Risk assets decoupled last week, as FX markets stay in a holding pattern waiting for the formal Spanish bailout

Tom Tong15/Oct/2012Currency Updates

There was a marked and unusual divergence last week across financial markets. Equities worldwide continued their retreat from recent cycle highs, but commodities and peripheral spreads more or less held their ground. Weakish earnings reports from the US reporting season gets under way carry most of the blame for equities’ poor performance. Meanwhile, the dollar rallied through much of the week, only to give back most of its gains on Thursday and Friday. Volumes in FX markets are dropping, and it is clear that investors are waiting for the Spanish bailout details before deciding on the next Euro trend. Meanwhile, Sterling had a very quiet week, returning to form as a low-bet version of the Euro against the US dollar.


Industrial production figures out last week largely confirmed the negative sentiment surveys that had been released earlier in the month. August production was significantly weaker than expected and the running average over the last quarter is now pointing to a contraction of nearly 2.8% saar. This data generally confirms our view: after all calendar issues and the impact of the Olympics is accounted for, the UK economy is at best flat lining, and likely shrinking slightly, which does not bode well for the evolution of the job market in the medium term. Mr King appears to agree with our outlook, as he indicated in last week´s speech that the Bank of England policy will be increasingly tolerant of deviations from the inflation target in order to pay more attention to macroeconomic unbalances. While another member of the MPC (Mr. Weale) sounded a more hawkish view, on balance we think that last week´s communications confirm our view that further QE will be announced at the November meeting of the BoE, and therefore expected a resumption of the weakening trend in Cable.


There were strong macroeconomic numbers for the first time in months out of the Eurozone. Industrial production in France, Germany and Italy, driven mostly by higher-than-expected car production. It is very difficult to square this data with the weaker sentiment indices and, particularly, with the sharp drop in car sales reported through the summer in the Eurozone. We believe that the new seasonality patterns generated since the 2009 crash may have something to do with this. However, we will be looking very closely at the manufacturing PMI and industrial production numbers over the next month to see which converges to which. Beyond the macro picture, the FX markets remain in a holding pattern with respect to the Euro. They are waiting for the formalization of the Spanish bailout and what conditions are attached thereto. We think this is the most critical development in Europe over the next few weeks. If the conditions imposed are heavily weighted towards further fiscal austerity, we think the downward trend in the Euro will resume immediately. However, given the IMF statements against excessively front loaded austerity last week, we hold some hope that the focus will be instead on structural reforms aimed at lowering costs while minimizing the impact on aggregate demand.


A week of mixed but, on balance, mildly positive macroeconomic reports. On one hand, consumer confidence indices, labour market indicators and housing data continue to point to moderate economic growth, at least for this quarter and the next. On the other, the trade report last week pointed out to a notable slowdown in US exports to the rest of the world. We are not overly concerned by this negative data point, as our forecast for US growth in the 1.5%-2.5% range is predicated on internal demand, housing and consumer expenditures primarily. It bears pointing out that the jobs recovery from the 2008-09 recession, while disappointing by US standards, is actually proceeding at a faster pace than is typically the case in countries that have experienced bursting real estate bubbles and major financial crisis since WWII. Focus is now shifting to the political front. After the presidential election, the US faces the so-called fiscal cliff, a combination of sharp tax increases and sudden cutbacks in expenditure unless Congress and the President reach a deal. We remain relatively unconcerned by this risk, as history has shown again and again that such situations always end in a last-minute deal after much political posturing from both sides. We see therefore no reason to change our relatively positive view of the US dollar among major currencies as “the best of a bad bunch”.


Written by Tom Tong

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