Dollar pulls back as Fed, Japanese equity selloff spooks markets
28/May/2013 • Currency Updates•
Last week we saw a fairly rare market move: both global equities and Government bonds sold off, the former led by a large move in in Japanese equities. These dropped over 7% on Thursday. though it must be noted that the sell off comes after one of the fastest rallies in Japanese market history, and stocks in Tokyo only gave up the previous two weeks of gains last week.
The catalyst for the moves was the publication of the FOMC minutes and Mr. Bernanke’s testimony before Congress. These showed that a debate is taking place within the Fed as to the best time to start “tapering” down large-scale asset purchases, and that September of this year is an entirely plausible date for this tapering to start. Not surprisingly, yields backed up, and those markets where long positions were further stretched sold hardest. We attribute the somewhat counter-intuitive moves in the dollar (lower) and the yen (higher) to this stretched positioning.
The two biggest news items last week in the UK, inflation and the publication of the MPC May minutes, gave diverging signals as to the future direction of monetary policy. The CPI release was a significant downward surprise. Headline inflation dropped from 2.8% YoY to 2.4%. More significantly, almost the entire drop was in the less volatile core components, which dropped from 2.4% to 2.0% YoY. This development would seem to open the way for further QE, but the minutes from the May MPC meeting actually showed a hardening of views on the part of the six (of nine) members that voted against further stimulus, relative to the April minutes.
It must be noted that the Minutes are by now three weeks old. Therefore, we are inclined to give more weight to the CPI, and maintain our forecast of further QE expansion at the August meeting. Investors appear to agree with our assessment, and they sent sterling down against both the euro and the dollar for the week.
The most timely indicators of the state of the eurozone economy, the PMI confidence indices, were released last week. They showed a slight improvement, and the composite PMI rose 0.8 to 47.7. However, they remain firmly entrenched in recession territory, and are consistent with GDP shrinkage of 1% saar. It is worth noting that every single index in every single mid-size or larger economy in the eurozone is below the 50 level that indicates stagnation. Everything so far points to a continuation of Europe’s perma-cession into the second quarter of 2013. Markets, however, reacted less to these largely expected macroeconomic developments, than to the cleaning out of stretched positions in FX markets, and the euro eked out a 1% rebound against the dollar and slightly more than that against sterling.
Second-tier economic reports released last week did not change significant the picture in the US. New home sales increased more than expected, as did prices, and the inventory of unsold houses tightened further. All of this points to further housing strength in the second half of the year, and we continue to expect housing to provide a 0.5%-0.75% boost to GDP growth throughout 2013. News from the manufacturing sector were more mixed. The PMI edged down for the month, though at 51.9 is still consistent with moderate expansion. New orders for durable goods were also strong, and point to an expansion of about 5% in this quarter’s real spending on equipment and software. Our view for moderate growth in the range of 2.5%-3.5% over 2013 remains intact, and we expect the gap in economic performance to support the greenback against European currencies.