Markets remain volatile as investors square positions
10/Jun/2013 • Currency Updates•
Fears that the Federal Reserve will end the expansion of easy money sooner than was expected continued to roil markets last week. The common theme across markets seems to be that those positions that had been most popular as investors reached for yield are being hit hardest. Therefore, last week saw continued selloffs in riskier fixed-income. In FX markets, the dollar suffered, as the record long speculative positions on the US currency continue to be unwound, particularly against the Yen. As of last Tuesday (latest available data) IMM data on positioning showed that dollar longs had been pulled back, though still remained near the highest level of the year. Therefore, we would advise caution in any long dollar positions in the very short term.
Last week saw unambiguously good news out of the United Kingdom. The key PMI indices showed healthy gains in manufacturing and services and construction business sentiment. All of them are now over the 50 level that separates contraction from expansion, and the composite of all three is in line with its historical average. This is consistent with an expansion of output in the 2% range. We note that the relationship between PMI and GDP growth is somewhat less tight in the UK than in Europe or the US, but nevertheless this data introduces clear upside risk to ours and consensus forecasts for Q2 growth and any further expansion in the Gilt target. Should output data validate these surveys, we will revise both our forecasts for Sterling and our call for further QE expansion in August.
Investor reacted quite enthusiastically to the news, sending GBP 2.5% higher against the dollar and over 0.5% higher against the Euro.
The ECB stayed on hold at its monthly meeting last week. It also disappointed our expectations of an announcement that action was imminent to ease credit access to Eurozone SMEs. In fact, Draghi explicitly said that no such action is to be expected until “the long term”. A spate of less-bad-than-feared news no doubt provided ammunition to the hawks in the ECB council. PMI services improved slightly from their dismal levels; the composite PMI index rose 0.8 to 47.7, while still remaining deep in contraction territory. Spanish payrolls were essentially flat in May, bring some hopes that Spanish employment had, at long last, reached bottom. The ECB clearly intends to repeat its pattern of overreacting to any mildly positive news, while ignoring bad news as long as it can. We now expect no easing moved from the ECB absent a notable worsening of economic conditions in the Eurozone.
On the negative side, bank lending rates to corporations and households has so far failed to benefit from the easing of market financial conditions. Borrowers in the periphery are not benefiting so far from the lowering of sovereign spreads engineered by the ECB since summer of 2012, and this is the reason why we maintain for now our forecast of a mild GDP contraction for the second quarter of 2013.
All eyes where fixed in the all important non-farm payrolls report out of the United States on Friday. The report was reasonably upbeat. Payrolls increase by a net 175,000, which is in line with the average over the past year or so. This number is moderately ahead of the rate of natural growth in the labor force, so the slow trend lower in unemployment should continue. The latter rose 0.1 to 7.6%, but this rise was driven by a large increase in the labor force, and is therefore not worrisome. In the all-important question of the Fed “taper” did not edge closer to resolution. The job creation number was solid though unspectacular, and it is offset by the slight increase in slack. Our view right now is that there is roughly a 40% chance that the “taper” will start in September, a 40% that it will wait till December, and a 20% chance that it will be delayed into 2014. Given this relatively high likelihood that monetary easing will be reined in in the near future, we expect the dollar to bounce back strongly once the current market positioning is cleared out.