lunedì 21 dicembre 2009

Is it time to overweight US financial markets?

This is an excerpt from out latest Top Down Outlook:
In the first three weeks of December US financial assets have significantly outperformed other international financial assets, driven by the US Dollar appreciation against all major currencies. Indeed, the Dollar Index has risen by almost 3% so far in December, and by 4.7% against the Euro, boosting returns on US equity and bond indexes. The table below shows the December performance by major equity and bond indexes using the European ETFs as a benchmark, as they replicate the underlying index performance.

The exchange-traded funds give ample evidence that the Nasdaq100 and the S&P500 are the top performers for December and that the US bond indexes have outperformed both the European and emerging market bond indexes this month.

As we pointed out in last week’s Global Strategy Weekly (“Focus on exchange rate market”), we expect the Euro to continue its downtrend against the US Dollar into the coming months as there is a clear possibility that the Fed and not the ECB will be the first Central Bank to hike rates in 2010. The news items that emerged during the week support this idea. In the US, industrial production for November and the leading indicator for December came as positive surprises. Both the data suggested that US economic activity is gathering strength and that the economy will likely continue on its path to recovery in the first half of 2010. In Europe, the Greek crisis seems far from resolved, with the rating agency Standard and Poor’s following Fitch in cutting its rating on Greek government debt to BBB+ from A- on the grounds that the measures the Greek authorities have recently announced to reduce the high fiscal deficit are not enough to rebalance public accounts.

Moreover, Germany’s industrial production and factory orders data for October released last week served as a grim reminder that the economic upturn may be slower than many economists have been expecting. The improvement in the December IFO business climate index is unlikely to assuage investor concern short term. Only a sharp upswing in economic activity at the tail end of the year may revive investor optimism about the European economic prospects. Overall, we believe that the Euro will weaken further against the US Dollar with a medium/long term target of 1.17, in line with the EUR/USD exchange rate fair value based on the PPP calculated by the OECD.

However, the majority of the Central Banks will likely wait the first rate hike by the Fed before tightening, with some minor central banks (i.e. Australia, Israel, Norway, India) the only exception. This may well be the case of the Swiss National Bank and the Riksbank, which are not seen tightening ahead of the Fed and the ECB as inflationary pressures are under control and with a view to fending off currency appreciation. Even the BoE does not forecast a rate hike any time soon, as economic growth is expected to remain anaemic for several quarters.

Under this scenario, US financial assets will likely continue to outperform other international financial assets going forward, unless negative economic surprises emerge. For this reason, beginning next week we recommend buying the Nasdaq100, which we prefer relative to the S&P500 due to its higher relative strength.

martedì 15 dicembre 2009

Norges Bank may raise rates to 1.75% tomorrow

In our weekly Top Down Outlook we pubblished over the week end we have analysed the outlook for the Norges Bank monetary policy meeting. The Norges Bank was the first European Central Bank to reverse the expansionary monetary policy pursued since the crisis erupted in 2007. On October 28 the Norwegian CB hiked rates by 25bp to 1.5% as economic activity picked up more rapidly than previously expected, driven by the implementation of several monetary policy measures (rates were slashed from 5.75% to 1.25% in less than 9 months), larger fiscal stimulus packages and investments in petroleum. In the statement released after the meeting, the Norges Bank predicted a 0.25% rate increase to 1.75% in the period to the publication of the Next Monetary Policy Report (March 24, 2010). Although we do not see any urgency for the CB to raise rates given the encouraging international environment, we do not exclude the possibility that the Norges Bank will decide to tighten rates again in December, in line with the indications of our estimated equilibrium model based on the Norges Bank’s estimated equilibrium model. Indeed, underlying inflation is higher than the economic weakness anticipated and slackness in economic activity is low. Looking ahead, we expect the Norges Bank to continue to tighten rates in 2010 as economic activity is likely to be stronger in Norway than in other major international economies. Indeed, a global recovery will likely push up oil prices, with positive effects on the country’s economy. Moreover, should other major central banks set upon a tightening path, this could boost the Norwegian Key Rate as the external money market rate is a key variable for the NB’s equilibrium model. Only a sharp appreciation of the Norwegian Krone could prompt the NB into loosening its policy.

FOMC meeting preview: only slight change in the statement expected

In our weekly Top Down outlook report we said the announcement due after current week’s monetary policy meeting the Fed is widely expected to make only minor changes to the statement released after the November 4 FOMC meeting. Following the latest monetary policy meeting, FOMC members have repeatedly confirmed that "economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period". Indeed, while the economic prospects have improved in recent weeks, even though less than previously estimated, the medium-term economic outlook is clouded in uncertainty as economic growth seems to be fuelled only by the fiscal and monetary stimulus packages that governments have implemented so far. Given a rosy short-term inflation outlook we expect the Fed to consider that the costs of moving too soon are probably higher than those of being late. We do not pencil in a Fed rate hike before H2 2010, when the current slack in resource utilization could reverse and inflation expectations improve should the ongoing economic recovery turn out to be sustainable.

lunedì 14 dicembre 2009

Euro/Dollar update

Over the past couple of weeks the foreign exchange market has been hit by various news items that could change the foreign exchange scenario in the months ahead. In the Euro area, investor attention has focused on the negative Greek national accounts figures, which triggered a downgrade by Fitch from A- to BBB +, and, although to a lesser extent, on Spain, which saw its outlook revised down from stable to negative by Standard & Poor's, a move that follows the January downgrade from AAA to AA+ by the rating agency.

Nevertheless, Greece’s market environment is very different from that of Spain. On the one hand, Greece, which is plagued by a severe credibility crisis due to the lack of a clear plan to slash the high public deficit and upset by growing internal tensions, could pull itself out of recession only with the support of the European Union and by paying a high price in terms of unemployment and economic growth for several years. On the other hand, Spain, one of the hardest-hit countries over the past two years, should not see its credibility undermined going forward, although economic growth is expected to remain more sluggish than that of the EU due to the need to revamp its economic model based on the real estate market and to the loss of competitiveness in recent years. Therefore, last week’s fall of the euro against the U.S. dollar - the single currency slipped below the 1.47 mark from the 1.51 level touched a week earlier - wasn’t totally unexpected. Investors were even surprised at the euro’s slight decrease against the US dollar, as clear evidence that the problems facing Greece are not a real threat to the Eurozone economy. Indeed, the country’s GDP accounts for only just over 2% of the Euro area GDP.
The troubles affecting the Greek economy, therefore, may only confirm that the economic upturn in the Euro area will likely be slower than estimated by the data released in the past few weeks. Germany’s industrial production and factory orders for October showed that the economic recovery may decelerate in the coming months as the positive effect of the fiscal stimulus that has supported the central part of 2009 wanes. The idea that the Fed and not the ECB will be the first central bank to raise interest rates during 2010, even though the ECB is in the early stages of an exit strategy (decided in the December meeting) might therefore take concrete shape among operators
The above-mentioned view had already started to circulate among operators last Friday after the publication of the U.S. labour market report for November, which showed that non-farm payrolls were almost flat (compared to consensus expectations of a loss exceeding 100 thousand units) and the hours worked per week increased. Furthermore, the Euro/Dollar exchange rate should also bear the brunt of its overvaluation against the PPP calculated by the OECD (approximately 30%), which was usually been accompanied by a price realignment. Overall, the US Dollar seems highly likely to begin to stage a gradual rebound against the Euro. In the face of fresh turmoil in world financial markets leading to higher risk premiums, the dollar would retain its safe haven role.

mercoledì 9 dicembre 2009

Swiss National Bank Outlook

Swiss National Bank monetary policy meeting (Thursday 10) – The SNB will hold its quarterly monetary policy meeting on Thursday 10 and is broadly expected to leave the target range for the three-month Libor unchanged at 0-0.75%, aiming for a three-month Libor of 0.25%. Even though the Swiss economy has performed better than expected in the last few quarters (with 0.3% GDP growth in Q3 and a further increase in leading indicators, the SNB is likely to revise up both its 2009 and 2010 GDP forecasts), we believe that the SNB is highly unlikely to start removing the expansionary monetary policy it has implemented since the crisis erupted in 2007. In particular, we expect the Central Bank to confirm its intention to prevent the Swiss Franc from appreciating further against the Euro. We believe that the SNB will maintain its current exchange rate stance until the economic recovery is well-established both in Switzerland and in the Euro zone. Indeed, the EUR/CHF exchange rate is likely to be a one-way bet for investors until a widespread recovery takes place in the Euro zone, as the Swiss Franc would appreciate due to the high current account surplus. The SNB will likely change its stance on the exchange market either in March or June and should not adjust its target range for the three-month Libor before H2 2010.

martedì 8 dicembre 2009

German industrial production highlighted uncertainty surrounding Eurozone recovery

Following the unexpected drop in October’s German factory orders (the data was released Monday 7), today’s figure for October’s German industrial production came in as a wakeup call for the believers in a strong recovery in the Euro zone economy. Industrial production fell by 1.8% m/m, versus the +1% m/m expected by the consensus. Manufacturing output fell 1.6% in October, driven by a 3.5% m/m drop in production of investment goods, energy production declined 3.4% m/m and construction output dropped 2.4% m/m. The annual change is -12,4%.

While the upward trend in IFO business confidence index indicate that industrial production may resume a growth path in the next few months (the December figure due for publication on December 18 will give more hint on German economic outlook), the growth rate is likely to weaken as the measures to stimulate growth will wane. The decline in German industrial production in October is also a negative signal for French and Italian data due for publication on Thursday 10.

Today’s data confirmed that, albeit the last week ECB’s decision to remove some long term extraordinary refinancing operations, the ECB is likely to leave rate unchanged at 1% for a long time. We do not pencil in a rate hike by the ECB before the end of H1 2010 as the ECB is very unlikely to do anything that could further strengthen the Euro.

Reserve Bank of New Zealand outlook

This is an excerpt from our weekly Top Down Outlook:
Monetary Policy Statement and OCR announcement  – During the week, the Reserve Bank of New Zealand is seen keeping rates steady at 2.5%. In the statement released on October 29, Governor Bollard said that he expects to leave the Official Cash Rate (OCR) unchanged at the current level until the second half of 2010 and we do not see any reason for the New Zealand CB to raise it any time soon as inflation is expected to remain within the target range at the end of the reference period and a rate hike may further widen the current account deficit (the RBNZ projected the current account deficit at 5.8% in 2010 and 7% thereafter). Indeed, although an early rate hike may have the positive effect of dampening the increase in house prices, which should boost demand in the short term, it may strengthen the NZ Dollar upward trend, hence prompting a further widening of the current account deficit.

lunedì 7 dicembre 2009

Preview of the Bank of Canada's monetary policy meeting

The Bank of Canada is widely expected to hold rates steady at 0.25% during tomorrow's monetary policy meeting. In our opinion, the economic data released after the October meeting did not change the short/medium-term outlook for the Canadian CB. Notwithstanding the above-estimate increase in the October cpi core (from 1.5% y/y to 1.8% y/y) the Bank of Canada should not revise its October projection and should maintain the policy rate on hold at 0.25% until the end of Q2 2010. Indeed, inflationary pressures will likely remain subdued in the coming months in the face of a stubbornly wide output gap and as the economy is not expected to reach production capacity before late 2011. Q3 GDP came in lower than the market expectation (+0.4% q/q ann.; see economic commentary section in the weekly "Top Down Outlook" report), suggesting that the pace of the economic upturn may be even slower than projected. With the Canadian Dollar close to its historical high against the US Dollar, we see the Bank of Canada leaving rates unchanged much longer than predicted and start rising them only after the Federal Reserve implements its exit strategy. Indeed, should the Bank of Canada raise rates ahead of the Fed, the Canadian Dollar would appreciate further against the US Dollar, dampening the expansion of exports (exports to the US account for more than 75% of total exports) as the CAD is already 13% overvalued against the USD according to the OECD’s Purchasing Power Parity.

venerdì 4 dicembre 2009

Green shoots in US labor market

November’s labor market data came in a lot better than market expectations, in line with the last two weeks positive indications in the initial jobless claims data. Initial jobless claims fell in the week to November 28 to 452k the lowest level since August ’08. The non-farm payrolls declined by 11k, versus market expectations of -120k and the unemployment rate edged down from 10,2% to 10%. Revisions added 159,000 from payroll figures previously reported for October and September. The October reading was revised to show a 111,000 drop in jobs compared with an initially reported 190,000 decline. Employees in the goods producing sector fell by 69k and in the service producing sector increased by 58k. Average workweek rose from 33 to 33,2 a very positive signal as employers expect are expected to increase hours for their current workers before hiring new ones. The indexes of aggregate weekly hours increased by 0,6 points, from 98,5 to 99,1, indicating that industrial production may have continued its recovery in November. Average hourly earnings were almost flat at USD18,74.

However, the labor market medium term outlook remains uncertain and a more sustained improvement is not expected in the short term. Some economists underlined that the November's improvement was due seasonal adjustment reasons and the fall in unemployment rate was due to a 291k decline in the size of the labor force. The participation rate fell to 65%, the lowest since recession began. Employers are not expected to return hiring until capacity utilization return to higher level (it was at 70,7% in October).

giovedì 3 dicembre 2009

Some thoughts on today’s ECB’s press conference

The ECB held today its monthly monetary policy meeting and the President of the ECB, Jean Claude Trichet, held a press conference at the end of the meeting.

The most important pieces of news arrived from today’s meeting were:
1) The December 12-month longer-term refinancing operation will be the last one and the rate will be fixed at the average minimum bid rate of the MROs over the life of this operation.
2) This decision on the 12-month longer-term refinancing operation does not imply anything as regards the perspective of Refi rate, held unchanged at 1% today.
3) The 2010 mid-point GDP projection was revised upward to 0,8% from 0,2% in September. 2011’s GDP was forecasted at 1,2%. Inflation estimate for 2010 was revised upward from 1,2% to 1,3%.
4) Trichet confirmed that he believe a strong US Dollar is in the interest of the USA, indicating in a polite way that the ECB is not happy with regard to the EUR/USD exchange rate trend.

Following today’s Trichet press conference we do not see any reason to change our estimate that the Refi rate would stay unchanged at least to the end of H1 2010. Even if the new ECB projections on economic growth and inflation are in line with a rising Refi rate to 2% by the end of 2010, we do not expect the ECB tightening monetary policy unless the Fed implements an exit strategy from its expansionary monetary policy before.
Indeed, an early ECB tightening monetary policy may further strengthen the Euro upward trend versus the USD. In a study published in ("Can we understand the recent moves of the euro-dollar exchange rate"), the economists Brender, Gagna and Pisani have offered evidence that the Euro/Dollar exchange rate moved broadly in line with the Fed’s and ECB’s monetary policy estimates until Lehman Brothers went bust.
With a EUR/USD already 25% above fair value according to OECD’s Purchasing Power estimate is very difficult to envisage that the ECB may take a similar decision. Moreover, due to Euro upward trend in the last few months, the Euro zone Monetary condition Index is well above the long term historical average, with a dampening effect on Euro zone economic recovery.

Looking ahead, the ECB is very unlikely to do anything that could further strengthen the Euro.

martedì 1 dicembre 2009

Monetary policy update: RBA increase rates to 3,75% and BoJ left rate unchanged in an unscheduled meeting

The Reserve bank of Australia (RBA) increased rates by 0,25% for the third consecutive month to 3,75%. While the decision did not come as surprise (it was forecasted by 19 of 20 economists surveyed by Bloomberg News), it was far from sure and was criticized by the Australian Industry Group Chief Executive Heather Ridout, who said in a Bloomberg interview that policy makers “could have afforded to take a pause until the New Year when the business outlook is clearer.”

In the Governor Steven’s statement released at the end of the meeting were underlined the reasons behind the rate hike. As regards economic outlook, Steven said that “Prospects for ongoing expansion of private demand, including business investment, have been strengthening. There have been some early signs of an improvement in labor market conditions. The rate of unemployment is now likely to peak at a considerably lower level than earlier expected”. As regards inflation Steven said that “inflation should continue to moderate in the near term, though it will probably not fall as far as thought likely six months ago.” Steven also indicated that the rise in exchange rate during this year will have the effect to dampen both in inflation and growth (via external sector) in the medium term.
Finally, Steven said that “These material adjustments to the stance of monetary policy will, in the Board’s view, work to increase the sustainability of growth in economic activity and keep inflation consistent with the target over the years ahead.”
Having increased rates for a third straight month, the RBA is likely to wait some months before taking other tightening steps to see the effect of recent rate increase on the real economy. Notwithstanding the positive signals recently came from both the labor market (employees increased by 24,5k in October) and the residential sector (house prices rose by 10% this year) the inflation is likely to remain subdue in the medium term due to the low level of capacity utilization worldwide. The RBA will not have a meeting until February 2010, and rates may remain unchanged a bit longer, even though rates are expected to continue rising in 2010.

In Japan, the Bank of Japan decided today in an emergency meeting to provide short-term loans to commercial banks amid pressure from Prime Minister Yukio Hatoyama’s administration to address falling prices and the yen’s surge last month to a 14-year high of 84.83 per dollar. The size of the short term loans is JPY10trilion, while the Central Banks monthly purchases of Government Bond remain unchanged at JPY1,8trilion. Today’s decision is another desperate move by Japanese monetary policy makers to bring the economy out from deflation and to face a rising Yen. We continue to do not see any reason to invest in Japanese asset classes by now, particularly in Japanese Government bond, as we said in the post “Away from the Empire of rising sun”.