Risky assets fall sharply on downbeat economic news, ECB/Germany row; dollar rallies
13/Jun/2011 • Currency Updates•
It was a difficult trading week for equities, commodities, and risk assets in general. Markets were hit by negative news on two fronts. On one hand, downward revisions to growth prospects continue to pile up, and now they appear to be spreading from developed countries to China and rest of the Pacific Rim, although it is hard to know how much of this is due to the one-time disruption of the Japanese earthquake. On the other hand, agreement on a fresh bailout for Greece appears to be farther away than it appeared last week, and in fact the row between the ECB and the German Government took a turn for the worse last week. Amid the general gloominess, it is not surprising that equities fell substantially, and the dollar rallied. In the medium term FX and financial markets in general will be focused on two key developments. First, whether the generalized slowdown in economic growth is temporary and driven by the Japanese supply-chain disruption, or whether it reflects a deeper unsustainability of the worldwide economic recovery. Second, whether the ECB and the German Government can agree on a mutually acceptable scheme to avoid a Greek default. The uncertainty was particularly damaging for the euro, which fell hard against nearly every major currency.
UK macroeconomic data was generally week, though noisy. Industrial production, construction indicators and household spending all disappointed expectations. The Bank of England met and did nothing, so no statement was published as is customary. This had been widely expected and brought forth no market reaction. However, the steady drumbeat of macroeconomic weakness, together with news that surveyed expectations for inflation had edged down, combined to press markets to push ever backwards into the future their expectations of Bank of England rate normalization. The macro data is worrisome enough that Chancellor Norborne is starting to make noises about the room for “flexibility” in the implementation of the austerity plans. Sterling put in a mixed week, rising strongly against the beleaguered euro but falling against the dollar.
With the macroeconomic calendar dominated by second tier releases, European markets were dominated by the ECB meeting on Thursday and the widening divergences between the German Government and the ECB on how to handle the Greek problem. As to the former, Trichet all but sealed a hike in the next meeting through the code word “strong vigilance”; however, ECB inflation expectations for 2012 were not revised upward, a gesture widely interpreted as dovish by markets. With respect to the latter, the German government is digging in its heals that private creditors must bear part of the cost of any further Greek bailout. It proposes that creditors be pressured into rolling over their maturing debt for seven years – no details being given on how this pressure would be applied. In the post-meeting conference, Trichet made clear that this is completely unacceptable to the ECB, and went so far as to assert that it has no intention of rolling over its own Greek debt, of which it is possibly the single biggest holder. Markets were increasingly bewildered by this conflict, and it is no surprise that the common currency fell sharply for the week, dropping over 2% against the dollar and losing ground against just about every major currency during the week. With the resolution to the Greek drama further away than it appeared just a few days ago, we expect weeks of very volatile trading in the common currency.
The long streak of downward surprises in US macroeconomic data is worrisome and continued last week unabated. However, there is a legitimate question as to whether this weakness is giving hints of the lack of sustainability of economic recovery in the US without further stimulus(fiscal or monetary). Some observers make the case that the combination of the supply disruption brought about by the Japanese quake with very high gasoline prices are their main culprits, and now that both start to wear off we should see notable improvement in US data. Time will tell. In any case, the greenback traded more on international events (particularly those surrounding Europe) than in domestic news, benefiting from the generalized flight to safety to rise nearly 1% for the week.