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Date:

30th April 2009

The Federal Reserve kept its targeted interest rates unchanged at 0.0-0.25% and made no change to its quantitative easing programme. The Fed in its statement noted "the pace of contraction appears to be somewhat slower" though they think "economic activity is likely to remain weak for a time" (click here to see the Fed's full statement).

Yesterday's US GDP data was slightly worse than the market was expecting, reporting a 6.1% annualised decline in Q1 compared to 6.3% in Q4. This two-quarter contraction was the worst in 60 years. The Q1 out-turn was approximately half-way between the bank stress test baseline scenario of minus 5% and the worst case scenario of minus 6.9%. The markets took some encouragement from a positive reading for consumer spending of 2.2% growth – the best in two years. Looking at previous US recovery cycles, consumer spending generally leads any recovery – not investment – so a small ray of hope here (click here for some interesting reading on these cycles). Inflation picked up a bit too (2.9% from 0.6%), helping to alleviate fears of deflation.

However, the other GDP components were very poor with private investment collapsing at a 51.8% rate, exports slumping at a 30% rate (highlighting the collapse in world trade) and government spending down 3.9%. The investment and export numbers are especially eye-popping. Inventories dropped by around $100 billion (the biggest fall since records began in 1947) and as I have mentioned before, this very sharp inventory contraction is likely to unwind which points to ‘better’ GDP and industrial production numbers during the rest of Q2 into Q3.

The steepening of the US yield curve in particular over the last month might point to stronger growth. The yield curve has long been used by economists as a business cycle indicator with an inverted curve (short rates above long rates) pointing to recession in approximately 12 months time, a flat curve indicating weak growth and a steep curve (long rates above short rates) indicating recovery. The Cleveland Fed has just published a report which contains some interesting charts and analysis on all of this and they think that US GDP growth might pick up to a 3% rate over the next year (click here for the report).

Overnight news highlighted that Chrysler is expected to seek Chapter 11 bankruptcy today and the WHO has upgraded its flu pandemic alert level to phase 5. Also, Ireland is suffering the worst downturn of any developed economy since the Great Depression. But this has had little impact on equities which continue to grind higher. Risk appetite is improving and the ‘pain trade’ for investors is being left behind as the equity market moves higher. Bears will suffer. An improvement in risk appetite is reflected in this chart from Bloomberg (click here) which shows a strong correlation between USDJPY, the copper price and the Chinese stockmarket – i.e., the yen is going down, copper is rising on a reflation/China infrastructure play and equities are up (the Chinese stockmarket is an advance indicator as it was the first to pop and the first market to recover). I note that Taiwan's stockmarket has gone up the most since 1991 after allowing Chinese investments for the first time since the civil war 60 years ago and that the Korean won is the second best performing currency(after the rand) so far in April against the US dollar (click here for the Bloomberg table of carry trade performance).

The Conference Board's consumer confidence index for April jumped the most in three years in data reported earlier this week. There have only been three other times that consumer confidence has dropped to a three year low and then jumped 10 points the next month. This was in April 1974, February 1975, and April 2003. The last two both led to one-year gains of 20% plus in the S&P equity index (click here for some analysis).

Missing a bull market in equities can be costly as,on average, the first six months of a bull market provides 27% of an entire bull market's performance. If you miss the beginning of a new bull market in equities then actually investing in bonds will outperform buy-and-hold indexing over the economic cycle (click here for data on stockmarket returns following a recession low). Other things to note: IBM will increase its quarterly dividend by 10%; and 64% of the 235 S&P500 companies that have reported so far for Q1 have beaten earnings estimates.

Finally, our Investment Committee adviser, George Magnus, thinks financial stability remains elusive and that banks will have to raise more capital (click here to see his thoughts).

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Date:

29th April 2009

The FOMC announces its latest monetary policy decisions this evening. The markets expect no change in the Fed funds rate which currently stands at 0.0-0.25%. The markets expect the FOMC to be less downbeat in its assessment of the US economy given tentative evidence that the rate of decline in output and demand is decelerating. Today's US GDP data for Q1 will likely show that the Q4 out-turn of minus 6.3% at an annualised rate was the cyclical trough in GDP. However, I think the FOMC will need to keep official rates close to zero for some time and I can't see them wanting to signal the possibility of an early upturn in rates. Note that FOMC staff are reported as concluding that the ‘ideal’ fed funds rate would be minus 5% which some commentators have argued points to the possibility of further quantitative easing (QE).

In terms of other FOMC measures, I think the FOMC will stick to the overall shape of the existing programmes in terms of direct government bond purchases and the TALF (Term Asset-Backed Securities Lending Facility). It is possible that the FOMC might announce either expanded coverage of these programmes and/or announce more favourable terms to lending to encourage greater take-up of TALF. Indeed, the consensus in the market sees an increase in QE amounting to another $300-600 billion. This morning, I note that the yield on the 10-year US Treasury is hovering just above 3% and my guess is that the Fed will have to step up its purchases of Treasuries in order to cap yields at 3% (note that the 10-year yield is up 50bps since the Fed QE announcement on 18 March – click here for the Bloomberg chart). The need to do this is to ensure that mortgage rates (and the mortgage-treasury spread) fall/narrow, thus encouraging an improvement in the housing market.

The US Treasury needs to borrow $361 billion in Q2 (a record for this quarter) making for three consecutive quarters of record borrowing. The Treasury estimates that it needs to borrow $515 billion in Q3. Sharply rising deficits and higher debt levels increases funding risks but US private savings rates are going up and the US trade deficit is narrowing (as consumer demand falls) which means that the US is borrowing less not more from the rest of the world. So don't assume that more borrowing/debt issuance is necessarily negative for the US dollar.

To some degree, the FOMC's use of the asset side of its balance sheet in narrowing money market spreads (libor rates are lower and libor-OIS spreads are narrower) has been succesful. Credit spreads are still high though (relative to Treasuries) but I think there is investment value in this sector and I would expect credit spreads to generally narrow especially on high grade paper. Nevertheless, the fact that 4-week US treasury bill yields stand at 0.06% highlights that investor confidence is still low and that excess reserves prefer to be parked at the central bank rather than recycled as lending into the real economy.

Equity markets are in a fickle mood at the moment following the massive rally in March and they seem to be taking a pause for breath. Much of the March rally was a short squeeze sponsored by US government initiatives (QE – S&P up over 5%, PPIP announcement – S&P up 7%, mark to market changes – S&P up over 5%). Since the bear market began in October 2007, the average change in the S&P on Fed announcement days has been 1.04%. The last three FOMC meetings have seen the S&P gain 3.53%. If history repeats itself today, don't be surprised to see another leg-up in equities despite swine flu (click here for more on this) and the upcoming results of bank stress tests.

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Date:

28th April 2009

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Are we seeing "green shoots" of economic recovery as the markets are hoping or could it even be "daffodils" as Jim O'Neill at Goldman is claiming (Jim - the daffodils in my garden are already dying out ). Some like Prof Roubini think that the "green shoots" are merely "weeds" and that any notion of a durable recovery is misplaced. My former colleague at Merrill Lynch, David Rosenberg, points out that 59%of portfolio managers in the latest Barron's Big Money poll are bullish equities and that for every bond bull there are currently twenty bulls on the stock market. David also notes that these portfolio managers are looking for GDP growth of only 2% in the four quarters to 2010 (which would be the second weakest recovery on record) plus a 10% rebound in profits over the same period. David claims you need to see vigorous GDP growth of about 6% to activate an equity bull market.

Of course, during all the business cycles I have monitored over the years, economists debate the shape of the recession/recovery covering quite a few letters of the alphabet. Is it an L (Roubini, Krugman)? Is it a V? Or will it turn out to be a W, i.e. a "double-dip" shape. While the equity market recovery in March was certainly V-shaped, I think that this was largely down to significant short covering in financials(especially Citigroup which represented 12% of total short interest in the S&P) and consumer cyclicals (companies with the weakest fundamentals) aided by the fact that the US government wanted to avoid any publicly traded corporate bankruptcy. This morning I note that the WSJ is claiming that BoA and Citi will require more capital after failing to meet "stress tests" (and I think that there other banks especially regional banks that are technically insolvent) and that GM is effectively being nationalised (US government gets 51% stake). Plus swine fever is getting worse. All of which is weighing on equity markets at the moment and reducing investor risk appetite.

However, I have noted previously in my blogs that for both the US and UK economies, the inventory cycle is currently playing an important part in contributing towards the stream of "better-than-expected" economic data especially in the manufacturing sector (though I note rail freight traffic and road trucking volumes in the US are still trending down suggesting some caution as regards "recovery"). Through the latter part of 2008, there was a sharp run down in inventories as consumer demand collapsed. Now inventories are being rebuilt and this shows up in "better" confidence surveys (ISMs, PMIs) and data related to output and activity. The risk, in my view, is that once inventory accumulation is complete (by end Q2 say) then I think consumer spending won't be strong enough to soak up inventories to any real degree. That's when you may get the W-shaped or "double-dip" recession.

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Date:

27th April 2009

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Thoughts on sterling

Last week's UK Budget has introduced fresh worries regarding the health of the UK's fiscal position and what impact this might have on the UK economy. The weekend press in the UK highlighted the sharp deterioration in UK debt levels and government borrowing as well as the likely exit of entrepreneurs/high earners from the UK in reaction to the new 50% tax rate. Anatole Kaletsky in this morning's Times newspaper describes the tax increase as "Alistair Darling's biggest blunder" and I think Kaletsky is right. It is more than likely in my view that this is the thin end of the wedge and we can expect further increases in tax rates alongside cuts in public spending.

Future Chancellors will be heavily constrained in terms of what they can do and the bottom line is a combination of tax increases and/or cuts in public spending for some years to come. Government spending as a % of GDP in the UK is already at an all-time high and my guess is that this has to be curtailed sharply. Household consumption is largely being cut as UK consumers deleverage and repay debt. What this means is that an increase in the government budget deficit is being (partially) offset by a move from household budget deficit to a surplus. So on a net national basis the overall position is somewhat muted. But it's not just the UK that is being fiscally damaged. The IMF warned yesterday that the G20 economies will run a combined budget deficit of 6.5% of GDP next year. What does this mean for sterling? Well, the pound was under pressure in the run-up to the Budget last week but has since settled down. I think it might be sensible to see how the pound reacts this week. On my charts it looks as though the pound is moving into "oversold" territory and the latest positioning report shows that speculative traders still have net short positions in the currency (though to a slightly lesser degree than in Q4 next year). So it is not all gloom and doom for the pound.  Should UK economic data start to show some stabilisation this might help the pound in the short term but real money investors won't be expecting a rip-roaring bull market just yet.

To add to market concerns is the outbreak of swine flu. This is hurting airline stocks (but good for pharmaceuticals) but I guess you short oil, short agricultural commodities, and short commodity currencies. On top of a synchronised global financial and economic crisis, an outbreak of swine fever is the last thing we need just now given the adverse impact on the health of the labour force as well as disruption to transportation and distribution networks.

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Neil MacKinnon is away today. Today's blog entry has been written by Philip Manduca, ECU's Head of Investment

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An eerie calm has settled over the FX markets, although no one believes that this calmness portends anything other than another bout of heightened volatility in the weeks and months ahead. Why? Because the battle between hope and need on the one hand, and fear and reality on the other has yet to play out to its ultimate conclusion, where the psychology of denial will have been eradicated. Can it be so simple that massive doses of fiscal and monetary stimulus returns us to the “good old days”? Or is the viewpoint that life and wealth will never be the same again more relevant? As you may remember, our view has been and remains that a socioeconomic era has passed away, and that a chapter of history has been written and archived. The balance of global political and economic power is shifting, and with it comes necessary adjustments to relative economic prosperity. Riots in Thailand are about the fight of the underpaid, underprivileged classes for more pay and more say, and remind one of the class struggles in the UK in the 1970’s. Chinese demands for an independent global currency, and a shift away from the reserve currency status of the US Dollar, firstly make sense (after all, isn’t the control of the world’s currency by the US akin to a definition of financial authoritarianism) have an air of inevitability about them, and a movement out of US Dollars will occur sooner rather than later, reflecting the wishes of the new world with its cash rich, economic growth condition compared to the West’s debt ridden, recessionary condition. Indeed, one look at the football Premier League in the UK mirrors the story – a battle between US owners (Liverpool, Manchester United, Aston Villa) and emerging world owners (Manchester City, Chelsea and Arsenal). British owned clubs make up the numbers.

As this global economic and political battle ebbs and flows over the next one or two years, and if the ‘L’ shaped economic forecasts in the West become accepted wisdom, currencies will make further major adjustments. Equities, and especially financial equities, have rallied significantly in the last few weeks. As Neil MacKinnon has pointed out, it has been the biggest rally in a short space of time since 1933. But we believe this is a bear market rally, and I suspect that it might extend further than the bears feel comfortable with.

Why?

Because the issues of overpriced labour, over capacity of production, and lack of competitiveness continue to need to be resolved in the West as we attempt to fight off the challenges of an emerging world. The resolution will likely be defined to us by lower comparative standards of living, lower levels of consumption, lower debt borrowing, and more reality about the new world order and our position in it. It will feel tough, it will be different, and our economic and political powers will have diminished.

Euro swiss, euro yen, dollar yen and government bond markets, amongst other markets, are all signalling that equities may just have run ahead of themselves at present, and that a dose of financial sobriety lies ahead of us in the next few days. Yet the nostalgic dream of an “all our yesterdays” will be encouraged by politicians and financial spokesmen, hoping to uphold confidence levels amongst investors and consumers. Equities should seek the direction of greatest pain, too, which means under invested equity asset managers may be forced to participate, albeit at nosebleed levels in the next few weeks. The consensus that this is only a bear market rally will get stress tested first, and I consider the equity market itself will do everything it can to challenge the consensus bear market rally theory before capitulating to economic reality.

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Neil Mackinnon is away today. Today's blog entry has been written by Mike Hughes, ECU's Head of Risk Management

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New York used the traditionally thin Easter markets yesterday to hold a veritable Stopfest, particularly in the euro against the dollar and on the crosses. This morning has seen something of a small retracement in EUR/USD from its range highs around 1.3400 to this morning's 1.3280, as short term systematic traders seek to find quick profits. Cable on the other hand has held rock steady above 1.4800, and indeed looks ripe to test the important 1.5000 in the near future. What happens from there is still unclear, but as the rate moves higher, so the clamour for "carry" and the "risk on" trade gets louder. If stock markets remain buoyed, then this will add weight to the argument. "Green Shoots" or bear market rally?

Elsewhere, the Greenback has suffered another setback against the Yen, not helped by comments from the Japan Post Insurance Co, that they have no current plans to invest in foreign bonds. Coupled with a small decrease in the net overall short yen positions in the most recent Speculative Positions report, it seems like this pair could be headed for a retracement back perhaps as far as 96.60.

Of note overnight have also been comments by the Fed's Fisher (in Hong Kong) who seemed to be preparing the market for ever worsening US numbers in the coming weeks, suggesting that he sees a deeper retraction in the US GDP than at first thought.

So, all in all, it seems as though volatility remains as one of the predominant themes going forward, with traders continuing to look for reasons to get back into trades which had made them so much money pre 2008... and unfortunately lost them so much thereafter!

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Date:

9th April 2009

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According to Moody's, the credit rating agency, March saw the most global speculative-grade defaults in any month since the Great Depression. Standard & Poors reckons the first quarter was the worst for US dividend payments since its records began in 1955 (click here). This hasn't stopped equity markets recovering sharply during March though recent price action has been mixed. The Japanese stock market was helped overnight by the announcement of a fresh stimulus package. Hedge funds gained 1.8% in March with equity funds being the best performers with gains of 3.4% while global macro performed the worst with a loss of 1.21% (click here).

As far as economic developments are concerned, I have said that there are tentative indications of a deceleration in the pace of economic decline especially for the US and UK economies though much of this is related to a potential turnaround in the manufacturing inventory cycle. However, the current global economic situation is a balance sheet recession which requires deleveraging and pay down of debt (see my former colleague Richard Koo, the chief economist at Nomura, and who advises the Japanese government on balance sheet recessions here). This is likely to be a drawn out process in my opinion in which hopes of a durable broad-based recovery are likely to disappoint. In this regard, previous cyclical experience of recessions and recoveries are likely to provide little guide (see here data for US business cycle expansions and contractions).

Michael Mussa (former chief economist of the IMF and a member of the Council of Economic Advisers under President Reagan) has presented an interesting paper called "World Recession and Recovery: A, V or an L" and you can find it here. He makes the point that "deep recessions are always followed by steep recoveries" and Mr Mussa is forecasting that a cyclical turning point will occur about mid-year in the US economy.

For a more pessimistic (realistic?) view, I recommend for weekend reading Professor Buiter’s “The green shoots are weeds growing through the rubble in the ruins of the global economy" (click here).

Happy Easter!

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Date:

8th April 2009

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In the currency markets, the US dollar remains resilient despite zero interest rates, QE and worries over its longer term status as the world's leading reserve currency. Exchange rates are relative by definition and while the dollar is holding up well, the euro is starting to come under pressure again. Overnight, the Fed's Fisher said that the euro has more problems than the dollar. There is no doubt that the eurozone economies are weak especially Germany which is being hurt by the collapse in world trade. Other countries like Ireland which has experienced a housing/real estate bust is now under severe economic pressure and looks set to contract 8% this year though raising taxes and cutting spending might not be the best remedy (click here).

The European Central Bank has tended to lag behind the Fed in terms of its reaction to the economic crisis though official interest rates are now in line. The next step is for the ECB to follow the Fed and adopt quantitative easing. In the meantime, the euro looks under pressure this morning against all the key crosses. Euro/$ encountered technical trend line resistance at 1.3583 on 6 April and is now testing the 100 day moving average at 1.3149 and if this level gives way then a move back towards trend line support just above 1.2500 is possible. Note that there were unsubstantiated rumours this morning that China was on the euro bid.

Elsewhere, the FT reports that Europe is worried about the weakness in sterling. This re-iterates the concern voiced by the French Finance Minister, Christine Lagarde, on 22 January when euro/£ was at 0.93-0.94. Sterling is at its most undervalued against the euro since 1995. Mervyn King on 24 March said that the pound had fallen enough in his opinion and at the time I said this was an important statement indicating a change of tune with regard to the currency. I have also mentioned that there are tentative indications of some stabilisation in UK mortgage approvals and financials which are helpful in now underpinning the pound. I am not sure that either the ECB or the BoE would unilaterally or jointly intervene in euro/£ to push the pound up. However, market pressures might do the job for them. At tomorrow's BoE meeting, the markets expect no change in interest rates or any fresh announcements on QE and therefore will be a relatively quiet meeting for once.

In the equity markets, the recent rally is fading in front of Q1 earnings which are expected to post a negative 37% though a gradual improvement is expected throughout the rest of 2009 (click here). Alcoa, the world's largest aluminium producer, posted a larger than expected quarterly loss of nearly $500 million while Daiwa warned it would report an annual loss. George Soros also unsettled markets with bearish comments. In addition, there was a large drop in US consumer credit of $7.5 billion in February (data published last night). My guess is that the S&P index through the 820 level points to a short term dip down to around the 750-780 level.

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Date:

7th April 2009

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March was the best month for for the S&P500 index since 1933 (click here). A remarkable statistic considering that the consensus profits forecast for 2009 is 21% lower than it was in January. Interestingly, stocks that were in the worst decile of performers between 1 January and 9 March have rallied 63% since then. Of course, this was a classic bear market rally based on sentiment and positioning coming from extremes of investor pessimism. Remember that Wall Street saw five rallies of 20% or more between 1930 and 1932 lasting 35 days on average. The S&P index is now running into its 100 day moving average at 830 currently. The AAII survey shows the share of bulls has surged from 18.9% to 42.7% which is not far from the levels in January when the last market rally ended. The 100 day moving average has not been broken since June last year so it is likely we we will get a pause for breath....sell in May and go away?

At the moment, there are tentative indications that some the major economies like the US and UK are showing signs of stabilisation. I have previously highlighted the role that the inventory cycle can play in triggering some recovery in manufacturing output in the months ahead for both the US and UK economies. But this is an inventory-led recovery which by definition will prove short -lived. Goldman's economics team in their latest forecast now expect an annualised drop of 3% in US GDP in Q2 compared to an actual drop of 6.3% in Q1...so still negative but gradually improving. Consumers both sides of the Atlantic are still de-leveraging and paying down debts. In the US, house prices have never bottomed while unemployment is still rising. Morgan Stanley expect US house prices to trough by the middle of 2010 and the unemployment rate to peak in the first quarter of 2010.  In the UK, mortgage approvals may be stabilising but from a very low level and, again, house prices can't rise just yet given the dismal jobs situation in the UK. But this is a global balance sheet recession and the global economy is suffering shocks that compare with the 1930's depression ( see a lot of interesting comparative charts here).

Credit markets have been less enthusiastic in participating in the equity rally unless you are long TIPS (giving a year-to-date return of 2.51%). However,credit market worries are not surprising given that 53% of high yield US companies are expected to default over the next 5 years (that compares with a figure of 45% during the Great Depression...see here). The IMF are now forecasting that toxic debts racked up by banks and insurers could reach $4 trillion. CLSA's Mike Mayo, the former banking analyst at Deutsche Bank, is still bearish on the prospects for the banking sector generally and of the 11 banks he monitors, all are rated either "sell" or "underperform" (see here). He thinks loan losses will exceed levels seen during the Great Depression.

Elsewhere, the Bank of Japan (BoJ) kept interest rates unchanged at 0.10% overnight but announced that it would provide more funds to commercial banks by broadening the range of collateral it accepts in an effort to encourage lending to companies. You can expect the BoJ to announce more measures including an increase in the purchase of government bonds in the months ahead given the depressed state of the Japanese economy.

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Date:

6th April 2009

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Equity markets are in a better mood after the G-20 meeting last week. Although the small print revealed that the actual stimulus (about $100 billion) was much less than the $1 trillion dollars that was trumpeted by the politicians, nevertheless market sentiment is buoyed by the knowledge that policymakers accept the gravity of the economic and financial situation and are ready to implement the necessary remedial measures. However, I don't think we can sound the "all clear" on the economic situation. Last Friday's US jobs report was pretty awful with the unemployment rate rising to 8.5%. I think the unemployment rate will eventually exceed 10.0%. In the past six months in the US, 3.7 million jobs have been lost or 2.7% which is the biggest percentage loss in 50 years. The average workweek fell to 33.2 hours, the lowest on record dating back to 1964.

Elsewhere, the weakness in the Japanese economy is now being translated into a weaker yen. The previous appreciation of the currency, largely the result of an unwind in carry trades has severely dented Japanese exports and turned a trade surplus into a trade deficit. In turn the collapse in exports has resulted in a slump in industrial production and GDP. Japan is in a depression and a footstep (yet again) away from deflation. Prime Minister Aso wants his third fiscal stimulus package to amount to 2% of GDP but Japan's debt/GDP ratio is nearly 200%, the largest in the G7 area. Japan has had zero interest rates since 2002 and while its banking system is now in better shape the economy continues to stagnate. As a result, the Japanese authorities will want to see the yen "devalue" and hope that this turns the economy round. The yen is now at its weakest against the dollar since October and I think $/yen will start trading in a 100-115 trading range. If Japan depreciates its currency so will China and other Asian economies will likely play the currency card as well given the slump in export volumes throughout the region.

Britain has already had a "devaluation" in its currency but a deficit country cannot pursue such a currency "strategy" for long as foreign investors will have little incentive to buy UK financial assets and fund the UK budget deficit. As it happens, there are signs that sterling is stabilising aided by tentative evidence that the worst of the shocks in housing and financials are behind us (HSBC gets 97% support for its £12.5 billion rights issue). The UK needs foreign investors and the BoE governor's recent comment that the pound had fallen enough is important.

Elsewhere, traditional safe-haven currencies like the Swiss franc are under pressure and the "Gnomes of Zurich" are facing pressure to relax banking secrecy laws. Swiss banks have had a torrid time and are losing their reputation for conservatism. They have made bad loans to emerging markets (note that the IMF is urging Eastern Europe to adopt the euro) and have been caught out by the fall-out from the credit crisis. All of this is undermining the Swiss franc as a "safe-haven". The Swiss National Bank have cut rates to nearly zero and are threatening FX intervention (especially against the euro) if the Swiss franc strengthens.

The major threat for the global economies is a return to 1930's style "beggar-thy-neighbour" policies which feature competitive devaluations and increased protectionism. Such policies are politically seductive especially when unemployment becomes a massive issue for politicians and voters but actually only make the situation worse.

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3rd April 2009

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The G20's $1 trillion package bolstered equity market sentiment yesterday though overnight Asian markets have given a lukewarm response. Of the $1 trillion, $750 billion is for the IMF and will go some way to alleviating concerns of emerging market crises. Some of the IMF funding will come from gold sales which might cap further gains in the gold price. $250 billion is for trade finance but this is small in relation to global trade volumes and the world trade shock afflicting global exporters is down to a collapse in demand. So it is not clear how much of the $1 trillion will have any meaningful impact on turning the global economy round at the moment especially when you look at the small print. Sure, it bolsters confidence but confidence can be an ephemeral thing.

Equity market sentiment was also boosted by the shift in FASB accounting rules. For sure this helps banks avoid short-term write-downs that would arise from strict mark-to-market accounting but this only blurs the true nature of banks' accounting statements so I don't see why this is positive for equities/financials in the longer term (read a critical view of the change in rules here). Separately,it is worth noting that the latest US mutual fund flow data for the week ending 1 April reported an outflow of $8.5 billion i.e. funds are coming out of the stockmarket (click here for more detail).

I think what is more interesting is that the US economy might soon be the beneficiary of a significant turnround in the inventory cycle (click here for the Bloomberg chart). A sharp rundown in US inventories has been a key feature of the GDP data going into Q4 last year and this chart here shows the correlation between the US inventory cycle and US industrial production (click here for the Bloomberg chart). It looks as though restocking could generate better GDP numbers in Q1 and Q2 with the Q4 data in 2008 likely marking the cyclical trough in GDP. The monthly ISM new orders-inventory gap is a proxy for the output-demand gap and the data shows a correlation with manufacturing employment as well (click here for the Bloomberg chart).

Bottom line: Do not be surprised if the various US surveys of manufacturing activity (ISM, Philly Fed, Chicago PMI) start to show ‘better-than-expected’ readings in the months ahead. I mentioned in my blogs this week that there is tentative evidence from other monthly indicators that the pace of decline in the US economy points to some deceleration. This does not mean that the US economy is about to embark on a durable cyclical upturn. We need to see evidence that the consumer is recovering but de-leveraging still continues and there has been a bad dent in household wealth. The jobs market is still fragile as this afternoon's US jobs report will likely make clear. This chart shows the relationship between the Conference Board's ‘jobs hard to get’ index against the US unemployment rate (currently 8.1%). As you can see from the chart, the jobs situation looks grim (click here for the Bloomberg chart).

Elsewhere, the European Central Bank (ECB) cut the deposit rate 25bps to 0.25%. Mr Trichet says the deposit rate won't be cut any further and as I have pointed out before the deposit rate is the floor of the ECB's interest rate corridor and money market rates have been tracking the deposit rate since the ECB provided liquidity on demand from last October. The ECB is basically now in line with other major central banks short-term rates. Mr Trichet's comments at the press conference yesterday suggests that quantitative easing or “new non-standard measures” as he called them will have to wait until next month. The EURUSD exchange rate firmed in response on the notion that the ECB had ‘disappointed’ market expectations which had been looking for a 50bps cut. However, the 10-year bond yield differential is about 40bps in favour of the euro which is no more than the average yield differential for the year-to-date (click here for the Bloomberg chart which shows the correlation between the yield differential and the EURUSD exchange rate). Technically, my chart tells me that the EURUSD exchange rate faces tough trendline resistance around 1.3580 so the rally beyond here in the euro looks as though it might run out of steam.

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2nd April 2009

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Spring is sprung as far as Asian equity markets are concerned with the Nikkei up 4.4% overnight and Hang Seng up 5.4% (making the index nearly flat year-to-date). This all seems to be based on hopes that the global economy is stabilising (or at least, that the pace of decline is decelerating) and cyclical stocks have been outperforming defensive stocks recently. This chart of US consumer discretionary stocks shows a sharp recovery since the beginning of March (click here for the Bloomberg chart). In addition, the G20 is likely to give the IMF extra resources which again helps sentiment. US automakers are saying they are hopeful of a recovery in sales in the second and third quarters (auto sales in March came in at 9.9 million units compared to 9.1 million in the previous month – click here for a useful chart) and German carmakers are reporting extra orders linked to government subsidies for car purchases. The FT this morning reports that some hedge funds are now starting to see investor inflows, another sign of improving sentiment.

Yesterday's US economic data such as pending home sales, construction spending, and the ISM manufacturing index were ‘better than expected’. However, the ADP employment index dropped 742k in March and this points to a poor US jobs report tomorrow. Is this simply the market getting overly optimistic? Probably, in my view, and we should view any rallies in equities at the moment as purely being sentiment-driven until we get a better picture of what is happening in the real economy.

Nevertheless, the improvement in risk appetite is helping currencies like sterling and the Australian dollar at the moment which tend to be driven by an improvement in investor risk appetite/reflation plays (click here for a Bloomberg chart that shows relationship between the Australian dollar and the Nikkei). However, note that the Baltic Dry Index is at an eight-week low with base metals lower and oil below $50. Sterling enjoyed a rally this morning on the back of a 0.9% gain in house prices reported by the Nationwide (click here for the Bloomberg chart that shows the relationship between the trade-weighted exchange rate and house prices). Should today's gilt auction (£2.25 billion of 30-year) be well received, this might sustain the rally in sterling. 

Today's focus is on the ECB's monetray policy decisions(announcement at 12.45 London time and press conference at 13.30). Deutsche Bank's economics team is reflective of the consensus view. They expect the refinancing rate to be cut 50bps to 1.00%, the deposit rate cut by 25bps to 0.25% and the ECB to lengthen maturities on its long-term refinancing operations to 9/12 months from the existing 6 months. I think there is a good chance that the ECB will also announce quantitative easing initially related to purchases of private sector debt. 

Elsewhere, USDJPY is on the brink of moving through the 100 level. I am a yen bear given the state of the Japanese economy as well as the move into a trade deficit (the first in 13 years) as exports have plunged nearly 50% from a year ago. In addition, recent positioning and capital flow data is yen-negative. The latest data from the Tokyo Financial Exchange highlights that margin traders had increased their bets against the yen fourfold between 26 and 30 March according to Lee Hardman at Bank of Tokyo-Mitsubishi UFJ. Weekly flow data from the Ministry of Finance published last night reported a total net ¥3 trillion outflow in the latest week (mainly foreigners selling Japanese bonds) compared to ¥1 trillion in the previous week.

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1st April 2009

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The G20 meeting today and tomorrow is likely to disappoint financial markets. No fresh fiscal measures over and above what has already been announced will likely be forthcoming. Nothing on FX, certainly nothing that can upset the dollar despite all the talk about replacing the dollar as a reserve currency. The best that can be hoped for is an increase in resources for the IMF (click here to read Martin Wolf in this morning's FT, "Why G20 leaders will fail to deal with the big challenge").

In the meantime, those looking for ‘green shoots’ in the US/global economic recovery are also likely to be disappointed. Consumer de-leveraging continues, net wealth has been destroyed and unemployment is rising. The OECD's Interim Economic Outlook (click here) sees the OECD economy in the midst of its "deepest and most wide-spread recession in more than 50 years".

The US economy is expected to decline by 4% this year with no growth in 2010. The eurozone and Japan have negative growth rates in 2010. The UK sees GDP falling 3.7% this year and falling 0.2% next year and the OECD recommends that the UK keeps "the policy rate as close to zero as possible up to end-2010” even though the OECD expects the UK to have the highest CPI inflation rate of all the G7 economies next year.

Only for the US and Australia does the OECD see fiscal expansion "provide a stimulus that clearly exceeds 1% of GDP in both 2009 and 2010” though the OECD notes that fiscal positions are deteriorating dramatically in many countries. Japan ends up with gross financial liabilities as a percentage of GDP at 197.3% in 2010 compared to 100.0% for the US and 84.4% for the eurozone.

The OECD sees unemployment rates of above 10% in the US and euro areas and some countries will "experience falling price levels". The OECD also notes that real house price levels are falling in nearly all countries. In previous housing cycles, "the phase of contracting house prices typically lasted around five years with an average fall in real house prices of the order of 25%".

As far as markets are concerned overnight, Japan's Tankan survey for the first quarter was slightly ‘worse than expected’ with confidence at a record low, though I am not surprised by this given the extent of the decline in the Japanese economy. I can't see why the Japanese yen won't weaken and I do expect USDJPY to move into a 100-115 trading range for the rest of this year. Japan's public debt burden is immense (Japan intends to spend more according to recent reports with PM Aso dismissing Germany's concern about excessive public spending) and demographic trends in Japan don't help public finances (by 2050, there will be just 1.2 workers for every person aged 65 and above). A weaker yen can help the Nikkei which is the ‘cheapest’ stockmarket in the world with price-book ratio of 1 and a dividend yield of 3%.

EURUSD has scope to move lower and the ‘rally’ to the 38.2% fibonacci level of 1.3350 was on the button yesterday. If the ECB acts aggressively tomorrow which is what I believe then EURUSD can break technical trendline support at 1.3080 currently for an interim move towards 1.2500.

Sterling is holding up reasonably well and I think it can perform well against some currencies like the euro (Barcap says that the euro is at its most overvalued against sterling since 1995) as well as the Swiss franc in the near term. Paul Megyessi at JP Morgan shows a correlation between the trade-weighted sterling exchange rate and UK consumer confidence and UK mortgage approvals. There is tentative evidence of stabilisation after sharp falls in each of these two indicators (click here for the Bloomberg chart).

Previously in my blogs, I have highlighted correlations between sterling and a proxy of global investor risk as well as the FTSE350 bank index. Again, there is some tentative evidence of stabilisation here (click here for the Bloomberg chart): note this does not mean sterling is on the brink of a bull market. Remember that the longer-term prospects for sterling could be damaged by the sharp deterioration in the UK's fiscal and current account position and the UK's ‘sticky’ inflation backdrop (note the OECD's forecast for next year). A deficit economy like the UK will find it difficult to attract financing in a zero-yield environment which also reduces the attractiveness of sterling as a reserve currency. So don't get over-excited.

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