Dreadful macroeconomic news rocks risk assets; dollar steady
01/Aug/2011 • Currency Updates•
The steady drumbeat of negative macroeconomic news across the developed world continues relentlessly. The US GDP numbers for the second quarter surprised to the downside of already meagre expectations, and gave a picture of a US economy nearing stall speed. Over the weekend, it became clear that an agreement on the US debt ceiling was at hand, but this seemed to have a muted impact on risk appetite, as investors focused squarely on the sputtering economic recovery. European sentiment numbers also came out significantly lower than expected and peripheral spreads retraced all the compression of the previous week and now hover near all-time highs. Amid this gloom, equities and commodities dropped heavily. The dollar, somewhat surprisingly, failed to rally significantly, though the debt ceiling agreement is expected to be a positive for the greenback in the coming weeks.
GDP numbers for the second quarter in the UK came out roughly as expected, confirming the view that the economy is barely growing, up less than 1% on an annualized basis. This stall is particularly worrisome in view of the clear slowdown in the Eurozone and the US, as strong exports has been the source of whatever meagre growth the UK economy has managed for the last three quarters. However, markets perceived the news to be marginally less dreadful than what we are seeing elsewhere in the developed world, and sterling managed to end the week roughly unchanged against the USD and up nearly 1% against the EUR.
It was a very difficult week for the common currency. Macroeconomic sentiment indices generally came in lower than expected, giving clear indications that the peripheral crisis is starting to affect business confidence in the solidity of the recovery. These indices also showed that the gap between core Europe and peripheral country is widening, even as indices everywhere drop. Peripheral spreads in tier 2 countries (Italy, Spain and Belgium) retraced all the improvement they saw after the EU summit, and are now hovering near all-time highs again. At 10 year yields above 6%, it is doubtful whether the situation is sustainable much longer for both Spain and Italy. Surprisingly, the common currency held off fairly well against the US dollar, as the awful GDP number in the US made it difficult to tell which currency was in the worse shape.
The two key events of the week where the terrible GDP numbers published on Friday, and the debt ceiling agreement reached over the weekend (and hence too late to affect last week’s trading). Growth in the second quarter surprised to the downside, up barely 1.3% QoQ annualized. However, the worse news was a generalized downward revision to growth since the trough of the Great Recession, and particularly to the previous quarter growth, which was revised down to 0.4% QoQ annualized. The US economy over 2011 has clearly hovered dangerously close to stall speed, and the lack of job creation over the last few months is therefore of no surprise. As the fiscal stimulus fades, fiscal drag increases, and households continue to repair their balance sheets, it is very difficult to see what is going to provide a significant boost to job creation and growth, given that new stimulus appears to be politically impossible. We therefore believe that QE3 from the Fed is becoming a distinct possibility, and hesitate to recommend long USD positions in spite of the dire situations elsewhere in the developed world.