Weekly Focus: A Mixed Bag

Global update

• 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.

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