British Pound is Sterling
The US dollar is still consolidating/correcting its recent decline against most of the major currencies today. The notable exception is the British pound, where a considerably stronger than expected initial estimate of Q3 GDP (0.8% quarter-over-quarter vs 0.4% consensus) and an upgrade in its sovereign rating to stable from negative has bolstered the currency. The data would seem to undermine the prospects a new round of asset purchases this year. After underperforming in recent weeks, sterling began playing a bit of catch-up yesterday is firmer across the board today. The euro found support ahead of $1.39 in early Asia, but after being turned back from the foray above $1.40 yesterday, continued range trading is the most likely scenario. Stops are thought to be below $1.3880 now. The Swedish krona is the weakest currency today (off about 1% against the dollar) following the Riksbank’s guidance toward a slower monetary policy trajectory after the hiking rates the third time since July. Emerging market currencies appear to be in a consolidative mode.
Japanese stocks fell for a second day, led by exporters and brokerages, as the yen traded around 80.60, a 15-year high against the dollar. The Nikkei fell by 0.2%. At the same time the MSCI Asia Index fell by 0.6%. China’s stocks dropped from a six-month high, led by consumer companies, on concern an increase in fuel prices will stoke inflation. The Shanghai Index fell by 0.3%, while the Shenzhen increased by 0.1%. The selling continued in Europe as Stoxx 600 fell by 0.3%, led by a 1.3% drop in basic materials. Most European benchmark indices are down, including the FTSE down 0.8% led by a nearly 2% drop in tech stocks.
The UK’s outlook was raised to stable from negative by S&P (which affirmed the AAA ratings) according to a statement released by the rating firm this morning. The ratings outlook appears to be driven by the austerity measures and the UK goals to reduce the deficit, not the strong GDP figures. In a statement, the ratings firm said that the “2010 Spending Review reduced the risks to the governments implementation of its June 2010 fiscal consolidation program.” Yet not surprisingly, subsequent the news of the UK better-than-expected GDP figures Gilts sold off hard. The 10-year was up 11 bps followed by an 8 bps increase in the 2 year. Meanwhile, Greece’s 10-year yield spiked by 34 bps amid rumors of a likely default by 2013 as debt remains unsustainably high. And finally, the German 10-year yield increased by 5 bps after a report showed the nation’s import prices gained for a second consecutive month in September.
U.K. GDP came in stronger than expected, up 0.8% q/q and 2.8% y/y in Q3, with the q/q number double the consensus. This was the highest annual growth rate since Q3 of 2007. Service sector growth came in surprisingly strong, up 0.6% q/q, same as in Q2, while industrial production growth was 0.6%, after 1.0% in Q2. Construction sector output increased 4.0% q/q, after rising 9.5% in Q2 following the weather related weakness in Q1 2010. Given the recent fears of growth prospects this quarters GDP data are encouraging and reduces the immediate desire for further quantitative easing. However, the focus remains on the possibility of a growth slowdown ahead, stemming from government austerity measures and continued weak credit growth. Policy makers have left the door open for monetary policy to reduce the pain of government austerity which plans to cut nearly 490k public sector jobs over the next few years. Although the thought of further stimulus cannot be rule out entirely, following this report, it seems the door was shut for the rest of the year.
The prospect of QEII in the US remains a key market focus. While there is nearly universal opinion at the Fed will announce new long-term asset purchases next week, but there remains great uncertainty over the details. While US Treasuries have rallied as key Fed officials and voting members of the FOMC have signaled need for additional measures, it is difficult to know with any precision precisely what has been discounted. This is especially true, given that the US 10-year yield stopped falling on October 7th and has risen 20 bp since. At the same time, the Fed’s signaling channel has been very successful in raising inflation expectations as interpolated from various market prices. Some of these adjustments like the break-even on the Treasury’s Inflation Protected Securities. The breakeven on the 30yr TIPS was 1.84% prior to Bernanke’s Jackson Hole speech in late August and now stands near 2.55%. This compares with long-term average of about 2.30%. The five-year/five year forward, a measure of inflation expectations, cited by both the Fed and ECB in the past, was around 1.90% in late August and was 100 bp higher yesterday. Market based measures of inflation expectations can be distorted in “normal” conditions by supply and liquidity considerations. The distortion may even be more pronounced now given the gaming of the assets that the Fed may buy, including certain parts of the curve and TIPS themselves. That said, while some like the Fed’s Hoenig does not think the economy requires more stimulus, others who see the need for more stimulus want to rely on fiscal support are concerned about the inflationary implications of the reliance on monetary policy.
The Riksbank raised the repo rate by 25 bp to 1.00%, in line with consensus, but downplayed the need for future rate hikes. The central bank now expects a repo rate of around 1.3% in Q1 of 2011, versus 1.35% previously and of 2.0% by the end of 2011, compared to a 2.4% forecast earlier. By end of 2012, the rate is seen at 2.9%, a downward revision from 3.3% and by end of 2013, the repo rate is expected to reach 3.4%. The central bank noted weak developments overseas and low inflationary pressures as reasons behind revising down its rate forecasts, but reiterated that the repo rate should be raised towards more normal levels. The Riksbank, however, raised its 2010 GDP forecasts and expected CPI to increase this year yet revised down longer durations. That said, Svensson voted in favor of a steady rate and is now joined by Ekhol, both of which put in reservations against the central repo rate path outlook in the new Monetary Policy Report.
Upcoming Economic Releases
At 9:00 EST / 13:00 GMT the US reports August’s CaseShiller home price index. The m/m is expected to fall by -0.2% from a 0.13% drop in July. The y/y index is expected to fall to 2.1% from a 3.18% increase in July. At the same time, October’s consumer confidence figure is expected to marginally increase to 49.9 from 48.5 in September followed the Fed’s Richmond index. ABC confidence is reported at 17:00 EST and the Fed’s Dudley speaks at 16:30 EST.