Global Macro Daily (London Open) – 04 August 2011

n The ECB is meeting on Thursday, one month after having raised the refi rate by 25bp (to 1.50%). We do not expect much to come out of the press conference, and neither does the market. We look at the options the ECB has in terms of bond buying (see Focus on next page).
n The MoF surprised the market by stepping in to sell JPY in the Tokyo morning session today, pushing up USD/JPY from around 77.30 to 79 yen so far. We have been arguing that now is not the best timing for intervention to maximize effectiveness – before risk events like the US NFP release this Friday, a potential downgrade of US sovereign debt by rating agencies, and additionally the FOMC meeting next week (9 Aug). Full Story
n In the latest quarterly refunding policy statement, the Treasury stated that it expects to modestly decrease nominal coupon issuance in the coming months. We expect only front to intermediate auction sizes (2s, 3s, and 5s) to be affected and that too only to the tune of $2-3bn. Such a move, in our view, would stabilize the ratio of bills to outstanding debt at around 16% and gradually increase the average maturity of outstanding debt. Full Story
n The first speech made today by Italian PM Berlusconi in the Lower Chamber did not turn market sentiment decisively. We feel the government should re-open the reform agenda, as markets have been increasingly focused on the prospects of the real economy and, hence, on the solvency of the sovereign. Full Story
n The UK services PMI was significantly above expectations in July, increasing to 55.4 from 53.9 previously (BarCap: 53.0, consensus: 53.2), consistent with solid growth. The improvement in activity was visible across the survey. Full Story
n Our PMI-based GDP indicator for the euro area has weakened, to imply trend expansion of just 0.13% q/q for Q3, significantly below our projection. There is a common trend in place across all euro area countries of deceleration in business confidence, generally led by the service sector. Full Story
n The SNB surprised the market with its announced intention to weaken the CHF – effectively, quantitative easing. We recommend selling the CHF against other relatively safe currency or assets. In our view, given the issues facing the US, the most attractive are the JPY and, despite its level, gold. Full Story
n The CBT is convening an extraordinary interim policy meeting to discuss concerns over the European sovereign debt market problems. We think it is likely that, having already signalled its discomfort with the pace of recent lira depreciation, it will take additional steps to lean against this depreciation. Full Story
Focus
What to expect from the ECB on Thursday? Probably little
Laurent Fransolet
The ECB is meeting on Thursday, one month after having raised the refi rate by 25bp (to 1.50%). We do not expect much to come out of the press conference, and neither does the market.
The money markets have completely removed any further tightening from the yield curve over the coming years, and have actually even rallied beyond that. Indeed, EONIA is now priced to print at around 1.20% for the foreseeable future: the short end is pricing EONIA to stay much lower than before, and way below the refi rate. This is understandable, given the dynamics of borrowing at the ECB recently, and the patterns of frontloading from the banks (a lot more precautionary than before). If anything, there is a risk that EONIA will print even lower in the coming months: in the current maintenance period, EONIA is on track to print almost 40bp below the refi rate. The short end is also now essentially flat, which is implicitly probably reflecting some chances of a rate cut by the ECB in H1 12: this seems unjustified, in our view, and could be removed from the market soon. But any back up is likely to be somewhat constrained, and focused on post one-year rates, rather than the very front end.
Indeed, with the ECB now unlikely to announce a move away from full allotment in 3m LTROs at its September meeting (full allotment is a very useful, relatively cheap, backstop in times of uncertainty), the liquidity surplus is likely to remain high, therefore, EONIA is likely to continue to print low. Practically, these developments have almost completely offset the July 25bp rate hike in short rates: EONIA, and 12m Euribor (important for a number of peripheral mortgage markets) have been stable since late April.
Next to keeping full allotment on its current operations (weekly MRO, 1m and 3m) for as long as needed (and probably well into 2012), the ECB is unlikely to announce any other changes to its liquidity operations, at the August or September meetings. While there have been expectations that a separate facility for addicted banks could be introduced (maybe as early as in September), ECB comments over the past few months suggest that this is not likely. Similarly, we do not expect the ECB to announce the reintroduction of longer LTROs than three months on Thursday: although this is a move that could be put in place very quickly (at any time, in fact) and could have some benefits (secure long-term funding), it is not at the heart of the current problems.
Lastly, and more importantly, markets will scrutinize whether the ECB provides any hint on peripheral bond buying, given the very elevated current stress in the Italian and Spanish markets.
In theory, there are different options open to the ECB:
n The ECB could revive the Securities Markets Programme (SMP), which has been used to buy about EUR75bn of Greek, Irish, and Portuguese securities since May 2010 (in each market, roughly 15-20% of the outstanding debt). These purchases, while held to maturity, are sterilized on a weekly basis via term deposit auctions. The SMP, though still open, has not been active since March 2011: it is entirely at the discretion of the ECB, so could be reactivated quickly, but the ECB has expressed concerns about its usage, the eventual risks accumulating on the Eurosystem balance sheet, and the blurring of monetary and fiscal responsibilities. Obviously, an intervention in the Italian or Spanish bond markets, which are about 3.5 times bigger than the Greek, Irish and Portuguese markets combined, would raise substantial questions in the same areas.
n The ECB could decide to buy peripheral bond markets, as per the SMP, but not sterilize its interventions, ie, embark on quantitative easing/monetizing the debt. Given the prohibition of monetary financing of governments, which is at the heart of ECB rules, it seems unlikely that such a step would be taken (at least for now). True, secondary market purchases might not be considered as direct monetization of the debt, but it would still be another Rubicon to cross for the ECB.
n The ECB could intervene in the peripheral bond markets on behalf of the EFSF/EU, with the risks being taken by the latter, and not the Eurosystem. This was announced on July 21, essentially, but is yet to be implemented. It is unlikely that this can be put in place in the coming months (more likely towards Q4 11). One alternative would be for the ECB to act before the EFSF changes have been enacted in full, but with guarantees of some sort (whether from the EFSF/EU or from specific countries) ensuring that it is not acting on its own behalf. We do not know how feasible this is, and we doubt it would be implemented as a temporary measure before the EFSF changes are implemented.
In practice, we would be surprised if the ECB announces, or even hints, at any of these at the August meeting. At the same time, we suspect that ECB Trichet will not close the door to any of these either, unlike in May 2010, before having to do a U-turn. The bottom line is that in the very near term, we would expect little relief to come from the ECB side.
Market Insights and Events
Asia Pacific
Japan: Estimating the macroeconomic effect of the JPY-selling intervention
Kyohei Morita, Yuichiro Nagai
The MoF conducted JPY-selling intervention this morning, but the sustainability of the effects remains to be seen. For reference, we estimate that a JPY500 rise in the Nikkei Average, a 3-yen weakening of the JPY versus the USD, and a 10bp (0.1%) decline in long-term interest rates would raise Japan’s real GDP by 0.17% in Year 1, 0.27% in Year 2, and 0.18% in Year 3. The weaker yen would have a particularly strong impact in Years 1 and 2. Full Story
JPY: Repeated action will be needed
Masafumi Yamamoto
The MoF surprised the market by stepping in to sell JPY in the Tokyo morning session today, pushing up USD/JPY from around 77.30 to 79 yen so far. We have been arguing that now is not the best timing for intervention to maximize effectiveness – before risk events like the US NFP release this Friday, a potential downgrade of US sovereign debt by rating agencies, and the FOMC meeting next week as expectation for QE3 grows, all of which may result in a weaker USD and reduce the effectiveness of intervention. Full Story
New Zealand: Q2 employment print unlikely to change RBNZ’s view
Gavin Stacey, Joaquin Vespignani
New Zealand’s Q2 labour market data printed in line with market expectations. The rise in full time employment and hours worked is likely to be particularly encouraging for the RBNZ after February’s devastating earthquake in Christchurch. We continue to believe the next move from the RBNZ will be to remove the 50bp ’emergency’ cut made at the March MPS in September, global market conditions permitting. Full Story
Australia: Have AU easing expectations reached the point of no-return?
Gavin Stacey
Based on history, current market pricing would be consistent with an easing cycle within months. To get such an outcome, however, we would need a calamitous global event with a resultant substantial rolling over in commodity prices. That is not our view. Our economics team does not expect recent developments to culminate in a “double dip”. While we do not believe it is the time to be heroic in the AU rates market, we think the AU 1y1y vs AU 3y swap flattener appears to offer an attractive opportunity. Full Story
Philippines: 2011 budget deficit to be smaller than government’s projection
Prakriti Sofat
The fiscal deficit in June was PHP7.7bn, pushing the shortfall for H1 2011 to PHP17.2bn. This compares with a deficit of PHP196.8bn in H1 2010. The government’s 2011 projected budget deficit is PHP300bn (3.2% of GDP). Our forecast stands at PHP275bn (under 3% of GDP). We believe the risks to our forecast are clearly biased to the downside. Full Story
AUD/NZD: NZ employment data may provide good entry level for long AUD/NZD trade ahead of RBA’s SoMP
Aroop Chatterjee
The increasing uncertainty about global growth and the resultant lack of clear direction in asset markets make directional trades in risky assets difficult. It is in cases such as this that relative value trades are, we believe, more attractive than usual. While volatility remains high in risky currencies (such as the AUD and NZD), the AUD/NZD cross is moving broadly in line with the AU-NZ rates differential, reflecting the market’s divergent views on monetary policy in those countries. Full Story
North America
Flattening continues amid choppy economic data
Anshul Pradhan, Vivek Shukla
The Treasury curve flattened again on Wednesday. While 2y and 5y yields rose 0.8bp and 1bp, respectively, 10y and 30y yields declined by 2.5bp and 4.5bp, respectively. The long end of the curve was particularly volatile – bonds richened up to 12bp intraday. Economic data were mixed on the day, with ADP surprising to upside and ISM non-manufacturing index for July printing below consensus. Factory orders in June declined 0.8%. There were also signs of an increase in risk aversion – peripheral European bank/sovereign CDS widened and global equities and commodities declined – despite a statement from the European Commission President Barroso highlighting the urgency of implementation of contagion preventing measures.
Some market volatility was also driven by speculation of further monetary easing ahead of the FOMC meeting on August 9, 2011, based on reported statements of ex-Fed directors Donald Kohn, Vince Reinhart, and Brian Madigan, that put probability of new economic contraction at 20-40% and that the Fed should consider a third round of bond purchases only if inflation slows from recent levels. 5y forward 5y breakevens have declined 18bp since the beginning of this month but still remain elevated. While we are biased toward a steeper 10s30s curve on a medium-term horizon, we recommend caution in the near term, due to the likelihood of QE3 speculation picking up ahead of the FOMC meeting on August 9, particularly around the Fed extending the duration of its portfolio.
Separately, in the quarterly refunding policy statement released on Wednesday, the Treasury kept sizes for the upcoming 3y, 10y, and 30y auction at $32bn, $24bn, and $16bn, respectively; unchanged from the previous new issuance. It also noted that it expects to modestly decrease nominal coupon issuance in the coming months, while gradually increasing TIPS issuance. We expect only front to intermediate auction sizes (2s, 3s, and 5s) to be affected and that too only to the tune of $2-$3bn. The reason being that rising amount of maturing coupon debt would offset the decline in borrowing requirements, suggesting that gross coupon issuance can be cut only marginally. Such a move, in our view, would stabilize the ratio of bills to outstanding debt at around 16% (the bill universe would expand marginally in absolute terms), and result in a gradual increase in the average maturity of the outstanding debt. As noted by Mary Miller, the Treasury’s Assistant Secretary for Financial Markets, in the post refunding conference, the Treasury remains committed to do so.
The Fed is scheduled to purchase $2.75-3.5bn in the 5.5-7y bucket. In previous operations in this bucket, it has focused on OTR7y securities – in the last operation in this bucket, OTR7y comprised 90% of the total purchase amount ($4.4bn out of total purchase of $4.9bn). OTR7y (2.25% Jul18s), Old 7y (2.375% Jun18s), and 2.625% Apr18 look the cheapest versus our Treasury spline going into the operation.
US factory orders report: Slightly stronger orders and shipments, but weaker inventories
Peter Newland
Factory orders declined 0.8% in June, above our forecast (-1.2%) but in line with the consensus. Durable goods orders declined 1.9% (revised up from the -2.1% estimate in the initial durable goods report) and non-durable orders were flat on the month. Total shipments rose 0.2%, reflecting a 0.5% increase in durables (unrevised) and a flat reading on nondurables. Full Story
US non-manufacturing ISM declines in July
Peter Newland
The non-manufacturing ISM index fell to 52.7 from 53.3 in July, below our forecast (54.0) and the consensus (53.5) and the lowest since February 2010. This reflects declines in the new orders index (to 51.7 from 53.6), the supplier deliveries index (to 50.5 from 52.0) and the employment index (to 52.5 from 54.1). The business activity index struck a stronger tone, rising to 56.1 from 53.4. Given the weakness of growth in H1, the declines in the manufacturing and non-manufacturing ISMs are a disheartening start to H2, although there remain solid reasons to expect growth to rebound modestly. Full Story
US Fixed Income Outlook for August 4, 2011
Ajay Rajadhyaksha, Dean Maki
In the latest quarterly refunding policy statement, the Treasury stated that it expects to modestly decrease nominal coupon issuance in the coming months. We expect only front to intermediate auction sizes (2s, 3s, and 5s) to be affected and that too only to the tune of $2-3bn. Such a move, in our view, would stabilize the ratio of bills to outstanding debt at around 16% and gradually increase the average maturity of outstanding debt. Full Story
Europe
Italy: PM Berlusconi speech unlikely to turn market sentiment
Fabio Fois
The first speech made today by PM Berlusconi in the Lower Chamber did not contain anything specific to turn market sentiment decisively. While we don’t think markets had any specific expectations, we think they are likely to remain focused on the issue of weak potential GDP growth. As we argued in Euro Themes – Italy: The time to act, we feel the government should re-open the reform agenda, as markets have been increasingly focused on the prospects of the real economy, and hence on the solvency of the sovereign. Full Story
Euro area retail sales fall 0.3% q/q in Q2
Julian Callow
Euro area retail sales volumes in June rose by 0.9% m/m. For Q2 retail sales volumes fell by 0.3% q/q in the euro area, after a drop of 0.2% in Q1. In y/y terms retail sales volumes were down 0.5% in Q2, the weakest annual rate of decline since Q4 09. The trend outside of Germany has been soft and in some cases very weak, namely in the troubled periphery. Full Story
UK services PMI indicates solid growth for the sector
Blerina Uruci
The services PMI was significantly above expectations in July, increasing to 55.4 from 53.9 previously (BarCap: 53.0, consensus: 53.2), and at this level it is consistent with solid growth. The improvement in activity was visible across the survey. The new business index increased by 1.6 points to 55.6, supported by better market conditions, higher enquiry levels and improved demand. The business expectations index also improved, increasing by 1.7 points to 67.3, although it remains below historical levels. Full Story
Euro area PMI data signal significant deceleration in activity in Q3
Julian Callow
Our PMI-based GDP indicator for the euro area has weakened to imply trend expansion of just 0.13% q/q for Q3, significantly weaker than our projection (0.3% q/q – though, as we warned in last Friday’s Global Economics Weekly, we do see downside risks to this, and will review our projections when we receive the euro area “flash” Q2 GDP reports in mid-August). Overall, there is a common trend in place across all euro area countries of deceleration in business confidence, generally led by the service sector. Full Story
UK MPC Preview: MPC set to steer unchanged course through choppy waters
Chris Crowe
The MPC’s latest policy meeting starts today and we will receive an announcement of the committee’s policy decisions tomorrow at noon. We expect another month of unchanged policy. The MPC has signalled that its near term inflation profile is likely to be pushed up somewhat, and we expect its near term growth forecasts to be nudged downwards, when we receive the August Inflation Report next Wednesday. We continue to expect the first rate hike in May 2012. Full Story
Switzerland: SNB moves to QE to counteract appreciating CHF, and cuts official rates
Thorsten Polleit
This morning the Swiss National Bank (SNB) announced that it will, over the coming days, increase the Swiss monetary base (that is banks’ sight deposits held with the SNB) from currently around CHF30bn to CHF80bn – a measure that can be rightly described as “quantitative easing” (QE). In effect, the bank will repurchase outstanding SNB Bills. The measure aims to bring the 3-mths Swiss Libor target rate to “close to zero as possible”. Full Story
CHF: Will the SNB intervention prove effective?
Paul Robinson, Sara Yates
The SNB surprised the market with its announced intention to weaken the CHF this morning. According to its statement, the SNB intends to aim for three-month Libor as close to zero as possible (the current range is 0-0.75%), as well as significantly increasing the supply of liquidity to the Swiss franc money market over the next few days. Will it prove more effective than the intervention of spring 2010? Full Story
EEMEA
EEMEA cash credit curves – opportunities after the UST moves
Andreas Kolbe
EEMEA cash credit spread curves have steepened sharply over the past couple of days, partly driven by a flattening of the UST yield curve. For spread-oriented investors in particular, we recommend switching into the long end of the Qatar/South Africa curves from the respective 5y sectors and switching from Hungary $41s into Hungary $15s in return. These re-allocations should also result in a more defensive portfolio, better shielded against contagion from the euro periphery and slower global growth. Full Story
Turkey: An extraordinary MPC meeting
Koon Chow, Piotr Chwiejczak, Andreas Kolbe
The MPC is convening an extraordinary interim policy meeting on 4 August to discuss heightened concerns over the European sovereign debt market problems. We therefore think it is likely that the CBT, having already signalled its discomfort with the pace of recent lira depreciation, will take additional steps to lean against this depreciation. Full Story
Romania: Turning more cautious
Daniel Hewitt, Koon Chow, Andreas Kolbe
We close our long RON recommendation at current levels (4.23 per EUR). We had this recommendation through owning a 6m T-bill. This recommendation had recently become a pure FX trade, which until now, we were happy to hold against the EUR. We now feel that a combination of less helpful local macro developments and growing contagion risks from the growth and debt market challenges in the euro area warrant greater caution on the RON. Full Story
The Next 24 Hours
Asia Pacific
No significant events or releases today.
North America
US – Initial Claims: We expect initial jobless claims in the week to July 30 to edge higher to 400k from 398k.
Europe
Germany – Factory orders: June factory orders are expected to more than offset the increase in May (+1.8% m/m), dropping by 2.0% on the month. In y/y terms, order growth would decelerate to about 5.6% in June, reflecting the ongoing decline in order momentum.
UK BOE monetary policy decision: We expect the outcome of the August MPC meeting to be unchanged monetary policy. We forecast Bank Rate to remain unchanged at 0.5% until May 2012 as a fragile economic recovery is likely to keep the majority of the MPC members on wait-and-see mode, even as inflation is expected to increase further towards the end of the year. It appears that the majority on the MPC continues to believe that the high inflation rate is mainly a result of a series of one-off factors that cannot be tackled with monetary policy tools.
Euro area – ECB interest rate announcement: With the ECB’s Governing Council having elected to raise rates in early July, there is no requirement for it to signal any change in its economic assessment or operating procedures at its August policy meeting. The more important meeting will be in early September, when it will have the new set of economic projections and will, therefore, need to consider whether it is minded to raise rates at the October meeting (Mr Trichet’s last policy meeting) or whether, as we expect, it will continue with unchanged rates, given the exceptionally high financial market tensions that are prevailing. Overall, therefore, the main interest in the press conference is likely to be in the Council’s evaluation of the recent EU agreement on Greece. However, we do not think that President Trichet will give any indication of how the ECB might direct the potential secondary market purchases by the EFSF.
EEMEA
Czech Republic: The CNB has indicated its intention to stay on hold until Q4 11. Recent CPI data were higher in May and lower in June, so the net effect is minimal. We do not expect a rate hike until November 2011.
Romania: Real wages are still declining because of government wage cuts and weak economic growth.
Russia: Weekly price readings show no inflation so far, indicating that CPI will continue to decline.
Latin America
No significant events or releases today.n      The ECB is meeting on Thursday, one month after having raised the refi rate by 25bp (to 1.50%). We do not expect much to come out of the press conference, and neither does the market. We look at the options the ECB has in terms of bond buying (see Focus on next page).
n      The MoF surprised the market by stepping in to sell JPY in the Tokyo morning session today, pushing up USD/JPY from around 77.30 to 79 yen so far. We have been arguing that now is not the best timing for intervention to maximize effectiveness – before risk events like the US NFP release this Friday, a potential downgrade of US sovereign debt by rating agencies, and additionally the FOMC meeting next week (9 Aug). Full Story
n      In the latest quarterly refunding policy statement, the Treasury stated that it expects to modestly decrease nominal coupon issuance in the coming months. We expect only front to intermediate auction sizes (2s, 3s, and 5s) to be affected and that too only to the tune of $2-3bn. Such a move, in our view, would stabilize the ratio of bills to outstanding debt at around 16% and gradually increase the average maturity of outstanding debt. Full Story
n      The first speech made today by Italian PM Berlusconi in the Lower Chamber did not turn market sentiment decisively. We feel the government should re-open the reform agenda, as markets have been increasingly focused on the prospects of the real economy and, hence, on the solvency of the sovereign. Full Story
n      The UK services PMI was significantly above expectations in July, increasing to 55.4 from 53.9 previously (BarCap: 53.0, consensus: 53.2), consistent with solid growth. The improvement in activity was visible across the survey. Full Story
n      Our PMI-based GDP indicator for the euro area has weakened, to imply trend expansion of just 0.13% q/q for Q3, significantly below our projection. There is a common trend in place across all euro area countries of deceleration in business confidence, generally led by the service sector. Full Story
n      The SNB surprised the market with its announced intention to weaken the CHF – effectively, quantitative easing. We recommend selling the CHF against other relatively safe currency or assets. In our view, given the issues facing the US, the most attractive are the JPY and, despite its level, gold. Full Story
n      The CBT is convening an extraordinary interim policy meeting to discuss concerns over the European sovereign debt market problems. We think it is likely that, having already signalled its discomfort with the pace of recent lira depreciation, it will take additional steps to lean against this depreciation. Full Story
Focus
What to expect from the ECB on Thursday? Probably little
Laurent Fransolet
The ECB is meeting on Thursday, one month after having raised the refi rate by 25bp (to 1.50%). We do not expect much to come out of the press conference, and neither does the market.
The money markets have completely removed any further tightening from the yield curve over the coming years, and have actually even rallied beyond that. Indeed, EONIA is now priced to print at around 1.20% for the foreseeable future: the short end is pricing EONIA to stay much lower than before, and way below the refi rate. This is understandable, given the dynamics of borrowing at the ECB recently, and the patterns of frontloading from the banks (a lot more precautionary than before). If anything, there is a risk that EONIA will print even lower in the coming months: in the current maintenance period, EONIA is on track to print almost 40bp below the refi rate. The short end is also now essentially flat, which is implicitly probably reflecting some chances of a rate cut by the ECB in H1 12: this seems unjustified, in our view, and could be removed from the market soon. But any back up is likely to be somewhat constrained, and focused on post one-year rates, rather than the very front end.
Indeed, with the ECB now unlikely to announce a move away from full allotment in 3m LTROs at its September meeting (full allotment is a very useful, relatively cheap, backstop in times of uncertainty), the liquidity surplus is likely to remain high, therefore, EONIA is likely to continue to print low. Practically, these developments have almost completely offset the July 25bp rate hike in short rates: EONIA, and 12m Euribor (important for a number of peripheral mortgage markets) have been stable since late April.
Next to keeping full allotment on its current operations (weekly MRO, 1m and 3m) for as long as needed (and probably well into 2012), the ECB is unlikely to announce any other changes to its liquidity operations, at the August or September meetings. While there have been expectations that a separate facility for addicted banks could be introduced (maybe as early as in September), ECB comments over the past few months suggest that this is not likely. Similarly, we do not expect the ECB to announce the reintroduction of longer LTROs than three months on Thursday: although this is a move that could be put in place very quickly (at any time, in fact) and could have some benefits (secure long-term funding), it is not at the heart of the current problems.
Lastly, and more importantly, markets will scrutinize whether the ECB provides any hint on peripheral bond buying, given the very elevated current stress in the Italian and Spanish markets.
In theory, there are different options open to the ECB:
n      The ECB could revive the Securities Markets Programme (SMP), which has been used to buy about EUR75bn of Greek, Irish, and Portuguese securities since May 2010 (in each market, roughly 15-20% of the outstanding debt). These purchases, while held to maturity, are sterilized on a weekly basis via term deposit auctions. The SMP, though still open, has not been active since March 2011: it is entirely at the discretion of the ECB, so could be reactivated quickly, but the ECB has expressed concerns about its usage, the eventual risks accumulating on the Eurosystem balance sheet, and the blurring of monetary and fiscal responsibilities. Obviously, an intervention in the Italian or Spanish bond markets, which are about 3.5 times bigger than the Greek, Irish and Portuguese markets combined, would raise substantial questions in the same areas.
n      The ECB could decide to buy peripheral bond markets, as per the SMP, but not sterilize its interventions, ie, embark on quantitative easing/monetizing the debt. Given the prohibition of monetary financing of governments, which is at the heart of ECB rules, it seems unlikely that such a step would be taken (at least for now). True, secondary market purchases might not be considered as direct monetization of the debt, but it would still be another Rubicon to cross for the ECB.
n      The ECB could intervene in the peripheral bond markets on behalf of the EFSF/EU, with the risks being taken by the latter, and not the Eurosystem. This was announced on July 21, essentially, but is yet to be implemented. It is unlikely that this can be put in place in the coming months (more likely towards Q4 11). One alternative would be for the ECB to act before the EFSF changes have been enacted in full, but with guarantees of some sort (whether from the EFSF/EU or from specific countries) ensuring that it is not acting on its own behalf. We do not know how feasible this is, and we doubt it would be implemented as a temporary measure before the EFSF changes are implemented.
In practice, we would be surprised if the ECB announces, or even hints, at any of these at the August meeting. At the same time, we suspect that ECB Trichet will not close the door to any of these either, unlike in May 2010, before having to do a U-turn. The bottom line is that in the very near term, we would expect little relief to come from the ECB side.
Market Insights and Events
Asia Pacific
Japan: Estimating the macroeconomic effect of the JPY-selling intervention
Kyohei Morita, Yuichiro Nagai
The MoF conducted JPY-selling intervention this morning, but the sustainability of the effects remains to be seen. For reference, we estimate that a JPY500 rise in the Nikkei Average, a 3-yen weakening of the JPY versus the USD, and a 10bp (0.1%) decline in long-term interest rates would raise Japan’s real GDP by 0.17% in Year 1, 0.27% in Year 2, and 0.18% in Year 3. The weaker yen would have a particularly strong impact in Years 1 and 2. Full Story
JPY: Repeated action will be needed
Masafumi Yamamoto
The MoF surprised the market by stepping in to sell JPY in the Tokyo morning session today, pushing up USD/JPY from around 77.30 to 79 yen so far. We have been arguing that now is not the best timing for intervention to maximize effectiveness – before risk events like the US NFP release this Friday, a potential downgrade of US sovereign debt by rating agencies, and the FOMC meeting next week as expectation for QE3 grows, all of which may result in a weaker USD and reduce the effectiveness of intervention. Full Story
New Zealand: Q2 employment print unlikely to change RBNZ’s view
Gavin Stacey, Joaquin Vespignani
New Zealand’s Q2 labour market data printed in line with market expectations. The rise in full time employment and hours worked is likely to be particularly encouraging for the RBNZ after February’s devastating earthquake in Christchurch. We continue to believe the next move from the RBNZ will be to remove the 50bp ’emergency’ cut made at the March MPS in September, global market conditions permitting. Full Story
Australia: Have AU easing expectations reached the point of no-return?
Gavin Stacey
Based on history, current market pricing would be consistent with an easing cycle within months. To get such an outcome, however, we would need a calamitous global event with a resultant substantial rolling over in commodity prices. That is not our view. Our economics team does not expect recent developments to culminate in a “double dip”. While we do not believe it is the time to be heroic in the AU rates market, we think the AU 1y1y vs AU 3y swap flattener appears to offer an attractive opportunity. Full Story
Philippines: 2011 budget deficit to be smaller than government’s projection
Prakriti Sofat
The fiscal deficit in June was PHP7.7bn, pushing the shortfall for H1 2011 to PHP17.2bn. This compares with a deficit of PHP196.8bn in H1 2010. The government’s 2011 projected budget deficit is PHP300bn (3.2% of GDP). Our forecast stands at PHP275bn (under 3% of GDP). We believe the risks to our forecast are clearly biased to the downside. Full Story
AUD/NZD: NZ employment data may provide good entry level for long AUD/NZD trade ahead of RBA’s SoMP
Aroop Chatterjee
The increasing uncertainty about global growth and the resultant lack of clear direction in asset markets make directional trades in risky assets difficult. It is in cases such as this that relative value trades are, we believe, more attractive than usual. While volatility remains high in risky currencies (such as the AUD and NZD), the AUD/NZD cross is moving broadly in line with the AU-NZ rates differential, reflecting the market’s divergent views on monetary policy in those countries. Full Story
North America
Flattening continues amid choppy economic data
Anshul Pradhan, Vivek Shukla
The Treasury curve flattened again on Wednesday. While 2y and 5y yields rose 0.8bp and 1bp, respectively, 10y and 30y yields declined by 2.5bp and 4.5bp, respectively. The long end of the curve was particularly volatile – bonds richened up to 12bp intraday. Economic data were mixed on the day, with ADP surprising to upside and ISM non-manufacturing index for July printing below consensus. Factory orders in June declined 0.8%. There were also signs of an increase in risk aversion – peripheral European bank/sovereign CDS widened and global equities and commodities declined – despite a statement from the European Commission President Barroso highlighting the urgency of implementation of contagion preventing measures.
Some market volatility was also driven by speculation of further monetary easing ahead of the FOMC meeting on August 9, 2011, based on reported statements of ex-Fed directors Donald Kohn, Vince Reinhart, and Brian Madigan, that put probability of new economic contraction at 20-40% and that the Fed should consider a third round of bond purchases only if inflation slows from recent levels. 5y forward 5y breakevens have declined 18bp since the beginning of this month but still remain elevated. While we are biased toward a steeper 10s30s curve on a medium-term horizon, we recommend caution in the near term, due to the likelihood of QE3 speculation picking up ahead of the FOMC meeting on August 9, particularly around the Fed extending the duration of its portfolio.
Separately, in the quarterly refunding policy statement released on Wednesday, the Treasury kept sizes for the upcoming 3y, 10y, and 30y auction at $32bn, $24bn, and $16bn, respectively; unchanged from the previous new issuance. It also noted that it expects to modestly decrease nominal coupon issuance in the coming months, while gradually increasing TIPS issuance. We expect only front to intermediate auction sizes (2s, 3s, and 5s) to be affected and that too only to the tune of $2-$3bn. The reason being that rising amount of maturing coupon debt would offset the decline in borrowing requirements, suggesting that gross coupon issuance can be cut only marginally. Such a move, in our view, would stabilize the ratio of bills to outstanding debt at around 16% (the bill universe would expand marginally in absolute terms), and result in a gradual increase in the average maturity of the outstanding debt. As noted by Mary Miller, the Treasury’s Assistant Secretary for Financial Markets, in the post refunding conference, the Treasury remains committed to do so.
The Fed is scheduled to purchase $2.75-3.5bn in the 5.5-7y bucket. In previous operations in this bucket, it has focused on OTR7y securities – in the last operation in this bucket, OTR7y comprised 90% of the total purchase amount ($4.4bn out of total purchase of $4.9bn). OTR7y (2.25% Jul18s), Old 7y (2.375% Jun18s), and 2.625% Apr18 look the cheapest versus our Treasury spline going into the operation.
US factory orders report: Slightly stronger orders and shipments, but weaker inventories
Peter Newland
Factory orders declined 0.8% in June, above our forecast (-1.2%) but in line with the consensus. Durable goods orders declined 1.9% (revised up from the -2.1% estimate in the initial durable goods report) and non-durable orders were flat on the month. Total shipments rose 0.2%, reflecting a 0.5% increase in durables (unrevised) and a flat reading on nondurables. Full Story
US non-manufacturing ISM declines in July
Peter Newland
The non-manufacturing ISM index fell to 52.7 from 53.3 in July, below our forecast (54.0) and the consensus (53.5) and the lowest since February 2010. This reflects declines in the new orders index (to 51.7 from 53.6), the supplier deliveries index (to 50.5 from 52.0) and the employment index (to 52.5 from 54.1). The business activity index struck a stronger tone, rising to 56.1 from 53.4. Given the weakness of growth in H1, the declines in the manufacturing and non-manufacturing ISMs are a disheartening start to H2, although there remain solid reasons to expect growth to rebound modestly. Full Story
US Fixed Income Outlook for August 4, 2011
Ajay Rajadhyaksha, Dean Maki
In the latest quarterly refunding policy statement, the Treasury stated that it expects to modestly decrease nominal coupon issuance in the coming months. We expect only front to intermediate auction sizes (2s, 3s, and 5s) to be affected and that too only to the tune of $2-3bn. Such a move, in our view, would stabilize the ratio of bills to outstanding debt at around 16% and gradually increase the average maturity of outstanding debt. Full Story
Europe
Italy: PM Berlusconi speech unlikely to turn market sentiment
Fabio Fois
The first speech made today by PM Berlusconi in the Lower Chamber did not contain anything specific to turn market sentiment decisively. While we don’t think markets had any specific expectations, we think they are likely to remain focused on the issue of weak potential GDP growth. As we argued in Euro Themes – Italy: The time to act, we feel the government should re-open the reform agenda, as markets have been increasingly focused on the prospects of the real economy, and hence on the solvency of the sovereign. Full Story
Euro area retail sales fall 0.3% q/q in Q2
Julian Callow
Euro area retail sales volumes in June rose by 0.9% m/m. For Q2 retail sales volumes fell by 0.3% q/q in the euro area, after a drop of 0.2% in Q1. In y/y terms retail sales volumes were down 0.5% in Q2, the weakest annual rate of decline since Q4 09. The trend outside of Germany has been soft and in some cases very weak, namely in the troubled periphery. Full Story
UK services PMI indicates solid growth for the sector
Blerina Uruci
The services PMI was significantly above expectations in July, increasing to 55.4 from 53.9 previously (BarCap: 53.0, consensus: 53.2), and at this level it is consistent with solid growth. The improvement in activity was visible across the survey. The new business index increased by 1.6 points to 55.6, supported by better market conditions, higher enquiry levels and improved demand. The business expectations index also improved, increasing by 1.7 points to 67.3, although it remains below historical levels. Full Story
Euro area PMI data signal significant deceleration in activity in Q3
Julian Callow
Our PMI-based GDP indicator for the euro area has weakened to imply trend expansion of just 0.13% q/q for Q3, significantly weaker than our projection (0.3% q/q – though, as we warned in last Friday’s Global Economics Weekly, we do see downside risks to this, and will review our projections when we receive the euro area “flash” Q2 GDP reports in mid-August). Overall, there is a common trend in place across all euro area countries of deceleration in business confidence, generally led by the service sector. Full Story
UK MPC Preview: MPC set to steer unchanged course through choppy waters
Chris Crowe
The MPC’s latest policy meeting starts today and we will receive an announcement of the committee’s policy decisions tomorrow at noon. We expect another month of unchanged policy. The MPC has signalled that its near term inflation profile is likely to be pushed up somewhat, and we expect its near term growth forecasts to be nudged downwards, when we receive the August Inflation Report next Wednesday. We continue to expect the first rate hike in May 2012. Full Story
Switzerland: SNB moves to QE to counteract appreciating CHF, and cuts official rates
Thorsten Polleit
This morning the Swiss National Bank (SNB) announced that it will, over the coming days, increase the Swiss monetary base (that is banks’ sight deposits held with the SNB) from currently around CHF30bn to CHF80bn – a measure that can be rightly described as “quantitative easing” (QE). In effect, the bank will repurchase outstanding SNB Bills. The measure aims to bring the 3-mths Swiss Libor target rate to “close to zero as possible”. Full Story
CHF: Will the SNB intervention prove effective?
Paul Robinson, Sara Yates
The SNB surprised the market with its announced intention to weaken the CHF this morning. According to its statement, the SNB intends to aim for three-month Libor as close to zero as possible (the current range is 0-0.75%), as well as significantly increasing the supply of liquidity to the Swiss franc money market over the next few days. Will it prove more effective than the intervention of spring 2010? Full Story
EEMEA
EEMEA cash credit curves – opportunities after the UST moves
Andreas Kolbe
EEMEA cash credit spread curves have steepened sharply over the past couple of days, partly driven by a flattening of the UST yield curve. For spread-oriented investors in particular, we recommend switching into the long end of the Qatar/South Africa curves from the respective 5y sectors and switching from Hungary $41s into Hungary $15s in return. These re-allocations should also result in a more defensive portfolio, better shielded against contagion from the euro periphery and slower global growth. Full Story
Turkey: An extraordinary MPC meeting
Koon Chow, Piotr Chwiejczak, Andreas Kolbe
The MPC is convening an extraordinary interim policy meeting on 4 August to discuss heightened concerns over the European sovereign debt market problems. We therefore think it is likely that the CBT, having already signalled its discomfort with the pace of recent lira depreciation, will take additional steps to lean against this depreciation. Full Story
Romania: Turning more cautious
Daniel Hewitt, Koon Chow, Andreas Kolbe
We close our long RON recommendation at current levels (4.23 per EUR). We had this recommendation through owning a 6m T-bill. This recommendation had recently become a pure FX trade, which until now, we were happy to hold against the EUR. We now feel that a combination of less helpful local macro developments and growing contagion risks from the growth and debt market challenges in the euro area warrant greater caution on the RON. Full Story
The Next 24 Hours
Asia Pacific
No significant events or releases today.
North America
US – Initial Claims: We expect initial jobless claims in the week to July 30 to edge higher to 400k from 398k.
Europe
Germany – Factory orders: June factory orders are expected to more than offset the increase in May (+1.8% m/m), dropping by 2.0% on the month. In y/y terms, order growth would decelerate to about 5.6% in June, reflecting the ongoing decline in order momentum.
UK BOE monetary policy decision: We expect the outcome of the August MPC meeting to be unchanged monetary policy. We forecast Bank Rate to remain unchanged at 0.5% until May 2012 as a fragile economic recovery is likely to keep the majority of the MPC members on wait-and-see mode, even as inflation is expected to increase further towards the end of the year. It appears that the majority on the MPC continues to believe that the high inflation rate is mainly a result of a series of one-off factors that cannot be tackled with monetary policy tools.
Euro area – ECB interest rate announcement: With the ECB’s Governing Council having elected to raise rates in early July, there is no requirement for it to signal any change in its economic assessment or operating procedures at its August policy meeting. The more important meeting will be in early September, when it will have the new set of economic projections and will, therefore, need to consider whether it is minded to raise rates at the October meeting (Mr Trichet’s last policy meeting) or whether, as we expect, it will continue with unchanged rates, given the exceptionally high financial market tensions that are prevailing. Overall, therefore, the main interest in the press conference is likely to be in the Council’s evaluation of the recent EU agreement on Greece. However, we do not think that President Trichet will give any indication of how the ECB might direct the potential secondary market purchases by the EFSF.
EEMEA
Czech Republic: The CNB has indicated its intention to stay on hold until Q4 11. Recent CPI data were higher in May and lower in June, so the net effect is minimal. We do not expect a rate hike until November 2011.
Romania: Real wages are still declining because of government wage cuts and weak economic growth.
Russia: Weekly price readings show no inflation so far, indicating that CPI will continue to decline.
Latin America
No significant events or releases today.