In-depth analysis on Credit Writedowns Pro.

Correction or Consolidation?

Highlights

The US dollar is mixed in choppy trading as yesterday’s sharp moves are consolidated.  The shallowness of the euro’s pullback suggests continued position squaring may be taking place.  Some short-term momentum players may be playing from the long side, and there is talk of short dated euro calls being bought.  Sterling is underperforming following the much weaker than expected manufacturing data after recording new six day highs.    Rising equity prices, fairly robust data from Japan, China, Australia, New Zealand, India, and Sweden over the last couple of sessions, coupled with the ECB revising up this year’s growth forecasts for the region and the Bundesbank revising up German growth and the ECB’s promise of unlimited liquidity over the next three months has helped ease investor anxiety and bolstered the appetite for risk. 

Global equities are recovering.  The MSCI Asia-Pacific Index rose 1.3%, helped by the second consecutive 1%+ rally in the Nikkei.  The technology sector was particularly strong with positive comments from a couple of Taiwanese computer companies and news from the Semiconductor Industry Association raising this year’s forecast for microchip demand to 28% from its 10% forecast last November.   European bourses are participating too.  Of note, despite the FT Deutschland report claiming that the EU is preparing for a Greek-style crisis in Spain (and an official Spanish denial), Spanish equities have rallied 4.5% led by an almost 7% gain in the financial sector.   Financials are doing well throughout Europe.  It is the second best performing sector in the Dow Jones Stoxx 600, behind oil and gas. 

Debt markets are subdued, though with the gains in the equity markets a downside bias is evident in Japan and Europe.   There is a large German bond redemption (8 bln euros) and coupon payment (1 bln euros) today and it does not seem that the Italian bond sales was a good alternative for the freed up funds.  The Italy was able to raise the full 7 bln euros it was looking for, but demand was mediocre at best with the new 3% June 2015 BTP seeing a 1.27 bid-to-cover.  The two off-the-run issues (re-opening) saw slightly better reception, but not impressive. 

Currency Markets

There have been a number of positive developments in recent days that have broken the sharp downside momentum of the euro.  The unlimited liquidity that the ECB promised to provide over the next three months is helping to ease some of the tensions in the money markets.  Moody’s has opined that European banks can cope with the losses related to their holdings of peripheral euro zone bonds.  The ECB revised up this year’s GDP forecast from 0.8% to 1.0%.  The Bundesbank revised its GDP forecast for Germany to 1.9% this year from 1.6%.  The consolidation of Spanish cajas continue ahead of the month-end deadline to draw on the government’s fund. The euro’s technical tone has improved.  Today is the fourth consecutive session that the euro has recorded a higher low and a higher high.  There are positive divergences in the daily MACDs. Initial resistance on the upside is seen near $1.2150.  Next week the euro could test the 20-day moving average, which comes in near $1.2230.  The euro has not closed above its 20-day moving average for nearly two months.  .Further out, if this is going to be a genuine correction instead of a flattish consolidation phase, the euro could rise toward $1.25.    However, at the FT Deutschland report illustrates, even if denied, there has not been an underlying change in the debt dynamics, which is one of the drivers of the underlying trends. 

A local press report in Japan suggests that the new government is considering lifting its growth forecast for this fiscal year to 2% from the 1.4% forecast made at end the of last year, following on the heels of yesterday’s (small) upward revision to Q1 GDP.  The focus is in Japan, though is not so much on growth as fiscal policy.  In his first speech to parliament as prime minister, Kan indicated that the government will provide a medium term fiscal strategy and a long-term plan before the end of the month.  The thinking is that Kan wants this in hand going into the G20 summit in Toronto June 26-27.  Among other things it could entail a freeze on spending at this fiscal year’s level for the next three years and a retail sale tax increase.  On the political front, the new Japanese cabinet, as is typically the case of new governments, enjoys high public support, improving the DPJ’s chances of holding on to the upper house of parliament in next month’s election.   That said, Kamei, the Financial Services Minister resigned in a dispute with Kan over reform at Japan’s Post.  Kan previously committed to passing it during the current parliament but backed off, creating new opportunity for rearguard action.  Kamei represents the People’s New Party, a coalition partner.  There is some thought the exodus of some small parties in the coalition by perversely strengthen Kan by allowing him to focus more on the DPJ platform without having to dilute it.  However, Kamei’s replacement, Shozaburo Jimi is also from the People’s New Party.  As one would expect, the better performance of the global capital markets is seeing the yen soften.  The dollar faces resistance in the JPY91.85-JPY92.10 band.  Support is seen near JPY91.20-40.  In North America today, more inclined to see support tested. 

The UK industrial output data was sorely disappointing.  The consensus had looked for a 0.4% in industrial production and a 0.4% rise in manufacturing output.  After all the recent surveys suggested continued expansion.  But alas, industrial output fell 0.4% as did manufacturing output.  Weakness was widespread.  The only mitigating factor was that the March gains were so outsized, that economists and investors are probably better served looking at an average.  March industrial production was revised to 2.6% on a year-over-year basis from 2.0% initially and manufacturing output was revised to 3.7% year-over-year from 3.3%.  At the same time, though, the idea of introducing significant fiscal austerity when the economy seems so fragile appears fraught with risk of a double dip.  Separately the UK reported PPI data.  Input prices did not decline as much as expected and the increase in output prices was a little less than expected.  But the more important inflation news was the BOE’s inflation survey that showed expectations rose to 3.3%, a 2-year high from 2.5% in Feb. Sterling is under-performing today.  Initial support is seen near $1.46. 

Upcoming Economic Releases
The US reports May retail sales at 8:30 EST/12:30 GMT.  A soft number is expected.  The headline is expected to rise 0.2%, with a 0.1% gain excluding autos.  At 10:00 EST/14:0 GMT April business inventories will be reported.  A 0.5% increase is expected.  

Marc Chandler

About 

Marc Chandler joined Brown Brothers Harriman in October 2005 as the global head of currency strategy. Previously he was the chief currency strategist for HSBC Bank USA and Mellon Bank. In addition to frequently providing insight into the developments of the day to newspapers and news wires, Chandler's essays have been published in the Financial Times, Barron's, Euromoney, Corporate Finance, and Foreign Affairs. Marc appears often on business television and is a regular guest on CNBC and writes a blog called Marc to Market. Follow him on twitter.