The debt agency was upbeat on the results

Next report will be publish from August 24

Sunrise Headlines

• US Equities fell for a third consecutive day on Thursday as strong data from the euro zone failed to convince US investors ahead of the second quarter GDP data. This morning, Asian shares trade in negative territory.

• US Federal Reserve officials clashed yesterday over whether the central bank should be more aggressive in supporting the stumbling economy as one said the current Fed policy may be contributing to worrying low levels of inflation.

• China’s reform of its exchange rate regime is not having a major impact on the country’s exporters, deputy central bank governor Hu Xiaolian said this morning.

• Japan’s factory output marked its biggest fall in more than a year in June and manufacturers expect further declines in July, boding ill for the fragile economic recovery. Core consumer prices posted their 16th straight month of annual declines. A group of ruling party lawmakers renewed calls for the Bank of Japan to target inflation and weaken the yen.

• Hungary sold a more-than-planned 57.5 billion forints in government bonds, in its first long-term debt sale since talks with the IMF and EU collapsed. The debt agency was upbeat on the results, but the auction had no big impact on the forint, which weakened later yesterday.

• Moody’s Investors Service changed yesterday its rating outlook on Iceland to negative, indicating the country’s debt is more likely to be cut into junk territory over the coming year and a half.

• British consumer morale fell to its lowest level in almost a year in July as worries about the impact of government spending cuts drove expectations for the next 12 months to their lowest since the deepest point of the recession.

• Poland’s government is due to approve a document outlining public finance developments for the next four years as it struggles to rein in public debt and deficit levels that ballooned during the global financial crisis. According to sources, the deficit will be set at 45 billion zlotys.

• Today, the eco calendar contains the first estimate of US Q2 GDP, Chicago PMI, euro zone CPI inflation and the unemployment rate.

Markets

Regarding the economic data, The European data suggest that the EMU economy is the economic star performer that goes with strong momentum into the third quarter. This is unusually as at the same time, the US growth momentum is waning and similar signals are coming from emerging markets, with this time the Brazilian Central Bank saying that growth momentum is slowing. So, while we rejoice the European performance, we remain a bit sceptical and think that later on this year European growth might slow too, following a strong Q2 (and possible Q3). The euro is again stronger and the fiscal austerity measures taken in the zone will restraint spending going towards 2011. The German unemployment figures came out exactly in line with expectations, but this doesn’t hide the fact the labour market is improving. Germany is clearly leading the European economy. The European Commission confidence indicators confirmed the improving sentiment, that was already visible in the PMI’s and IFO, but the widespread nature of the improvement (including Portugal and Greece, but not Spain) and the positive details (thicker order-books and improving labour market sentiment) give more weight to the message send out earlier by the PMI’s and IFO’s. US Initial claims came out slightly lower than expected, while the continuing claims surprised on the upside. However, Initial claims are still elevated and the trend decline that was visible through much of 2009 stalled since February of this year. The most recent disappointing figures might be due to layoffs from state & local government workers and dislocations on the Gulf Coast.

Regarding markets, the strong European eco data and the batch of encouraging earnings results of many European bellwethers had some impact during the European and early US session in the form of stronger equities and euro, while the impact on global bonds was negligent (see below). However, equities couldn’t sustain as strong technical resistances in both the EuroStoxx (see graph) and the S&P held, setting the stage for profit taking later on. The euro closed with gains against the dollar, visited briefly the 1.31 threshold, but receded too. Commodities did well, including oil and copper. One instinctively looks to the dollar weakness as a driver, but it doesn’t completely satisfy. Equities at the end were lower, suggesting that growth indicators weren’t the strong market drivers.

Regarding global bonds, German and US bonds ended the session with modest gains, but in the case of German bonds, the gains were mostly an overnight thing, as the Bund closed little changed from opening levels. Also the gains of US bonds were very modest, making us describe the overall price action in the main bond markets as sideways oriented. German bonds ignored in the morning session both the strong (but largely as expected) eco data and the positive sentiment on the equity markets (due to good corporate results). In initial US trading, both Bunds and US Treasuries lingered around unchanged levels. However, after a strong opening of US equities, investors started to sell equities and this move was reflected in rising bonds. While the US bond rebound showed some vigour, this was missing in the German bond market. However, US bonds lost again some altitude in the run-up to the 7-year T-Note auction, also as equities recouped losses, and corrected somewhat further after the weak auction results were published. The auction stopped well above the WI bid at the stop and the bid/cover was weak, as was the buy-side participation. A late session renewed dip of equities lifted Treasuries to close the day with modest gains.

In the intra-EMU bond market, trading was thin. The sharp narrowing of the yield spreads of the peripheral credits to the bonds that ran out of steam earlier this week was followed by some profit taking and thus renewed widening of the spreads. This was visible in the Spanish 10-yr (yield spread widened 5 bps) and Italian market (+3bps). The Italian BTP auction went reasonably well, but couldn’t prevent a small widening of spreads. Portuguese, Irish and Greek 10-year bonds that had lagged the trend of narrower yield spreads, but caught up with the movement more recently saw their spreads re-widen too. Yield spreads at the shorter maturities (2-year) still narrowed somewhat. The yield spreads between core bonds and Germany were little changed.

Today, the eco calendar is well-filled. Most attention will go out to the first estimate of US Q2 GDP, but also interesting will be the euro zone CPI estimate, unemployment rate and US Chicago PMI survey.

In the US, GDP growth is expected have slowed somewhat further in the second quarter. The consensus is looking for an annualized growth figure of 2.5% Q/Q (from 2.7% Q/Q in Q1). The main growth contributor will probably be consumer spending, but also fixed investment is expected to make a positive contribution in the second quarter. Inventories and especially net-export might put a drag on growth. The government’s contribution is somewhat mixed as the Federal Government should have boosted growth due to the 2010 Census outlays, while local governments will probably have a negative impact due to budget woes. Recently put into the limelight by the California decision to declare a state of fiscal emergency. We have no reasons to distance ourselves from the consensus, but a weaker outcome won’t go unnoticed as it might (unfounded?) fears for a double dip. In the euro zone, CPI inflation is expected to have risen from 1.4% Y/Y to 1.7% Y/Y in July. We believe, however, that the risks might be on the upside of expectations as a 0.7% M/M decline of last year falls out of the calculation. Also German and Spanish CPI surprised on the upside of expectations. The unemployment rate is expected to stay unchanged at 10.0% in June. The Chicago PMI is expected to show a 3-points drop in July (56.0 from 59.1) after a slight decline in the month before. We believe however that the risks might be on the downside of expectations after the sharp drop in the Philly Fed indices; also the seasonal adjustment factor is a negative. The final figure of University of Michigan consumer confidence is expected to show a slight upward revision compared to the first estimate, which was a big disappointment.

Some regional Fed president’s spoke to the press. According to press articles, St- Louis Fed Bullard said that the risks of deflation Japanese style has risen somewhat compared to the beginning of the year, even if the main scenario is still for economic growth to continue ultimately lifting inflation of the current very low levels. However, should the risk scenario become the main one, Bullard said the Fed may do more quantitative easing and pump credit into the economy. At the same time, he was against the Fed’s vow to keep rates very low for an extended period of time as it may increase the probability of a Japanese-like outcome. He added however he was not inclined to follow Kansas Fed Hoenig in his dissent, but preferred to debate and to convince his colleagues at the FOMC. Dallas Fed Fisher was quoted as saying that further monetary accommodation would have as little effect in boosting the economy as “pushing on a string”. We will try to get a transcript of the comments and the research piece of Bullard to get a better insight in the reasoning behind these headline quotes.

Regarding bond markets today, US and European equities rejected yesterday a test of resistance and overnight Asian equities are trading down too. This should lead to weaker European equity trading in the European session. Weaker UK consumer confidence published overnight, bad Japanese eco data and Samsung downbeat comments about the outlook. This is a fertile ground for bonds. The Bund opened also strong. An upward surprise in EMU HICP is a small threat, but probably without lasting effect. Markets should have already positioned for such an outcome. We have put downside risks on both the US GDP and Chicago PMI, which would be positives too. However, despite this list of bond positives for today, we still think that any rise in German bonds is corrective in nature (on the previous down-move) and will keep them in their sideways range. In the US, the technicals show that the Treasuries are still in an uptrend, but the upside looks nevertheless limited to the recent highs (124-24).

On Thursday, after two days of directionless trading; the EUR/USD cross rate performed again quite a decent up-leg. As was often the case of late, the move was inspired by both dollar weakness and euro strength. It has been different in the recent past, but yesterday there was even some negative market chatter on the fiscal situation in the US. Rating agency Moody’s was quoted that the US needed to elaborate a credible plan to address its soaring debt to maintain its AAA-credit rating. In addition, the difficult fiscal situation in California got some coverage too, as governor Schwarzenegger declared a state of emergency of the State’s finance. We don’t say that all this had a big negative impact on the dollar, but it was no help either. On the other hand, the news flow from Europe was again mostly positive. Good results from several major (European) companies supported risk taking. German unemployment declined as expected and the EU sentiment indicators confirmed the positive trend of late. The US jobless claims were close to expectations. During the day, there was also market chatter on end of month repositioning which was supposed to be away from the dollar. This context was enough a reason for EUR/USD to test the key 1.3095 resistance area. A sustained break didn’t occur, as US equity indices failed to extend their gains. Nevertheless, the euro preserved most of the intraday gains and close the session at 1.3079, compared to 1.2896 on Wednesday.

Today, in Europe some attention will go to the July CPI estimate. However, the focus will be on the US with the first estimate of the Q2 GDP, the Chicago PMI and the final Michigan consumer confidence are scheduled for release. The key question is whether US economic growth is that weak so that additional Fed support is needed. If so, the dollar could face another setback, at least short-term. Today’s data is only one element in this debate. However, some kind of double dip in the US is not our basic scenario longer term.

Recently, the euro was in good shape. Nevertheless, the EUR/USD pair took a breather earlier this week before finally clearing the 1.3000 mark in a sustained way. From a technical point of view, the cross rate is currently challenging the 1.3095 resistance (10 May high). As is always the case, we could have chosen other technical/ tactical levels in this area. We took this one as it marked the top of the unsuccessful ‘rebound’ after the announcement of the EU rescue package during the weekend of 8/9 May. So, a break above this level could be seen as a further symbolic scaling down of the euro-skepticism that remained in place, even after the announcement of that huge rescue package. Recently, we held a tactically inspired approach as we thought that the euro had already succeeded a nice rebound (from 1.1877 to 1.30 +). In this framework we assumed that it wouldn’t be easy for EUR/USD to clear the 1.3095 resistance area, especially not if there was no high profile event to trigger more euro strength and/or dollar weakness. There was not really high profile news yesterday, but the ongoing positive news flow from Europe at least remains a surprising factor, especially if compared to the extremely euro negative sentiment that reigned until just a few weeks ago.

From a fundamental point of view, we think that quite some good news from Europe should be discounted after the recent euro rebound and the same might be true for the negative news on the dollar, especially as our basic scenario is for the US economy to muddle through this recent spot of weakness. Nevertheless, in a day-today perspective, there is no good reason to row against the tide now. So, EUR/USD longs should not be in a hurry to scale down EUR/USD exposure and can still wait to see how far this move goes, protecting its position with trailing stops.

Yesterday, EUR/GBP joined the broader euro rebound. In addition, the UK data (lending data, and earlier in the session the NationWide House prices) were slightly sterling negative too. There was strong support in place in the 0.8313/17 area. So, this combination was a good reason for the EUR/GBP to return higher in the established consolation pattern. Nevertheless, as was the case earlier this week, the EUR/GBP pair often showed quite some intraday swings, but no key barrier was hit. This was also the case yesterday. EUR/GBP closed the session at 0.8376, compared to 0.8330 on Wednesday. Overnight, the UK GFK consumer confidence came out weaker than expected. However, until now the impact on EUR/GBP trading is nonexistent (sterling is even a few ticks stronger against the euro). Later today, the calendar of UK eco data is empty.

Recently, some UK eco data were less negative, but at least for now, we don’t see them as enough a reason for the BoE to scale down policy stimulation in the near future. We see this week’s BoE comments as confirming this view. So, we expect King and Co to keep a wait-and-see approach for now. In this context, we don’t see a reason for EUR/GBP to break out of its recent consolidation pattern anytime soon. In a day-to day perspective, EUR/GBP yesterday moved away from the 0.8313/17/18 support area. For now, we don’t see a strong argument for the pair to drop below this level ahead of next week’s BoE meeting.

On Thursday, USD/JPY was just a good exponent of broader dollar weakness. The positive headlines from Europe (logically) were not really a big issue for this cross rate. The price action in EUR/JPY at best slowed the decline in the headline cross rate a bit. Nevertheless, the trend was obviously south and the pair closed the session at 86.79, compared to 87.47 on Wednesday. So, the mid-week rebound in the pair was very short-lived.

This morning Japanese eco data in global came out weaker than expected, with especially disappointing production data catching the eye. The Nikkei lost 1.64%; underperforming the rest of Asia. The disappointing Japanese data didn’t prevent the yen from attracting safe have bids. USD/JPY tested the year lows (86.25/27). Recently we had a wait-and-see approach on this cross rate. We felt that the downside in this pair had become more difficult as the market feared BOJ action in case of a drop to the 85.00 area. However, there was no positive trigger to unlock the recent stalemate. The pair probably needs a strong improvement in risk appetite or, even more, USD interest rate support to really move away from the recent lows. We don’t have to impression that this trigger will be available anytime soon. So we expect the pair to hover close to the current lows.

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