Welcome to Kit Juckes's Market Commentary blog. This page is updated regularly to cover events impacting the global financial and currency markets.

The most recent post appears at the top – scroll down for older entries.

Russia issued $5.5bn of bonds yesterday, the second largest ever emerging market dollar bond and the first from the Russians since their default in 1998. The cost of the bond is 125bp over US Treasuries. That means Russia is borrowing more cheaply than Spain, for example. Some comeback.

Maybe 12 years is considered a long time from default to return to the Bond market. But to be able to issue at such attractive rates is excellent for Russia and significant for markets. For the Russians, the new bond will establish a new benchmark for their big multinational private sector bond issuers and reduce borrowing costs all around – expect more money to flow to Russia now. More widely, though, it does seem that sovereign default is less awful than people think it might be. This is a huge difference between sovereign and corporate borrowers. If a corporate defaults, it is a pariah for a very long time and can only raise money at penal rates. Usually, of course, once companies default they go out of business and vanish. That isn't true of countries, which don't go away. And we therefore find a way of doing business with them.

There is a reasonable argument in the current European crisis that, in the absence of currency flexibility, you either need to provide money transfers to help bail out countries with an insoluble problem, or accept that the risk of default is higher than if you had flexibility. With Greek protesters clearly blaming 'foreigners' for their economy's plight, political opposition to default cannot be taken for granted. So the discussion between Greece and the rest of the eurozone will take on a new tone. And in the meantime, the cost of Greek borrowing just goes up (the Russians are borrowing at Libor plus 140bp, the Greeks at Libor plus 600bp – up from Libor plus 30bp only a month ago). And so this morning the euro remains under heavy fire – and will continue to do so.

Greece is the big story again, but there is a lot else going on. Economic data yesterday was broadly positive across the board, with the US seeing gains in existing home sales at the start of the Spring selling season, with the eurozone purchasing managers' surveys all pointing upwards and, even though UK retail sales data were a touch soft, the previous month's increase was revised upwards sharply. 4% annual growth in retail sales volumes is respectable even if it is not spectacular. The only worry within the data was a food-induced jump in US producer prices, up 6% annually. In India, where food is a bigger part of the overall shopping basket, food inflation is running close to 18%. The weather has played a role in fresh food prices everywhere, but this can have an effect on inflation expectations and hence on bond yields. I don't expect a major sell-off in bond markets, but if yields drift higher in the days and weeks ahead, we could see the equity market trade in a range rather than trend higher and higher – and those currencies which have suffered from rate convergence will do best. That means the US and Canadian dollars, and sterling, can rally against the euro and yen.

Today sees UK Q1 GDP which is expectd to increase 0.4%. This flash estimate isn't worth the paper it's printed on. The leaders' debate last night told me nothing new and polls are so firmly in 'hung parliament' territory it will take a major shift to change the outlook. The US sees new home sales and durable goods orders. And Canada, the country of my favourite currency, has inflation and retail sales data. Any upside surprises will firm up rate hike exepctations.

.

The UK inflation rate is up, the unemployment rate (well, the claimant count, anyway) is down and the MPC is getting more hawkish. The chances of the Bank's £200 billion quantitative easing programme being extended any further seem to be diminishing fast. And yet the futures market prices 3-month LIBOR at just 2.5% for the end of 2011 – a full percentage point lower than it was pricing at the start of the year. And 10-year Gilts are yielding just 4.01%.

I would have thought that as far as the outlook for UK public sector finances are concerned, this is about as bad as it gets. Political and economic uncertainty remain sizeable and policy-makers haven't revealed their plans for getting the public sector deficit under control. And the Bank of England has stopped buying Gilts. So why are yields not higher? People who fear a major UK sovereign credit crisis must surely have expected it to happen by now. The fact that it hasn't, and that the cost of funding UK Plc is still acceptable, surely provides cause for relief.

That doesn't mean I think Gilts are an attractive investment opportunity, I hasten to point out. I think yields will end 2010 higher than this – though crucially still in a 4%-5% range. But in an economy where the savings rate has spiked sharply higher (hence weak consumer demand), where banks are under presure to reduce leverage and improve the quality of their assets (only lend to 'safe' borrowers), and most of all where policy rates are on hold, there are buyers of Gilts.

Modest upward pressure on Gilt yields, a slow re-think at the MPC and an improving global economic outlook are a very positive mixture for the pound, which is starting to re-rate. There will be bumps in the road as the political end-game plays out and as the economy splutters into life, but there is no reason for GBP to be the most hated of the world's major currencies any more. Next step in the data calendar is the retail sales repot for March. The market exepcts a 0.5% gain, excluding petrol, after last month's 1.6%. That's strong, and in line with the anecdotal information we have been getting.

Outside the UK, risk appetite is marginally lower this morning. Greece (and the wider eurozone periphery) fears are still around and the US equity market has failed to move, for a day at any rate. The yen is marginally firmer on talk of an upgraded economic assessment. Outside of GBP, the Canadian dollar is my favourite (G10) currency and the euro in my personal dog-house – even if eurozone economic indicators continue to improve.
. .

Nobody expected the Bank of Canada (BoC) to raise interest rates yesterday but they dropped a phrase in their policy statement reflecting a conditional commitment to leave rates on hold until July, a pretty clear sign that we can expect a hike earlier than that.

The upshot of this announcement was a sharp appreciation by the Canadian dollar and a sharp move upwards in Canadian bond yields and swap rates. The 2-year swap rate jumped 20bp to 2.21% and is now nearly 1% higher than it was in early February. Steady appreciation by the Canadian dollar is less spectacular, which tells us a fair bit about market positioning – there's no doubting that speculators and investors are 'long' the CAD already, so the news has a less explosive effect.

Apart from a reminder that Canada was unique among the G7 economies in not suffering unduly from the credit crunch and is consequently – by some distance – the fastest-growing of the G7 nations, is there much that we can learn? For starters, to bang on an old drum, the global economic rebalancing continues away from G5 to what we used to call emerging markets and to those with the closest economic ties to those markets. I still like the CAD, but I think the lesson about how interest rate markets adjust to policy changes will also be worth learning. Rates will stay very low, until they don't. A smooth upward trajectory is highly unlikely – we should expect a step adjustment because the cost to market participants of holding trades that look for higher rates is just too prohibitive. 'Shorting' Canadian bonds was expensive and most of the people who did it last year were squeezed out. So when the move happened few were positioned. That will be repeated elsewhere – including in the UK. What I don't think we can do, however, is extrapolate BoC policy to the US. Historically, if there has been a relationship between Fed policy and BoC policy, the Fed has been the leader. But this time, the economic situation in Canada is very different from that in the US. That's not to say, however, that markets won't see this BoC move as a shot across the bows for policy-makers and start building slightly higher risk-premia into interest rate expectations. The last year has been all about convergence of market interest rates towards zero – perhaps that phase is now over.

Which brings me to the UK – and the pound. Political uncertainty remains and the next leaders' debate is approaching (tomorrow evening on Sky News and BBC Radio 4). But the inflation data yesterday were bad and if the retail sales and unemployment data in the days ahead are reasonably positive, Bank of England expectations are going to firm. And that could be a catalyst for a further GBP revival. I wrote about the inflation data yesterday and I am still confident that inflation will be a good bit lower in a few months' time. But it didn't take long for the UK press to worry and the MPC, so dovish last year, only needs to change tack slightly to trigger a market response. Today sees the release of the minutes of the last MPC meeting, March jobless data (expect a 10,000 fall) and earnings data (expect the headline rate to jump to 2.4% from 0.9% while the 'ex-bonus' figure rises to 1.6% from 1.4% – City bonuses are back). A fall in the unemployment rate from 4.9% is unlikely but would be a trigger for further GBP strength.

More widely, the resilience of risk assets continues, the reasons to be bearish of the euro remain intact, and the skies are slowly re-opening over Europe. The IMF has even downgraded its estimate of the cost of the credit crunch, by a mere $500 billion! The sun's shining and I am off to see if I can find a flight to London.
.

Today's UK economic (as opposed to political or atmospheric) highlight will be the release of March inflation data. Most expect a small rise in the headline index to 3.1% from 3%. That won't resolve the debate about whether we are storing up an inflation problem for ourselves. There's a risk too that the next month sees some upward pressure on all sorts of prices, notably of food. Globalisation has been wonderful but any damage to global trade routes – air or sea – and the impact is felt pretty quickly. However, as long as there isn't any growth in credit or any significant upward pressure on wages, imported inflation is going to be the only kind anyone experiences – and that depends on global growth and currency trends.

In this regard, the UK is certainly having more of a go at getting some inflation into the system than most. Monetary policy has either been consciously undermining the pound or, at the very least, neglecting it. But the US is trying almost as hard, the euro is seeing investors steadily lose faith and the non-G5 currencies are still being held back from the size of revaluation that market forces would otherwise cause.

I don't think sterling can weaken much more – and that being the case, any ash-induced blip in inflation will be temporary. The peak is now behind us, which is important because it gives the MPC leeway to keep rates at levels which give the economy as much chance as possible to recover.

What of markets? The S&P displayed amazing resilience yesterday afternoon and, with Apple and Goldman the main earnings attractions today, newsflows may try to counter the weaker mood – in the US anyway. So equities could be in a range. Germany sees the ZEW survey released, but Europe is clearly about much more then Germany now. And investors are fleeing. I expect the euro to resume its place as worst of the major currencies. And in the UK we are seemingly resigned to the notion of a coalition government. It seems priced in. So if the economic news is helpful, the pound will find support.

.

Welcome to ash, allegations against Goldman Sachs, a dip in US consumer confidence, tighter controls on real estate lending in China and more opinion polls with 'Hung Parliament' written all over them in the UK.

From a purely personal perspective, the ash is the biggest factor. My son reckons the positive – missing the start of term – outweighs any negatives. My flight back to the UK is cancelled and I will spend another week eating hotel food. The UK press is full of talk about how negative it is for growth but the real pain will be felt by the exporters of green beans and flowers in Kenya who've made it possible to buy seasonal goods at unseasonal times of the year.

Whatever the rights or wrongs of the SEC case against Goldman Sachs, the last thing the global economy needs is more obstacles in the way of a restoration to normality in the financial system. The two big barriers to a robust economic recovery are government debt (about to increase as airlines get bailed out) and the lack of bank lending. The more regulatory (and legal) pressure the financial sector faces, the more introverted it will be and the less it will help the recovery. And there's a link there to the political debate. Reports that the UK has seen a greater share of income go to a small minority than in other economies won't come as a surprise. Mr Clegg's Liberal democrats have been the most vocal in calling for a reversal and are capturing the public mood. The upshot is a growing debate about whether the UK is at a turning point where a decisive move away from two party politics is conceivable.

That's a question to which I simply don't know the answer. But I can draw two conclusions – the uncertainty caused by the case against Goldman, the ash and the UK political environment is causing a dose of risk aversion that can persist; and while the UK election uncertainty won't alter the need for fiscal retrenchment or change the economic outlook much, it is triggering some temporary sterling weakness which I see as an opportunity.

So markets start the week with equities softer and the dollar (and the yen) stronger. There's a lot of economic data to come, particularly in the UK, but the real news will be political and environmental. With consumer cofidence in the US dipping as equities rallied, there's a risk that we now see equities fall back for a while. I don't think this is the end of the 'risk rally' by any stretch of the imagination, but we may be in for some considerable nervousness..
.

The first UK election debate has the press giving all the plaudits to the Libral Democrat leader, Nick Clegg, while all the jokes are about the volcanic ash clogging up the flight paths – with plenty of sun-seeking parents and their children stuck abroad just as the school holidays come to an end. The pound is down, though not very much, and the FTSE is so far slightly softer.

I have tried not to let personal political bias enter analysis of the UK election, though I have observed before that the biggest risk is that everyone is disenchanted with the policies and leaders of the main parties, and will head for the pub rather than the ballot box. I struggle with the idea that voters would re-elect the government that presided over the deepest recession in a generation, but the failure of the Conservatives to offer much in the way of alternative policies is scary. The strong showing for Mr Clegg last night would seem to support the view that voters really don't want to vote Labur or Conservative. Now, the question is whether they want to vote Liberal Democrat when they know the result will be a hung parliament and a coalition which will return Mr Brown to power – probably the outcome most people want least of all. So the election takes a fresh and more tactical turn this morning. But my personal bias is that this could yet take the (undeserving) Conservatives to power, as the 'undecided' shift away from Labour. Here's an intruiging conclusion on the polls from the Times (though read it understanding the paper's bias – click here).

Something else that will turn up in the Times today will be a new letter of support for Labour from, apparently, 80 economists. The debate about how fast to tighten fiscal policy rages on, though I don't sense the major parties really disagree much about what to do. My own 'economic' gripe with Labour is that they complicated the tax and spending system unnecessarily. It's not what they did that bothers me as much as how they did it. But I am happy to concede that none of the other parties is set to reverse that complexity quickly – least of all Mr Clegg's Liberal Democrats.

Where does this leave the UK economy and currency? At this point, it looks as though Q1 will see a second consecutive quarter of 0.4% real GDP growth, despite the weather. No-one seems to trust the recovery but with Asia booming, the US consumer back in business, the pound unusually competitive and the savings rate a lot higher than it was, guarded optimism still seems appropriate. And that is enough to make me stick to a view that the pound is going to see a sharp bounce, either after the election is out of the way or sometime before as the outcome becomes clearer. Which, in turn, suggests that the current wobble may be the last sterling sell-off for a while.

There's not much news elsehwere. Greek worries have caused a 'risk-wobble', especially as some of the weekly economic indicators in the US are being messed around by Easter/Passover. The euro is still the least attractive of the major currencies, and the yen is the currency whose current bounce may be the biggest selling opportunity. The US earnings season will have its ups and downs but more of the former and the S&P looks set to move even higher.

.

Goldman Sachs, cheerleaders for the idea that the US economy is going to slow significantly, have raised their Q1 GDP forecast to 3% from just over 2%. Barcap, firm believers in global growth, have increased their 2010 Chinese growth foreast to 10.1% from 9.6%. And Jim Reid at Deutsche Bank, describes the current environment as Goldilocks versus Greece, which is so good I have to steal it (with attribution, naturally).  I wrote yesterday about how asset-friendly the news is, but pondered whether the mood is to 'buy the rumour and sell the fact'. That just goes to show how little I know as the S&P stormed through 1,200.  

The first quarter saw US retail sales growth, in cash terms, running at a 7.9% annualised rate. With inflation at a mere 1%, that's a stunning outcome. The world's biggest and best consumers are back in town. Unemployment, indebtedness, a lack of wage growthand the reluctance of banks to lend are not standing in their way. You have to be impressed even if it is hard to see how it continues. Over in the UK we have been far more shy sending the savings rate up as we hide in our shells. At least the US sees industrial production data today which should show a 0.7% increase – they are making as well as spending.
 
Meanwhile in China they are just booming, as an 11.9% growth rate in Q1 shows. With trend growth at around 9% and after a period of 6% growth, you can grow at this pace briefly before inflationary pressures build, but not for long. Credit growth is rampant, asset prices have been rising. Tighter policy is needed and the Yuan/Dollar peg will have to be adjusted very soon.
 
In Europe, Greek credit spreads widened again yesterday taking Spain and Portugal with them. Post-package euphoria didn't last as fears return about just how big the final bill will be and as opposition to bailouts remains vocal. Three major issues lurk just beneath the surface. Firstly, the eurozone just does not yet have the unity or the institutions to really pull together in an economic crisis. Secondly, all of Europe needs tighter fiscal policy and a major overhaul in the social security system which is a huge political hurdle to overcome. And finally, a decade without currency flexibility is exacerbating internal economic imbalances. At a global level, we worry about the notion that global recovery requires US consumers to overborrow and overspend, driving the US curent account deficit wider and wider to accommodate surpluses elsewhere. At a European level, the same is true with Germany's surplus getting ever bigger. Martin Wolf has written about this a lot recently in the FT, and George Magnus wrote about it for the Times last week. And to a significant degree, the European imbalances are a bigger problem since we know that unless policies change the structure of the German economy, imbalances will lead to huge transfers of money from Germany to the periphery, or movement of people towards the wealthy German economy. Neither would happen smoothly. In the meantime – and even though the general risk-friendly environment has seen the dollar and yen weaken further – I remain very bearish of the euro.

In the UK, it's debate-day. Polls still give us no clear winner to the election and my expectations of a bad poll or two causing sterling to slip are not materialisng. This is very frustrating.

.

This afternoon will see three economic releases which broadly sum up the state of play for the US economy. We kick off with the consumer price inflation data for March, likely to show the annual rate of 'core' (ex-food and energy) inflation falling again to 1.2% from 1.3% in a further reminder that whatever else is going on, price pressures are absent. Then, March retail sales are due and set to post a monthly increase that could be well over 1%. OK, so the data are flattered by the end of some horrendous weather, but the positive trend to the US economy is pretty clear. Finally, this evening sees the latest publication of the Fed's Beige Book. I will fall off my chair in amazement if it doesn't maintain the dovish tone we have been hearing repeatedly from the Fed. So - no inflation, decent demand and no risk of any change in tack from the super-dovish Fed.

The overnight news reflects how these consistent trends play out globally. Intel came out with strong results as PC demand held up. That negates the softer tone to Alcoa's figures the day before, though it hasn't sent S&P futures higher - yet. And, over in Asia, the Monetary Authority of Singapore has tightened policy and is allowing its currency to appreciate. Nick Leeson used to hang out in Boat Quay during the Asian bubble that was unleashed by super-low US rates in the early 90s. What goes around comes around but Asian central bankers are wise enough to be trying to tighten policy - and are getting the currency strength that follows naturally. A beer in Boat Quay just got a bit more expensive.

For a year, this mix of low inflation, low rates and gradual economic rehabilitation has sent investors out of G5 currencies and into higher-yielding assets. I am nervous at the moment that there could be a 'buy the rumour, sell the news' mentality evolving, so I am watching equities in particular from the sidelines. I am also watching the mini euro-revival and seeing it as a chance to sell against the dollar and the pound and, of course, against higher-yielding non-G5 alternatives.

.

There was a surge in risk appetite yesterday morning, but it fizzled out very quickly. Here are three stories in the overnight press that capture the mood. The first, predictably, is a verdict from the Telegraph on the Greek rescue package (click here). Predictable, because if anyone is going to pour cold water on any positive eurozone news, it's the Telegraph. For the record, the 5-year credit default spread on Greek debt is at 368bp this morning, tighter than on Friday but a long way wide of the 300bp funding package available to Greece from its eurozone partners. The second and third stories need looking at together since they are responses to the first of the big company earnings results for the first quarter. The FT reported that Alcoa's sales beat estimates (click here), while Bloomberg says sales missed expectations (click here). What changed between these two stories is that equity indices dipped back and in the Far East, some of the currencies which have benefited from the revival of risk appetite fell. So the newswires quickly made the news fit the facts.

The upshot is speculation that the first quarter earnings results will be characterised by 'buy the rumour, sell the news'. Next up is Intel tonight.

There is no getting away from the fact that we have a number of opposing forces at play. Firstly, the foundations for the risk rally and indeed for higher equity indices in the US are intact: Low rates and economic recovery, however patchy, are rocket fuel for asset prices now as they have been all along. Another story on my screens this morning is called 'Maturity wall shrinks $196 billion in 15 months' and picks up some JP Morgan Chase research highligting the scale of refinancing in the junk bond market in the last year, which has dramatically reduced expected corporate default rates. So much for the good news, however. In the opposing camp we have the realisation that more is priced in – with the S&P index within a whisker of 1,200 – than was the case a few months ago. And we have seen the threat that can come from buyer fatigue in government bond markets. We are also seeing policy tightening in Asia (this mornng there is talk of China raisng domestic fuel prices in a further measure to slow growth). I've been nailing my colours pretty firmly to the reflationary mast for the last year, and still think that the zero rate policy will win out (for asset prices, at least), but there is going to be something of a battle in the days ahead as the earnings season trundles on and markets continue to wonder whether Greece's funding needs are safe or not.

With the ‘risk-on’ vs ‘risk-off’ debate in centre stage, I would not be surprised to see pretty choppy trading for the next few days. Bond yields have made a short-term peak, reinforcing the notion that their trading range is holding. Equity markets may run out of steam again. On balance, I expect the US dollar to remain well supported by bright economic news but also because any return to risk aversion will benefit the US. By contrast, there remains a risk of a wobble for the pound. Another 'beware the UK' comment from Pimco, this one courtesy of Ed Balls's brother Andrew which ensures some coverage from the right-wing press (click here) and some softness in the latest RICS housing survey, could be symptomatic of what is to come. We get trade data this morning and I continue to exepct at least one very tight opinion poll in the days ahead. This, though, could be the last chance for GBP bears, particularly against the euro. Mr Balls's reasons to be negative of the UK seem a little tired to me and, to go back to an earlier story, the fact that corporate default rates have been so dramatically reduced by the ability of junk bond issuers to refinance, is equally true of the UK.

.

So, the Greeks get their ‘package’: a €30 billion commitment from EU Finance Ministers that provides three-year funding at around Libor plus 300bp, which for 3-year money represents around 5%, not cheap but a good deal cheaper than current market rates (click here for the EU statement).

The first reaction in European financial markets has been to welcome the deal. Short positions in Greek stocks and in the euro have been squeezed. That first reaction will, I am sure, give way to fresh concern in due course. This latest package solves Greece’s short-term funding problems and helps them get through the next six weeks of debt rollovers, but it is really just a further extension of the core theme of the last few years. Just as western governments have had to step in to bail out their banks (who borrowed far too much cheap money to lend to over-indebted consumers), so the European leaders have stepped in to bail out the Greeks, who also borrowed far too much money during the good days. This leaves two questions dangling. The first is how will the fundamental problem of excess borrowing be tackled? And the second is where does the rest of Europe get the money from? The answer is, to some degree, the same in both instances. The need to tackle excess borrowing is going to result in a higher savings rate (in Greece, as in the UK) and slower growth in spending as a result. That will be offset by very low interest rates. And the money will come from even more government bond issuance at the heart of the eurozone, where low rates, steep yield curves and a lack of inflation make it possible for Germany to continue issuing debt at under 1.5%, making the 5% they charge to Greece look like a reasonable return.

There are plenty of reasons to fear that shuffling the debt from over-borrowed consumers to banks, to government and on to bigger governments will end in disaster. However, before that happens the escape route remains the same as it has always been. As long as inflation remains low, interest rates can stay anchored and the higher equity prices rise, the more tempting it is for investors to buy government debt anyway. And if there is any threat of a buyers’ strike, then the debt can still be bought by the central bank as quantitative easing is ramped up again. So the Europeans have bought some time to let the Greeks get their fiscal house in order. The price, of course, is that fiscal policy will need to be tightened at a delicate point in the economic cycle. And the upshot, as far as I can see, is that for all the enthusiasm with which markets may greet this latest deal, the ECB is on hold for even longer and the euro will have to take some of the strain by weakening further.

Away from Greece, the Chinese released a rate trade deficit on Saturday. This owes more to the timing of the Chinese New year than the global economy but it helps the discussions that are ongoing about a revaluation of the renminbi. Everything points to a move, but a modest one – one that does not massively disrupt the global economy and allows recovery to continue while appeasing the US policymakers. The shift in the world economic order is not slowing down. And in the UK, a busy weekend of opinion polls sees the Labour party with just over 30% of the vote, the Conservatives with just under 40% and an outright majority for anyone remains elusive. Meanwhile the upbeat tone to economic commentary continued in the Sunday Times (click here). This week’s highlight (I suppose) will be the first of the televised debates between the party leaders on Thursday. The risk must be that no-one delivers a ‘knockout blow’ and markets get jittery. It doesn’t take much to look at how the eurozone rallied around Greece and conclude that the UK does not have that kind of support – though it does have the ability to let its currency slip.

.

Stronger economic data (US weekly retail sales results, UK industrial production, services purchasing managers’ surveys everywhere), may have failed to send bond yields any higher this week, courtesy of some solid US Treasury auctions, but equity markets are flourishing and in the US, an assault on the S&P 1200 level could be seen as early as this afternoon. That’s impressive in a week with two events many perceive to be negative for risk in the foreground: The ongoing travails of the Greek government and the growing talk of a revaluation of the Chinese Yuan. It’s a reminder, to my mind, of the main drivers of the asset price inflation we have been seeing for a year now. Firstly, low rates. Ben Bernanke was at pains to make sure we understood that US rates are not going up soon, and nothing that was said by central bankers anywhere makes you think rate hikes are imminent. I stick by a view that the UK, US and Eurozone, not to mention Japan, will probably have rates at current levels at Christmas. Secondly, as the global economy stabilises, corporate profits are improving. The first quarter earnings season kicks off in the US next week and with the economic data looking good, while labour costs remain very subdued, the omens are positive. That matters more than a modest revaluation of the RMB or the Greek tragedy.

The news in the last twenty-four hours remains helpful. In the UK, the daily YouGov poll shows the Conservative lead back out to 9 points, (here) while the weekly John Lewis figures are stellar, in part because of the timing of Easter and surely helped by better weather. (see here) . I have been optimistic about the outlook for demand in the UK economy for the last 6 months. The surprise in the fourth quarter of last year was that despite reasonably robust real disposable income growth, the focus was so firmly on paying down debt. That appears to be changing as the gain in house prices is not reversed, and as the employment outlook gets less awful. The final piece of UK data is less friendly, with the release of March producer price data showing a sharp (0.9%) monthly increase in output prices, and a 3.6% increase in input prices. So, companies’ raw materials are costing 10% more than they did a year ago, courtesy of the weak Pound and rising commodity prices. Factory gate prices, are up a more modest but uncomfortable 5%. That is heavily biased by a 24.8% increase in ‘petroleum products’. This increased cost doesn’t affect all of the economy and is offset by the softness of labour costs, but hauliers, taxi drivers and others who run businesses for whom this is a large cost, are having a tough time.

Outside the UK, the main event was the ECB press conference, where Jean-Claude Trichet repeatedly reassured everyone that there was no chance of Greece defaulting (what else would he say) but more importantly, where the changes to the ECB’s collateral regime were extremely minor. So another potential landmine for the Greek banking system is avoided, for now. That was the signal for the ‘risk-on’ mood to take over.

And on the other side of the world, the Economist has a piece today on Japan’s debt problems (Sleepwalking towards disaster, here). It’s a popular theme. The cure seems straightforward to me - lots of QE, and a much weaker currency. The problem is that this is not imminent and however much everyone else frets, the Japanese authorities are, indeed, sleepwalking.

 .

The outlook for the pound is something of a tug-of-war. My central fear/view is that any wobble in the recent widening in the Conservatives’ lead (increasing the risk of a hung parliament) will dent confidence and hurt the currency. This morning’s polls will make better reading for Gordon Brown than David Cameron with three polls all putting the Conservatives’ share of the vote back under 40%, and the daily YouGov poll putting their lead back to 5% (click here http://www.ukpollingreport.co.uk/blog/). However, this news is getting less attention as a raft of positive economic data releases hits the wires. First up, on the morning after I read a story about how the number of cars on the UK’s roads has fallen for the first time, new car registrations are up sharply in March. New car registrations totalled just fewer than 400,000 in the month, up 26.6% over the same month a year ago (in the depths of the gloom). The first quarter has seen 612,000 new cars sold compared to just under two million in the whole of 2009. Of course, incentives to scrap old cars are playing a huge role and cynics will have much to say about how few cars are made in the UK but even so, this is another positive sign for demand. Second up was the release of the latest Halifax house price data, which posted a 1.1% monthly increase and a 5.2% annual increase (click here). Third up were the industrial production figures just out and showing a 1% gain on the month, twice as big as expected. These figures will probably cause some upward revisions to Q1 GDP forecasts. The OECD already expects the UK to see the second strongest growth of the G7 economies in the first half of the year, with a growth rate of over 2.5%. Only Canada (expected to grow at a blistering 5.4%) is doing better. Here’s a link to the OECD outlook (click here). I’ve got a soft spot for the OECD since they paid for my education….

Spring is going to be good for the UK economy and I have argued for a while that this will be good for the pound once we can get the uncertainty of the election out of the way. The next couple of weeks, with political uncertainty at its height and the economic data coming in strong, are going to be a tricky period. But when the dust settles and throughout the summer, the extreme under-valuation of the pound relative to the euro in particular, will start to be corrected. Bloomberg’s estimate of purchasing power parity valuations suggests that the euro is 14% overvalued against the pound, with fair value around 0.75. And if the UK is the second-fastest growing of the major economies in the first half of the year, it is worth noting that only the euro has performed less well so far in 2010 – by contrast, while Canada’s growth is even stronger, the Canadian dollar is the strongest of the major currencies by some distance.

So much for the pound; the next UK event is the MPC announcement at noon. It is likely to be a total non-event. By contrast, the ECB President’s press conference will be more important. Rates will not move but details are expected of the collateral framework the ECB will apply from next year, which will be very important for the Greek banking sector - here is a quote from M. Trichet when speaking to the European parliament at the end of March:  

“Let me also take advantage of my presence in front of the European Parliament to lay out what I already mentioned in the hearing before the Economic and Monetary Committee on Monday. It is the intention of the ECB’s Governing Council to keep the minimum credit threshold in the collateral framework at investment grade level (BBB-) beyond the end of 2010. In parallel, we would introduce, as of January 2011, a graded haircut schedule, which will continue to adequately protect the eurosystem. I will provide the technical details when reporting on the Governing Council decisions of our next meeting on 8 April.”

The ‘haircut’ applied to collateral determines how much margin must be posted in return for funding from the ECB. If the terms under which the Greek banks can access ECB funding are too onerous, we will see even more pressure on a banking system suffering form capital flight. Greek CDS spreads have ballooned wider again today and, as equity markets soften, the dollar is benefitting and the euro weakening.

There is little news in the US. A well-supported 10-year Note auction yesterday was followed by typically dovish comments from Ben Bernanke about monetary policy, and yields have drifted a little lower. However, all eyes on are on the ECB, Greece, and growing talk of a Chinese currency revaluation.

.

One of the themes that I have returned to fairly frequently is the prospect of central banks in G5 economies leaving interest rates very low for a very long time. When the US FOMC last met, I had the pleasure of reading through their policy statement, looking for the tiniest of changes. Rates were left on hold but the question was whether they were planning to make even the most marginal moves in the direction of tighter policy. I commented in my blog at the time that at this pace of change, rates would not actually be raised for years let alone months, and I just could not understand why the consensus forecast of US economists looked for a 2010 hike. Last night saw the release of the Minutes of that meeting just before the Lionel Messi show (click here). The one-line summary is that the Federal Reserve is not anywhere near raising rates. What surprises me is that there is any response in financial markets at all. Falling core inflation, an unemployment rate at 9.7% and an output gap as big as the Pacific Ocean all suggest that, even if growth is at 3% this year, rates could easily still be at current levels in a year’s time.

With the Fed, the MPC, the ECB and the Bank of Japan all sitting around twiddling their thumbs, there are two core themes to currency markets. The first is obvious: the currencies of this bloc are all under-performing ‘the rest’; that is, any currency of any country whose central bank is inclined to hike rates like Australia, Canada, and China. The second is that in the absence of official rate moves what matters is how intermediate term interest rates move. Policy rates are static but 2- and 5-year market rates have continued to move against the euro, the pound and the yen, and in favour of the US dollar. Yesterday’s FOMC minutes stopped the pro-dollar move in market rates, but a pick-up in the jobs market (even if it was skewed towards temporary and lower-paid jobs) and an early Easter, suggest next week’s retail sales data could be strong and upward revisions to US growth forecasts for 2010 will continue. That is why, for now, I remain bullish of the dollar.

The yen and the euro remain floored by rates and the only real question is how much they can fall in the absence of actual policy rate hikes elsewhere. “A bit, but not too far,” isn’t a great answer, but the only one I have got. The difficult currency, by contrast, is the pound. It has bounced across the board in the last fortnight in a classic ‘short squeeze’, but this move is bereft of any support from the interest rate market, where 2-year rates at 1.6% are 40bp lower than they were at the start of the year. On the positive side, I expect positive economic data trends to continue for the time being. Purchasing managers’ surveys are reasonably upbeat (even if this morning’s services PMI was marginally softer than last month) and tomorrow should see a strong bounce in manufacturing output. I expect higher market interest rates and higher gilt yields in the weeks ahead. On the negative side, the pound has clearly benefitted from a slight increase in the chance of a Conservative election victory as opinion polls now give them a 10% lead. It is not so much who wins the election that matters, as much as the fear that nobody winning would cause policy paralysis and bring the risk of a credit downgrade closer. The negative aspect of this is that in such a close election campaign, there must be a really significant risk that we see opinion polls bounce around, and any fall back towards a 5% Conservative lead would make a hung parliament look very likely. And that suggests that the risk to the pound in the next week or two is biased to the downside from here.

.

So, there is going to be a General Election in the UK on 6 May. This isn’t exactly ‘new news’ but it is going to be official after Gordon Brown has been off to visit the Queen today. There are three new opinion polls for markets to think about. Two (Opinium and YouGov) put the Conservative lead at 10%, enough (just) to have a workable majority. A third, by ICM for the Guardian, puts the lead at 4%. Here’s the link (again) to the polling report website I use for updates (click here). Markets want a clear majority for someone which, in practice, means the Conservatives so they will probably welcome further gains in the Conservative lead regardless of any policies which are introduced in the days ahead.

There have been two minor economic data releases this morning in the UK; minor but noteworthy. The purchasing managers’ index for the construction industry came out at a very strong 53.1 and the Bank of England’s data on mortgage equity withdrawal shows that for a seventh consecutive quarter, UK homeowners paid back their mortgages to the tune of £4billion. In the fourth quarter of 2003 – the peak of equity withdrawal from the housing market – we collectively took out £17.3billion to put to other uses. Obviously this series is important insofar as mortgage equity withdrawal (MEW) was a major source of financing that allowed UK consumer spending to run ahead of disposable income growth in the go-go years. The story of 2009 is that incomes held up much better than many expected, but the money was used to pay down debt. And the questions for 2010 are how much income will be taken away by the new Chancellor in taxes, and how much of what is left will be spent now that the economy isn’t actually going backwards any more. We get consumer confidence data tomorrow, industrial production on Thursday and on the same date the next MPC meeting (when surely they will leave both rates and asset purchase targets unchanged). As for UK markets, equities get a lift from the global environment while gilt yields are being pulled up by the US Treasury market where 10-year yields look set to move above 4%. The pound, after a short-covering bounce, looks vulnerable in the near-term at the onset of the official election campaign.

Outside the UK, there are four main news stories for markets to focus on. Cracking US data, more talk of a Chinese revaluation, an Australian rate hike and the on-going Greek funding tragedy.

US economic data, starting with the employment report last Friday, continues to surprise on the upside. Non-farm payrolls increased by 162,000 with some hefty revisions to previous months. The non-manufacturing ISM index, released yesterday, jumped to 55.4% and this is perhaps more important than the strength of the higher-profile manufacturing index last week. Manufacturing is a smaller part of the economy particularly in terms of employment, and the accusation that the US cannot hope to have a manufacturing-led recovery is a valid one. These data suggest the recovery is broadening. Finally, there was a big jump (8.2%) in pending home sales in February, suggesting that whereas in January no-one set out to buy a home, once the weather improves there is some demand coming back at these low prices. Equity indices responded positively, but treasury yields are nudging steadily higher. With a further $74billion in 3-, 10- and 30-year bonds to be sold this week, there is a lot of Treasury supply to mop up and yields remain under upward pressure. As long as this doesn’t dent confidence in the equity market or send mortgage rates up so much that they send the housing market back into a downward spiral, this is a positive for the US dollar, but those caveats mean we need to watch this trend closely.

A Chinese revaluation, like the Greek financial tragedy, is a familiar theme now. China looks set to revalue in the second quarter of 2010 and the sooner they do, the sooner everyone can realise that it is not such a big deal. Greece has €32billion in funding to achieve this year and plans to issue dollar-denominated debt shortly, so the scare stories won’t go away. However, for me, the next flashpoint is not in Greece, but in Spain or Portugal. 

Finally, the Reserve Bank of Australia raised rates again to 4.25%. This just serves notice that while the US, UK and eurozone are struggling with huge deficits, there are countries out there which are simply returning to normal. Australia and Canada continue to move in the right direction and, with commodity prices moving higher also, their currencies reflect the new world order. Parity between the US and Australian dollars is some way away but I predict will happen within a year, while Canadian and US dollar parity is likely today.

.

Welcome to the second quarter of the year. The first quarter saw equity markets advance, commodity prices (slightly surprisingly) fall, bond yields go nowhere at all, and in currencies, the losers were sterling and the euro. The ‘winning’ currencies were the non-US North Americans: Mexico and Canada.

The Q1 economic summary is one of faltering economic improvement with the picture somewhat obscured by horrible weather. Emerging economies boomed away happily, led by China where annual GDP growth is expected to come in at an eye-popping 11%. In developed economies, the growth rate will be slower but the US may have managed 3% and the trend everywhere is positive, after a fashion. Inflationary pressures are largely absent although tax increases and imported commodity prices are having a temporary impact. Looking forwards, the divide between those who expect a ‘double dip’ and those who imagine a world where the spluttering stop-start recovery continues, remains as wide as ever. I remain in the latter camp.

Monetary policy remained on hold in most places. Quantitative easing is being phased out, slowly, but policy rates are on hold. Perhaps the biggest moves were in expectations about how long rates will stay down, with the first hike pushed further into the future in the UK and the eurozone, while Canada is now firmly in the box seat with the BoC set to hike before any other G7 central bank. That explained the biggest currency trends in Q1 too as market interest rates drove the Canadian dollar up against the euro and sterling. The USDJPY rate hardly moved over the quarter, and the EURGBP rate is likewise virtually unchanged. So, too, are US bond yields, with the most recent concern about higher yields representing little more than a move back to the levels we saw just before the (weak) December payroll report in early January.

Equity markets moved higher on the back of economic optimism (a bit) and easy monetary policy (more importantly). The most bearish equity market commentators repeatedly warn that earnings estimates are out of synch with realistic economic growth projections, yet what we see at the moment is companies hoarding cash, cutting costs and driving profits higher despite a sluggish economic recovery. That, and the absence of attractive alternatives.

So much for the first quarter – where are we heading next? More growth, less inflation, slightly higher bond yields and higher equity indices are my first thoughts. There is only one G7 central bank which could raise rates (the Bank of Canada) and the consensus view of forecasters is that they won’t. I suspect they might and the Canadian dollar stays at the top of my personal currency hit-parade. Second in my currency hit-parade is sterling, which has suffered terribly from political vacuum, and to the extent that will be resolved this quarter, I expect the pound to do well. The first economic data of the quarter was the March manufacturing PMI, up at 57.2 from 56.8, a new high for this series. The bottom of the currency hit-parade in this quarter though is a close-fought fight between the yen (suffering as long as the trend in bond yields is up) and the euro (where we will read plenty about Greece). The US dollar is caught somewhere in the middle.

I shall put more flesh on the bones of these thoughts after the Easter Break.

.