ECU's Investment Blog
"My only regret in life is that I did not drink more champagne” - John Maynard Keynes
As we move into the holiday thinned period of the US Thanksgiving celebrations, the data calendar is fairly light, yet what there is in the US (Durable goods orders, weekly jobless claims, PCE, Chicago PMI and Michigan confidence) is brought forward to today. While there has been some volatility in the US data of late, yesterday’s Q3 GDP revision, continues to highlight the significant economic momentum in the US. The 3.9% q/q annualised growth, led by consumer and business spending continue to support the case for higher short end US yields and a higher USD over the medium term. Something to celebrate over the Holidays!
"The next move in policy is going to be an increase” - Mark Carney
In the UK, this morning saw the revision to the Q3 GDP data. On a headline basis the data was in line with expectations of a (still strong) growth rate of 0.7% q/q. The economic momentum in the UK, in particular relative to its European peers, remains compelling. In the breakdown, private consumption was better than expected, as was the (dominant) service sector activity, however, an upward revision to the government expenditure component and a downward revision to net trade take some shine off the data. Business investment was also revised lower on the release, contrary to recent upward revisions, but we would be hesitant to extrapolate any weakness on this front as it is likely that the uncertainty surrounding the Scottish Referendum, brought with it a one-off pause in UK investment commitment.
This morning’s press covers much of the testimony of BoE governor Carney to parliament yesterday, in relation to the latest Quarterly Inflation Report. While many of the headlines, and much of the sentiment emphasises the governor’s statements that the economy "is still in need of stimulus”, the core differentiator in our perspective of the world is that unlike the Eurozone or Japan, the UK retains its tightening bias – "the next move in policy is going to be an increase”.
Furthermore, market expectations for the first rate hike in the UK are now broadly centred around November 2015. In our view this is too cautious and we would suggest that the first rate rise will come earlier than market expectations in the UK and that it is likely that the second rate rise may well come at around the time the market is currently expecting the first. This pace of normalisation would still provide a significant level of monetary "stimulus” (that Carney suggests is still required), not just in a historic sense but also in relation to the ‘new normal’.
We have discussed previously our view that the UK will likely continue to outperform expectations over coming quarters and the recent developments in the oil price only boost our expectations for consumption and investment over coming months. In that regard, headlines from tomorrow’s OPEC meeting may be significant, if not immediately apparent in the GBP exchange rates.
"Walking is the only way proven to stave off cognitive decline” Dan Buettner
The other big event of the week is the release today of Jean-Claude Juncker’s EUR 300B investment plan, which ECU Global Macro team member, Kit Juckes describes this morning as a plan "which moves money around like deck-chairs on the titanic rather than creating new investment funds”. Even as expectations of sovereign QE in the Eurozone grow (increasingly for the December meeting) the outlook for the Eurozone, from our perspective continues to be very bleak over the medium term. Interestingly, despite the significant fall in the value of the EUR in currency markets, German import prices are still falling at a 1.2% y/y rate. As Germany continues to import disinflation, the prospects for further easing from the ECB and further (significant) declines in the EUR remain likely as the region remains too weak to stand on its own feet – let alone walk!
"We shall seek to debate without division or rancour” Johann Lamont
Over the past 48 hours or so we have been given greater insight from Japanese, UK and US central banks, in all cases, there is evidence of reduced division among voting members. For many months now we have espoused our view that economic (and ultimately, monetary) differentiation will dominate the rationale for movement in FX in the medium term. The developments of this week, not only strengthen this view, but also provide a greater degree of clarity on the bullish and bearish examples.
"…give me reason to prove me wrong” - Linkin Park, New Divide
The US remains the stand out bullish case as far as we are concerned and, despite some recent stabilisation (and, in some cases corrections) the USD remains our favoured ‘buy currency’. Last night’s FOMC minutes, while perhaps emphasising their concerns over the ‘what if’ scenario of falling inflation expectations, or the ‘what if’ concerns over lower growth amid lower inflation, maintained the (albeit slow) progress towards Fed monetary normalisation.
While the debate over the "considerable time” language remains, its meaning has been "neutered” (as per Fed governor Richard Fisher) by its qualification as being data dependent. Beyond that, the FOMC appears to be less divided and perhaps even more hawkish. Furthermore, in a healthy development the Fed discussions chose to omit reference to market turbulence in order to avoid the "misimpression” that policy was likely to respond to volatility (a stance that we have commented on on previous occasions, and which somewhat undermines the credibility of the Fed at this stage of the recovery) - a first step towards removing the ‘Yellen put’.
Over recent weeks we have highlighted the decline in sentiment that has induced a sharp decline in GBP in FX markets, both in terms of growth and inflation. We have also been clear to express our view that the market has likely become far too pessimistic on the outlook for the UK economy and for GBP. While we are in agreement with the broad consensus that near term inflation is likely headed lower, possibly below 1.0% (a revelation that led to a sharp sell-off in GBP following the November inflation report), our views on the implications and connotations of this development differ. Yesterday, the Bank of England provided further colour on their expectations of the future path of growth, inflation and monetary policy, in the November MPC meeting minutes.
Whereas the October MPC minutes suggested that the 2 hawkish dissenters on the committee (Weale and McCafferty) were isolated against a dovish majority. The statement in the November minutes that there was a "material spread of views on the balance of risks to the outlook” suggests that the ‘majority’ may not be as cohesively dovish as was previously believed. Furthermore, the MPC pointed out that "business investment growth remains robust” (a point that we highlighted last week as being very important for maintaining economic momentum) and that a "majority saw risk of a faster erosion of slack”.
If, as we would anticipate, the UK data continues to point to significant economic momentum then we would expect further hawkish dissent going into 2015, and ultimately a rate hike in the UK that is now significantly earlier than the current delayed expectations (November 2015). On this basis, we feel that the bearish market expectations for GBP that have risen sharply, even after such significant falls, are at best overly pessimistic. The much stronger than expected retail sales figures for October, released this morning, are a case in point.
"Across this new divide” Linkin Park, New Divide
In Japan (following the BoJ meeting earlier this week), the JPY slide continues to dominate with the latest extension taking the JPY to depths not seen since late 2007. The central bank maintained the pledge to expand the monetary base at an annual pace of JPY 80 trillion (the surprise initiation of which saw the explosive break of 110 at the end of October). Whilst the backing of this measure was marginal in October (at 5-4), this month’s vote all but eradicated the divide with a far more decisive 8-1. We have alluded to the subtle shift in drivers of FX markets from USD to JPY over recent weeks, further commitment from the BoJ and the Japanese government (as Abe calls for further economic stimulus and a snap election to validate the continued public commitment to Abenomics) to the path of QQE, likely only makes the JPY decline stronger and more entrenched.
"The truth that lies across this new divide” Linkin Park, New Divide
In Europe, while there were no new developments from the ECB (who do not have a formal published policy vote in any case), the balance of payments data released yesterday provided some significant information. The current account surplus reached EUR 30 billion in September. The data are balanced by persistent currency and deposit outflows (on negative domestic sentiment and low deposit rates). The current account surplus has helped support the EUR to a certain degree, however, this potentially means that EURUSD is now more sensitive to short term interest rates (2 year US treasury yields are likely a key barometer) and after a period of stability around the 1.2500 level we feel that the EUR is shaping up for the next leg lower.
US CPI data could provide the next impetus for foreign exchange and any topside surprise to the headline or core inflation rate could well be the trigger for higher US yields and a higher USD across the board.
The "whatever it takes” mantra is synonymous with Mario Draghi and the return of confidence to peripheral bond markets, as the ECB President announced the) backstop sovereign bond buying measure of OMT (Outright Monetary Transactions) back in mid-2012 (and as yet, still untested). More recently, this mantra has been adopted by Kuroda et al. in Japan as they unleashed another monetary stimulus package by further raising the target for the expansion of Japan’s monetary base, at the end of October.
Today, following the very disappointing Q3 GDP data from Japan at the start of the week, and the continual downward revisions to both growth and inflation forecasts in the Eurozone (not to mention the explicit reference to buying sovereign bonds by Mario Draghi to the European Parliament yesterday), we consider what "whatever it takes”, will take!
"Current euro area performance is abysmal” - Mario Draghi
Furthermore, after Draghi referred to the current euro area performance as "abysmal”, we briefly discuss whether the impact of the further deterioration in the Eurozone and Japan (and the monetary fiscal measures that will, or have already, accompanied the decline) might undermine the momentum behind the recovery paths of the stronger economies that, hitherto, have been leading the way, notably the US and the UK?
Over recent sessions, we have witnessed more of a two way progression in the USD (amid heightened volatility) and a more protracted decline in GBP, as a function of a more dovish view of the UK interest rate trajectory. Geography and trade concentration mean that the slowdown in the Eurozone has bigger implications for the UK than the US. However, following on from our initial thoughts on the BoE Quarterly Inflation Report last week, we feel that the market has become perhaps too negative on the outlook for UK economic growth. After all, we are at a pivotal point whereby real wages are beginning to rise and lower oil prices are likely to feed through into petrol, utility and broader consumer prices to support personal consumption. UK rate hike expectations have already shifted further back (Q4 2015), in line with markedly lower inflation projections. However, from this point onwards we fail to support this as a reason to justify a lower GBP, having already corrected in excess of 9% against the USD and over 3% on a broad trade weighted basis (and the EUR) since the Summer.
"US not yet feeling the impact of external cooling” - Fed Powell
In the US, the progression is perhaps clearer, and despite the ‘flash crash’ in Treasury yields that we witnessed in October, the macroeconomic picture in the US remains supportive of USD outperformance. Economic and monetary divergence in favour of the US (and UK despite the recent deferment), in our view, continue to suggest that USD and GBP should benefit from the tightening bias of the respective central banks, most notably against those that have the most acute easing bias, Japan and the Eurozone.
In Japan this morning, we have seen further developments as PM Abe calls for the dissolution of parliament and orders ministers to start preparing for another Japan economic stimulus. He also stated that, after the first sales tax hike had such a profound and prolonged negative impact on consumption and investment, the second sales tax rise (needed to answer rating agency questions of fiscal sustainability and investor confidence) will not now be implemented for 18 months. In our view, this supports further USD gains against the JPY, although there is potentially a case to be made that the backdrop evolving is more one of a "sell JPY” story, rather than necessarily a ‘Buy USD’ story. Technically USDJPY could extend towards JPY124.00 within this cycle, notwithstanding its overbought condition in the short term.
"Fed needs to prepare markets for a sooner lift-off” Fed Plosser
What is perhaps most likely is that the focus on the data in the UK and the US becomes even more acute and, amid this, GBP and USD may face a heightened baseline volatility. In both countries, policy makers have made it clear that monetary policy is now predominantly data dependent.
On that note, this morning’s UK inflation data was not as low as anticipated. However, the headline rate will continue to come under pressure in the near term and, over coming months, we would expect Mark Carney to contemplate the content and sentiment that would be contained in his letter to the Chancellor, should he be required to pen one. However, in the US and the UK, we do not expect economic growth momentum to deteriorate in the way that it has in Japan and the Eurozone. ECB Board member Peter Praet said yesterday that the eurozone "outlook is likely to be revised downwards in December”. There is, however, every chance that widespread expectations of a slowdown in the UK by the market (and the BoE) are not in fact played out by the data.
This is a topic that will likely remain central to our thoughts and discussion over coming weeks / months. However, despite the fears and concerns of some commentators and market participants, we continue to see USD (and GBP) outperformance as core FX themes as Japan and the Eurozone compete to do whatever it ‘respectively’ takes!
"Outlook is beset with uncertainty” – Swiss government statement
After a brief period of relative anonymity in FX, yesterday saw an acute focus on GBP, with the release of the latest employment report and the highly scrutinised Bank of England Quarterly Inflation Report (QIR). Going into the data, expectations were dovish. Those expectations were tempered initially as the employment report, while showing no further progress in the unemployment rate, revealed higher than expected wage growth (putting real wage growth into positive territory for the first time in 5 years). If maintained, this is a significant positive development for the UK consumer and for growth going forward. Then it was the turn of BoE governor Mark Carney and the November Inflation Report.
One core pronouncement from the QIR was that near term (far less relevant for policy considerations) inflation projections were lowered sharply, to account for external factors such as the weaker commodity prices and further downward revisions to the growth forecasts of primary trading partners, namely the Eurozone. However, longer term inflation projections (and equally important for policy, inflation expectations) remained unchanged.
Recent significant revisions in the UK show that investment is rising, which bodes well for future increases in productivity and, in addition to these positives the slowing in employment growth may also be a signal of rising pressure on UK wage growth. In the near term, the modest downward revisions to GDP forecasts from the QIR, have weighed on GBP, however, even these lower projections remain close to trend. At this stage the lowering of unemployment rate projections has not resulted in higher wage inflation projections but yesterday’s higher than expected average earnings data was compounded by positive expectations from Carney in the Q&A. Ultimately the emphasis of BoE policy has now switched to data dependence (a la Fed).
"Tightening remains in prospect” Mark Carney
While the inflation report will likely be described as dovish by the majority, Carney stressed the fact that the QIR and indeed the BoE view remains "consistent with a tightening of policy over the forecast horizon”, and, while he also reiterated that it is the shape of the yield curve, or the slope of projected rate increases that is most important at this stage of the recovery (as opposed to the specific timing of the first rate hike), "tightening remains in prospect”. This tightening bias continues to differentiate this stage of the UK recovery from those of the Eurozone and Japan where the bias is clearly an easing bias (and even in Australia where there is no bias, implicit or otherwise).
While the QIR maintained the level of inflation at the forecast horizon, suggested that the current level of market pricing for the first rate hike was consistent with the view of the Bank, and maintained the tightening bias: in the near term, GBP has come under pressure. Whilst we maintain our view of UK economic and monetary outperformance in the medium term, the near term is likely to continue to remain challenging.
Tomorrow is another day!
After the release of Eurozone (national) inflation data this morning (which was in line with expectations) tomorrow brings the first release of the Q3 GDP data from the Eurozone (both at national and Eurozone level). The key focus will be on Germany, France and Italy where expectations are for stagnation across the region’s biggest economies. Failure to outperform these expectations will likely turn the focus of market attention back to the ingrained weakness of the Eurozone, and while many have begun to point to growing political risks in the UK, a continued lack of growth will likely bring with it political risks for the Eurozone as well, which could go far beyond those of the UK. Indeed, the rise of the Spanish Podemos party (leading in the polls despite not being in existence a year ago) and the rising domestic pressure on Angela Merkel in Germany are a case in point.
Further afield, comments from the Reserve Bank of Australia last night that currency intervention remains a possibility, as well as reiterating that "AUD remains above most estimates of fundamental value” have, so far, failed to contain the recent rally in AUD. We maintain our view that the AUD remains structurally overvalued at this stage and continue to anticipate further declines over the medium term.
Tomorrow also brings the first significant data release of the week in the US in the form of the October retail sales report. Expectations are for a modest (+0.2% m/m) increase from the previous month and a reading above these levels may shape the focus of market attention back towards the USD outperformance theme, particularly as US yields continue to support this view.
"Dystopian futures are also a reflection of current fears” - Lauren Oliver
With very little on the data calendar at the start of this week, the lull provides us with an opportunity to reflect on recent events and re-evaluate our thoughts and expectations going forward. Last week, we discussed the latest ECB statement (and press conference) and the unexpected aggressive further easing from the Bank of Japan, which (in the near term at least) suggest a ‘dystopian future’ for those respective currencies. Our focus this week, turns towards the US and the UK.
"Recent appreciation of the USD not a concern” Boston Fed, Eric Rosengren
Last Friday’s US employment report was another impressive development in the US labour market recovery story. With an annual increase in jobs at 1.93%, it is the fastest period of job creation since 2006. Furthermore, the household survey saw employment jump by an impressive 683K, 2.6% higher than a year ago, leading to a drop in the employment rate to 5.8%. Despite this there is still some market doubt that this impressive jobs growth is enough to significantly boost GDP further (amid weak productivity) or boost inflation (amid tepid wage gains). Indeed, US yields and, to a certain extent, the USD suggested a lack of ‘new news’ from the report, as yields fell back and the USD eased (possibly aided by position squaring) into the close. After a period of consolidation, however, both US yields and the USD have shown some resilience. Our view on the USD remains unchanged – we expect further significant gains (at the very least against EUR and JPY, but also AUD and NZD)
"Clarity affords focus” Thomas Leonard
In the UK, after a period of anonymity in FX, while the central focus was elsewhere, GBP comes back to the fore this week. Tomorrow brings the September unemployment report (and October claimant count) which we expect will reveal an unemployment rate below 6.0%. Despite the debate about levels of productivity and their impact on the ‘equilibrium level of unemployment’, there can be little doubt that the rate of labour market recovery in the UK (back to mid-2008 levels) has been impressive.
Much of the focus on the UK of late has been on the slowdown in activity going into Q4 and, despite significant job gains, a lack of wage price pressure adding to broader disinflation from energy price declines and moderating activity (largely due to the continued slowdown in Europe). However, following a period of negativity towards GBP and UK rate expectations, we feel that the risks now favour both GBP outperformance and a (perhaps modest in the near term) re-pricing of wage pressure and interest rate expectations. This likely suggests asymmetric (positive) risks for GBP.
In this regard, tomorrows average earnings data and the projections from the Bank of England Inflation Report (QIR) are key. Expectations for the QIR are firmly dovish and, after a year in which the UK has outperformed both expectations and its peers (except perhaps the US), we see little reason to get dovish at this stage – at the very least relative to the broader global economy. We continue to favour GBP in FX markets against EUR, JPY, AUD and NZD as the theme of economic (and monetary) differentiation continues to play out.
For today the data calendar is very light, and as such FX markets will likely take their cue from interest rate and equity market sentiment. With Dow Jones, S&P 500 and Nikkei 225 all making new highs, risk sentiment likely remains positive and, against this backdrop, US yields continue to normalise. This should be a strong platform for what we view as a secular bull market for the USD. Furthermore, counter to geography and trade ties, GBP is likely to remain more aligned to the USD than EUR.
"US looks like an island of prosperity versus the rest of the world” - James Bullard
On Tuesday, we discussed the recent economic and monetary developments in the global economy and suggested that the USD was "the only game in (FX) town”. Events since then have only added to our conviction. While earlier in the week the fireworks were undoubtedly in the JPY, in the aftermath of the ECB meeting it is likely that the USD’s assent against the EUR becomes a more engrained theme.
"Overall, the euro area is grinding to a standstill and poses a major risk to world growth” OECD chief economist Catherine Mann
In the run up to this month’s ECB meeting, speculation had grown (in large part due to a Reuters report published on Tuesday) that there was growing disquiet within the governing council over the communication policy of Mario Draghi; in particular with respect to his explicit reference to the expected size of ECB balance sheet expansion. His references at the two previous press conferences had implied a EUR 1 trillion balance sheet expansion through covered bond and ABS purchases. If the disquiet were to be believed then it potentially reduced the commitment of the ECB behind such a scale of expansion and thus (again potentially) stood to unwind some of the implicit easing bias of the ECB.
"Read my lips…” George H. W. Bush
In a change to the opening paragraph, Mr Draghi put paid to such speculation; firstly, by maintaining the magnitude of the expected balance sheet expansion (back to 2012 levels) and, secondly, by revealing the formal description of that ‘expectation’, as contained in the statement had been agreed and signed by ALL governing council members.
In a press conference that brought with it little expectations from analysts and commentators Mr Draghi’s rhetoric in relation to the ECB balance sheet expansion went a step further. Not only did he explicitly state that "ECB assets are to expand as others contract”, he also suggested that even as covered bond and ABS purchases expand, the ECB stand ready to increase the stimulus if it is not enough to have the desired impact. Furthermore, he stated that they are "unanimous in their commitment” to act again if growth or inflation expectations disappoint further. The governing council has also tasked staff with "preparing new measures to be implemented, if needed”, which likely means markets will increasingly anticipate purchases of corporate bonds (as well as perhaps some technical amends to the TLTRO programme), or even sovereign bonds, possibly as soon as December.
"Germany expects low ECB rates ‘somewhat’ beyond 2016” Wolfgang Schaeuble
It is precisely this economic and monetary differentiation (that we have been proclaiming for some months now) that we feel continues to favour the USD over both EUR and JPY. Furthermore, as the US (and the UK) move further into the process of monetary normalisation, it is likely that this divergence continues (and widens) for some time to come. The USD remains the dominant force, but the economic and monetary characteristics and momentum of the UK should align GBP far closer to the USD than the EUR or JPY
In the UK, in contrast to the sharp downward revisions to growth prospects in the Eurozone (most significantly of late in Germany), this week the National Institute For Social and Economic Research (NIESR) in the UK raisedits forecast for 2015 GDP growth to 2.5% from 2.3%. Furthermore, we feel that the current market expectations for when UK interest rates may start to rise have moved too far back. Consequently, we believe that economic momentum and interest rate expectations in the UK now offer a positive risk / reward trade-off for GBP in general. Politics remain a slight drag for GBP at the current juncture, but at least against EUR (as well as AUD and JPY), the economic and relative value case for GBP outperformance remains compelling.