Research Radar: Beyond Hollande and Holland…
Markets have been dominated this week so far by the fallout from Sunday’s French presidential election, where Socialist Francois Hollande now looks set to beat incumbent conservative Nicolas Sarkozy in the May 6 runoff , and the collapse of the ruling Dutch coalition on Monday. Public anxiety about budgetary austerity in Europe was further reinforced by news on Monday of a deepening of the euro zone private sector contraction in April. That said, euro equity, bond and currency prices have stabilised relatively quickly even if implied volatility has increased as investors brace for another month or so of political heat in the single currency bloc. The French runoff is now on the same day as the Greek elections and May 31 sees Ireland going to the polls to vote on the EU’s new fiscal compact. Wall St’s volatility gauge, the ViX, is back up toward 20% — better reflecting longer term averages — and relatively risky assets such as emerging market equities remain on the back foot. The euro political heat and slightly slower Q2 world growth pulse will likely keep markets subdued and jittery until mid year at least. At that point, another cyclical upswing in world manufacturing together with the passing of the EBA’s euro bank recapitalisation deadline as well as the introduction of the new European Stability Mechanism may well encourage investors to return at better levels.
Following are some interesting tips from Tuesday’s bank and investment fund research notes:
- JPM economists reckon finding the reason behind the backup in US weekly initial jobless claims over the past couple of weeks is key to assessing whether a sub-par March payrolls report is repeated in April. It says it’s possible the claims jump move is a seasonal factor as unadjusted claims are closely tracking 2007′s pattern and Easter holidays fell on the same dates in both years. If 2007 was repeated, there would be a sizeable late April drop in claims and JPM looks for some of that on Thursday with a 14,000 forecast drop. (Reuters poll consensus is for a 11,000 drop)
- Following the surprise news last week that dovish Bank of England policy maker Adam Posen is no longer voting for more UK money printing, Barclays FX team said it’s turning more positive on the UK economy and also says sticky inflation may mean the Bank of England’s current monetary stance may be too accommodative. As a result, it lowered its euro/sterling 3-month forecast to 0.79 from 0.84. However, it cautioned about being short euro/sterling until after Wednesday’s Q1 UK GDP report, which it said could come in weaker than expected due to temporary factors. (Reuters poll consensus is for a 0.1% rise Q/Q)
- As everyone watches the FOMC outcome on Wednesday, Bank of New York Mellon‘s Simon Derrick highlights widespread expectations of further Bank of Japan easing and asset purchases on Friday. He reckons the economic arguments for more easing in Japan may be sound but it’s worth considering whether BoJ governor Masaaki Shirakawa may want to start facing down heavy political pressure for endless BoJ easing.
- Rabobank‘s emerging markets team flag their concern about Poland’s zloty, which has been one of the best performing currencies of the year so far. They say the zloty is a high “Eurozone beta” play, seen in the correlation of the eur/pln rate with composite euro periphery sovereign CDS spreads, and as a result will suffer if euro tensions rise further over the next month or two.
Calculating euro breakup shocks
Euro breakup risks, although subsiding, are still high on investor minds.
Almost one in two fund managers surveyed by Bank of America Merrill Lynch last month said they expect a euro zone country to leave the monetary union.
Technology services company SunGard, which has modelled different euro breakup scenarios, says the departure of Greece and Portugal will lead to a 15 percent rise in the euro against the dollar, a 20 percent fall in euro zone yields, a 15 percent fall in euro zone equities and a 20 percent increase in credit spreads.
Below are other findings:
- If all PIIGS left the euro, the single currency would rise 25% and regional equities would fall 20%. U.S. stocks would drop 15 percent. European banking stocks would fall by 25% and ITRAXX Financials credit spreads would increase by 100%, which would imply losses of up to 20% in high-grade corporate debt. VIX would be over 50.
- A total collapse scenario would see European equities down 40%, U.S. and global equities down 30%, euro yields down 75% and ITRAXX Europe and ITRAXX Financials credit spreads up 150% and 200%respectively.
- Oil would fall across the scenarios, ranging from 5% from a Greece departure through to a 50% decline from a complete breakup.
- Sterling would strengthen against the Euro by between 5-25% across the scenarios.
The results seek to model the impact of each scenario over three months, looking eight weeks before and six weeks after the shock to form a balanced picture.
Pity Poor Pound
Britain’s pound has long been the whipping boy of notoriously fickle currency markets, but there are worrying signs that it’s not just hedge funds and speculators who have lost faith in sterling. Reuters FX columnist Neal Kimberley neatly illustrated yesterday just how poor sentiment toward sterling in the dealing rooms has become and the graphic below (on the sharp buildup of speculative ‘short’ positsions seen in U.S. Commodity Futures Trading Commission data) shows how deeply that negative view has become entrenched.
While the pound’s inexorable grind down to parity with the euro captures the popular headlines, the Bank of England’s index of sterling against a trade-weighted basket of world currencies shows that weakness is pervasive. The index has lost more than a quarter of its value in little over two years — by far the worst of the G4 (dollar, euro, sterling and yen) currencies over the financial crisis. The dollar’s equivalent index has shed only about a third of the pound’s losses since mid-2007, while the euro’s has jumped about 10% and the yen’s approximately 20% over that period.
There’s no shortage of negatives — Britain’s deep recession, recent housing bust, near zero interest rates and money printing, soaring government budget deficit (forecast at more than 12% pf GDP next year, it’s the highest of the G20) and looming general election in early 2010. In the relative world of currency traders, not all of these are necessarily bad for the pound — the country is emerging tentatively from recession, the dominant financial services sector is recovering rapidly and short-term interest rates (3-month Libor at least) do offer better returns than the dollar, yen, Swiss franc or Canadian dollar.
But recent data from the IMF on global hard currency reserves shows there may be a more disturbing exit of central bank reserve managers from the pound (no stranger to process of losing reserve currency status, as its pole position was ceded to the dollar after WWI). Sterling’s share of the almost $7 trln of world central bank reserves — which are rising sharply again after a brief hiatus due to the credit crunch — is being steadily eroded.
Although nominal reserve holdings of sterling (the rise of which prior to the crisis was seen as a powerful supporter of both the currency and gilt market) did rise by more than $10 bln in the second quarter, they remain about $24 billion below the peaks of Q2 2008. What’s more, Citi economist Michael Saunders estimates that once you adjust for revaluation effects of currency rate swings, central bank holdings of sterling actually fell in Q2 this year. He reckons that, accounting for these adjustments, Q2 was the second consecutive quarter of net sterling sales by central banks and that the 4 billion pound drop in nominal sterling holdings was the biggest on record. Saunders concludes:
The huge inflows of global FX reserves into sterling and gilts have played a big role in financing the fiscal deficit in recent years. At present, the fiscal deficit is being wholly funded by the BoE, but sterling remains vulnerable and gilts seem highly vulnerable as and when QE ends.
(Graphs by Scott Barber and IMF/Citi)
I don’t know why people get so worked up about this. The drop in sterling is doing exactly what it should do – relieving stresses in other parts of the system. Thank God we’re not in the euro. They’ve gone quiet for the moment, but believe me the French and others will soon be screaming again about the strength of the euro against the pound and even more so against the dollar. The one-size-fits-all suit now has a 54 inch chest and keeps growing, and most of the eurozone is looking pretty bloody daft in it.
from MacroScope:
Rip-off Britain or the cost of cheaper sterling?
Inflation is plunging faster than analysts are forecasting just about everywhere in the developed world. Except for Britain. Those accustomed to high prices and inflation-busting increases in tube and rail fares at the start of every year were probably not surprised.
A tiny decrease in January inflation to 3.0 percent from 3.1 percent, left plenty of City analysts scratching their heads and talking of a blip in the data that is sure to be followed by significant drops in months ahead.
The puny move is all the more puzzling given the fact that forecasters have been suprised by the speed inflation has been falling elsewhere. In the euro zone, inflation has already tumbled to just 1.1 percent.
Until you consider the huge drop in sterling. The pound has collapsed over the past several months -- so much so that droves of continental Europeans rushed to London over the Christmas sales for bargains when sterling fell so far it was nearly on par with the euro. But it takes time for exporters to adjust their prices. Recent data show sharp rises in the cost of non-oil imports, which make up about half of retail goods in the UK.
Visitors to Britain often grumble about bad weather and high prices. For Britons, whose currency is now worth a lot less than it used to be, the weather is still bad and prices are still high.
from Davos Notebook:
London — warmer and cheaper
London is cheaper and warmer, at least compared with Davos, says London Mayor Boris Johnson.
"The fall in the pound is of huge value to London's exports and all sterling-denominated assets. We're seeing a very impressive effect here. We take advantage of the upside and the upside is that the pound is competitive," Johnson told Reuters.
"And everybody in Davos, once they finish this massive negotiation of egos, this complete vanity, should come to London. It's considerably cheaper and considerably warmer."
Davos 2009 Conference Shows The World At An Economic Crossroads……
http://wcgfairfield.blogspot.com/2009/01 /davos-2009-conference-shows-world-at.h tml
Wish I hadn’t said that…
As sterling sinks to a 7-1/2 year low against the dollar, traders and investors are wondering who was the established political figure that made the following comments when Britain was kicked out of the Exchange Rate Mechanism in 1992.
“A weak currency arises from a weak economy which in turn is the result of a weak government.”
Answer: Gordon Brown, then Shadow Chancellor, in an article in London’s Evening Standard newspaper.
History may have caught with Gordon Brown, but it has to be stress that his statement released on Evening Standard does not entirely reflect the current economic situation. The international economic mechanisms have broken down and the United Kingdom can not fix them on its own even if great savings where made in booming time. To show his flexibility, he has even tried to borrow Tories policies, which he intends ti implement soon though noone knows whether this will work or not. Gordon Brown has the credential around the world as one of the best economy managers and the situation he finds himself in is rather exceptional, but as in any good democracy, he has to be held responsible
