Gloomy economic data push down equities and the Euro
19/Nov/2012 • Currency Updates•
Negative economic news out of the eurozone and the UK continued to put downward pressure on risk assets in general, including equities, credit and commodities. The euro, the dollar, and sterling spent the week in a holding pattern. The focus of attention among major currencies was the continuing sell off in the yen. Perhaps the most notorious change in FX market correlations is that the Japanese currency no longer rallies on equity weakness, as Japan’s fiscal and monetary authorities become ever more frantic in their efforts to simulate the economy and weaken the currency.
The focus of the week was on the publication of the Bank of England Inflation Report. It had a distinctly pessimistic tone, with very weak GDP growth expectations and a significant deterioration of the expected trade off between inflation and growth. This very negative outlook leads us to maintain our call for a further expansion of the Gilt purchase target next month, in spite of policymakers’ misgivings about the diminishing effectiveness of this policy tool. We also note that Mr. King explicitly voiced the MPC’s dim view of any currency strengthening, as they expect the main impetus to demand to come from the export sector.
The week also brought further bad news in the form of higher-than-expected inflation, driven by tuition hikes, and worse-than-expected reports on retail sales and the labour market. Sterling, however, was largely unaffected, and like most major currencies, other than the yen, spent the week trading in a very tight range to end nearly unchanged against both the dollar and the euro.
The likelihood of Spain applying for a formal bailout in the near future increased sharply last week. Spanish bond yields have been creeping higher over the past few weeks, there is no improvement in either the economic or the policy situation in the country, and EC Vice President Rehn suggested that there would be few or no additional austerity measures demanded from the country if it did so. By contrast, EU dithering continues over Greece, as the IMF is increasingly unwilling to go along with the charade and demands a new restructuring that actually puts the country on a sustainable path. Macroeconomic news continue to be ugly. The composite PMI index of business confidence dropped to 46.3, consistent with a zone-wide pace of GDP contraction of more than 1% in the fourth quarter. Overall, our view remains that policymakers’ new-found willingness to slowly and grudgingly accept reality is developing too slowly and not keeping up with fast-deteriorating fundamentals, and expect the euro to maintain a depreciating trend into year-end and 2013.
Data last week was very weak, but it must be interpreted very carefully as it was directly impacted by Hurricane Sandy. Retail sales declined 0.3% in October, as did industrial production, while jobless claims increased sharply from 261,000 to 439,000. This later figure almost exclusively reflected the impact of the hurricane, however. We remain sanguine about US prospects. There were hints last week that the political battle over the “fiscal cliff” may be less protracted than the market expects, as Republicans increasingly come around to the view that some increase in fiscal pressure for higher incomes is inevitable. Also, we note that any weakness in economic growth in the fourth quarter due to Hurricane Sandy will be reversed throughout 2013 by cleanup and reconstruction expenditures. The housing recovery continues, and were it not for the gloomy news from Japan and the eurozone, we may consider upgrading our forecast for GDP growth for 2013 from its current 2% level. We are, however, increasingly comfortable with our view that the dollar will stay on its current appreciating trend.