Forex Special
Sunrise Headlines
- US Equities traded flat on Wednesday, bringing an end to the five-day rally as investors focused on weak retail sales, while strong earnings from Intel failed to inspire trading. This morning, most Asian shares trade slightly lower as Chinese economic growth slowed in the second quarter.
- China’s economy slowed in the second quarter as the government steered monetary and fiscal policy back to normal after a record credit surge last year to counter the global crisis. Annual GDP moderated from 11.9% to 10.3%.
- The Minutes of the latest FOMC meeting showed the Federal Reserve downgraded its expectations for the economy and said further central-bank action might be necessary if the economic outlook were to worsen appreciably.
- The Bank of Japan kept rates unchanged at 0.10% and held off new policy initiatives as expected. The Bank raised its economic forecast for the current fiscal year, but highlighted that Europe’s debt woes could pose a risk to the outlook.
- Spanish Prime Minister Zapatero stressed yesterday its commitment to cutting the country’s yawning budget deficit and revamping its sluggish economy as new Spanish central bank data showed that local banks borrowed a record amount from the ECB in June.
- The IMF urged Japan to act soon to reduce its huge public debt through measures that include a gradual increase in its consumption tax.
- The EU won’t reach agreement on new rules for the region’s financial-services industry before the beginning of August, pushing a final deal on the legislation until September at the earliest, EU negotiators said.
- The Irish government will likely have to make additional spending cuts or tax increases if it is to meet its goal of cutting its budget deficit to 3% of GDP by 2014, the IMF said yesterday.
- Today, the US eco calendar contains the NY and Philly Fed surveys, industrial production, the weekly claims and PPI data. JP Morgan Chase and Google will announce Q2 earnings.
Markets
Regarding markets, the rally of riskier assets like equities and commodities, stalled yesterday. US equities closed little changed after a streak of five winning sessions. US and German bonds had a similar intra-day trading profile, largely mirroring the gyrations of equities, but the Treasuries largely outperformed the Bunds ending the day with solid gains. Indeed, in a daily perspective US yields were 6.4 to 8.9 bps lower, while German bond yields were even 1.4 to 3.6 bps higher, small part of the difference between US and Germany was due to differences in Tuesday’s closing levels.
Concerning economic data, markets were looking forward to the US retail sales, but they came out close to expectations. Retail sales dropped by 0.5% M/M, slightly below the expected 0.3% M/M decline. Weakness was mainly based in cars and gasoline stations, as the retail sales excluding autos and gas rose by 0.1% M/M. The outcome indicates that household consumption slowed during the second quarter, but due to an overhang will still print strong in Q2, however deteriorating the outlook for Q3. In the euro zone, inflation date came out exactly in line with expectations, while industrial production grew at a slower pace than expected.
Despite strong Intel results after Tuesday’s bell, equities couldn’t sustain the rally and eased already somewhat in the European morning session, but bonds could only profit modestly, keeping a more sideways trading pattern, only temporarily influenced by auctions in Germany, Italy and Portugal (see below). At the start of the US session, Treasuries and bonds got some more positive momentum, as US retail sales were weak (but as expected) andrumours about a Spanish downgrade by Fitch, later denied. The German Bund spiked higher, as did US Treasuries, but when US equities after a weaker opening turned higher, the Bund reverted to near intra-day lows while the US Treasuries held on to some gains. Later on the Bund, in after market trading erased losses, but US Treasuries made further headway, first on a stronger 30-year bond auction, later on the Minutes of the FOMC meeting that showed Fed governors downgraded eco- and inflation prospects and implicitly left open the possibility of more stimulus if the eco situation would deteriorate further.
In the intra-EMU market, there was generalized spread widening versus Germany, which was marginal for countries like the Netherlands, France and Belgium, but more pronounced for the higher yielders. The Portuguese and Italian auctions were a factor, as was a stronger German auction. The Irish spread widened the most (+16 bps in 10-yr tenor), as the IMF said Dublin would not meet EU agreed deficit targets and a ESRI think tank that capital injections in the banks would raise this year’s deficit substantially. In Spain, the annual state of the nation debate started with the PM asking to back his pension reforms and other austerity measures. However, opposition was very critical for the minority government and asked new elections.
Yesterday, Germany, Italy and Portugal tapped the markets. The German auction went fairly well. The reopening of the 2.25% April 2015 Bobl attracted €7.2B of bids of which €4.03B was accepted leading to a bid/cover of 1.8 (previous 1.1), helped by the smaller size though. The average yield of 1.60% was up from 1.47% in the May auction and the tail was very tight. Italy sold €6.8B of 5-, 13- and 30-year BTP bonds. Demand was tepid as bid covers amounted to 1.41, 1.51 and 1.35. Despite the price concession ahead of the auctions, the market digested the new supply difficult and spreads to German benchmarks widened further post-auction. So, the overall conclusion is that the Italian auction disappointed. The Portuguese bond auction fared rather well, but the amount sold was a modest €1.68B, which topped the indicative range of €1-to-1.5B slightly. The two lines on offer were the June 2012 and the June 2019, which each were upped by slightly more than €0.8B. Demand was okay, but not spectacular with bid/covers of 2.3 and 1.8 respectively, both lower than previously. The June 2013 was sold at an average yield of 3.159% (April: 1.715%) and 5.332% (June: 5.225%). Concluding, it is a success that one day after the downgrading of its rating, Portugal attracted sufficient demand for its bonds on offer. Following a good Spanish auction last week, this is positive news.
Contrary to the US 3- and 10-year T-Note auctions in the past days, the 30-year US T-bond auction was solid. The auction (reopening May 2040) stopped at 4.08%, well below the bid in WI trading. The bid/cover was well above average, while the buyside participation was a bit soft, especially the Direct bid. The Indirect bid was ok, but not particular aggressive. Concluding, all in all, it is an encouraging result for the Treasury after two weaker auctions.
The Minutes of the June FOMC meeting revealed a number of interesting features. Fed policymakers lowered their growth and inflation projections, while projections for the unemployment rate were modestly raised. 2010 real GDP had a tendency of 3-to-3.5% (down from 3.2-3.7%, while for 2011 projections were lowered to 3.5-4.2% from 3.4-to-4.5% in April. Unemployment rate for 2010 was left at 9.2 to 9.5%, but for 2011 and 2012 they were raised to respectively 8.3-to-8.7% and 8.1-to- 8.5%. PCE inflation for 2010 was 1-to-1.1%, 1.1-to-1.6% for 2011 and 1-to-1.7% for 2012. The risk assessment for growth also shifted as now about halve of the FOMC participants see downside growth risks, while still a substantial number of participants saw upward risks. The governors that see downside risks pointed to recent developments abroad and contagion as important elements. Also problems in commercial real estate and effects of regulatory reform on credit were mentioned. The second message from the Minutes was that the FOMC is not ready to sell assets that might lead to a tightening of financial conditions to some extent. And the changes in the outlook were relatively modest and not warranting policy accommodation beyond what is already in place. That would change if the situation deteriorates more. Currently, the Fed reinvests the maturing Treasuries it owns but not the maturing MBS. Asset sales were still regarded as inappropriate by most as additionally the eco situation had deteriorated. However, a majority also continues to anticipate that sales will only start after the Committee had started to increase short-term interest rates. Concluding, the Minutes add to the growing conviction that the Fed may soon consider while it should ease policy further. Various venues are possible: lower the interest rate on excess reserves (currently 0.25%), more QE or another facility, expressively construed to facilitate credit provision for small and medium sized firms.
The US eco calendar remains well-filled today with the NY and Philadelphia Fed surveys, industrial production, the weekly claims and PPI data. In the EU, the eco calendar is thin, but supply is again abundant as France, Spain and the UK will tap the market. The results of JPMorgan (before market opening) and Google (after closure) and their reception by markets might affect overall sentiment, including on the bond market. The ECB will publish its monthly bulletin.
In June, the NY and Philly Fed surveys showed a different picture as the NY Fed index stabilized, while the Philly fed indicator dropped sharply. For July, the consensus is looking for a slight increase in the Philly Fed index (10 from 8), while the NY Fed is forecasted to drop somewhat (18 from 19.57). We have no reasons to distance ourselves from the consensus as it confirms the expectations for a slowdown in activity toward the end of the year. In June,US industrial production is expected to drop for the first time in a year. A slight decline by 0.1% M/M is forecasted as hours worked in the manufacturing sector dropped significantly, but the warmer weather might have supported utility output. In the week ended July the 10th, US initial claims are expected to have dropped by 9 000 (to 445 000) after a 21 000 drop in the week before. A downward surprise is not excluded as GM kept 9 of its 11 plants open, while the seasonal adjustment factor assumes a 17% rise in the claims owing to shutdowns at automotive plants. PPI inflation is expected to have dropped sharply in June (from 5.3% Y/Y to 3.1% Y/Y).
Regarding supply, the Spanish auction with the July 2025 on tap for an amount of €2-to-3B will be the eye-catcher. Last week’s Spanish auction went relatively well, but each auction remains a hurdle for Spain that remains under market pressures. The French and UK Gilt auctions shouldn’t pose many problems.
Regarding bond market trading, it was Treasuries that stole the show yesterday, while the Bund traded rather lacklustre. In the absence of EMU eco data, attention may go to supply, but traders will also have to digest the FOMC Minutes, released yesterday eve, that contained bond-positive news. That may be the reason the Bund trades about 10-15 ticks above yesterday’s last trade (not official closing). Also equities may be weaker at the start of European trading. However, attention will soon afterwards turn to the US eco data to verify whether the growth slowdown quickens. The manufacturing surveys are in this respect interesting, while also the initial claims will get attention. Will the decline in claims last week be confirmed? From a technical point of view, we draw your attention on the test of the downside by the US Treasury Note future, which was at least for now rejected. However, it would surprise us if the future would now move above the contract high (123-01). For the Bund, while there may be a positive session, we would remain cautious. A renewed run to the high would be good to take profit on longs, but we favour the correction down to go somewhat further, if not today than maybe in the next days. However, ahead of the stress tests at 23 July, losses should be contained too. So, there is a rather dull outlook for the next few trading days.
On Wednesday, EUR/USD was blocked in a very tight sideways range close to the 1.27 mark for most of the day. The rally on the European equity markets stalled and the eco data (EMU core CPI and industrial production) had no lasting impact on EUR/USD trading. The trade-weighed dollar held close to the recent lows, but there was also no driver for big additional USD losses. Traders were awaiting the US retail sales and the next price move on the US equity markets. The retail sales release was marginally weaker than expected. The dollar lost a few ticks after the publication, but this release was also a non-event for global markets. The euro was temporary lower on market rumour that Fitch was going to downgrade the credit rating from Spain. However, Fitch simply repeated that it had a stable outlook, removing the issue from the radar. US equity indices opened slightly lower and were also not able to give currency trading a clear direction. Finally, some stop-tripping at the close of the European markets caused a brief up-tick in EUR/USD. The pair set a minor new high, but once again there were no follow-through gains. In the minutes of the previous Fed meeting, the US central bank turned less positive on its growth outlook and indicated that they should consider additional steps to support the economy if the outlook were to worsen appreciably. However, markets largely ignored this soft message from the Fed. EUR/USD closed the session at 1.2743, compared to 1.2724 on Tuesday. So, the price moves in EUR/USD were again limited, but the dollar continued its albeit very gradual slide of the previous sessions.
Today, there are no important eco data on the calendar in Europe, but investors will keep an eye on the auctions, especially on the Spanish 15-year auction. In the US, the PPI, claims, industrial production, Empire manufacturing survey and Philly Fed survey are scheduled for release. We continue to keep an eye on the data that might tell us something more the one pace of the US recovery. The question is still the same as was put for yesterday’s retail sales: will poor US data cause additional dollar weakness and, probably less relevant at this stage, what will be the EUR/USD reaction in case of a strong figure? Will the dollar then regain its composure or will the euro profit from better sentiment on risk? Yesterday’s price action in EUR/USD (and in the trade-weighted dollar) only confirmed that the market hasn’t made up its mind on this issue. Nevertheless, for now, it looks as if the balance is slightly tilting toward underlying dollar weakness.
We continue to keep a close eye at the technical charts. Recently, we advocated that easiest part of the EUR/USD rebound was over and that a sustained break north of the 1.27 area wouldn’t be that easy. After the price action of the previous sessions, one can not but note that the pressure in this pair is still to the upside. A clear break would pave the way for further EUR/USD gains toward the early May reaction high at 1.3094. In a longer term perspective, we doubt that a scenario of disappointing growth in the US (and also elsewhere in the world) should turn out to be euro supportive. This is not only a story of risk appetite. Europe desperately needs growth in the rest of the world for exports to counterbalance the negative impact from its budgetary austerity measures on domestic growth. However, for now its looks that the currency market is still adjusting USD long positions as it becomes clear that US monetary policy will stay accommodative for much longer than anticipated until recently.
Sterling was an outperformer yesterday. However, in a broader perspective, the EUR/GBP cross rate was again moving up and down within the ranges that were already at work earlier this week and at the end of last week. The correction of the UK currency against the euro has apparently run its course. The UK currency was well bid in Asia and early in Europe and the move was reinforced by decent UK labour market data (even as the were close to expectations). There was also some market chatter on a newspaper interview with BoE’s Sentance as he repeated its call to raise rates from the current extremely low levels. However, there was not much new in this interview, compared to what he said in a speech earlier this week. The decline in EUR/GBP halted again in the 0.8320 area (as was the case on Tuesday). So for now, it looks that the EUR/GBP has found a short-term equilibrium after the recent rebound with investors looking out for a new theme to decide on the next move.
Today, the UK calendar of eco data is empty. However, the BoE will release a speech of policy member Miles. Short-term, we expect more sideways trading. 0.84289/43 is still the key resistance on the topside. A slide below the 0.8300 area would be a signal of a loss of momentum for this cross rate.
Yesterday, USD/JPY drifted south for most of the session. The rally on the equity markets slowed and the dollar was in the defensive overall. This was enough a reason for the USD/JPY cross rate to reverse the gains from the previous 24 hours. The pair reached an intraday low in at 88.08 after the publication of the Fed minutes. So, the pair was again testing the 88.00 support area (previous highs/recent lows). This testing is ongoing this morning as the Chinese growth data failed to support risk appetite. At its policy meeting, the BoJ kept its assessment that the economy is showing further signs of a moderate recovery. It revised up its growth forecast for the current fiscal year from 1.8% to 2.6%, but slightly lowered its forecast for FY 2011/12 to 1.9% (from 2.0%). As is the case for the dollar overall, the pressure in this cross rate is also to the downside. A break below the 88.00 level would open the way for retest of year low at 86.96.
