ECU's Market Commentary

By Neil Staines on 23/04/15 | Category - Comment

"The longer the excuse, the less likely its the truth”Robert Half

Over recent weeks the US economic data has disappointed expectations. Throughout this, we have maintained the view that the recent ‘dip’ understates the current economic momentum in the US and that if you strip out the weather and seasonal negatives, as well as the supply disruptions and distortions due to such large moves in the oil price, the picture is far more rosy that the data currently suggests.

However, there is only so long that anyone can maintain the view that the data are wrong, without it becoming merely an excuse. In this respect the April US employment report is key. Unfortunately, we will have to wait until 8th May for its release.

"I never gave or took any excuse”Florence Nightingale

Our view on the UK is not dissimilar to our view of the US in that we feel economic momentum is stronger than the data (and certainly broader sentiment) suggests. However, in the UK (at least in the near term), the uncertainties are more political than economic.

Yesterdays release of the Bank of England MPC meeting minutes from April 8th and 9th was, in our view, significant. While we would stop short of describing the minutes as outright hawkish, they certainly removed the dovish bias that has been a theme for recent months. Indeed, the comment that "All MPC agreed next move in rates likely to be up” removed the uncertainty brought about by Chief Economist Andy Haldane who had previously spoke of the prospect of further rate cuts.

From our perspective, perhaps the most significant part of the report was the discussion of the relationship between inflation and GBP. The minutes highlighted the "risk of faster inflation pick up from GBP strength” and that the "GBP feed through to CPI may be faster than expected”. This more hawkish interpretation of inflation likely supports our view of UK rate expectation and GBP outperformance after a resolution to the General Election uncertainties. If economic momentum is maintained or even accelerates as we anticipate going into H2, then rate hike expectations could be moved significantly closer than their current 2016 liftoff timeline. The huge move lower in Gilts yesterday, overshadowing the move in Bunds, is perhaps indicative of the sensitivity of markets to such a possibility.

"He who cannot dance claims the floor is uneven”

Over recent weeks, it has been this stabilisation and, in some cases, upturn in the eurozone data metrics that has led to a stabilisation in the value of the EUR. At the same time there has been a moderation and downturn in the US data metrics. However, just as the market was getting comfortable with the concept of improving eurozone data, this mornings flash PMI estimates disappointed expectations, particularly in France and while the data across the region has shown signs of broad stabilisation, growth remains at very low levels and economic momentum remains fragile.

"Excuse me while I kiss the sky”Jimi Hendrix

Furthermore, we expect the US economic data to recover after a weak Q1 as the weather and supply disruption effects are unwound. On a relative basis, therefore, we expect that the economic surprise indices will turn back in favour of the US, at least relative to the eurozone. If we then consider the recent developments in the EURUSD rate, which has broadly ranged between 1.05 and 1.10, amid anecdotal and empirical evidence that long USD positioning has been significantly reduced, the performance of the EUR amid significant relative data outperformance has been singularly unimpressive. If, as we expect, the forthcoming data impetus shifts positively in the US and falls back in the eurozone, then we would expect the EUR to become vulnerable, and for the broad USD rise to reassert itself.   
By Neil Staines on 21/04/15 | Category - Comment

"It is pointless to go short on the Euro”Mario Draghi

Last week the Greek crisis was largely ignored by the FX markets and as US economic data disappointed, long USD positions were squeezed. This week amid a wave of international interjection, urging a resolution to the Greek standoff, uncertainty and concern have begun to turn the focus back to the EUR.

Greece, and increasingly the rest of the eurozone are caught between a rock and a hard place. On one side the ‘red lines’ of the Syriza election pledges are in direct conflict with the ‘rules’ that the rest of the eurozone must adhere to to avoid a disastrous contagion to other programme countries (Political uncertainty across the region remains rife as the Eurosceptic Finns Party surged to second place in the Sunday Election in Finland).

"Growing minority of ECB governors said to oppose Greek ELA”ECB Official

Statements from EU officials that a resolution is unlikely by Fridays Eurogroup meeting, and the increasing signs of frustration at the Greek government (and their progress) add to the uncertainty and as Greece moves funds from regions to the Central Bank and faces the unenviable choice of whether to pay public sector wages at the end of the month (EUR 1.7 billion) or pay its creditors in the first week of May (EUR 1 billion).

It may be true that default does not automatically imply an exit from the eurozone or the EU, particularly as somewhere in the region of 80% of Greek people want to remain in the eurozone, however, a greek default without a Greek exit ‘Grexit’ is likely the single most negative outcome for the EUR. On the current political and economic trajectory, we find it difficult to agree with Mario Draghi’s statement that "it is pointless to go short on the Euro”.

From Extraordinary to Extreme?

As the market focus centres on the US data, the main driver of the USD became US rates (and rate rise expectations). The key question is whether the recent weakness is temporary and a function of whether and West coast supply disruptions (and not forgetting the significant and anomalous impact of the oil price declines on everything from CPI to retail sales), or something more concerning. Our view remains that the US economic momentum has been maintained and that Q2 will bring renewed strength in the key data metrics.

Furthermore, if we are correct in our view that the US economic momentum has been maintained, then US interest rate expectations have become far too dovish. Rate markets are now pricing the first rate hike from the Fed around December and futures do not price a rate above 1.00% until 2017. Our view point remains that the argument against raising rates, from the emergency stance of zero, is weak with such strong employment growth, rising real wages and an oil price boost to consumption (and dampener on inflation). If Fed funds were already at 2.00% then this would likely not be the case.

This sentiment was mirrored by Fed Vice Chairman Stanley Fischer in referring to a 25bp rate rise as moving from "extraordinarily to extremely” accommodative monetary policy and further by NY Fed President William Dudley, who said "when, hopefully, the data support a decision to lift off later this year, it does not mean that US monetary policy will be tight.”

"Exchange rate plays a role in economic adjustment”RBA Glenn Stevens

Further afield Reserve Bank of Australia Governor, Glenn Stevens has been clear to talk down the AUD over recent sessions, saying things like "I would be surprised if AUD does not go down some more”, amid the suggestion of further policy easing.

In the UK, the political backdrop is if anything becoming less clear as neither major party appears able to gain ground on the other, adding pressure on GBP ahead of the May 7th election. In Japan, the stabilisation of USD yields and recent equity strength has supported a decline in the JPY and across the board, while perhaps by default (no inference intended) the USD remains in a strong position for further gains ahead.  
By Neil Staines on 16/04/15 | Category - Comment

"Eventually it is a game of cricket”Sachin Tendulkar

The ‘corridor of uncertainty’, a cricketing term, made infamous by Geoffrey Boycott, describes the pitch of a delivery where the batsman is unsure whether to play the shot or to leave the ball and let it run through to the wicketkeeper (or potentially hit the stumps and get the batsman out). The ‘delivery’ of the US data and the backdrop of weak global global growth and poor market liquidity (a bumpy wicket?) has seemingly placed the USD firmly in the corridor of uncertainty!

This week’s US data has, in particular, epitomised this analogy. Retail sales data earlier in the week caused much consternation as it fell short of expectations. However, it is likely that most, if not all, of the weakness in US retail sales data is a function of the recent oil price decline. Retail sales data is not inflation adjusted, therefore the series does not account for the very large decline in oil (petrol) prices (or the significant decline in y/y petrol station sales as a function of the fact that the oil price itself has declined so markedly) - a dynamic that has been a key component over the last four months of retail sales ‘weakness’. The rest of the series (ex petrol stations) actually showed relatively strong activity. Yesterday’s weak industrial production was lead by sharp declines in utilities, which is also likely to be affected by the oil price decline.

We retain our positive view on US economic momentum, and while the near term volatility and uncertainty surrounding the data makes expressing that view more complicated, in this sense (and to paraphrase Janet Yellen) ‘patience’ is likely a virtue.

"in [FX] market top trumps QE plus negative rates beats everything”Kit Juckes

The big event of yesterday was the April ECB decision and press conference. From our perspective the key development from the meeting, was that there were no developments. Fixed income markets had begun to fear a bond bubble (driven by concerns over a scarcity of bonds to buy under the QE programme) and thus the sustainability of the QE programme through to its "intended” end date of September 2016. Draghi played down the fears of both and in doing so maintained the green light to buy German Bunds, the yield on which (10 years) duly traded below 10 basis points - this morning we are below 9bps.

From our perspective, Draghi’s testimony mirrored our macro views. He stated clearly that the recent recovery in economic and sentiment indicators in the eurozone and the ECB (and subsequently other institutions such as the IMF yesterday), upward revisions to growth are "conditional on the full implementation of our [ECB] monetary stance”, and that overall growth remains fragile with economic risks to the downside. As ECU Global Macro Team member Kit Juckes put it, "in market top trumps, QE plus negative rates beats everything”. EUR and european bond yields remain vulnerable.

"They came to see me bat, not you bowl”W.G. Grace

With three weeks to go until the UK General Election, the term uncertainty is also firmly applicable to the UK and to GBP. While we retain a bullish view of the UK economy and GBP relative to both market expectations and its peers, we are happy to remain on the sidelines at present as far as GBP is concerned in order to avoid the asymmetric negative risks of a hung or split parliament after May 7th.

Elsewhere, the USD move was exacerbated in the major FX space yesterday by a sharp rally in the oil price, which undermined the USD and caused a sharp correction (higher) in the CAD. In Australia, a better than expected employment report (the unemployment rate fell unexpectedly to 6.1% as a result of higher employment) caused a further ‘flush out’ of long USD positions in the Asian trading session.

In summary, we continue to view the USD as the leader of the group of ‘currencies i would like to buy’. However, US data outperformance is still key to unlocking the next leg higher for the US currency, and removing markets from the ‘corridor of uncertainty’. Until that point market volatility is likely to remain heightened, and should opportunities arise, in cricketing parlance, it may be appropriate to look for a quick single rather than to try and knock it for six!  
By Neil Staines on 14/04/15 | Category - Comment

"There are no facts, only interpretations”Friedrich Nietzsche

Over recent months there have been a number of core themes that have dominated financial markets: prolonged weakness in the global economy and, in particular, global aggregate demand; The oil price decline and how the resultant investment, consumption and employment dynamic plays out; Greece and the ECB and; Fed lift-off from its (overly?) long held zero interest rate policy (or zirp).

None of these questions have a simple answer or a one dimensional structure and all are likely to continue as dominant themes. The last, however, is likely to be brought into a more acute focus over the next couple of weeks, starting with this afternoon’s US retail sales data and culminating with the March employment report (and a firmer handle on the weather, or other transitory impacts on the February disappointment).

"I don’t measure America by its achievement but by its potential”Shirley Chisholm

Regular readers will be well aware that we maintain a positive view on US economic momentum and the US (relative to both its peers and consensus expectations) and that we maintain the view that the June FOMC meeting remains our favoured lift-off date. In order for that to occur, and for rate expectations to come forward, the US data is key. There are still hurdles for the US data to jump in order for this June liftoff potential to become a reality, however, we maintain our view that as the headwinds to growth in Q1 (some of which are transitory) lift, economic momentum going into Q2, likely prove enough to justify action.

"Politics is too serious a matter to be left to the politicians”Charles de Gaulle

In the UK, this morning headline inflation was shown to have held steady at 0.0% y/y for a second month in March. Rather disappointingly the data also highlighted a further decline in core inflation (ex volatile food and energy components) to just 1.0% y/y. Elsewhere, BRC retail sales rose 3.2% year on year on a like-for-like basis in March, underlying the strength of economic momentum in the UK. However, as the General Election approaches, political risks and uncertainties remain the dominant factor in FX and while we see significant potential for GBP (and for higher UK interest rates) in H2 2015, the near term bias for GBP is at best stable.

In the mean time, fixed income and FX markets are increasingly focussed on the seemingly inevitable progression of 10 year German Bund yields into negative territory. At the start of 2014, the yield on 10 year German Bunds was around 1.96%, however, substantial disinflationary (and ultimately deflationary) pressure in the region, in addition to weak and fractious growth culminating in two interest rate cuts into negative territory and the initiation of a substantial QE programme, have taken the equivalent yield to just 0.14% today. In many respects this highlights the limited stock of eurozone bonds relative to the size of asset purchases under QE and the substantial downward pressure this puts on longer dated yields. This is also likely weighing on longer yields in the US and UK among others.

Elsewhere, the JPY strengthened yesterday on the back of comments by an adviser to PM Abe, that 105 would be an appropriate level for USDJPY. With BoJ QQE still in full flow we would argue that the bias in USDJPY remains to the topside, though in the short term, convictions may be tested. In Australia the monetary bias also remains to the downside and with disappointing (albeit very volatile) trade data release from China earlier in the weak AUD looks set to remain vulnerable in the short term.

Above we outlined a number of themes that dominate financial markets at the current juncture, in FX the most pressing, and likely the most tangible theme is the US data and its impact on rate lift off timing expectations. After a quiet start to the week, that focus returns today.
By Neil Staines on 09/04/15 | Category - Comment

"What was once the unknown and frightening becomes the new normal”     Robin S. Sharma

For many months now we have expressed our central view that US rate normalisation process (lift-off) will come at the June FOMC meeting. Over recent weeks, the underperformance of a number of US data metrics have led the market to become less confident in US economic recovery and push back its expectations of rate liftoff. On balance, we are still inclined to view the recent ‘underperformance’ as ‘volatility’ in the data (exacerbated by some temporary factors such as the adverse weather and the supply disruptions of the west coast port strike).

Last night’s release of the March 17th, 18th FOMC meeting stated that "several Fed officials judged a June liftoff would be warranted”. From our interpretations of recent rhetoric from voting members and from the derivation of the term ‘several’ from the Fed lexicon, we expect that number to be somewhere between 4 and 7. In our view, this leaves a June lift-off (albeit marking the start of a very shallow flight path) firmly on the table.

"downside surprises mostly due to temporary factors”         William C. Dudley

While we are very aware that there were also a number of cautionary remarks surrounding the USD (as a drag on exports and growth) and oil (as a drag on jobs and inflation), we continue to view this progression as USD bullish by default. US data is an increasingly acute focus from here and, after the disappointing March payroll gains in the US, the April report will likely be key.

In the UK, service sector PMI outperformance earlier in the week supports our view that UK economic momentum remains stronger than the general consensus. While the proximity of the General Election increases the uncertainty in the near term, our medium term view of GBP is unwavering, expecting further outperformance relative to both expectations and its peers. A rate hike in the UK may well come significantly before the current market expectation - we retain our view that Q3 2015 is still a valid option for BoE rate liftoff here. USD and GBP remain our favoured longs - albeit with a short term caveat to GBP. The issue over a possible IN/Out Referendum cannot be ignored but we will consider this if and when it transpires.

"USD may rise more on policies overseas”          March 17th, 18th FOMC minutes

Elsewhere in the world there is less reason to be cheerful. The recent bounce in the macroeconomic data in the eurozone is a positive for global growth and those countries that have strong domestic demand. However, the political risks in the eurozone remain significant, absolute levels of growth remain pedestrian at best and without the structural reforms that Mario Draghi persistently urges, the bounce will likely prove temporary. Furthermore, the monetary policy bias in the eurozone remains firmly dovish, and with interest rates in negative territory the marginal shift away from global FX reserves held in EUR will likely continue to weigh for some time to come.

In Japan, despite the disappointments of some that the BoJ did not add further stimulus in their first meeting of the new Fiscal Year yesterday, monetary policy remains firmly and aggressively dovish. JPY likely remains highly correlated to US yields and if the US data continues to point to Fed normalisation, then there is likely further upside in USDJPY as US yields (reluctantly) rise. CAD remains vulnerable to any setback in the oil price as was apparent amid yesterday’s sharp oil sell off and AUD, despite stronger data overnight and an unexpected (by many) hesitation to cut rates earlier in the week, the monetary policy differentiation continues to undermine AUD going forward.

"We either live with intention or exist by default”           Kristin Armstrong

Overall therefore, despite the recent disappointments in the US data (now overcome by US interest rate markets) and the debate over the impact and implications of further USD strength on US exports and growth, there is likely (perhaps by default) still only one game in town. By the time the US data provide an ‘obvious’ signal for US rate lift-off (June, July and even September are ahead of current market pricing), the USD may already be significantly higher!

By Neil Staines on 27/03/15 | Category - Comment

"Falling unemployment will herald ‘boom time’ for US”James Bullard

A lot has been written over recent days, espousing the view of a decline in US economic momentum, delays in the process of US monetary normalisation and the end of the USD rally in FX. Little has been mentioned about the possibility that the ‘slowing’ of GDP momentum that was mooted by Janet Yellen at last weeks FOMC press conference is a function of extreme weather conditions and the west coast port strikes. While we would likely refrain from using the term ‘boom’, we expect US economic momentum to bounce back strongly in Q2, leaving the door open for the start of monetary normalisation from the Fed in June, and a further (perhaps substantial) leg higher for the USD.

"See more volatility from differing monetary policies”Christine Lagarde   

The recent ‘correction’ (and we still maintain the view that it is a correction and not, as many have suggested, the end of the rally) in the USD has been exacerbated by liquidity. Low liquidity has induced high volatility, or perhaps more correctly, a higher volatility of volatility. We maintain the view, as alluded to by IMF head Christine Lagarde, that divergent monetary policies are a key driver of volatility and that this dynamic has significantly further to play out in FX.

"Economic impact of a strong dollar is slight”James Bullard

Since its correction there has been much speculation about the impact of the rise in the value of the USD as a headwind to growth, and thus its importance in determining the timing of the initiation of monetary normalisation in the US. Furthermore, the recent strength of the USD was cited by many as the key factor behind the downward revision of the FOMC Summary of Economic projections, or ‘the dots’. We would argue that the level of concern over a rising USD at the Fed remains modest and that in many respects, particularly if it fosters a growth recovery in Europe and Japan (among others) the Fed would agree with Treasury Secretary Lew that "its good for the US; its good for the world”   

"Stronger dollar the inevitable result of policy divergence”Benoit Coeure

In the world of FX, however, any individual currency is only one half of the story. We maintain the view that the USD will outperform over coming months and that there are a number of strong contenders in the ‘sell’ camp.

EUR remains a key area of political and economic fragility and thus likely remains high on the list. ECB Peter Praet stated this week that the current recovery in the eurozone is "cyclical and not structural” as he continues to push lawmakers for much needed structural reform across the region. We would argue that monetary easing, negative interest rates (and yields across a vast amount of the eurozone yield curve), the lack of a Greek resolution as well as political uncertainties surrounding several General Elections in the region will continue to weigh on the EUR.

Elsewhere, there is a negative case to be made for several other developed world currencies. In Japan, the start of the new Fiscal Year next week could herald a new wave of retail money into equity markets and fuel the higher Nikkei, lower JPY theme that seems to have lost some impetus of late. In Australia, concerns over the path of China growth momentum, alongside deteriorations in mining investment and terms of trade will also likely weigh on the AUD.

In the UK, the story is more mixed, and we maintain a cautious approach towards GBP as a function of the political uncertainty surrounding the General Election in 6 weeks time. This morning’s release of a Speech by BoE Ben Broadbent echoed our own sentiment however, as he played down the prospects of both deflation and a further rate cut in the UK as being extremely slim. After the election we envisage a strong bounceback in UK economic momentum, business investment and GBP as the BoE move towards monetary normalisation in the wake of the Fed. For now, however, at least as far as GBP is concerned, we wait patiently on the sidelines.

"Things are looking better - in fact they are looking downright good”   John Williams

While it may be the third quarter in the UK, rather than the second quarter in the US, we are inclined to open our minds to the possibility (refreshing after such a long absence) of significant economic outperformance in the US (and ultimately the UK). Here comes the boom?

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