Policy Theater Intermission; Economic Concerns Return

BBH CurrencyView

• Risk aversion continues to weigh heavily on equity markets and EZ sovereigns; Dollar mostly firmer across the board
• EZ policy developments remain in spotlight with growth expected to slow; UK inflation moderates
• In the North American session US data comes into focus; Singapore retails sales likely bellwether for Asian growth

The European morning was dominated again by a risk-off tone amid concerns over policy developments in the euro zone, with the market testing the ECBs bond buying appetite. Most worrying is that contagion is spreading outside the periphery, with spreads and CDS prices in France, Belgium and Austria now widening by similar magnitudes as the periphery, despite Spain’s decent auction results. The 5-year CDS price in France, Italy, Belgium, Austria and Spain have all reached new highs, while France’s 10-year yield spread to Germany has now reached 182bps, nearly double its monthly average. The intensification of financial stress is also evident the interbank market, where it now costs nearly 120bps to swap EUR for USD for a 3-month loan, surpassing the recent September high. EuroStoxx 600 bank shares down 3%. Elsewhere, October UK inflation moderated more than expected to 5.0% y/y from 5.2% y/y prior.

Policy developments in the EZ remain front and center. Markets indeed appear to be broadening the scope of their concerns about the EZ as pressures build on Spanish, Belgian, and French bond markets. The focus on the growth outlook over the medium term is building. For EZ policies to be deemed credible, they will need to balance austerity and growth. Preliminary Q3 growth was decent and came in the same as in Q2 at 0.2% q/q and was in line with the market consensus. There is no expenditure breakdown with the preliminary numbers, but indications from Germany and France suggest that domestic demand supported Q3 growth. The strength in export growth seen over the last couple of quarters is reassuring, though weaker external demand will dampen export growth going forward. Adding to the subdued Q4 outlook are the results from the German ZEW (econ.) survey, which dropped to a worse than expected -55.2 in November from -48.3 in October. This forward-looking survey adds to expectations for a sharp slowdown in Q4 German GDP from the 0.5% see in Q3. The wider EZ ZEW was also weaker than expected at -59.1 vs. -51.2 in October. The euro remains under pressure, and near-term levels of support are seen near 1.3484, 1.3400, and 1.3350.

In the North American session many are likely to be focused on US data reports, including PPI, retail sales and the first glimpse of November data provided by the Fed’s Empire manufacturing index. Markets for the most part expect both the headline and core producer prices to moderate from the previous month, driven in part by seasonal base effects and recent drop in crude oil prices. Oil prices have in fact fallen by nearly 14% since the peak in April, although some of the contribution from falling oil prices is likely to be offset by the marginal rise in food prices. What’s potentially more interesting is that the main driver of the potential drop in producer prices is likely to come from the sharp drop in motor vehicle prices, which have recently moderated after the sharp spike following supply chain disruptions in H1 2011 . A moderation in October PPI is likely to remain supportive of a benign picture for consumer prices. Retail sales, while expected to grow at a decent rate of 0.3% m/m, are seen moderating from the very robust clip of 1.1% m/m seen in September. The core rate (excluding autos, gasoline and building materials) is also expected to grow at a healthy pace, but looking ahead the trends in consumer demand look less sustainable. Recent consumption growth has come from a falling savings rate, rather than faster income growth. Finally, US manufacturing survey data in September and October showed signs of stabilizing, and so manufacturers do not seem as downbeat as they were earlier this year. Empire survey is the first reading for November, and it will be interesting to see if the ongoing crisis in Europe remains a threat to business sentiment.

In EM the focus was the weak Singapore retail sales print, which showed the first negative year-over-year drop since February. In fact, Singapore’s retail sales fell 0.1% y/y in September, much weaker than the consensus forecast for 3.6% y/y. The drop came off the back of a 9.8% y/y fall in motor vehicles sales, which dropped -2.4% y/y. While the magnitude of the decline fall is not too large, the worst than expected print could be a bellwether for Asian domestic demand growth. As a result, this may be an early indication that weak exports are starting to constrain domestic demand, In spite of the decent fundamentals, SGD is not a safe haven and in fact will continue to trade with the rest of the EMs, though we expect it outperform other regional peers in particular and other EMs in general. The SGD has now retraced nearly 62% of the move since early October, with an upside break of 1.30 paving the way for 1.32.