Has the EU summit been a damp squib?At the time of writing the EU summit was coming to an end in Brussels and there had been no showpiece event like an aid request for Spain. The chief outcome has been an agreement with Europe’s leaders that the ECB will eventually be the single body responsible for all banking supervision in the Eurozone. There is no concrete time table to bring in this uber-banking regulator and there was no commitment to finalise either the date of implementation or exactly what the supervision will entail. For example, will large financial centres like Paris and Frankfurt be under more scrutiny compared with small centres like Finland and Austria? It is difficult for the markets to react to this summit as there is only scant detail and the impact of a banking regulator will be felt in the long term and thus only have a limited market impact right now.
The other development from the summit was Germany solidifying its opposition to using the ESM (the EU500bn long term rescue fund) to directly re-capitalise the banks in Europe. There was some expectation that Germany could allow this to happen, which would essentially ease the strain on sovereign finances from bailing out bad banks, particularly for Ireland and Spain. It became clear yesterday that Germany would not agree to this; for one if the ESM did inject money into the banks would that leave all Eurozone taxpayers holding the liability, and potentially the cost, of future bailouts? For now, Germany is keeping bad banks a domestic problem. Chancellor Merkel has been accused of playing politics at this summit and refusing any further cash injections until German elections are over next year. This surely means that Spain should get an aid request in quickly?
On that note, Spain already has a banking bailout of EU100bn. It is unclear at this stage if Germany’s resistance at the summit means that the Spanish state has to guarantee that money, which could weigh on state finances. Late on Friday the Spanish 10-year bond yield did start to rise, although it remained 40 basis points lower compared to the week prior and well below the critical 7% level. However, the news out of Spain this week has not been good. Its bad loan ratio has risen to 10.5% - another record high, thus the EU60bn recapitalisation as recommended in its last round of banking sector stress tests may not be enough if the bad loan rate continues to rise in the coming months. Thus, the outcome of this summit may have long term negative ramifications for Spain if it sees continued upward pressure on its bond yields, as this could push Spain closer to applying for a formal bailout, which may not be forthcoming from Berlin.
Spain’s regions will be in focus this weekend as regional elections take place in the Basque country and in Galicia on Sunday followed by one in the important state of Catalonia in 4 weeks’ time. If there are heavy losses for Rajoy’s Peoples’ Party it may spook markets as it may mean that the government might find it tougher to reign in regional public spending, which could threaten fiscal targets for this year. There is already some concern that the regional bailout fund set up by the central government is not enough at EU18bn to deal with all of the regions in trouble. Some think Spain may now wait until the next finance ministers’ meeting in mid-November before making a request for a credit line that would trigger the ECB’s OMT programme, however if regional finances continue to deteriorate then a full bailout may be waiting in the wings.
Overall, the EU summit does not alter the current state of affairs for Spain, but in the long-term it could have negative ramifications for Madrid, which could weigh on its bond market and hurt the euro.
Is global growth reaching a bottom?
Over recent weeks concerns about the global growth outlook have reached a crescendo. The IMF recently revised down its growth outlook for this year and next, but this could mark the low in the latest economic cycle. Data out of the US and UK surprised to the upside last week and gave some very encouraging signals that growth may have woken up from its summer slump. In the US retail sales growth was well above what the market expected in September, industrial production picked up and there was some encouraging data from the housing sector. This was partly tempered by a jump in initial jobless claims last week, but on balance the effect of a falling unemployment rate is finally giving consumption some traction, which is good news for the US where the consumer accounts for 70% of the economy.
This has helped push Treasury yields higher. The 10-year is testing key 200-day moving average resistance at 1.8%. Since Treasury yields move closely with USDJPY, which broke above the daily cloud last week for the first time since April, if yields can get above this pivotal level then we may see UDJPY push higher towards 80.00.
The growth outlook still faces a few hurdles and should not be greeted by traders with unbridled enthusiasm. There have been more misses than hits in the Q3 earnings season in the US at approximately 60-40. Some notable misses were Google, Intel and IBM. Usually tech stocks are good lead indictors for overall economic performance. The decline in sales growth last quarter could be down to uncertainty facing the US economy because of the upcoming fiscal cliff. This could be weighing on investment and marketing spending, which may hurt companies like IBM and Google. We will know by the end of the year if we avoid the cliff or go over the edge, if we avoid it (as many expect) then sales could pick up in 2013. Hence, the divergence between US corporate earnings and macroeconomic data may not persist.
The other bright spot on the global economic stage was the UK. Last week we saw stellar retail sales, boosted by weather-related clothing sales and a bounce in online sales after the Olympics was blamed for a slump in online spending in August. The labour market also produced a positive surprise. The unemployment rate fell to 7.9% from 8.1% in August, and the UK economy crated another 200k+ jobs in the three months to August, rounding off stellar job creation since April this year. But the big event for the UK next week is undeniably the first estimate of Q3 GDP. Expectations are high that the UK will bounce back from its first double dip recession in 30 years. The market expects a 0.6% gain, up from -0.4% in Q2. The risks are to the upside after better than expected economic data of late. This makes us hesitant to sell sterling at this juncture, as it has been particularly sensitive to positive data surprises in recent months. Thus, if we see a 0.6% + reading in Q3 GDP then we may see GBPUSD re-test the 1.6300 12-month highs in the near term.
The Eurozone economy could even experience some glimmers of hope after a very weak Q3. Its October flash PMI readings are released next week. The market expects these indices to move towards 50 but not get above this crucial level. But expect the markets to react to any positive PMI surprises from the Eurozone next week. As the London session ended EURUSD was edging back towards 1.30. 1.2980 is good support ahead of 1.2850. A negative outcome for PM Rajoy in Sunday’s Spanish elections could hurt the euro early in the week, but we think any dips will provide good buying opportunities as people try to benefit from a potential Spanish aid request as early as next week. Added to that, EURUSD could bounce back to the 1.3150-75 highs on the back of “strong” PMI readings. Overall, the past week hasn’t provided financial markets with any solutions to the sovereign debt crisis and we are in much the same position as we were last week, thus we could be range bound in EURUSD for the medium term unless a big event – a Spanish aid request or volatility in Spain’s bond market – gives the market some direction.
US data and FOMC in focusIn the week ahead, top tier economic data is due out of the US with the key report being Friday’s advance GDP figures for 3Q. September new home sales on Wednesday and durable goods orders on Thursday are also notable releases. Growth is expected to pick up to a q/q annualized rate of 1.8% from the prior 1.3% as personal consumption is forecast to pick up to 2.0% from the prior 1.5%. Retail sales figures and confidence surveys are supportive of the view that US consumer activity increased in the third quarter. Though growth may be accelerating, a 1.8% print is still soft relative to historic growth rates. The implication is that Fed stimulus is likely to remain in place for some time as growth is required for sustained labor market improvements. Any surprises in the economic data is likely to see the dollar respond more the impact on the risk environment rather than Fed expectations. Therefore better than expected readings may see the dollar softer on improving sentiment while misses could see dollar gains amid risk aversion.
The FOMC also meets next week and we do not anticipate any changes to policy. With newly announced stimulus it is not likely that the Fed will make any adjustments without having time to monitor the impact. There may be fine tuning in the statement, however as we have seen from recent Fed speeches, members have different views on when stimulus should be adjusted based on labor market and price indicators. Therefore the FOMC is likely to be a nonevent as we anticipate the Fed to deliver no new measures and amid the ongoing internal discussion of what will trigger adjustments to the current QE3 program.
Bank of Canada may not be as hawkishRecent comments from Canadian officials have caused the Loonie to fall over -1% against the US dollar so far this week. On Thursday, Finance Minister Jim Flaherty said that Canada may have to revise down its economic outlook and that Canada is not immune to world economic challenges. Earlier in the week Bank of Canada Governor Mark Carney spoke and his speech lacked the usual reiteration of his hawkish remarks that higher rates “may become appropriate”. The absence of hawkish statements underscored the potential for a shift to a neutral stance from the BoC. Furthermore, the governor said that there “is some evidence that global uncertainty is affecting domestic activity”.
The Bank of Canada will meet on Tuesday, October 23, and in our view there is scope for a shift in the policy stance as the Bank may remove the tightening bias from its statement thereby taking more of a neutral position. The initial reaction may weigh on the Loonie, however this would likely be a knee jerk move and we maintain our bullish outlook over the longer term as even a neutral monetary policy stance is viewed as a positive for the currency at a time when most other major central banks continue to provide more easing.
Lower than expected inflation figures released on Friday morning reinforce the view that the BoC will take a less hawkish stance. Consumer prices in September showed a monthly increase of 0.2% (cons. 0.3%) and yearly gain of 1.2% (cons. 1.3%) on the headline readings while the Bank’s core CPI readings fell to 0.2% m/m from 0.3% and 1.3% y/y from the prior 1.6%. Carney also indicated that the Bank will act to meet its 2% inflation goal. With inflation running below target and falling, we feel that the removal of the tightening bias from the statement is warranted.
Technically, USD/CAD broke above the top of a 4-month long bear channel and is currently trading above the 0.99 figure. The next key upside level is around 0.9995/1.0000 which is where the 100-day and 200-day simple moving averages (SMA’s) converge. We favor fading a rally towards this level and a sustained break above parity would negate out bearish outlook on the pair.
Australia and New Zealand CPI to support easing biasOn October 24, Australia will see the release of its quarterly CPI figures. Expectations are for 3Q CPI to accelerate to 1.6% y/y from 1.2% and 1.0% q/q from 0.5%. The consensus shows that even though inflation is expected to pick up, it remains well below the Reserve Bank of Australia’s (RBA) target of between 2-3 per cent. Unless there is a significant surprise to the upside, the data is likely to provide added support that the RBA will cut rates at its next meeting on November 6. Minutes from the October meeting and recent comments from Governor Stevens indicate that there is scope for the Bank to reduce rates further.
AUD/USD was given a boost by broader risk sentiment as the pair broke above the 200-day SMA and tested above the 1.04 figure, however it was unable to establish a daily close above 1.04 and the 55-day SMA appeared to cap the upside on a daily closing basis. Furthermore, daily candlestick analysis shows a potential shooting star that formed the day AUD/USD was rejected from above 1.04 which suggests a correction may be due.
The Reserve Bank of New Zealand (RBNZ) will announce policy on October 25 and we anticipate that the Bank will maintain the official cash rate at 2.50%. Therefore, the statement is likely to dictate price action in the kiwi (NZD). This past week New Zealand 3Q CPI figures showed an unexpected drop to 0.8% y/y – this is the lowest rate of yearly inflation since 1999. The 13-year low in CPI suggests that the RBNZ may shift to a more dovish tone as the 0.8% print falls below the CPI target range of between 1-3 percent with a 2 percent target midpoint. This may weigh on the NZD which has remained relatively firm above the 55-day SMA (which is currently around the 0.8150 level). A decline through this technical level may see towards the pivotal 0.8050 100-day SMA as the next key support.