Markets poised for Carney's arrival
01/Jul/2013 • Currency Updates•
Investor exegesis of Federal Reserve intentions and communications continued last week. Federal officials are clearly trying to fine-tune their message in both hawkish and dovish terms. While it is increasingly clear that absent negative surprises the tapering down of QE3 will start in September, New York Fed President Dudley indicated interest rate markets may now be pricing in too early a date for actual rate hikes. Equity markets rallied strongly, fixed-income markets stabilized, and precious metals, quite ominously, dropped another 7%. The dollar rally continued, however, as the greenback benefited from the clear repricing of Federal Reserve expectations and rose against just about every single major currency, while Sterling and Yen put in the weakest performance.
While economic data continued to be fairly positive, markets attention was focused on the changing of the guard at the Bank of England. Carney takes over from King as of tomorrow, and he will chair his first MPC meeting on Thursday. Investors clearly expect that he will impart a tilit towards greater activism and, perhaps, more aggressive policies, and have sent Sterling down against most major currencies over the past couple of weeks. We expect no significant change at his first meeting, particularly given the generally more positive tone we are seeing from domestic demand indicators, which are now consistent with moderate growth in the second quarter. Therefore, we think that the current sell off in GBP is overdone, and expect sterling to stabilise against the dollar and bounce back strongly against European currencies once the fears over Carney’s dovishness abate.
Euro area leading indicators showed some improvement last week. The composite PMI index of business sentiment, which has the best track record in predicting Eurozone GDP growth, rose 1.2 points. It is now consistent with stagnation in the Eurozone as a whole, although large differences remain across countries and peripheral PMIs are still indicating contraction. There were significant news in the policy front as well. Eurozone finance ministers agreed to enforce the traditional hierarchy of bank creditors in any future resolution of failed banks, and made it clear that senior bondholders and large depositors will be forced to bear the cost of such failures in the future. The “Cyprus solution” has clearly become the blueprint for any future bank bailouts. For now, investors are not paying attention. Last week they remained squarely focused on the diverging paths of the ECB and the Federal Reserve, and sent the common currency down towards the 1.30 level against the greenback.
The final revision to first quarter growth brought it down from 2.4% to 1.8%, reflecting mostly weaker consumer demand than first estimated. However, more timely indicators of consumer demand suggest this weakness will be transitory. May car sales appears to have risen to 15.7 million in June, which would be a new high for the current expansion (though still short of the previous 2007 peak). Consumer surveys (Michigan and Conference Board, primarily) rose strongly and are also at or near record highs since the 2009 bottom. Finally, home sales indicators were very strong, somewhat surprisingly given the severe back up in mortgage rates brought about by the sell off in fixed-income markets. We think the US economy is still on track to deliver 2-3% growth overall in 2013 and 150-175k net jobs per month, and therefore expect the “tapering” of QE3 to start in September. This will buoy the dollar, and we think that the recent trend towards a stronger greenback has further to run.