Risk recovery weathers a weak run of PMIs
What happened overnight
– China manufacturing PMI falls to 50.9, weaker than consensus
– Euro area manufacturing PMI unrevised from preliminary
– Swiss, UK PMIs weaker than expected
– Italian, Spanish PMIs fall below 50
– Hungary and Greek PMIs bounce
Currency markets have maintained a moderate bid for risk despite disappointing PMIs in China and across Europe. AUDUSD traded down to 1.0668 lows on the China data but has since recovered and maintained levels above 1.07 through the European morning. EURUSD held above 1.4465 in Asia and has traded to new highs for the week above 1.4550 in Europe. Hungary was one of the few economies to report a better-than-expected PMI and HUF has outperformed. In contrast, the combined effects of improving risk appetite and a weaker Swiss PMI have weighed on the CHF, with EURCHF trading up to 1.23, while GBP has also lost more ground vs. the EUR after a weak UK PMI.
Equity markets have been generally resilient despite the data, with most markets in Asia gaining and Shanghai only closing slightly lower. In Europe, the Euro STOXX 600 bank index is up 0.9% and the S&P future is flat. Peripheral spreads continue to narrow, with 10-year Spain-Germany in 9bp and Italy-Germany in 4bp. The German-US 2-year spread has continued to rewiden, recovering to nearly 120bp this morning.
The ability of risk sensitive currencies to shake off this morning’s PMI news has been impressive. Price action suggests markets are getting more comfortable that, even as activity has slowed, we are avoiding the double dip scenario that markets were fearing through much of Q2. This is in line with our own roadmap for global activity, but maintaining this incipient rally in momentum trades is very much contingent on a stable ISM reading later today. Our own economics team has raised their estimate for ISM to a steady 53.5 from 51 following yesterday’s strong Chicago PMI and Kansas City Fed data. Numbers in line with their estimate should be supportive for risk but a further drop towards 50 in the headline or new orders numbers could be quite damaging and could see weak USD shorts scramble to cover into the weekend. We summarize the results of global PMI reports in the table on page 3
What happened overnight, continued
China’s June PMI fell 1.1 points to 50.9 in June, slightly weaker than the consensus forecast of 51.5. New orders fell 1.3 points to 50.8 while input prices fell 3.6 points to 56.7. In the pre-crisis period, the headline and core PMIs tended to fall about one and three points respectively in June from May. One bright spot is that machinery orders were up in June and our economist thinks this could be due to an increase in infrastructure investment. The PMI data is still supportive of our expectation for Chinese GDP growth to slow to around 8-9% in H2 from 9.8% in Q1 but not pointing to a “hard landing”, where GDP growth is less than 7%. This is still consistent with the good performance of China growth proxy currencies such as the AUD. Also note that the Australia manufacturing PMI was reported this morning at an 11-month high of 52.9
The latest run of the June manufacturing PMI surveys in Europe has been disappointing. We observed a broad based fall in headline indices across Europe, with the exception of Hungary and Greece (the Greece index rose from a very depressed level). The overall euro area manufacturing PMI was left unrevised at 52, the lowest reading since December 2009, down from 54.6 in May. Most worrying perhaps were the falls in Italian and Irish headline PMIs below 50, with their new orders components slipping to 47.5 and 49 respectively. Outside of the euro area, manufacturing PMI fell the most in Switzerland and Sweden, although we note that Swiss employment intentions were still elevated in June and Swedish export orders were fairly resilient. The data suggests the Q2 slow spot has begun to hit home in Europe, though markets are likely to anticipate reacceleration here if US activity confirms signs of having bottomed.
The UK manufacturing PMI index declined a further 0.7 points to 51.3 in June against consensus for a small rebound to 52.3. Components were mixed; new orders rose 1 point but remained in the contraction zone while employment fell to 51.6 from 56 in May. Input prices fell by a striking 10.6 points in June, the largest mom fall since November 2008, indicating some evidence of easing input inflation pressures. While weak growth and tentative evidence of easing inflation pressures could put the BoE on hold for longer, with the market having already priced recent dovish surprises from the BoE, we think further EURGBP upside will come from unwinding of market bearishness about Greek risk to the EUR and ECB policy. We continue to look for EURGBP to edge higher towards our 0.91 near-term target.
Korea CPI inflation rose to 4.4%yoy in June from 4.1%yoy in May, slightly higher than the consensus forecast of 4.3%yoy. The persistence of high inflation increases the pressure on Korea’s central bank (BoK) to normalise still easy monetary conditions. This was driven largely by a rise in food and fuel prices. Core inflation also nudged higher to 3.7%yoy from 3.5%yoy in May. Export growth fell to 14.5%yoy in June from 22.4%yoy in May and weaker than the consensus forecast for 17.6%yoy. The 1.1 point fall in the Korean manufacturing PMI to 51.1 in June reaffirms the softening outlook for Korean exports. Despite weaker export data today, USDKRW has traded through the lows in May to around 1,066 currently. We think this reflects the authorities’ current primary focus on controlling inflation.
In contrast, Indonesia CPI inflation fell to 5.5%yoy in June from 6%yoy in May, slightly higher than the consensus forecast of 5.4%yoy. Moreover, core inflation was slightly lower than expected at 4.6%. This is the first time in eight months that inflation has dropped back into Indonesia central bank’s (BI) 4-6% target range and should keep BI on hold near term. Exports rose a very strong 45.3%yoy in May, above the consensus forecast for 32.4%yoy, pushing the 12-month rolling trade surplus wider to $25bn from $24bn in April. We remain of the view that the macro conditions for foreign inflows into the IDR should continue to improve over the coming months.
Thai CPI inflation fell slightly to 4.1%yoy in June, below the consensus forecast for an unchanged CPI. This was driven largely by seasonal factors and a higher base. Core inflation is also slightly below the consensus forecast at 2.6%yoy in June. Our economist expects both headline and core inflation to resume marching higher in Q3 and for the Bank of Thailand to continue to tighten policy rates by another 75bp to 3.75% by year-end. However, the THB will likely continue to underperform other Asian currencies until we get more political stability. Polls point to the opposition Pheu Thai (PT) Party winning in this Sunday’s general election. This can potentially lead to renewed political turmoil as the anti-PT groups could call on the military to take power.
What to watch for today
USD: ISM forecast revised higher to 53.5. Our economists have revised their forecast for June ISM manufacturing to 53.5 from 51.0 in response to the stronger-than-expected Chicago PMI data released yesterday. If in line with our new forecast, the data would be above the consensus forecast of 52.0 and aligned with the 53.5 reading reported in May. An unchanged ISM in June would support expectations of an early exit from the ongoing “slow patch” and as such would be supportive for risky assets. Final Michigan sentiment is also released and could weaken a bit further from the 71.8 preliminary reading and the May 74.3 result.
What to read today
Demand for non-traditional reserve currencies remains strong. The latest IMF (COFER) data shows that reserve managers shied away from the main reserve currencies in Q1 as uncertainty rose over QE2 plans in the US, and as euro peripheral financing stress built again. “Other currencies” were the main beneficiaries of this aversion, while the GBP and the JPY also attracted net inflows on an exchange rate-adjusted basis. In terms of total reserve accumulation, we find that global central banks continue to accumulate reserves at a fairly steady pace of about $300bn per quarter (including interest accrued).
US yields to stabilize. Our US interest rate strategy team argues in its latest US Interest Rate Strategy Weekly that the US rates market should stabilise and trace out higher prices over the next week as bank demand increases post quarter-end. For FX markets, this implies US yields are unlikely to be disruptive to renewed USD weakness.
US mutual fund flows. Our US economics team notes substantial retail outflows from domestic equities and the first fall in flows to foreign equity in June. We add that despite the latter, the USD struggled to rally over the past month. If risk appetite continues to recover over the next month, as we expect it should, we think the USD will reweaken as US outflows into foreign investments resume.
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Credit Suisse
FIXED INCOME RESEARCH & ANALYTICS