- Investors face substantial economic risks that justify cautious positioning. However, we believe that there are significant positives in the investment context as well (see Focus below).
- Continued concerns about Greece’s ability to pass the austerity programme necessary to gain access to EU/IMF funding weighed heavily on EGB spreads and an outright market rally on weak economic data on both sides of the Atlantic did not help sentiment. The market has shrugged off some relatively positive announcements recently, possibly on disappointment that policymakers were not quicker to act in a firmer, more integrated way.
- US jobless claims data point toward modest job gains in the upcoming June employment report. We look for a 75k increase in nonfarm payrolls, a 100k increase in private payrolls, and the unemployment rate to hold steady at 9.1%.
- The Central Bank of Turkey kept policy rates unchanged at its MPC meeting, and some of the subtle language changes in the MPC statement indicate that the CBT has become more dovish. We no longer expect additional RRR hikes, but maintain our forecast for 75bp of hikes in Q4.
FOCUS
Silver linings in the financial backdrop
Michael Gavin
The message of the just-published 2HGlobal Outlook was cautious, taking note of the slow recovery process in over-leveraged economies such as the US and the important event risks that face market participants now. We maintained our recommendation of a neutral allocation to risky assets, including equities, despite valuations that seem appealing from a historical perspective. We also favoured trades that seem likely to perform well in the event that one of the more acute risks materializes in the months to come. If there is a common strand in the feedback we have received from conversations so far, it is uncertainty regarding whether our investment recommendation is cautious enough in light of the substantial risks that face asset markets in the months to come. At the risk of sounding unbalanced, we take the opportunity here to highlight some of the redeeming features of the investment context as we see it.
An important element of our stance is our disagreement with market anxieties that the US economy is at risk of a ‘double-dip’ recession. But beyond this, we feel the market is likely to find support from a cautious and lightly positioned investor base, and correspondingly attractive valuations.
It seems to us that investors’ ‘psychological positioning’ is now highly conservative. Our recently published Global Macro Survey reported weak conviction and a somewhat bearish outlook on markets; in sharp contrast to previous surveys, only 20% of investors thought that equities would perform best in the coming quarter, while nearly a third of them believed that high-quality government bonds would perform best. (In the March survey, only 12.5% of investors favoured high-quality government bonds.) Optimism about commodities is also sharply down from previous surveys, spotlighting concerns about global growth.
Financial positioning is conservative as well, with nearly 40% of investors categorizing their positions as ‘light’; up roughly 10 percentage points from previous surveys. Mutual fund flows and other surveys of retail investors corroborate the message that investors seem nervous and cautiously positioned.
Not coincidentally, equity market valuations are attractive. Our US equity team notes that should the S&P 500 fall to 1250, its estimate of the equity risk premium over US Treasuries would match the August 2010 peak of nearly 8%. Clearly this is a global equity, not a US phenomenon.
Valuations are to some extent in the eye of the beholder, and in the near term even conservatively positioned investors can still sell risk on bad news. But with bonds priced to offer real returns ranging from negligible (in euros) to negative (in USD and GBP) for years to come, a permanent disengagement from equity risk seems highly improbable. It may be a nerve-wracking moment, but we think there are good reasons to stay the course with a neutral allocation to risk assets, with an eye out for potential buying opportunities in the months to come.
MARKET INSIGHTS AND EVENTS
Asia Pacific
Korea: Inflation expectations remain stubbornly high
Wai Ho Leong
The key takeaway for us from today’s release of the Bank of Korea’s consumer confidence report for June is the price expectations component of the index, which ticked up again, despite receding meat and vegetable prices (which had been falling since the foot-and-mouth outbreak in the winter). The BoK’s index of expected price changes six months ahead moved up to 147, up from 146 in May, led largely by the resurgence in international energy prices. While the index is below the April peak of 153, it remains well above the 139 average level since the series began in July 2008. The expected inflation sub-component remained at 3.9% in June, the same level as last month, and at the upper limit of the central bank’s range. In our view, this is a sign that inflation expectations in Korea are not well anchored and the risks to core inflation are tilted to the upside.
Taiwan: IP falters, accentuated by one-time disruptions to petrochemical output
Wai Ho Leong
May IP rose 7.92% y/y, beating consensus (+5.9%) and our forecasts (+5%). This print comes in the wake of the recent export orders report, which also surprised on the strong side of expectations. On a seasonally adjusted m/m basis, however, IP fell 0.7% m/m in May, extending the 3.4% drop in April and the fourth straight monthly decline.
Philippines: Fitch upgrades to BB+, maintain overweight Philippines
Prakriti Sofat, Avanti Save
Fitch raised the Philippines long-term foreign currency ratings to BB+ from BB. The sovereign had been on a Stable outlook since 2006 and Fitch retained the Stable outlook with today’s one-notch upgrade. The move is more upbeat than our expectation that the country’s outlook would be raised to Positive by at least one rating agency in H2 11. Moody’s rates the sovereign Ba2 (Stb), and S&P rates it BB (Stb). We continue to expect at least one of these rating agencies to raise the outlook to Positive in H2 11.
China: Stay with 5y receiver
Ju Wang, Kumar Rachapudi
The RRR hike in China effective from 20 June 2011 has resulted in a sharp spike in the 7d repo fixings, with the fix moving from 4.18% on 14 June to above 9%, above the highs seen in late January this year. The 4% stop-loss on our 5y receiver trade was triggered, but we recommend maintaining the position and moving the stop-loss to 4.2%. We still recommend looking to pay short-end rates on dips, as we expect the country’s policy stance to remain tight until growth slows enough to bring down inflation.
Singapore: Administrative charges push May CPI higher
Wai Ho Leong, Prakriti Sofat
Singapore CPI May inflation came in above expectations, at 4.5% y/y (market: 4.1%, BarCap: 4.2%) unchanged from April. The faster-than-expected inflation was due to higher utility and conservancy charges for public dwellings in May, as government rebates are paid in alternate months this year from April – ie in April, but not in May. We underestimated the impact of this distortion, which pushed housing inflation up to an 8.7% y/y pace from 5.1% in April.
Next week’s data highlights in Japan
Kyohei Morita, Yuichiro Nagai
Next week’s key releases will be the June BoJ Tankan and May CPI and industrial production data.
Japan calendar for today
James Barber, CFA
May corporate service prices. Bloomberg median forecast: -0.8% y/y, etc.
North America
Treasuries rise amid elevated risk aversion and a stall in debt ceiling negotiations
Anshul Pradhan
Treasury market rallied strongly on Thursday, led by the belly, on weak economic data and a deadlock in debt ceiling negotiations. 2y, 5y, 10y, and 30y rates declined 3bp, 9bp, 8bp, and 6bp, respectively. Initial jobless claims, at 429k, were higher than the consensus forecast of 415K and the previous revised value (420K). After the disappointing May non-farm payroll report, initial jobless claims have now surprised to the downside in two out of three reports for June. New home sales, while better than consensus, also registered a m/m decline, likely affected by adverse weather conditions in some parts of the country. There was also an increase in risk aversion as the European heads of states began their European Council meeting in Brussels. VIX and Libor-OIS spreads increased, global equities fell, and US dollar and CDS spreads on peripheral sovereigns rose.
Adding to the European uncertainty was the intensification of debt ceiling negotiation in the US. The Biden Commission, tasked with finding a bipartisan solution to the debt limit crisis, unraveled today when House Majority Leader Eric Cantor left the negotiations, citing little progress in revenue discussions. The negotiations are now likely to involve the President and House Speaker John Boehner, particularly given the tight Treasury-imposed deadline of August 2. We believe that even if the debt limit is not raised by August 2, a delay in coupon payment is extremely unlikely. Investors should instead focus on the potential for fiscal drag, in our view. We maintain our 5s30s steepening bias.
US new homes sales fall modestly while inventory remains at historical lows
Michael Gapen
New home sales fell 7k to 319k in May from an upwardly revised 326k in April (previous: 323k). This was slightly above our (312k) and consensus (310k) expectations. The 2.1% m/m decline in May was foreshadowed by a decline in MBA mortgage applications for purchase and is consistent with weakness in recent home activity data on the heels of adverse weather that affected many parts of the South and Midwest.
US jobless claims and other data suggest only a modest improvement in employment ahead
Michael Gapen
US jobless claims and other data suggest only a modest improvement in employment ahead. For the upcoming June employment report released on July 8, we look for a 75k increase in nonfarm payrolls in the establishment report and a 100k increase in private payrolls. Government payrolls have declined by an average of 24k over the previous three months and we look for this trend to continue. In the household survey we look for the unemployment rate to hold steady at 9.1%.
US jobless claims deliver a mixed signal in the survey week for June employment
Michael Gapen
Initial jobless claims rose 9k to 429k in the week ending June 18, from an upwardly revised 420k in the previous week (prior: 414k). We (410k) and the consensus (415k) had been looking for a flat or small decline. However, despite the rise in claims, the four-week moving average held steady at 426k. The week ending June 18 is the survey week for June employment report and this week’s jobless claims report presents a mixed picture: the level of claims at 429k is above the 414k seen in the May survey week, while the four-week moving average has fallen from 440k to 426k.
Europe
Europe contagion risks are increasing; firmer policy action would help
Cagdas Aksu
Thursday was a notable risk-off day in Europe. Continuing concerns about the ability of Greece to pass the austerity programme necessary to gain access to EU/IMF funding weighed heavily on EGB spreads and an outright market rally on weak economic data on both sides of the Atlantic did not help sentiment, either. The front end of the EUR curve was very strong, with Schatz rallying by 11bp, outperforming the front end of the US and UK curves. In the periphery, curves flattened as bonds underperformed with 2y Irish and Portuguese bonds moving 82bp and 52bp, respectively, wider vs Bunds. The Italian and Spanish front ends also widened vs Bunds by 24bp and 28bp, respectively, as their 10yr bonds lagged by 18bp and 15bp each, taking spreads back close to record wides, with outright yields also approaching key technical levels. Moves were not confined to the usual suspects, however; there were also significant moves in the highly rated core.
On the data front, the focus will be on IFO numbers in Germany and the US GDP number on Friday. There are no bond/bill auctions in EGB space. Also on Thursday, ECB borrowing by Greek banks was announced. This showed an increase of just under EUR11bn in May to EUR97.5bn, which may put the focus back on deposit flight in Greece, especially ahead of M3 data to be released next Thursday.
Despite continuing concerns about Greece’s ability to pass the austerity programme next week, and relatively weak global economic data, we think it is fair to say that the market has not given much attention to some of the relatively positive announcements: namely, the successful “vote of confidence” in the Greek parliament; approval of the method for increasing the effective lending capacity of EFSF from EUR250bn to EUR440bn; dropping the preferred creditor status of ESM loans to “programme” countries; and agreement on a decentralised (ie, even softer) Vienna-initiative-style private sector participation for the new Greek package. In our view, part of the reason for this is probably that the market is thinking that policymakers should have been quicker to act in a firmer, more integrated way. The available near-term policy options to stop further contagion are limited. Indeed, if spread widening were to gain more momentum in periphery, we would not be surprised if periphery bond purchases by EFSF in the secondary market came under discussion once again. Recall, this was rejected at the March EU summit, when policymakers decided that the EFSF and ESM could buy bonds only in the primary market. However, given Germany’s recent U-turn on changing the preferred creditor status of ESM loans, further radical actions cannot be ruled out in the current environment.
Belgium: third fall in a row for the BnB business confidence index
Francois Cabau
The Belgian national Bank business confidence index fell for the third month in a row, although to a much lesser extent than the two previous drops. The decline in foreign orders (-6 points) in the current assessment category of the manufacturing survey does not bode well for the future, and notably highlights that the slowdown in the euro area and global economy is likely to weigh on the prospects of the Belgian economy.
Irish GDP bounced back in Q1 but we remain cautious; euro area Q1 GDP could be revised to +0.9% q/q in the third estimate (from +0.8% q/q)
Francois Cabau
Irish GDP went up 1.3% q/q, the strongest GDP bounce since Q4 2007. However, today’s outturn should be taken with a pinch of a salt because of the usual high volatility of the quarterly growth series. The “lumpiness” in the Irish quarterly GDP series is driven by the very large growth in contribution of net exports and the high volatility in this series.
UK retail sales drop sharply as outlook for the sector worsens
Blerina Uruci
The reported sales balance of the CBI distributive orders survey reported a significant drop of 20 points to -2 in June. The weakness of the survey echoes concerns expressed by major UK retailers throughout June about the difficult conditions facing consumers and the subdued outlook for the retail sector in general. We do not expect the consumption headwinds to disappear over the coming months and hence expect the environment in the retail sector to remain challenging.
Euro area ‘flash’ June PMIs: Services remained more resilient through the quarter; still point to upside risks to our GDP forecast of +0.4% q/q in Q2
Francois Cabau
The breakdown of “flash” June PMIs is a good example of the overall Q2 trend that we have been expecting and seeing throughout the quarter. The manufacturing index fell 2.6 points to 52.0, while the services sector was reported by Markit data to have dropped by just 1.8 points to 54.2. A key takeaway for us is our expectation that there could be a marked divergence between surveys and hard data in this quarter.
UK credit demand remains subdued on account of economic climate
Blerina Uruci
The BBA lending and deposit data suggested that credit conditions remain tight, with both consumer credit and mortgage activity remaining subdued. Net mortgage lending was flat in May at £1.2bn. The number of mortgage approvals for house purchase increased slightly to 30.5k from 29.7k previously; however, it remains below levels seen in March when the number of mortgages was boosted by expectations the Bank Rate would increase soon.
Sweden: PPI -0.9% m/m and 1.0% y/y
Marcus Widen, Mikael Nilsson
May total PPI decreased 0.9% m/m, mainly on energy-related goods such as district heating and refined petroleum. Excluding energy, PPI decreased 0.5% m/m and PPI for consumer goods increased 0.1% m/m. More importantly for our inflation forecast is the price on domestic supply which has been fairly unchanged, although upward pressure seems to have started to get a bit stronger. We believe this supports our view that the current low CPI inflation on goods and services is starting to gradually rise.
Greece: Update on meeting schedule; ‘Troika’ discusses apparent re-opening of some fiscal measures
Antonio Garcia Pascual, Julian Callow, Frank Engels
Various media reports have suggested that the “troika” is involved with talks concerning some concessions that the Greek cabinet made to secure the agreement of Pasok to the new austerity measures. We reiterate our baseline view and present an updated timeline.
EEMEA
Nigeria: Sanusi removes one-year limit
Ridle Markus, Dumisani Ngwenya
Reuters reported earlier today that Nigeria will be lifting the restriction requiring foreign investors to hold local debt for a minimum period of one year on 1 July. The change will only affect new capital inflows only. Sanusi was quoted as saying that the lifting of the one-year limit will have a positive impact on investments and will help with currency stability. With Nigeria struggling to contain double-digit inflation and the outlook uncertain given the planned removal of fuel subsidies and excessive fiscal spending, we expect the lifting of the limit to be currency positive and to help with inflation.
Czech MPC Tracker: CNB still holding rate at 0.75%
Daniel Hewitt, George Christou
The CNB kept its policy rate on hold at 0.75% in its June MPC meeting and made no other changes, notwithstanding the much higher growth and inflation outturn in 2011 than CNB predictions. The CNB predicts it will stay on hold until Q4 11. We concur with this prediction.
Turkey: MPC Tracker – staying the course, while focusing on ‘core’ inflation
Christian Keller
As we and the consensus expected, the CBT kept policy rates unchanged at the MPC meeting. The decision and statement highlights the CBT’s determination to stay the course. If anything, some of the subtle language changes in the MPC statement indicate that the CBT has become more dovish. We no longer expect additional RRR hikes, but maintain our forecast for 75bp of hikes in Q4.
Latin America
Mexico: Jobless recovery with downward inflation surprises
Marcelo Salomon
May unemployment printed higher than expected at 5.2%, rising 10bp from the April reading, while both headline and core CPI continued to surprise on the soft side. The news flow remains quite supportive for a prolonged period of stable interest rates in Mexico.
Brazil FX Regulation Update: New PTAX methodology starts July 1
Marcelo Salomon
The BCB announced last year (September 2010) changes in the PTAX USDBRL fixing exchange rate, used to settle both onshore and offshore trades, which are due to be effective as of July 1, 2011. The idea is to increase transparency and deliver a better expression of the market. Instead of announcing at the end of the day a weighted average of the inter-bank FX market, the BCB will now use a simple average of four daily price collections (10am, 11am, 12pm, 13pm local time).
Uruguay: BCU hikes rates 50bp to 8%, as expected
Sebastian Vargas
The Central Bank of Uruguay (BCU) hiked rates 50bp to 8.0%, as we expected. In its statement, the BCU highlights that inflation is its first priority because capacity remains low. It also mentions that it expects inflation rates to abate in the coming months, which is in line with our view.
THE NEXT 24 HOURS
Asia Pacific
Japan corporate services price index: We estimate that the corporate service price index (CSPI) fell 0.7% y/y in May after a 0.8% decline in April. Month on month, this implies a second consecutive decrease of 0.1%. We believe deflationary pressures will continue to ease more slowly for services than for goods, given that services are less vulnerable to global price pressures.
Singapore: Higher pharmaceutical output in May, but high base last year to compresses headline rate.
North America
US Q1 11 GDP – Third estimate: We expect Q1 GDP growth to be revised up to 2.0% in the third estimate, from 1.8% in the second, largely reflecting greater inventory accumulation. More broadly, we forecast the general picture of fairly soft growth to remain – ie, drags from government expenditure and structures investment offset by gains in equipment and software investment, inventory accumulation, and modest consumption growth.
US durable goods orders: We expect durable goods orders to increase 1.5% m/m in May, following a decline of 3.6% in April. The rise should be nearly completely driven by a large gain in nondefense aircraft orders, which would be consistent with recent industry data. We expect orders for vehicles and parts to decrease for the second month in a row, as reflected by industrial production data. Finally, we look for a 1.0% fall in core capital goods orders, which largely reflect the general manufacturing sector, given the weakness of regional manufacturing surveys during the past two months.
Europe
Germany – Retail sales: In April, German retail sales (real, sa, excl. cars/petrol) are forecast to rise 0.8% m/m after 0.3% m/m reported for March.
Germany – IFO: In June, we expect the IFO index to drop to 113.9 from 114.2 in May (current assessment: 120.9, down from 121.4 earlier, expectations: 107.0, down from 107.4).
EEMEA
Hungary: Retail trade has remained remarkably weak. Small improvements should start to show up.
Turkey: Capacity utilization has stayed below pre-crisis levels. Weak PMI data suggest it stays this way.
Latin America
Mexico trade balance: A decline in oil prices, along with softer US manufacturing activity, suggests lower exports and, therefore, a softer trade balance.
BARCLAYS CAPITAL
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