- Estimated official intervention in May was larger than expected, given the USD’s firmness during the month. Our base case is that EUR/USD will edge higher as the European situation stabilizes, but there are risks, given the fragile market environment and market positioning imbalances that are fostered, in part, by intervention (see Focus below).
- The FOMC has decided to complete its purchases of $600bn in longer-term Treasury securities by the end of this month and “will maintain its existing policy of reinvesting principal payments from its securities holdings.” It did not attach specific language to its reinvestment policy (as it does through the use of “extended period” language with the federal funds rate).
- The minutes of the June MPC meeting show that the committee voted 7-2 to keep the Bank Rate at 0.5% and 8-1 to hold the stock of asset purchases at ?200bn, in line with expectations. Differing views seem to be crystallising within the majority camp about the next policy move, but the debate is evolving slowly.
- Euro area manufacturing new orders rose 0.7% m/m – a moderate rebound after last month’s drop of 1.5% m/m and slightly below our and market expectations. Looking at the “core” series of orders reinforces the view that orders’ underlying momentum is rather weak, declining for the second month in a row.
- In Brazil, the May labor report was in line with expectations, showing a flat unemployment rate at 6.4% in May and another record low of 5.9% after stripping out seasonal factors. Although job growth is likely to moderate, we are concerned about the pace of wage gains, which is likely to keep consumption power on the rise and pose upside risks to the inflation outlook.
- As was widely expected, the Norges Bank today left its key policy rate unchanged at 2.25%. Though the Norges Bank policy rate announcement struck a somewhat more hawkish tone than we anticipated, we maintain our central scenario that the policy rate will reach 2.75% by year-end 2011.
FOCUS
May intervention: Larger than we thought
Jeffrey Young, Aroop Chatterjee
The FOMC statement was largely as expected, although slightly to the hawkish side on inflation and on the optimistic side on growth prospects, confirming our view that the bar to any potential “QE3” is quite high. As markets weakened in June, speculation about QE3 pushed the USD down at times, but we expect such talk to fade as the economy evolves roughly in line with the Fed’s thinking. Furthermore, our fixed income strategists have made no changes to their view on US rates based on the FOMC statement. With US monetary policy firmly on hold for the time being, we suspect that other factors, including positioning and flows, will be important for the USD’s prospects. Below, we review recent trends in official intervention as an important component of these flows.
Estimated official intervention in May by major emerging economies was larger than expected, given the USD’s firmness during the month. High intervention probably reflected the weakness of the USD at the beginning of May and then the inevitable lags in the behavior of central banks. The large intervention in April and at least part of May may have helped to “set up” the USD’s May rally by withdrawing USD from the market. Our baseline view is that the EURUSD rate will appreciate in the next few months as the European situation stabilizes, but risks to this view are high, not only from the sovereign issues in Europe, but also from market imbalances fostered, in part, by intervention.
There are three main points about intervention in May. First, it was large. Intervention was 2.3 times the US current account deficit on an annualized basis, compared with an average of 1.4 times since the first quarter of 2007 (Figure 1). Second, China’s estimated intervention remained high: in May, Chinese intervention was about 64% of total EM intervention, up from about 50% in the previous three months. Third, intervention across emerging markets was highly correlated with China’s intervention, with positive correlation in seven of the nine emerging Asia economies we track (this ratio was routinely below 50% in prior years). Correlated, but uncoordinated, activity tends to tilt official sector activity even more toward one side.
The size of intervention generally runs opposite to the direction of the USD – rising when the USD is weak and falling when the USD is strong. In May, intervention bucked this trend somewhat: the level fell from April, but remained quite high, even though the USD rose against most currencies. Most likely, this reflects some persistence in central bank activity from April; then, the USD was on a strong downward course, as the ECB hiked rates and risky assets enjoyed strong rallies. Early in May, it was not clear that the USD’s short-term trend had shifted, so intervention continued.
Countries have different reasons to intervene, but in general, the large and persistent intervention in recent years has been aimed at limiting the appreciation of local currencies, limiting volatility, and absorbing capital inflows. At times, though, if the market becomes imbalanced, intervention can backfire by precipitating sharp spikes in the USD. Recently, the private market has become very short USD, as evidenced by near-record short USD positions on the CFTC (Figure 2). The public sector has been buying (and holding) USD, possibly in large amounts relative to the underlying supply (the US current account deficit).
At the same time, USD rallies based on positioning tend to fizzle unless other supporting factors come into play. At present, the traditional candidates – strong US economic growth or Fed tightening – are not likely any time soon. On the other hand, the end of QE2 is a wildcard that is difficult to discount: while we do not classify the end of asset purchases per se as monetary tightening, the effect remains uncertain. In particular, there are signs that markets are unconvinced that current USD weakness against the EUR will last given the sovereign problems in Europe; in a rather atypical fashion, EURUSD risk reversals are becoming more deeply negative (representing higher demand for EUR puts than calls), even as the spot EURUSD rate rises (see Global Macro Daily (New York Open), June 22, 2011). If European problems worsen, EURUSD may fall aggressively, and the imbalanced demand from central banks might unintentionally encourage such an outcome.
MARKET INSIGHTS AND EVENTS
Asia Pacific
EM Asia: Showtime – The Final Scene
Peter Redward
This note provides an overview of our EM Asia trade ideas. For a detailed discussion of the fundamental drivers of these trades, please refer to The Emerging Markets Quarterly, Summer Storms, 21 June 2011.
North America
FOMC statement confirms that the bar for further stimulus remains high
Anshul Pradhan
Treasury markets were almost unchanged on Wednesday despite high intraday volatility, economic data that surprised to the upside, and an FOMC statement that was relatively hawkish on inflation trends. The FHFA house prices index increased 0.8% m/m, better than the consensus forecast of a 0.3% decline, and the FOMC dropped the language about low “underlying inflation” from its statement. Furthermore, there was likely some decline in risk aversion after the failure of the Greek no-confidence vote on Tuesday. VIX and Libor-OIS spreads were lower.
In the economic projections released today ahead of the press conference, the Fed lowered its forecast for 2011 and 2012 GDP and raised its forecast for 2011 and 2012 core PCE inflation. This is the second consecutive month in which it has lowered the GDP forecast and raised the core inflation forecast. The Fed now expects the GDP to grow between 2.7% to 2.9% in 2011 and 3.3% and 3.7% in 2012, down from 3.1% to 3.3% in 2011 and 3.5% to 4.2% in 2012. It now expects core PCE inflation of 1.5-1.8% in 2011 and 1.4-2.0% in 2012, up from 1.3-1.6% in 2011 and 1.3-1.8% in 2012. This change in projections, together with our economics team’s interpretation of the change in language regarding underlying inflation, suggests that economic data would have to surprise significantly on the negative side for the Fed to commit to further monetary stimulus.
In addition, the NY Fed announced slight changes to the way it will conduct purchase operations when reinvesting paydowns. While the distribution will be nearly identical, the Fed will combine 10-17y and 17-30y into one bucket and purchase a total of 6% from that bucket instead of the earlier 2% and 4% from the individual buckets. The Fed will aim to conduct seven operations per month, one in each bucket. In terms of positioning, we maintain our call for a flattening of the swap spread curve. 2y LOIS spreads are still well below their average in November-December 2010, the last flare-up of concerns about sovereign risk. Uncertainty about the progress of the US debt limit negotiations should also put flattening pressure on the spread curve.
Federal Reserve Commentary: June FOMC and Press Conference – A downshift to neutral with more emphasis on overall inflation
Michael Gapen
The June FOMC statement and press conference suggest the Fed will conclude purchases next week and sit patiently in neutral before deciding its next steps. The committee revised down growth projections but saw a rise in headline inflation as shifting the balance of risks against further stimulus. We believe that the committee is not inclined to lean against commodity price pressures while inflation expectations remain contained.
The Congressional Budget Office’s Long-Term Budget Projections: Demographic factors to put sustained pressure on the federal budget
Troy Davig
The Congressional Budget Office (CBO) released its annual Long-Term Budget Outlook this morning, which provides fiscal projections over the next several decades and highlight the stark choices policymakers must confront in the near future. Our projections, as well as those from the CBO, continue to see the deficit narrowing in line with recovery until 2014. After 2014, however, both our and CBO projections see demographic factors pushing deficits increasingly wider without some kind of fiscal reform.
US FHFA home prices surprise; rise 0.8% m/m in April
Michael Gapen
The Federal Housing Finance Agency (FHFA) Purchase-Only House Price Index rose a surprising 0.8% m/m in April, following a revised 0.4% decline in March (previous: -0.3%). This reading was much better than we (-0.4%) and the market (-0.3%) expected, leaving the y/y decline at -5.7% in April, versus -6.2% in March.
Europe
Euro area manufacturing new orders rebounded modestly in April, but their easing of momentum should continue
Francois Cabau
Euro area manufacturing new orders rose 0.7% m/m, slightly below both ours and market expectations (BarCap: 1.0% m/m, consensus: 1.1% m/m), thus showing a moderate rebound after last month’s drop of 1.5% m/m. Looking at the “core” series of orders (excluding heavy transport and equipment) reinforces the view that orders’ underlying momentum is rather weak, as they declined for the second month in a row, by -0.6% m/m after -1.1% m/m in March.
UK MPC: Doing the splits
Simon Hayes
The minutes of the June MPC meeting show the committee voted 7-2 to keep Bank Rate at 0.5% and 8-1 to hold the stock of asset purchases at ?200bn, in line with expectations. Differing views appear to be crystallising within the majority camp about the next policy move, but the debate is evolving only slowly.
INSEE June business survey continued to improve in Q2
Francois Cabau
INSEE composite business survey remained stable in June at 108, thus being only one point down since its last cyclical high in April. As a result, it is key to note that business sentiment in France continued to improve in Q2, albeit at a slower pace. It will thus be interesting to see whether the PMIs and the Banque de France business survey confirm this surprisingly strong momentum, which could renew upside risks to our Q2 GDP forecast (at +0.4% q/q after +1.0% q/q in Q1).
Italy: two more confidence votes for the government this week
Fabio Fois
Yesterday, PM Silvio Berlusconi’s government won a confidence vote 317 to 293 in the Lower Chamber. While we had expected the government not to face any difficulties, we would have expected it to have won the vote with a smaller majority. Today and tomorrow the majority coalition faces two more confidence votes, on the composition of the majority, as over the past few weeks several MPs have left the government coalition and have been replaced by others.
Spain: A summary of IMF’s annual Article IV consultations
Antonio Garcia Pascual
The IMF presented the summary results of its annual Article IV consultation on Spain. Overall the report welcomes the measures on fiscal consolidation, labour market reforms, pension reform, and restructuring of the saving banks, but indicates the reforms have not gone far enough. It states the export-led recovery implies real GDP growth of 1.5-2% by 2014. We consider the assessment well-targeted, and it broadly coincides with our views on policy strengths/weaknesses and key outstanding issues.
Greece: Support in the confidence vote should favor next week’s MTFS vote
Antonio Garcia Pascual
All 155 PASOK MPs supported the government. In the opposition, 143 MPs voted against the government and two abstained. We see this as a clearly positive outcome as it shows government support from all its MPs following last week’s cabinet reshuffle. We consider this vote as the best indication available of the likely outcome of next week’s vote on the MTFS, which will be submitted to parliament on 28 June. Some PASOK MPs indicated after the confidence vote that this support is not unconditional.
Norway: The Norges bank left the policy rate unchanged but adopted a more hawkish tone than expected
Marcus Widen, Mikael Nilsson
As was widely expected, the Norges Bank today left its key policy rate unchanged at 2.25%. On its forecast policy rate path, it raised the path for 2011 and left a slightly lower path for 2012 and beyond. All in all, though the Norges Bank policy rate decision was somewhat more hawkish than we anticipated, we maintain our main scenario for the policy rate to reach 2.75% by year-end 2011 and 3.75 by year-end 2012, ie, only slightly lower than the NB’s own assessment.
Sweden: Unchanged unemployment rate, 7.9%
Marcus Widen, Mikael Nilsson
Today the labour market report presented an unchanged unemployment rate in May of 7.9%, higher than our 7.5% and market 7.7% estimates. The seasonally adjusted unemployment rate increased from 7.5% in April to 7.7% in June.
Sweden: Slowing sentiment indicates growth entering mature phase
Marcus Widen, Mikael Nilsson
Today the NIER Economic Tendency Survey for June indicated a slowdown in the general sentiment indicator to 110.6 from 112.4 in May. The decline in the indicator applies to all sectors except manufacturing. We have long argued that sentiment is slowing from historical highs and growth is entering a more mature phase. All sectors except retail are still well above historical averages. Sentiment must still be seen as broadly based, suggesting above-trend growth numbers in 2011.
EEMEA
South Africa: Headline CPI above expectations at 4.6% y/y yet core inflation remains modest
Gina Schoeman
Headline CPI rose to 4.6% y/y in May, up from 4.2% y/y in April. This was above our forecast and Bloomberg consensus of 4.4% y/y each. The upward surprise in today’s CPI number came from a larger-than-expected increase in food inflation. We expected 5.5% y/y, yet CPI food rose by 6.3% y/y. Critically, core inflation measured 3.2% y/y, in line with our expectations and still modest. We maintain our view that the repo rate will rise by 50bp in January 2012.
Latin America
Mexico: Retail sales surprised on the upside
Marcelo Salomon
April retail sales in Mexico increased by 4.9% y/y, above our and consensus forecasts of 1.7% and 2.7%, respectively, and consistent with a 1.2% m/m SA gain. This is a positive start for Q2, as the quarterly trend growth of sales had slipped to 0.1% in Q1 from 0.6% in Q4 2010. This, along with the 2.2% m/m SA increase in imports also observed in April, indicates that consumption remains a strong driving force behind domestic demand and real GDP growth.
Brazil labor market: Tight and getting tighter
Guilherme Loureiro
May labor report was in line with expectations, showing a flat unemployment rate at 6.4% in May and another record low of 5.9% after stripping out seasonal factors. The details of the report also indicated a strong 2.6% m/m SA rebound of the real wage bill in May. Although job growth is likely to moderate, we are still concerned with the outlook of wage gains in Brazil, which is likely to keep consumption power on the rise and pose upside risks to the inflation outlook.
Argentina: Cristina Kirchner announces candidacy
Sebastian Vargas
President Cristina Kirchner announced her candidacy for a second term as president, as we expected. Her announcement comes after weeks of uncertainty amid press speculation that she would not run. The uncertainty will now center on her choice of VP. The hard legal deadline to announce a VP candidate is Saturday June 25. The Kirchners have traditionally opted for politically moderate VPs, such as Scioli (Peronist) and Cobos (Radical). That said, these ‘moderate’ VPs have not necessarily always been able to act as restraining forces, as in the escalation of the farmer conflict in 2008. As was the case with VP Cobos, President Kirchner might select a moderate candidate who maximizes her electoral chances by appealing to middle-class voters. However, this time around, we think the VP candidate is more likely to be one she can fully trust.
THE NEXT 24 HOURS
Asia Pacific
Singapore: We expect CPI inflation to ease on lower oil prices, which will be offset to some extent by slightly higher COE premiums and higher utility tariffs.
Taiwan: Temporary supply disruptions in the auto industry likely to weigh on industrial production, although the impact will be mitigated by strong electronics production volumes.
North America
US new home sales: We look for new home sales to decline 3.5% m/m, to 312,000 units, in May, and for supply to hold steady at about 6.5 months. New home sales rebounded in March and April after falling to 278,000 in February, but we expect the decrease in MBA applications for purchase in May to translate into softer new home sales. These have been rangebound at 275,000-331,000 since last May, when the effects of government stimulus on housing activity began to wane; we look for them to remain there until months’ supply falls further.
Europe
Euro area – PMIs: We expect euro area “flash” PMIs to continue their ongoing downward correction in the last month of the second quarter, consistent with our view that economic activity should decelerate in Q2 from Q1. Besides, we should also see a further resilient performance in this downward correction from the services sector, which should drop at the euro area level from 56.0 to 55.0, while we foresee the manufacturing PMI falling 1.3 points to 53.3. All in all, we expect the euro area composite PMI to decline to 54.5 from 55.8.
UK CBI total retail sales: We expect the CBI distributive trades balance to have fallen to 10 in June from 18 the previous month, as the tough economic conditions facing British consumers should continue to rein in spending. Furthermore, retailers have continued to report difficult trading conditions in June so far, and have expressed concerns about the outlook for consumer spending for the rest of the year.
EEMEA
Czech: The MPC members have already indicated their votes, and the CNB will keep rates at 0.75%. We expect the first move in November.
Turkey: We do not expect rate hikes until Q4, but could see additional RRR hikes.
Latin America
Mexico unemployment rate: Favorable seasonality is the key driver of the strong slowdown in the unemployment rate. After adjusting for this effect, the contraction should be more modest (to 5.0% from 5.2%).
Mexico CPI inflation: After a soft reading, we expect some pickup in perishables food inflation and energy-related components. On the core side, we pencil in relative softness of processed food, due to seasonal patterns
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