Market Mood Sours Ahead of the Weekend
BBH CurrencyView
- Asia and European session dominated by safe haven flows; Fitch & S&P both downgrade New Zealand
- Germany’s upper house and Austria vote on EFSF measures; we still feel EFSF 2.0 is still not enough
- Brazil’s budget and inflation report in focus in LATAM; China’s manufacturing continues to slow
The dollar maintains a supportive amid the sharp stocks market declines in Asian and Europe due in part to lingering concerns over the euro zone debt crisis and stagnation in Chinese manufacturing. Asian stocks were mostly lower, with the MSCI’s leading benchmark ex Japan losing more than 1%, while European shares are under pressure again, trimming the EuroStoxx 600 index largest weekly gain in three months down over 2%. Financials are leading the losses, down over 3.6%, with the DAX the regional underperformer, down over 3%. Meanwhile, dollar bloc currencies continue to be bogged down by soft equity markets, though the kiwi appears to still be reeling from yesterday’s downgrades from Fitch and S&P. On the European data front, the Swiss KOF leading indicator dove to a 2-year low, while a jump in EZ inflation all but assures the ECB will not cut by 50bps next week. Nevertheless, we would not rule out a 25bps cut, along with a focus on additional liquidity measures.
The votes cast this week to back the expansion of the EFSF, while a step in the right direction, is certainly not a going to relieve all of the euro zone’s ills. The euro zone lacks a master plan to deal with the recapitalization of euro zone banks when Greece inevitably restructures some of its debt. We continue to think that EFSF 2.0 is not enough and a bolder course of action will be required for the euro zone to hold together in its current form. Looking ahead we continue to think that despite the unexpected rise in September HICP inflation ( 3.0% y/y vs. 2.5% y/y) we continue to think the ECB is likely to bring forward some form of monetary easing at next week’s meeting, which is likely to weigh on the EUR/USD. Nevertheless, outside the euro zone there has been a smattering of economic data, which for the most part has been brushed aside amid the ongoing euro zone crisis that has not been too bad. In fact, over the past month while economic data in Asia (New Zealand and Japan) has generally performed worse than expected, economic data reports in most EMs, G10 and LATAM has generally outperformed market expectations. Indeed, in the UK it appears consumers are able to bear the travails of its neighbors with some fortitude given the slight improvement in consumer confidence reported this morning. What’s more after bottoming out in May economic data surprises in the US continue to show gradual improvement with the wide gap seen between “hard” and “soft” beginning to close, as survey data continues to improve – albeit modestly. For the US we expect today’s data reports to fall in line with trends in the immediate past. Sentiment data (consumer and businesses, alike) are expected to moderate, yet remain consistent with economic expansion, which on the whole is unlikely to boost risk appetite much. Thus, we expect to see the dollar remain bid, with the dollar bloc (CAD in particular) and scandis likely to remain under pressure.
In LATAM today Brazil consolidated budget data for August is out. Central government data Thursday was slightly worse than expected, and markets will need more evidence of fiscal tightening that could justify aggressive monetary easing that is expected. We expect the rise in the public sector primary surplus in comparison with August 2010 is likely to be explained by an increase in the results for the regional governments, which is expected to lead to a decline in the net debt-to-GDP ratio in August. At the same time, the central bank’s quarterly inflation report was released. The central bank said “moderate” adjustments in interest rates are in line with its forecast for inflation to fall to the 4.5% target in 2012. Market took this comment as a signal the bank may not quicken the pace of interest rate cuts. Some have been talking about 75-100 bp cut in October, but 50 bp seems more likely to us, despite the unfavorable inflation backdrop due to the deterioration in the global economy and its impact on Brazil’s domestic economy. In Asia, China PMI (HSBC/Markit) was 49.9 in September, identical to the final reading in August but above the "flash", or preliminary, PMI reading of 49.4 in September that was released last week. The index has now been below the 50 boom/bust level for three straight months. However, the index’s creators notes that a PMI reading as low as 48 is consistent with annual growth of 12-13% in China’s industrial output and a 9% rate of increase in GDP even if the index does imply a pull-back in activity on the month. China’s official PMI for September is due out this Saturday, and is expected to improve slightly from the 50.9 reading in August, which is expected to support the notion of a soft landing in China and would also be favorable for Asia currencies as well. Elsewhere, Turkey’s trade deficit narrowed amid a boost in exports.
What would help settle fears are a new set of stress tests on US and European banks which include significant write-downs of EU periphery debt. With those figures out there the states might have to bail out their banks as I doubt that private money will be forthcoming. In fact to punish banks they should also have to deeply discount (40% plus) new share issues to get sovereigns to take up stakes. That would both punish existing shareholders and allow a return for tax payers for bailing the banks out. Without that investors will still be betting on bank failures. In addition attach warrants to the new government holdings that grant the taxpayer free shares if the share price falls below a set price. This will further dilute private investors who might be tempted to short the banks.