Economic Data Spark Improvement in Risk Appetite

BBH CurrencyView

• Safe havens decline against backdrop of improved risk appetite; stocks and oil both up over 1%
• EZ PMIs and Norwegian GDP both surprise to the upside; attention shifts to Richmond Fed in NY
• EM markets supported by flash China PMI; Russia politics back in focus amid Putin’s potential return

The dollar continues to weaken off the back of improving market sentiment following a raft of positive data surprises in Europe and the better than expected flash PMI data in China. Consequently, European stocks are up for the second day, while US futures suggest a positive open on Wall Street amid the drop in market volatility. Asian stocks climbed higher as well, with the MSCI Asia Pacific index up nearly 2.5%, boosted in part by the flash China PMI and the expected announcement of a policy put from the Fed this Friday. Against this backdrop of better than expected data, advancing stocks and limited movement in peripheral yields the euro is posting a decent rally, up over 0.8%, with sterling trailing the euro’s advance driven in part by the strong CBI industrial trend report. As a result, the demand for perceived safe has declined for the moment as yen and swissy both trading on a softer footing, while growth sensitive currencies outperform led by the 1.1% rally in SEK.

Focus in the North American session today is likely to be driven by whether the momentum of better than expected data reports from Europe will continue in the US, which is key to maintain the improved market sentiment. For the most part, European data results were much better than anticipated, with the composite EZ PMI exceeding estimates by nearly 2 standard deviations and Norway’s Q2 GDP easily beating consensus expectations (+0.4 versus Bloomberg median of 0.1%), though Germany’s ZEW survey posted a downside surprise. The PMI breakdown showed a marginal services reading change of 51.5. Yet a dip in the manufacturing reading that was less pronounced than expected, but still brought the reading to 49.7, below the 50-point no change mark and pointing to a slight contraction in manufacturing activity. The country breakdown as available so far shows very diverging developments with the German manufacturing reading remaining steady at a robust 52.0 after the unexpectedly strong orders number, while the services reading fell back. In France on the other hand the services reading improved, while the manufacturing reading fell below 50 to 49.3. At the same time, Spain’s borrowing costs fell after its successful auction this morning, selling €2.9bln of bills and just shy of the maximum target. Taken together, the data has been quite supportive of market sentiment, boosting equities, and in turn softening the dollar. On the other hand, ahead of the North American open the euro is unlikely to break $1.45 without a positive read from the Richmond Fed report, with markets expecting a drop of -5. Indeed, many observers remain fearful about taking on risk following the horrific results of the recent Fed surveys and their drag on sentiment. However, with the majority of economist expecting a downside surprise (4 of out 10 economists in the BBG survey expect a figure below -5 and 3 are in line with the median) an upside surprise would likely provide the market with a jolt of confidence after weeks of negative news.

In EM Asian markets were supported overnight but the stabilization of global risk appetite and supportive data. China PMI came in higher than expected at 49.8. Though still sub 50, it is in line with a soft landing scenario but nevertheless it indicates that while growth remains soft it appears to be stabilizing. Of note, four out of the five headline components appear to have improved, although the forward looking new orders component dropped below 50 for the first time since the summer of 2010. All told, a likely indication that China’s economy has bottomed out and in turn a signal that perhaps the tightening cycle may be drawing to a close. In Russia, some observers are beginning to wonder whether Medvedev will run for president again or if Putin will step back into center stage. This matters to Russian markets – even though we don’t think it should. Locals tell us that there is a large “Putin discount” factored into asset prices. Some say the discount is worth as much as 10% in equity markets, but we doubt it is that much. The reason is that Medvedev is seen as the more progressive and market friendly one of the tandem. This Putin discount is amongst the factors that have led to such sharp moves in Russian equities and FX. The other factors include lower oil, risk appetite, capital outflows and falling current account surplus. We think the RUB/BASK move was overdone and reflects an overshoot combined with a more hands-off central bank. It appears that the central bank has allowed greater volatility of the ruble, in effect, letting it become a shock absorber. This is also in line with the bank’s desire to shake off some carry trades. We look for entry points to position for a RUB rally back towards the 33.70 level at least (currently at 34.67).