this only served to highlight the weak US outlook and exacerbate USD weakness. We will be closely monitoring employment data in particular next week, with increases in Eurozone unemployment rates potentially highlighting the risks ahead on the Continent. As well, we are mindful of the upcoming G8 summit in Italy on June 12-13, and the potential for USD weakness to be cited as a concern. In the last two weeks, we have heard Japanese, EU, and Canadian officials voice concern over the rapid appreciation of their currencies, suggesting a consensus against further USD weakness may be building. US Treasury Sec. Geithner's trip to China may also see some important statements on the USD (see below).
In terms of price levels, EUR/USD broke above a bull flag consolidation pattern with the move up over 1.3960/70 on Friday, potentially targeting additional gains to the 1.4500/30 area. We think the immediate upside remains in play while that break level is sustained. However, the 1.4150/4250 area sees some significant resistance from multiple Fibonacci retracement levels, and the top of the weekly Ichimoku cloud is at 1.4184. USD/JPY seems content to trade broadly between 94/98. In GBP/USD, the 1.5750/5800 area looks to be key support for the overall move higher, while upside targets are now toward the 1.6600/6750 area. AUD/USD still has potential higher while holding above 0.7800/30 and gains look set to target the 0.8350/8400 area. JPY-crosses seem likely to remain well supported until there is a more significant setback for stock markets; we are watching the 875/930 levels in the S&P 500 as likely break-out points. Gold looks on track to re-try the mythical $1000 level for a third time, but the 965/967 level needs to hold as support, or it's a false break higher. In general, we will be alert for any sudden reversal of this past Friday's moves as it would suggest the key breaks were false and more heavily driven by month-end trading conditions. Mr. Geithner goes to Beijing
US Treasury Sec. Geithner will meet with top Chinese officials on June 1-2 in his first trip to China since taking over Treasury. His ostensible purpose is to thank China for doing its share to support the global economy with a sizable fiscal stimulus package and to urge them to move away from an export driven economy and toward greater domestic consumption. Chinese officials on the other hand are more likely to express concern over the value of the USD and to seek assurances that US deficit spending will eventually be reduced. In term of official comments, we would think that Chinese officials are most likely to express confidence in the US administration's efforts to rejuvenate the US economy, which may be interpreted as a commitment to continue buying US debt and support the USD. For the Chinese to signal anything less would be taken as an extremely negative sign for Treasuries and the USD, of which they are massive holders and presumably do not wish to devalue unnecessarily. For his part, Mr. Geithner is likely to repeat the strong USD mantra on more than one occasion. Positive soundings from China could be a significant catalyst to stabilize the greenback and possibly trigger a rebound. Data suggest recession still far from over
The US economic data this week left some doubt in the notion that the recession is quickly coming to an end in the months ahead. Reports in the consumer, housing and business space were lackluster at best and some even showed renewed weakness. Here we offer a brief review.
The most upbeat reports came on the consumer confidence front. The Conference Board index pushed higher in May as the expectations component jumped to 72.3 from 51.0 the prior month. The present situation read increased modestly to 28.9 from 25.5, so it is clear that hope continues to drive confidence. The employment differential (which measures jobs hard to get minus jobs plentiful) improved to -39.0 but remained below the -34.0 January read. This coupled with the new record high in continuing claims, which are quickly approaching the seven million mark, suggests another bleak employment report is in the offing on June 5. Should employment losses continue at current levels for the foreseeable future, we would expect confidence to retrace. The jump in oil prices this week (on another huge decline in inventories) to above $66/bbl will not bode well for expectations once this trickles through to higher prices at the pump. Comparisons between the tech and oil bubbles suggest that $50-70/bbl could be the new normal for some time.
Housing remained on shaky ground and the forward looking statistics do not suggest a turnaround anytime soon. The April existing home sales report showed a worsening in the inventory overhang to 10.2 months' worth of supply from 9.6 prior. Prices collapsed to a -15.4% annual rate (worst since January) as nearly half of the sales came from the distressed properties space. Speaking of homeowners in duress, we also got the 1Q mortgage delinquency data and it flashed a spike in the default rate to a new record 9.1% from 7.9% the prior quarter. Subprime mortgages saw the delinquency rate jump to a staggering 25.0% from 21.9% to boot. The rub here is that these numbers occurred during a period when many US banks engaged in a foreclosure moratorium at the behest of the US government. This means that the 2Q numbers are only likely to get worse. And it also looks like mortgage rates are about to go higher. The recent back-up in Treasury yields has seen the 30-year Treasury to 30-year mortgage spread narrow to just 45 basis points, the lowest since early 2005. We find it hard to believe that banks will continue to provide such cheap lending rates should government yields continue their upward trajectory (isn't that what got us into the subprime mess to begin with?). Bank rates react with a bit of lag, but the recent narrowing in this spread suggests 30-year mortgage rates are on their way back up towards a 6% handle.
On the business side, things are looking anything but up. While the "stellar" April durable goods report (up 1.9% on the headline vs. expected 0.5%) had many jumping for joy and once again calling the end of the US recession, the details suggested the exact opposite. The core number, which excludes the notoriously volatile defense and aircraft components, actually fell -1.5% on the month to match the cycle low annual run-rate of -24%. The Chicago PMI report also disappointed in a major way. The headline collapsed to 34.9 in May from 40.1 but that wasn't the worst of it. The details of the report were downright ugly. The standouts were employment which sank to a new cycle low 25.0 from 31.8 and new orders which relapsed to 37.3 from 42.1 the prior month. If past is prescient, we could be setting up for a dismal ISM report on June 1. Both durables and Chicago PMI provide an ominous sign for 2Q capital expenditures as the hand-off will be similar to what we saw in 1Q. The lack of business investment will continue to put pressure on jobs and this in turn will hurt retail activity in the months ahead. Bottom line, we are far from out of the woods in this economic downturn. A busy week for central banks; the ECB may steal the limelight
The week ahead brings policy meetings from the ECB, BOE the RBA and the BoC. The market is not expecting any of these central banks to change policy though the rhetoric will be closely examined for any signs of cautious optimism. In May, both the BoE and the ECB were more dovish than the market had expected. Not only did the BoE surprise the market by extending the amount of its quantitative easing by GBP 50 bln to GBP125 bln, but this was followed a week later by the Inflation Report which introduced the risk that UK growth this year could contract by as much as 6% y/y during the first part of this year. Despite the dovish tone of the BoE, it is likely to take a couple more months before it has bought its present quota of bonds suggesting scope for policy surprises from the BoE this week is limited. Sterling may trade cautiously ahead of the policy meeting but it is probable that consumer confidence and PMI data will garner a bigger market reaction. The ECB may therefore be the more interesting policy meeting.
In the press conference that followed May's ECB meeting, President Trichet was keen to make the point that 1% was not necessarily the floor for interest rates. While the May rate cut had been anticipated, the announcement that the ECB would buy covered bonds had not been. As yet, the EUR has not suffered from the ECB's plan to use unconventional policy, since the small amount outlined by the ECB last month (EUR60 bln) is no match floor the quantitative easing policies adopted by both the Fed and the BOE. On June 4 the ECB should put some flesh on the bones of its bond buying plan. The market should also pay close attention to any comments regarding the outlook for inflation. Following the May policy meeting Trichet commented that inflation will turn negative mid-year. The impact from lower energy prices (which helped drive Eurozone CPI to flat y/y in May) should be temporary and therefore this does not contribute to fears of deflation. However, there is talk that the weakness of the real economy in the Eurozone may be translating into more sustained downward pressure on inflation. If the ECB agrees with this outlook, the chances of further rate cuts in the months ahead will rise and this will weigh on the EUR. Key data and events to watch next week
The US data calendar has some top tier events lined up. The action kicks off Monday with personal income/spending, ISM manufacturing and construction spending. Tuesday brings pending home sales and motor vehicle sales while Wednesday has ADP employment, ISM services and factory orders on deck. We'll see the usual weekly jobless claims on Thursday along with nonfarm productivity. Friday rounds out the week with the all-important employment report and consumer credit. Look for comments from Treasury Secretary Geithner as well, who will be holding talks with officials in China early in the week (could be important for the US dollar). Fed Chairman Bernanke will also testify before the House budget committee on Wednesday.
It is top-tier week in the Eurozone as well. PMI manufacturing is up on Monday while Tuesday has eurozone unemployment and French producer prices on tap. Wednesday brings the PMI composite measure (manufacturing and services), eurozone GDP and eurozone producer prices. Thursday is the big day with the ECB rate decision and press conference. That day also has eurozone retail sales and French unemployment.
The UK also has some important data on tap. PMI manufacturing starts things off on Monday and this will be followed by consumer credit and consumer confidence on Tuesday. PMI services is up on Wednesday. The highlight of the week is Thursday with the BOE rate meeting and Friday ends it with the producer prices report.
It is extremely light in Japan. Vehicle sales are lined up for Monday while capital expenditures close out the week of data on Wednesday.
The agenda in Canada is characteristically light, but important nonetheless. Industrial product prices and monthly GDP are up on Monday. Thursday sees building permits, Ivey purchasing managers index and the Bank of Canada rate decision. The employment report highlights the week on Friday.
It is an important week down under but all of the noteworthy action is in Australia. Retails sales kick off the week on Monday. The current account and RBA rate meeting are scheduled for Tuesday while GDP is up on Wednesday. Thursday ends it with the trade balance.
Brian Dolan, Chief Currency Strategist
Jacob Oubina, Currency Strategist Forex.com http://www.forex.com
DISCLAIMER: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
Long-term interest rates jumped this week, as the Treasury received only lukewarm demand for it $101 billion in medium-term securities. The spread between the Treasury's 10-year note and 3-month bill rose 27 basis points this week and is the widest since last November.
Ordinarily a steeper yield curve would be a persuasive sign of a recovery. This does not appear to be the case today, however. Long-term yields are rising because of the Treasury's enormous issuance and worries that inflation will accelerate over the long-term. There is little-to-no evidence that investors' appetite for risk has improved or private-sector credit demand has strengthened. Higher long-term interest rates today are a roadblock to recovery not a milepost.
With the run-up in long-term Treasury yields, mortgage rates for 30-year fixed-rate loans have risen above the psychologically important five percent mark. The rise has cut into demand for refinancings and home purchases. Applications for refinancings have fallen 24 percent over the past month. Commercial loan demand has also weakened and remains soft.
Economic Reports Remain Consistent With a Fall Recovery
While rising interest rates heighten the risk that the economy will stumble on its way to recovery, we believe the recession will end later this year, probably late summer or early fall. This week's economic reports were generally supportive of that notion. One of the brightest spots was the surprising 15.7 point jump in the Conference Board's Consumer Confidence Index, which brought the index back to its highest level since September.
While the Consumer Confidence Index surged, there was a huge gap between expectations of future economic conditions and sentiment about current economic performance. Consumers' assessment of current economic conditions rose just 3.4 points, as many more households remain concerned about the lack of job opportunities and the weakened state of business in general. By contrast consumers' expectations for future economic conditions jumped 21.3 points following a 20.8 point rise in April. The increase coincides with the 28 percent rebound in the Dow Jones Industrial Average. The surprising strength in the Consumer Confidence Index helped send stocks even higher this week, as hopes for a recovery strengthened.
Most of this week's other reports remained consistent with a lessening in the rate of the decline in economic activity. Sales of both new and existing homes rose in April, but data for the previous month were revised down and the underlying demand for housing remains weak. The National Association of Realtors estimates that 45 percent of the homes sold in April were either foreclosure sales or some other form of distressed sale. New homes sales rose 1,000 units in April to a 352,000 unit pace. Data for March were revised down, however, so the increase actually resulted in sales being 8,000 units lower than they reported to be one month earlier. Inventories of unsold new homes continue to decline and have fallen to their pre-boom levels. Cancellation rates remain high, however, and the bulk of the oversupply problem is in existing homes rather than builder inventories.
Weekly first-time unemployment claims fell 8,000 to 623,000. The drop marks the 2nd consecutive weekly decline and helped bring the four-week moving average down for the 6th time in the past 7 weeks. Despite the improvement, the actual level of jobless claims remains high and continuing unemployment claims are still rising. The insured unemployment rate rose another 0.1 percentage point, marking the 12th consecutive weekly increase. The current data suggests the unemployment rate will rise to 9.4 percent for the month of May and may reach 10 percent by summer's end.
U.S. Outlook
Personal Income • Monday
Personal income fell 0.3 percent in March, led lower by the continued decline in wages & salaries which fell for the fifth straight month. With the labor market remaining extremely weak we do not expect wage & salary growth to pick up for quite sometime. Personal income and more notably disposable income will likely rise significantly in April as withholding tables are changed for the new tax provisions. We expect personal income rose 0.1 percent in April. Spending may climb from here, but growth will be weak. The personal saving rate should remain relatively elevated as consumers continue to exercise caution.
Previous: -0.3% Wachovia: 0.1%
Consensus: -0.2%
ISM Manufacturing • Monday
The Institute for Supply Management's (ISM) index of activity in the manufacturing sector likely rose for the fifth consecutive month in May, but remains squarely in recession territory. Weak ISM readings are consistent with declines in industrial production and manufacturing jobs. However, recent increases corroborate the notion that economic recovery will begin late this year. Durable goods orders rose in April, suggesting new orders and order backlogs should also increase, likely indicating strength in the pipeline. The regional purchasing managers' reports remain weak, but have shown tentative signs of improvement. Still, the outlook for the manufacturing sector is that it will remain under considerable pressure.
Previous: 40.1 Wachovia: 40.3
Consensus: 42.0
Nonfarm Employment • Friday
Job losses have been extraordinarily broad based, with virtually every industry other than government and education & healthcare posting employment declines. The largest losses continue to be in manufacturing and construction, where close to half the 5.7 million overall job losses have been. Even areas once considered recession resistant like state and local governments are being hit hard.
While weekly first-time unemployment claims have dropped two consecutive weeks, continuing claims have skyrocketed. Additionally, the insured unemployment rate has continued to rise a tenth of a percentage point a week which has matched nearly perfectly with the rise in the unemployment rate. The latest figures suggest the unemployment rate will climb to around 9.4 percent in May. We continue to expect the unemployment rate to rise well into 2010, peaking somewhere around 10.6 percent.
Previous: -539K Wachovia: -540K
Consensus: -530K
Global Review
Tensions on the Korean Peninsula
Geopolitical tensions rose again this week when North Korea conducted an underground nuclear blast on Monday that was followed by missile tests. South Korea and the United States said that they would stop and search North Korean ships in an effort to stop nuclear trafficking, and Pyongyang responded by saying that it no longer considers itself bound by the 1953 armistice that ended the Korean War. Is war imminent on the Korean peninsula?
Investors don't seem to be worried if the reaction in Korean financial markets is any indication. Yes, the Korean won weakened 1.0 percent versus the dollar (see chart at left) and the Kospi stock index fell 2.0 percent on the day after the tests occurred, but they had largely recouped their losses by the end of the week. Perhaps investors are more focused on South Korean economic news at present.
Recovery Under Way in South Korea?
In that regard, recent data suggest that recovery may already be under way in South Korea. Industrial production (IP) rose for the fourth consecutive month in April, bringing its cumulative rise from its cyclical low in December to 18 percent. Moreover, the marked rise in business confidence in May suggests that industrial production has probably continued to increase this month.
What is behind the rebound in Korean industrial production? Clearly, foreign trade is playing a role. As shown in the middle chart, the country is posting trade surpluses again. Part of the swing from surplus to deficit and back again reflects the rollercoaster ride in oil prices over the past two years that has led to wide swings in the country's imports. That said, some of the improvement in the trade balance reflects exports, which have risen more than 40 percent in value since January. Exports plunged last autumn as trade finance dried up. Now that credit markets are beginning to function again, exports are rebounding.
There are also some indications that domestic demand is stabilizing. Real retail sales were essentially flat in the first quarter relative to the previous quarter, and the increase in an index of consumer confidence, which rose to a 2-year high in May, bodes favorably for consumer spending going forward. Policymakers have also responded aggressively to the downturn. The sharp contraction in economic activity late last year and the subsequent decline in inflation allowed the Bank of Korea to slash its main policy rate by 325 bps between October and February. In addition, the government enacted a program of infrastructure spending and tax cuts for both businesses and individuals. Expansionary macroeconomic policy has surely helped to stabilize the economy.
Although economic recovery may be taking hold in Korea, we believe that the pace of the upturn will be rather sluggish. First, the global recovery likely will take some time, which should constrain growth in Korean exports going forward. Second, Korean households have increased their leverage over the past few years, and we expect a period of slow growth in consumer spending as households reduce leverage. That said, Korea appears to be climbing out of its brief, albeit sharp, recession.
Global Outlook
U.K. Manufacturing PMI• Monday
The plunge in the U.K. purchasing managers' index late last year and early this year is consistent with the sharp contraction that has occurred in the U.K. economy. The manufacturing PMI has risen in the past two months, but it still remains below the demarcation line that separates expansion from contraction. Data released on Monday will give investors some insight into the state of the manufacturing sector in May. The PMI for the construction sector will print on Tuesday, and the service sector PMI will be released on Wednesday.
The Bank of England holds its monthly policy meeting on Thursday. The Bank's main policy rate currently stands at 0.50 percent, and few analysts expect it to cut rates further. However, the Bank could announce plans to increase its purchases of government bonds and/or private sector securities.
Previous: 42.9
Consensus: 44.0
Canadian GDP • Monday
On Monday of next week the official numbers for first quarter real GDP will be released. The Canadian economy likely contracted at an annualized rate of roughly seven percent. We expect the change in inventories to have weighed on growth in the first quarter, which may help set the stage for a recovery later on this year. While the Canadian economy contracted substantially in the first quarter, there are several signs that things are turning around. On Thursday of next week we will get some clues about the recovery in residential construction when the building permits data for April are released. In March, permits jumped 23.5 percent, so it wouldn't be a huge surprise to see a give-back in the April data.
The May employment report comes out on Friday. In April, Canada added 35.9K workers to its payrolls even as most other countries were laying people off. Consensus expectation is for a decline in jobs of roughly the same magnitude as April's gain.
Previous: -3.4% (CAGR) Wachovia: -7.0%
Consensus: -6.5%
Euro-zone GDP • Wednesday
The Euro-zone released its first estimate of GDP growth in the first quarter a few weeks ago, but the breakdown into the demand-side components was not available at that time. Although the 9.6 percent rate of contraction in the first quarter is not likely to be revised significantly, the information on the demand side components may give investors a clearer understanding of how the economy will evolve from here.
Revised data on the manufacturing PMI in May will be released on Monday, and the service sector PMI will print on Wednesday. On Thursday, the European Central Bank will hold its monthly policy meeting. Although most analysts expect the ECB to maintain its main policy rate at 1.00 percent on Thursday, the central bank could announce further unconventional steps to support the economy.
Previous: -9.6% (CAGR)
Consensus: -9.6%
Point of View
Interest Rate Watch
Fiscal Policy and Federal Deficits
Monetary and fiscal policies are not independent. Each policy has an impact on the economy and in turn, forces a response from other policies which may contradict publicly stated policy objectives. Current fiscal policy is highly expansionary in an attempt to increase aggregate demand and thereby lead this economy out of recession. But this also puts upward pressure on capital markets and interest rates. In an environment of global weakness from last fall to mid-May, this effect had been offset by the flight-to-safety bet of investors, the easier monetary policy and Treasury purchases by the Federal Reserve. But this game is rapidly ending.
Future federal deficits will not decline as rapidly as promised. Continued, large fiscal deficits have called into question the quality premium attached to U.S. Treasury debt. Unfortunately this draws monetary policy into the mix. Monetary policy is not independent of the contradictions between budget promises and realities. Fiscal policy stimulus multipliers anticipate that the federal funds rate will remain at zero for a long time after the hike in government spending, and that the fiscal stimulus is expected to be temporary. But what if fiscal stimulus lasts longer than expected?
Increasingly, private estimates of the budget deficits and estimates by the Congressional Budget Office suggest large, rising federal deficits, but is this consistent with a zero interest rate policy? Will the Federal Reserve continue to buy more Treasury debt? Effectively, if not on purpose, these purchases will keep today's interest rates low, but at the risk of higher inflation and interest rates down the road. At present, private markets are already voting on this outcome.
Topic of the Week
Recession Probability Drops
In a significant turn, the probability of recession six months from now has downshifted sharply. After taking a look at a very broad set of economic variables, we have developed a monthly recession model which predicts the probability of recession six months from now. Plugging in the April data, the model indicates that the probability of recession six months from now has dropped from 97 percent in March to 47 percent in April. This is a significant change and signals to us that the current recession could be on course to end in the second half of this year. While the official recovery call will come from the National Bureau of Economic Research, our outlook is that the recovery will begin in the fourth quarter led by federal government spending and a modest improvement in consumer spending as well as from diminishing drags in residential construction and inventory investment.
While we do expect recovery in the pace of economic growth, employment remains an issue for both cyclical and structural reasons. Job declines have been widespread with the only bright spot in the healthcare and education sectors, but even there gains have decreased. Another signal of the weakness in the job market is the rise in the duration of unemployment. The impact on those losing jobs will be more severe. Moreover, the structural trend of declining employment in blue-collar manufacturing continues as it has since the early 1970s. These declines reflect the high cost of labor relative to capital that has prompted the increased use of technology and capital to substitute for skilled workers as well as the evolution of consumer demand from “goods” to “services”.
Our full report is available on our website at the address posted below. Wachovia Corporation http://www.wachovia.com
Disclaimer: The information and opinions herein are for general information use only. Wachovia Corporation and its affiliates, including Wachovia Bank, N.A., do not guarantee their accuracy or completeness, nor does Wachovia Corporation or any of its affiliates, including Wachovia Bank, N.A., assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or any foreign exchange transaction, or as personalized investment advice. Securities and foreign exchange transactions are not FDIC-insured, are not bank-guaranteed, and may lose value.
Thursday and Friday presented the unusual spectacle of American equities, Treasuries and the dollar all falling at the same time.
The price of 10-year Treasury Notes dropped more last week than any week since June 2008; the rate rose above 3.4% for the first time since last November. The dollar tumbled below 1.4000 to the euro for the first time this year. Its 3.6% loss for the week was the largest decline against the euro after it sank 4.8% in the five days to March 20th. And the Dow declined four days out of five, rising over 200 points on Monday but finishing the week flat.
All three markets were reacting to the same stimulus: the enormous amount of debt, $3.25 trillion that the United States Government has to sell by the end of its fiscal year on September 30th to fund its operating deficit, various financial rescues, and economic stimulus payments.
For the bond market the vast supply of current and pending issuances threatens to overwhelm demand. It is not that the government will not be able to sell debt and fund the deficit, it will, the question is at what cost. Higher rates for Treasuries will add substantially to the government’s funding costs further increasing the deficit. They may also boost mortgage and consumer interest rates, just as the Federal Reserve is attempting to keep rates low to foster consumer spending and economic growth.
The dilemma for the Fed and Ben Bernanke is keen. On March 18th the Fed announced that it would buy $300 billion of US debt over the next six months. Since then ten year bond yields have increased 92 basis points to 3.45% and the dollar index, which tracks the US currency against a basket of euro, yen, pound, Swiss franc, Canadian dollar and Swedish krona, has lost 11% since its March 4th high. The last FOMC minutes contained comments from some Fed officials which indicated that even more asset purchases may be necessary to secure an economic recovery.
But in the current economic environment, and especially in light of the government’s unprecedented funding needs, extensive Fed purchase of government notes, commonly called ‘quantitative easing’ might cause as much harm as good. 'Quantitative easing' or monetization of government debt increases the money supply and stokes fears of future inflation. It also contributes directly to present inflation by undermining the dollar and increasing the cost of dollar priced commodities like crude oil which feeds back into consumer price inflation. Last summer’s $4.00 a gallon gasoline was at least partly caused by a historically weak dollar. Oil prices and the dollar began their inverse moves within days of each other in July and oil prices have again gained in the past few weeks even though there has been little change or prospect for a rise in demand. A depreciating dollar also makes US securities that much less attractive for foreign investors who are the major buyers of US Government debt.
In a normal economic situation the anticipation of higher US rates would support the dollar. But these are not normal times. At this point in a standard recession, with three quarters of negative growth already passed, historically low rates and massive amounts of added liquidity, thoughts would naturally turn to the beginning of the next Fed rate hike cycle. The dollar would follow these thoughts higher.
But Fed rate policy is constrained by the unabated recession, by the residue of the financial and banking crisis, and by the fear of a deflationary price spiral. The Fed cannot raise rates. With its ability to fight inflation near zero for the immediate future, the prospect of higher Treasury rates only means more Fed quantitative easing to keep consumer and mortgage rates low and an ever increasing danger of inflation.
Compounding or highlighting the US debt problem was the rating agency Standard & Poor’s (S&P) downgrade for the outlook of United Kingdom sovereign debt to negative from neutral. S&P said the UK faces a 1 in 3 chance of a rating cut as its total debt approaches 100 % of GDP.
If the UK is at risk, what of the US with its massive funding needs? The risks to the world’s economic and financial system which in the past nine months have worked strongly in favor of the US currency as the safe haven trade have been replaced by risks specifically to the dollar from the US debt and deficit burden.
US debt is currently about 80% of GDP. "Both the UK and the US have deficits of 10% annually as far as the eye can see" said Bill Gross co-chief investment officer of Pacific Investment Management Company (Pimco) of Newport Beach California in an interview with Bloomberg Television. “At some point over the next several years they (the US) may approach 100% of GDP which is a level at which country downgrades tend to occur.” “The markets are beginning to anticipate the possibility of” a downgrade to the US’s top rating though, “it’s certainly nothing that is going to happen overnight”, he said., “eventually” the US will lose its top rating.
Higher rates for US Treasuries if they indicate an oversupply of dollar assets are dangerous for the dollar’s status as the world’s reserve currency. One of the basic functions of a reserve currency is as a store of value for liquid assets. If investors look into the future and see only an ever increasing supply of inflationary dollars in numbers far beyond the rate of economic growth in the US, issued by Washington to fund its deficits, then suspicions that the US is attempting to inflate away its mountain of debt will gain credence.
The current administration isn’t just issuing record debt this year or next but projects record deficits for the next ten years. The government’s position is that this scale of debt is necessary to help the US avoid the worst effect of the recession. But the political nature of much of the stimulus spending has been roundly condemned by administration critics. If the concerns of critics are accurate and the budget emphasis is misplaced, and the stimulus does not produce substantial economic recovery by the end of the year, then the debt and the deficits will weigh heavily on the future of the dollar.
If the credit markets can absorb the US issuance over the next three months without driving up interest rates and the US economy begins to show signs of positive growth by the beginning of the fourth quarter then the stage is set for a return of the dollar to strength. But if Treasury rates continue to rise and the Fed is forced into extensive quantitative easing to contain them then market judgment against the dollar could be harsh indeed.
Joseph Trevisani
FX Solutions, LLC
Chief Market Analyst FX Solutions
IMPORTANT NOTICE: These comments are for information purposes only. Past results are not necessarily indicative of future results. Trading Futures, Options on Futures, and Foreign Exchange involves substantial risk of loss and may not be suitable for all investors. You should carefully consider whether trading is suitable for you in light of your circumstances, knowledge, and financial resources. You may lose all or more of your initial investment. Opinions, market data, and recommendations are subject to change at any time. The information contained on this email does not constitute a solicitation to buy or sell by FX Solutions,LLC., and/or its affiliates, and is not to be available to individuals in a jurisdiction where such availability would be contrary to local regulation or law.
US data were a mixed bag over the past week. While regional business surveys and consumer confidence improved further, the housing data were mixed.
German IFO data disappointed on the surface, but the forward-looking expectations index improved for the fifth month in a row.
Asia continues to impress. This time Japanese industrial production and exports rose further and production plans point to a marked recovery of production during Q2 and Q3.
Swedish GDP fell markedly in Q1, although not as much as feared.
Bond markets took centre stage as downgrade fears and stronger data led to further increases in bond yields. This dented the positive impact on the equity markets from stronger growth signals.
Market movers ahead
A big week in US is coming up with both ISM and non-farm payrolls. We look for further positive surprises in ISM while payrolls is likely to show a further big decline.
In Europe focus turns to the ECB meeting. Rates are expected to be unchanged, but ECB will likely announce details on how the non-standard measures will be implemented
In Denmark numbers for the currency reserve should show a further increase and we expect Danmarks Nationalbank to narrow the spread to Euroland by a further 10bp
Global update: More positive data
Growth signals improved further - not least in Asia
The past week offered more evidence that a healing of the global economy is taking place. In US the regional business surveys from Richmond and Dallas rose further, pointing to improvements in the US manufacturing sector. And consumer confidence surprised markedly on the upside, rising from 40.8 to 54.9. The cumulated increase in consumer confidence over the last two months is the biggest since 1974. US labour market data also gave signals that the worst is probably behind us in terms of job losses. The job component in the consumer confidence report (jobs plentiful minus jobs hard to get) improved for the second month in a row and the weekly jobless claims fell a bit further.
US housing data was a bit mixed this week, though. House prices from FHFA fell by back by 1.1% in April. And the Case/Shiller house price index - which contrary to the FHFA series also capture distressed sales - continued its relentless decline in April. We expect house prices to drift lower throughout the year before stabilising next year. On a more positive note, home sales look to be stabilising with both existing and new home sales rising a bit in April. The stabilisation is probably driven by a marked increase of affordability stemming from the decline in house prices and mortgage rates.
In Euroland the German ifo disappointed on the surface but the details in the report were more encouraging. The forward-looking part of ifo - the expectations subindex - rose for the fifth month in a row (see Flash Comment). In Asia, Japanese exports data rose for the second month in a row adding to the picture of a much faster turnaround in the Japanese economy than generally expected. Industrial production also rose strongly and production plans point to further increases in coming months (see Flash Comment). We look for growth to become positive already in Q3 as demand is rising and at the same time need to rebuild depleted inventories. Bond sell off created jitters in the equity market
The continued positive data flow gave more impetus to recovery trades in the beginning of the week: Equity prices rose further, credit spreads narrowed and bond yields rose. Commodity prices continued higher as oil reached USD64 per barrel. The Baltic Freight index has also risen further to the highest level since October last year - a further indication that global trade is picking up again. The positive sentiment in equity markets was dented later in the week, though, as the focus turned to the strong rise in US bond yields - these accelerated late Wednesday with the 10-year yield reaching 3.74%, taking the cumulated increas e this year to 165bp. Inflation fears are also starting to get some attention as oil prices continue higher. The gold price - often seen as a hedge against inflation - is back up to the highest level in three months. Downgrade fears added to bond market sell off
On top of better data, the bond market is being challenged by massive supply and downgrade fears in the market after S&P put UK on negative outlook. Market participants immediately got worried over a potential downgrade of US as debt levels could easily rise to 100% of GDP over the coming years unless the budget deficit comes down in the years to come. Both Moody's and S&P have reiterated, though, that the outlook for US is stable. We believe the downgrade fears are a bit exaggerated as US benefits from being the world's reserve currency. And even if US should be downgraded it would probably not be punished materially. If "competing" bond markets are also downgraded, an AA+ rating could suddenly become the new "safe haven". The downgrade fears could easily continue in the market, though, and be another excuse for selling US bonds which will most likely see higher yields anyway during 2009 as data improves and the huge supply has to be absorbed. Inflation fears could also get more focus as the economy recovers and investors get the jitters over the large sums printed and poured into the US economy.
Market movers ahead
Global
In the US the coming week a stream of important data, starting with the ISM index for the manufacturing sector on Monday. We expect the index to continue to climb in May, and it could very well break through the expansion threshold of 50 towards the end of the summer. The May employment report is also released in the coming week. We should now have put the biggest falls in employment behind us and are looking forward to positive growth in employment towards the end of the year. In the short term the picture is muddled somewhat by the motor industry, with the two giants Chrysler and GM shedding vast numbers of jobs in the coming months.
In Euroland the main event is the ECB meeting on Thursday. The refinancing rate will be kept unchanged at 1.0 % and it will be kept at this low level until the recovery is so mature that the ECB starts to hike rates. We expect that ECB's assessment of the economic situation has become slightly more positive, although the growth forecast for 2009 as a whole will be dragged down by the enormous drop in economic activity in Q1. Much more interesting are the details we will get on how the non-standard measures announced at the last council meeting will be implemented.
In Asia focus next week will be on the release of China's two manufacturing PMIs on Monday. While we do believe that the underlying picture remains an improving economy, we do not rule out the possibility that we could see a small decline in the NBS PMI due to distortions in seasonality adjustment. On Monday 1 June the semi-annual Strategic Economic Dialogue meeting will start in Beijing. However, compared to earlier summits there will probably be little drama. Geithner will probably reiterate the US administration wishes for a more flexible and stronger CNY, but will not push the issue aggressively.
In Denmark Danmarks Nationalbank will announce on Wednesday that the foreign-exchange reserve has increased further in April. We are confident that the voluminous reserve and a strong DKK soon will lead to a narrowing of the spread to the ECB, but the exact timing is uncertain. Accordingly, we expect a 10 bp cut to 0.55 % either Wednesday which would be convenient prior to the weekly market operations or Thursday where the outcome of the ECB rate decision will be known (Friday is a Danish bank holiday).
Very light agenda in Sweden in terms of macro data the upcoming week. All attention on the Swedish market is likely to be directed towards developments in the Baltic countries. The risk of devaluation looms large and any signals of such an eventuality are likely to move Swedish short yields lower and EUR/SEK higher.
In Norway focus turns to PMI and consumer confidence where we expect further rises.
Financial views
Equities
We continue to have a positive view on equities in the medium term. However, the "easy" part of the gains is behind us, and the road from here will be more bumpy. The market will need confirmation that the recovery is real, and more drivers have to join in, including a further stabilisation in US housing, further healing of credit markets and improvement in earnings expectations.
Fixed income
Global: Bond yields are expected to rise on a three- to six-month horizon based on improving macro conditions, rise in risk appetite and heavy supply. US to underperform Euroland in sell-off.
Intra-Euro: We have just taken profit on our overweight in peripherals (Italy, Greece and Spain) versus Germany and now stand sidelined. On longer maturities we still prefer France and Finland to Germany.
Scandi: We have closed our underweight long Danish government bonds versus Finland in the 10Y area, but we still have an overweight in Swedish government bonds versus Germany in the 5Y area. We recommend overweight of Norwegian govies versus Germany in 10y segment. We have a neutral weight on Danish mortgages versus government bonds in all segments (callable, Capped Floaters and non-callable) except the non-callable mortgage bonds with a maturity below one year where we have an overweight.
Credit
During the past couple of months credit has enjoyed a very strong spell across the sectors and capital structure and spreads have tightened significantly. At the same time the activity in the primary market continues to be at a record-high as more and more companies (are able to) turn to the capital markets instead of the banks for funding. The strong sentiment is largely the result of a significant improvement in the conditions in the money market and lower volatility.
We question the sustainability of this massive rally as the pace is simply too fast in our view. The macroeconomic outlook is still challenging and defaults are currently increasing. A while ago we moved to overweight based on the large liquidity and risk premiums for credit. Both these premiums have now been reduced substantially and we go from overweight to neutral.
FX outlook
EUR/USD is set to drift lower in the short run, but to continue upwards in the medium term. Important drivers for EUR/USD are equities as a proxy for risk and most recently oil prices. EUR/GBP is heading down as sterling is supported by positive economic data. USD/JPY will probably break above 100 in the near term. Carry can keep on performing, while defensive currencies will face additional headwind.
Swedish krona and Norwegian krone both have solid potential against the euro. Currently however, risk aversion is still too high to see the Scandies exploit their full potential. The Danish krone is attractive (e.g. against Swiss franc) due to sound carry.
Commodities
Base metals like copper and zinc continue to perform fuelled by heavy Chinese buying and global growth optimism. Oil prices have continued to rise the past week to USD65 per barrel
However, we argue that short term the risk of a correction is growing. In our view the market is neglecting near-term weakness like weak oil demand and huge stocks in base metals. However, looking six months ahead we expect a new leg up in prices when the different market balances are expected to tighten for real.
Full Report in PDF Danske Bank http://www.danskebank.com/danskeresearch
Disclaimer
This publication has been prepared by Danske Markets for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Markets´ research analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for private customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S, which is regulated by FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange.
Treasuries: supply pressure and quality doubts weigh on dollar
Substantial foreign demand for T-notes at auctions
ECB set to keep refi rate on hold
ECB staff to revise down growth and inflation projections
Focus Shifts to US Government Bonds
In the last fortnight, the forex markets' focus has shifted somewhat. Up until about 10 days ago, the dollar's weakness was primarily a sign that international investors' risk appetite was gradually growing in view of the first green shoots of economic improvement and favourable equity markets. The EUR-USD rally from 1.36 to 1.40 in the middle of last week, however, was triggered mainly by sharp falls in Treasury prices. Within a few days, yields on 10-year T-notes climbed from around 3.20% to 3.60%, even peaking at over 3.70%. The yields on equivalent Bunds also rose from around 3.35% to 3.60%.
The interest rate increase corresponds to a certain extent with hopes that an economic recovery is on the way - safety is no longer the number 1 priority. In this case, however, supply side factors played a decisive role. Apparently the yield jump was triggered by the US Treasury's announcement that the following week it was planning to issue over 100bn of 2-, 5- and 7-year T-notes (plus 61bn of 3- and 6-month T-bills). This drew investors' attention to the extraordinarily high level of public borrowing. Then it was announced that S&P had changed Britain's credit rating outlook (up to now AAA) from stable to negative. This intensified investors' worries. A considerable number of market participants also see the “yellow card” given to the UK as a warning to the US to keep an eye on its own credit quality.
The dollar is under pressure because the US government is borrowing abroad on a large scale. At the end of 2008, $3215bn US government bonds, more than half of all privately held US Treasury securities, were in foreign hands. China's holdings alone amounted to well over $700bn. The depreciation of the dollar shows that international investors are becoming less willing to hold existing dollar-denominated debt, let alone increase it.
At the beginning of the week, the leading article in the Financial Times provided some degree of reassurance. It said that, despite critical comments by government spokemen in the last few months, China's official foreign exchange authorities were still buying US government bonds. The last few days' auction results show that about 45 per cent of the $101bn T-notes were bought by indirect bidders (foreigners). Compared with previous years, this is quite a reasonable proportion; it should be borne in mind, however, that the proportion of foreigners interested in the longer maturities was smaller, and that prices, particularly at the long end, had fallen significantly beforehand. ECB set to keep refi rate unchanged
The ECB governing council's monthly meeting is being held next Thursday. We are expecting the refinancing rate to be kept on hold at 1%. At the beginning of May, the council had kept its options open for further interest rate cuts, but had given no clear indication that rate cuts were planned. According to the ECB, the dramatic GDP collapse in the first quarter had been taken into account when rates were lowered to 1%. The economic outlook has not deteriorated significantly since then. The leading indicators are currently signalling that the downswing is slowing, but an economic recovery in the eurozone is still a long way off. However, this is more or less in line with expectations.
We predict that the new ECB staff projections will be adjusted in accordance with the revised view of the ECB council. The staff should reduce its GDP forecast for 2009 significantly to about -4%, but the forecast for 2010 is not likely to be revised at all, or only slightly to just below zero. The inflation forecasts could also be revised down somewhat. The growing output gap is creating a deflationary impetus, which, however, is being partially offset by the expected increases in energy prices (the staff projections derive the expectations from the forward prices). But on the whole we are not expecting the revised ECB staff projections to give any fresh indication as to future policy.
The ECB has announced that on 23 June it will conduct the first long-term refinancing operation with a maturity of one year. Full allotment is planned at the current refi rate. Apparently, the council is considering extending this offer by setting a sort of “interest rate floor”. The idea seems to be that the tender could become less attractive if markets are expecting further interest rate cuts. In our view, if such a commitment is made, it will at best be worded in very general terms, given the considerable macroeconomic risks. BHF-BANK http://www.bhf-bank.com This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK Group") solely for the information of its clients. The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities.
After their long weekend bond traders came back with a mission -to teach the authorities who's who. Long-dated US Treasury prices slashed, the threat of inflation and devaluation, let alone potential ratings downgrades too much to bear. Benchmark ten-year hardest hit, yields backing up from 3.00% the previous Monday (2.05% at the start of this year) to 3.75% and the spread over two-year yields a record 275 basis points. Thirty-year touched 4.66% from a low of 2.50% at year-end. Ten-year Bunds reached 3.70%, their highest this year and well up from January's 2.85% record low, though Gilts were a lot better behaved. In contrast Money Market and Treasuries out to two-years barely budged from the comatose state and their lowest yields in decades. The US dollar lost ground against most currencies, the South African rand up 4.00% this week, and 25.0% over the last three months, to 7.9200, New Zealand not far behind at $0.6385 and Cable $1.6185. This helped drag some commodity prices higher, Spot Gold to $978.30 per ounce, Silver outperforming at $15.55, Nymex Crude Oil to $66.25 per barrel and Gasoline $1.9355 per gallon. Baltic Dry and Capesize freight rates are higher again though Tanker ones are as low as they have ever been. Equity indices remain stuck just below March's highs for a fourth consecutive week, some emerging market ones fractionally higher, Brazil, China and Russia doing best.
Political and Economic Developments
South Africa slashed their repo target by 100 basis points to 7.50% while Swedish Q1 GDP at -0.9% Q/Q and -6.5% Y/Y was the worst on record. Eurozone May CPI for the first time ever is running at 0% Y/Y, Germany's (on this basis) its first ever negative at -0.1% Y/Y, while Tokyo's excluding fresh food is -0.7%, as low as it got to in 2003 though above the 2001 record low -1.5%.
The Federal Deposit Insurance Corp's Sheila Bair described banking as being 'in the clean up phase'. So far this year 36 US banks and thrifts have failed, following 25 in 2008 and 3 in 2007. In Q1 2009 there are 305 problem banks (highest since 1994), from 252 in Q4, with assets of $220B versus $159B. Non-current loans add up to $291B or 3.76% of the total, the highest since 1991. Meanwhile the insurer's war chest shrank to $13B and were it not for a $100B line of credit from the Treasury one can see how quickly the sums will not add up.
Underlying Themes
Investors must learn to distinguish between sentiment indicators (e.g. Consumer Confidence, GfK Surveys, IFO) and economic figures. Man, the eternal optimist, is programmed to 'look on the bright side' - 'jam yesterday and jam tomorrow, but never jam today'. This week the former were more upbeat, but the latter still grim. US property, the epicentre of financial distress, had Y/Y price declines of -18.7% to March in the 20 metropolitan areas measured by Case-Shiller. The National Association of Realtors reports nationwide declines of -15.4% in the year to April, the median home worth $170,200, condos -18.5%, -21.8% in the West, 45% being distressed sales. On homes worth over $750,000 there is a backlog of 40 months' supply, four times that of new homes. The US Census Bureau reports a doubling of delinquencies on prime fixed-rate loans in April, while Freddie Mac says half past due loans are on empty homes - where the borrowers have given up and moved out. Twelve per cent of all mortgages are delinquent or foreclosure starts, known as 'not current', says the Mortgage Bankers Assoc.
What to watch for next week
Whit Monday holidays in many European countries June 1st as the Reserve Bank of Australia decides on rates (expected unchanged at 3.00%). Japan April Labour Cash Earnings, US Personal Income and Spending, Core PCE, Construction Spending, UK May Hometrack Survey, Manufacturing PMI, and US ISM. Tuesday UK April Consumer Credit, May Construction PMI, Eurozone April Unemployment, US Pending Home Sales and May Vehicle Sales late in the day. Wednesday UK May Nationwide Consumer Confidence, Services PMI, BRC Shop Price Index, US Challenger Job Cuts, ADP Employment Change, April Factory Orders and EZ16 Q1 GDP. Thursday the 4th EU Parliamentary elections start and continue through to Sunday. Japan Q1 Capital Spending, US Q1 Nonfarm Productivity, EZ16 April Retail Sales while the Banks of Canada, England and the Eurozone decide on rates (all expected unchanged at 0.25%, 0.50% and 1.00% respectively). Friday US April Consumer Credit, UK May PPI, US Nonfarm Payrolls and Unemployment. Monday 8th June Orthodox Whit Monday holiday.
Positioning and Technical Analysis
Generalised US dollar weakness should be the focus, possibly because the moves might be very large as many are forced to react. The Yen will continue in a world of its own and there may be a tendency to weakness in Eastern European currencies. This will supply an underlying bid to many things priced in dollars, including shares but not fixed income. For European equities though, particularly those of exporters, is has an opposite effect - a drag on potential gains. Long-dated Treasury yields should retreat, brought back in line by rock-steady short-dated paper, US ones probably lagging badly. Mizuho Corporate Bank Disclaimer The information contained in this paper is based on or derived from information generally available to the public from sources believed to be reliable. No representation or warranty is made or implied that it is accurate or complete. Any opinions expressed in this paper are subject to change without notice. This paper has been prepared solely for information purposes and if so decided, for private circulation and does not constitute any solicitation to buy or sell any instrument, or to engage in any trading strategy.
US Q1 GDP Second Estimate and German IFO Survey Feature
We are expecting a small upward revision to US Q1 GDP in the second estimate based on a slightly more positive contribution from net exports. However, the depth of GDP contraction will have remained historically steep, see chart 1. Also this week, we are looking for a second consecutive monthly rise in the key German IFO business survey. This mirrors other European surveys that show the region's recession is easing, but output still contracting, see chart 2. In addition, a plethora of speeches by ECB President Trichet and members including Weber, will be interpreted for comments on incoming data and clues about the likely impact of economic developments on economic policy. In addition, the US Treasury has a heavy auction schedule of $101bn of notes, while the outcome of the UK DMOs £1.25bn sale of 1.25% gilts due 2032 will be closely monitored following financial market concern over S&P's medium-term debt downgrade. UK and US markets are closed on Monday.
UK data will continue to be perused for signs of the economy stabilising - house prices and the CBI distributive trades & GfK consumer confidence surveys are all due. The market consensus forecast is for the Nationwide house price index to have fallen close to 1% on a monthly basis in May, compared with a decline of 0.4% in April. Whereas this is an improvement compared with the 12-month average trend of -1.4% and may well provide limited evidence that house price falls may be steadying, annual prices are still dropping at a hefty pace of -13.7%. While last week's stronger than expected official retail sales data prepares the way for a less pessimistic CBI distributive trades survey outcome - we expect an index level of -12 in May, significantly better than the 12-month average of -31, the figure is likely to be worse than +3 in April. Finally, the GfK consumer confidence index may have worsened to -30 in May from -27 in April, indicating that household spending may fall for the third consecutive quarter in Q2, after 1% quarterly contractions in both Q1 and in Q4 2008.
Q1 annualised GDP second estimate is the key US economic data release of the week - it may show a contraction of -5.5% compared with -6.1% in the preliminary release, due to an upward revision in the contribution of net external trade. Durable goods orders, excluding transport, due Thursday, are notorious for backward revisions and any changes in the monthly series will impact on the Q1 GDP second release outcome. Other data may enhance the view that there are small economic improvements underway in the last few months - consumer confidence, existing & new home sales and the Chicago PMI manufacturing survey may have strengthened. Also important, the weekly US initial jobs claim figure may be lower again this week, but with the jobless rate still rising, continuing claims, the total number of people filing for unemployment benefit, could break the 6.6m high.
We expect German Q1 GDP (final) to confirm a massive contraction of 3.8% in the quarter and 6.9% on an annual basis, as investment plummeted and exports dropped due to contracting markets and the strong euro. However, more recent data has improved and the key IFO index of business confidence index may rise for a second consecutive month in May, after increasing off a 26-year low last month as significant monetary and fiscal stimulus may have started to ease the recession. This is in line with other eurozone business surveys, such as the PMIs, that portray a similar story. Also important, EU-16 industrial orders which have been contracting at a massive annual rate of almost 34.5% may rise on a monthly basis in March due to stronger German data. Despite some early signs of the recession easing, the EU-16 unemployment rate may have risen to 9% in April from 8.9% a month earlier and is likely to be very close to 10% by end -year.
Full Report in PDF Lloyds TSB Bank http://www.lloydstsbfinancialmarkets.com Disclaimer: Any documentation, reports, correspondence or other material or information in whatever form be it electronic, textual or otherwise is based on sources believed to be reliable, however neither the Bank nor its directors, officers or employees warrant accuracy, completeness or otherwise, or accept responsibility for any error, omission or other inaccuracy, or for any consequences arising from any reliance upon such information. The facts and data contained are not, and should under no circumstances be treated as an offer or solicitation to offer, to buy or sell any product, nor are they intended to be a substitute for commercial judgement or professional or legal advice, and you should not act in reliance upon any of the facts and data contained, without first obtaining professional advice relevant to your circumstances. Expressions of opinion may be subject to change without notice. Although warrants and/or derivative instruments can be utilised for the management of investment risk, some of these products are unsuitable for many investors. The facts and data contained are therefore not intended for the use of private customers (as defined by the FSA Handbook) of Lloyds TSB Bank plc. Lloyds TSB Bank plc is authorised and regulated by the Financial Services Authority and is a signatory to the Banking Codes, and represents only the Scottish Widows and Lloyds TSB Marketing Group for life assurance, pension and investment business.
Speculation that the Fed may boost its asset purchase programme to reinvigorate economic growth and rising concerns about the credit standing of the US saw the dollar come under strong selling pressure this week. The dollar index, which measures its performance against its key trading counterparts, fell to its lowest level so far in 2009, slipping below 80 on Friday, from a peak of 89.11 in March. Further signs that strains in credit markets may be easing, with 3-month US $ Libor recording its biggest weekly decline this year, may also have dulled the safe haven allure of US assets and the $ this week.
The greenback closed the week lower against all the G10 currencies, with the New Zealand leading the way with a gain of 5.9%. Boosted by rising commodity prices and higher interest rate yields, both the Australian and New Zealand dollars set seven-month highs against the US$. The pound extended its recent gains, despite a leading credit rating agency changing its outlook guidance on the UK from ‘stable’ to ‘negative’, although reaffirming its triple A status on long-term debt. £/$ closed the week up 4.1%, hitting a six-month high of 1.5943. €/$ finally broke through the psychologically important 1.40 level on Friday, closing the week 3% higher at 1.4016. $/Y closed the week lower at 94.40, after the BoJ left interest rates on hold at 0.1% but improved its economic assessment, while the finance minister also ruled out intervention to weaken the yen. However, data showed the Japanese economy shrank by a record annualised 15.2% in the first quarter of 2009, following on from a drop of 14.4% in the previous quarter.
In the emerging markets, a resounding victory for the ruling Congress party saw the Indian rupee briefly strengthen below 47 against the US$ this week for the first time in 2009. Chinese yuan 12 month non-deliverable forwards rose to a 9-month high of 6.67. The Russion ruble extended its gains to hit a 4-month high against the $, underpinned by higher crude oil prices. Eastern European currencies performed particularly well this week , led by the Hungarian forint. The South African rand also rallied sharply higher against the $, buoyed by metal prices and its high yield.
In the UK this week, there was confirmation that the economy contracted by 1.9% in the first quarter, led by a drop of 1.2% in consumer spending and 3.8% decline in investment. However, there were some hopeful signs that this could prove to be the low point in this recession, with rapid corporate de-stocking again contributing significantly to the fall. The latest data on retail sales were also stronger than expected, with a 0.9% rise in sales volumes in April. There was also a sharper than expected drop in inflation in April, with annual CPI inflation easing to 2.3%, from 2.9% in March. With inflation likely to continue to fall rapidly in the coming months, the minutes of the 6-7 May BoE MPC meeting highlighted that the final size of the asset purchase programme may exceed the initial £150bn already sanctioned, if economic conditions warranted it.
Although it was the UK that experienced negative watch to credit rating this week, speculation that the credit standing of the US could also come under pressure saw the dollar apparently come under more sustained selling pressure. This followed the release of the minutes of the FOMC 29 April meeting earlier in the week, which revealed that some members felt that asset purchases may need to be increased to boost the US economic recovery.
Interest rate market review - bonds, cash and swaps
Standard and Poors changed its UK AAA ratings outlook to 'negative' from 'stable', because the country's debt could reach 100% as a proportion of GDP. The announcement led to a sell-off in gilts, as benchmark 10-year yields hit a high of 4.75% and 30-year yields reached a 4-month high of 4.66%, though strong demand at the 5-year gilt auction helped limit the rise in yields. Five-year swaps rose 7bps to 3.22%. Yields at the short end of the curve were little changed, as inflation came in weaker than expected, while minutes of the May MPC meeting confirmed expectations that the vote to keep interest rates at 0.5% and to expand quantitative easing by a further £50bn to a total of £125bn was unanimous.
UK annual CPI inflation fell to 2.3% in April from 2.9%, a bigger drop than expected, while annual RPI inflation fell further into negative territory to -1.2%. Looking ahead, we expect annual inflation rates to fall significantly in the coming months, with the CPI measure likely to drop below the 2% target next month for the first time since September 2007. In fact, we see annual CPI around the zero mark by the year end. The Bank of England's own central projection is for annual CPI to fall to around 0.4% in the final quarter of this year.
With this scenario for UK inflation in mind, the MPC minutes revealed that the Committee may consider asking the Chancellor to expand the current limit of the quantitative easing programme, if conditions warranted it. In terms of the economic outlook, the MPC said that, although there were 'promising signs' that the pace of decline is moderating, the economic recovery is expected to be 'relatively slow'. The second estimate of Q1 GDP supported this view. Quarterly growth was unrevised at -1.9%, the steepest contracton for thirty years, but the expenditure breakdown showed that the sharp pace of negative inventory adjustments in response to falling demand was easing. However, the quarterly contraction in both consumer and investment spending intensified. Other data showed that retail sales rose more than expected in April, but the figures do not account for weaker spending on services and cars.
Euro zone bond yields also rose in the past week, with 10-year bund yields rising above 3.5% for the first time in 6 months, pulled higher stronger equities and improvements in the ZEW and PMI surveys. The German ZEW index of investor expectations rose to a 3-year high, while the euro zone composite PMI increased for the third consecutive month to 43.9, though this still remained far below the key 50 no-growth level.
The increased risk of a UK downgrade led to concerns about the implications of rising US debt. Ten-year treasury yields rose a 6-month high of 3.43%, as the supply of $162bn of notes and bonds loomed next week. US 5-year swaps rose 19bps to 2.66%. The Fed also purchased less goverment debt than expected, which put further upward pressure on bond yields. The minutes of the 29 April FOMC meeting indicated that the Fed may increase its purchases of government debt, but the downward impact on yields proved to be short-lived. The Fed's prognosis on economic prospects was more optimistic, as the inventory adjustment runs its course, but the recovery in demand was expected to be sluggish. US initial jobless claims remained above 600,000, consistent with a sharp rate of decline in employment, while the Philadephia Fed manufacturing survey indicated that the pace of contraction had eased in May.
US interbank rates continued to decline, as money market tensions fell further. Dollar 3m libor fell 17bps to 0.66%, while sterling 3m libor fell 7bps to 1.29%, though euro 3m libor was marginally higher at 1.26%. Elsewhere, the Bank of Japan left interest rates on hold at 0.5%, as Japanese Q1 GDP fell 4.0% on the quarter. Nevertheless, the BoJ upgraded its view on the economy, saying that exports and production were beginning to level out, though economic conditions were still deteriorating.
Full Report in PDF Lloyds TSB Bank http://www.lloydstsbfinancialmarkets.com Disclaimer: Any documentation, reports, correspondence or other material or information in whatever form be it electronic, textual or otherwise is based on sources believed to be reliable, however neither the Bank nor its directors, officers or employees warrant accuracy, completeness or otherwise, or accept responsibility for any error, omission or other inaccuracy, or for any consequences arising from any reliance upon such information. The facts and data contained are not, and should under no circumstances be treated as an offer or solicitation to offer, to buy or sell any product, nor are they intended to be a substitute for commercial judgement or professional or legal advice, and you should not act in reliance upon any of the facts and data contained, without first obtaining professional advice relevant to your circumstances. Expressions of opinion may be subject to change without notice. Although warrants and/or derivative instruments can be utilised for the management of investment risk, some of these products are unsuitable for many investors. The facts and data contained are therefore not intended for the use of private customers (as defined by the FSA Handbook) of Lloyds TSB Bank plc. Lloyds TSB Bank plc is authorised and regulated by the Financial Services Authority and is a signatory to the Banking Codes, and represents only the Scottish Widows and Lloyds TSB Marketing Group for life assurance, pension and investment business.
