The next two weeks will be dominated by moves to try to boost the global policy response to the economic crisis. The upcoming G-20 summit in London on April 2nd will focus on four areas. Firstly, lifting global co-operation on fiscal stimulus measures, with the Euro-zone in particular being encouraged to do more. Secondly, there should be and probably will be moves to increase the funding the IMF can provide to emerging countries in trouble. Thirdly, there will hopefully be a high-profile political commitment to avoid any new protectionist trade distortions. Finally, some initial steps may be agreed on financial regulation. These measures in the end are likely to bring a more interventionist regulatory regime and so-called “counter-cyclical” bank capital reserve ratios; higher ratios generally but especially in the good times to provide some leeway for reserve ratios to fall in the bad times.
The investment climate should improve during the course of 2009 but for a while longer it is probably best to stay cautious. The money and credit markets have deteriorated since the beginning of March on the worry that the latest bank rescues packages could hit bond-holders as well as share-holders. But stocks have moved up sharply on comments from the big US banks that they were “profitable” in early 2009, on GE managing to avoid a multiple debt downgrade, and on some continued resilience in US retail sales. The VIX volatility measure has also remained far lower than in the September-November 2008 market panic period, which suggests a lot of bad news has been priced-in. Nevertheless, the massive fall in US household sector wealth caused by the housing and stocks bust has been confirmed and any US economic recovery, which we expect will start from Q4 2009, is likely to be sluggish. The next big test for stocks will be completion of the bank “stress tests” and Q1 earnings, which kick-in from early April. Profits could still shock on the downside but top-down market expectations have dropped far. The Bloomberg consensus now sees US profits dropping 10% in 2009 as a whole, after 2008’s 14% fall, with Q1 the worst quarter at minus 35%. Over the next few days the big market event will be the Fed meeting (the 17th) which could see quantitative easing extended.
Japan faces a long and painful economic adjustment. Latest data has brought a sharp narrowing of Japan’s usual external surplus on a seasonally adjusted basis. On a non-adjusted basis, it has gone into deficit. The declining external surplus reflects crashing exports and, as its population has aged, a household savings rate decline. People in work tend to save what they can whilst retirees then draw down accumulated wealth. problem is that. Japan’s economy will recover but will need the rest-of-the-world to improve first. The disappearing external surplus and higher capital outflow should limit any further yen strength, although a near term appreciation threat is the imminent tax cut on foreign profits which could lift capital repatriation inflow. This week, the markets will also watch the BOJ meeting (on March 18th) for signs that quantitative easing will accelerate.
UK’s quantitative easing has started well and should lift the economy by the second half of 2009. The BoE move to buy government debt has lowered 10-yr gilt yields (lifting prices) and also cut credit spreads. This is because lessons have been learnt from Japan’s 1990s mistake. The UK programme is big; at an initial 5% of GDP and equivalent to 30-35% of outstanding gilts in the part of the market being targeted. The major uncertainty is when the easing will bring stronger bank lending and revive the economy. Recent UK data have stayed dire and, despite some bottoming signs (see chart), the UK housing bust is probably only half way through. But government ownership of large parts of the financial system increases the chance that banks will lend more soon. We believe that the recession is at its worst point now and expect some improvement from mid-year. But the recovery when it comes will be more “L-shaped” than “V-shaped”, because the household savings rate and unemployment will likely move up for several more years. An “L-shaped” GDP recovery will also subdue the rebound in UK profits, and will likely for some time cap the future upside for stocks at lower levels than in previous upswings. Government bonds should rise further with deflation set to intensify near term. Sterling has fallen sharply, especially against the euro. We forecast more EUR/GBP slippage but the risk to this view is that all the UK’s problems are now discounted.
Swiss central bank FX market intervention should keep the yen weaker and ups the pressure on the ECB to ease further. In a move aimed at averting entrenched deflation, the SNB on March 12th cut rates to virtually zero, followed the BoE into the world of quantitative easing, and was active in the FX market to weaken the CHF. The result has been dramatic so far, especially against the euro (see chart). There are two wider implications. Firstly, the BOJ is now more likely to intervene should the JPY threaten to rise again. Secondly, the ECB will come under more pressure to ease. Recent economic data; especially German industrial production, has remained dreadful, inflation is disappearing, and the overall tone of ECB commentary points to more stimulatory moves soon. SCB expect the ECB to cut rates again in early April (down to 1.0%). All this should be a near term negative for the euro but there is a good chance that an EU summit set for March 19th will announce new policy support for the Emerging Europe countries in trouble, which may curb one recent source of EUR weakness. In addition, if the equities rally continues, then the US dollar will probably fall. SCB believes that the USD rally induced by capital-repatriation is now almost over and forecasts a stronger euro over the medium term.
USD
Dollar down on stock market rebound
· U.S. equities posted a week of relatively strong gains, sparked off early last week by positive news on Citigroup. It was reported in the media that Citigroup CEO Vikram Pandit had said in an internal staff memo that the bank was profitable in the first two months of this year. This was followed by similar claims from top management of JP Morgan and Bank of America last week, sparking hope in the market that a turn-around in the banking sector could be in sight. The USD lost ground through the rest of the week as stocks gained, in line with improving risk appetite levels. On the economic data front, advance retail sales boosted market sentiment as well, after the February reading came in better than expected at -0.1 per cent month-on-month (mom), against consensus expectations of -0.5 per cent. The January reading was also upwardly revised to a hefty +1.8 per cent mom gain. Of the upside risks to market sentiment that we highlighted last week, one arguably materialized in the form of unexpected claims of year-to-date profitability by some of the major banks. We think progress on the Public-Private Investment Fund remains another possible upside risk and sentiment could also see another bout of strength if the Federal Reserve moves to expand its quantitative easing measures through the purchase of U.S. Treasuries. Materialization of these risk factors could see the near term retracement in the Dollar continue. But it is too soon to determine this to be the end of the dollar rally, and current bias is still for some dollar strength to re-emerge beyond the near term USD weakness.
EUR
Sharp falls in manufacturing activity
· The euro rose over the past week on broad USD weakness. But macro economic data coming out of Europe remains extremely poor. In the past week, we saw manufacturing activity falling off a cliff – January Industrial production in Germany and France came in at -7.5 per cent month-on-month (-19.3 per cent year-on-year) and -3.1 per cent mom (-13.8 per cent yoy) respectively, sharply below consensus forecasts. German factory orders plunged 8.0 per cent mom (37.9 per cent yoy). The ECB’s relative reluctance towards aggressive monetary policy easing could be partially supporting the euro, but the central bank is at rising risk of falling behind the curve, given the extremely poor numbers we are seeing from the Euro zone. From a positioning perspective, net short EUR position in speculative trades suggests we may see further near term gains in the EUR/USD if investment sentiment continues to improve near term. We expect short term policy rates to bottom at 0.5 per cent in Q209.
JPY
Changing relationship between USD/JPY and risk aversion
· The upside pressure on the USD/JPY eased off and the currency pair ended lower last week at 98.01. From recent price action, the relationship between the USD/JPY and world equities appears to have reversed. Correlation between the USD/JPY and the MSCI World equities index over a 10-day period had fallen from an average of 0.63 in the month of January to an average of -0.48 so far in the month of March, suggesting that USD/JPY is now likely to rise when equity markets are falling. On the economic data front, numbers continue to be very poor. The leading economic indicator fell further in January, down to 77.1 from December’s 79.4 reading. Machine orders (Jan) and machine tool orders (Feb) continued to post sharp declines on a year-on-year basis from previous months, reflecting the steep contraction in capital expenditure on earnings pressure and poor economic outlook. But the Economic Watchers survey proved to be less gloomy, with both the outlook and current conditions indices turning up in February. January current account balance turned to a deficit for the first time since 1996, coming in at -172.8 billion yen against forecasts of -15.3 billion yen. Likelihood is for the current account to remain negative near term on poor investment income and weak exports, and this may have negative implications for yen strength going forth.
GBP
Sterling down, succumbing to more weak economic data
· The sterling succumbed to weak economic data after sentiment was battered by the upping of the government’s stake in Lloyds Banking Group announced over the previous weekend. Industrial production came in sharply below expectations last week, down 2.6 per cent mom (-11.4 per cent yoy) against consensus of -1.2 per cent mom (-9.9 per cent yoy). The Bank of England (BoE) began quantitative easing last week, purchasing near GBP 2 billion worth of gilts through an auction. Since BoE’s announcement of its quantitative easing (QE) programme, near two weeks back, longer term gilt yields have fallen substantially, with the 10-year yield down to 2.96 per cent in the week ending 13th Mar, from 3.62 per cent in the week ending 27th Feb. Near term, we remain wary of expecting further significant declines in the GBP to be sustained.
CAD
Unemployment rate spikes up
· The USD/CAD pushed to an intra-day high of 1.3064 Monday, before easing over the rest of the week to end at 1.2718 Friday on dollar weakness. Last Friday, employment numbers showed a loss of 82,600 jobs in February, against consensus expectations of job loses of 55,000. The unemployment rate rose sharply to 7.7 per cent, from 7.2 per cent in January and against consensus of 7.4 per cent. Risk taking sentiment improved after last week’s news of profitability from U.S. banks and USD/CAD could ease further near term. But as demonstrated by last week’s employment numbers, economic data releases are likely to stay weak, suggesting that sustained CAD strength is not likely for now.
AUD
AUD/USD rises on improved risk appetite levels
· The Aussie dollar pushed higher on an improvement in risk appetite levels last week. The National Australia Bank Business Index fell further in February, reflecting the pressure on earnings and the deterioration of trading activity. But business confidence from the same survey rose, likely on optimism that effects of the fiscal stimulus package could set in by Q209. Unemployment turned up more than expected in February, rising to 5.2 per cent against consensus of 5.0 per cent, though it is noted that the workforce participation rate (percentage of working-age persons at work or actively seeking work) rose to 65.5 per cent in February from 65.3 per cent in January. But even this improved participation rate could be a result of growing insecurity, forcing spouses to enter the workforce. Year-to date, the AUD/USD kept to a broad sideways trend. We had been wary of the AUD breaking lower given the headwinds to the economy i.e. erosion of its term of trade advantage with the steep fall in commodity prices and pressure on domestic consumption given declining house values and rising unemployment. While the “Aussie” had shown resilience so far, we remain open to the possibility that the AUD/USD could head lower towards the 0.60 level as economic conditions remain difficult in the next few months.
NZD
RBNZ cuts policy rates by 50 bps, in line with consensus
· The Reserve Bank of New Zealand cut interest rates by 50 bps, in line with consensus expectation. The NZD/USD rose after the rate announcement with the move being less than some economists’ projections. According to Bloomberg news, three of 13 economists they had surveyed predicted a 75 bps cut while three had expected a full 1 percentage point easing. RBNZ Governor Alan Bollard also signaled that 2.0 per cent was likely to be the lowest that the short term policy interest rate will go, saying that it would be “unlikely, unusual and have some undesirable effects” if rates were to go below that level. We suspect the statement was bullish for the NZD as well, quelling some worries that New Zealand’s rates will head even lower than 2 per cent. Our view is for policy rates to reach 2.0 per cent by Q209, and for it to be held at that level for the rest of the year. The positive NZD sentiment could spill over to this week, providing some support for the NZD/USD, if risk taking sentiments hold up.
KRW
BoK surprises, keeping interest rate on hold
· The Bank of Korea (BoK) surprised by keeping policy short term interest rate unchanged at 2.0 per cent last Thursday, against market consensus of a 25 bps cut. The central bank indicated that interest rates had been lowered at a rapid pace in a short time period, and it was opting to go on hold and to observe the effects of the previous rate moves. Recent weakness in the KRW could likely have been a consideration for the BoK to keep to the sidelines as well. Measures to help the South Korean economy were announced at the end of the week. A 40 trillion won fund will be set up to buy distressed corporate bonds and assets from financial companies, while additional fiscal stimulus will come in the form of a 6.1 trillion won package to help the poor. The handout package will be part of a supplementary budget worth around 30 trillion won which is expected to be introduced some time in March. Improved risk appetite levels and the surprise interest rate move by the BoK supported the won against the dollar. The pull-back in the USD/KRW should continue this week if risk taking sentiments hold up.
INR
Rupee strengthens on equity market rebound, but risks weakening again near term if optimism fails to hold
· The rupee ended higher against the dollar on a rebound in the domestic equity market, and a broadly weaker dollar last week. The USD/INR fell to 51.51 Friday, off the all time high of 52.18 reached this month. The rupee should continue to strengthen against the dollar this week if risk appetite holds up. However, one-month forwards pricing indicates market bias towards expectations of a weaker INR in the weeks ahead. This suggests risk of renewed pressure on the rupee this week if optimism in the equity markets fails to sustain. But we remain positive on the rupee on a longer time frame. The country’s fiscal deficit is rising, but it is largely financed domestically and hence should have limited impact on the external balance. We believe the medium to long term prospects for India remains bright, and expect portfolio inflows to resume and foreign direct investments to strengthen once global growth concerns recede. These developments will be constructive for the rupee, which should strengthen going further into the year.
