Several policy implications from the recent data reports
The US dollar is marginally softer as North American players return to their posts. The better-than-expected official Chinese manufacturing PMI (53.1 from 51.0 in Feb and consensus for 50.5) saw steeper losses in the greenback, but the disappointing euro zone manufacturing PMI (47.7 same as the flash but weak details) helped cap the euro in front of last week’s highs, ahead of 1.34, and weighed on European equities. The UK CIPS survey surprised on the upside (52.1 vs 50.7 consensus) and sterling extended recent gains, though we suspect it will struggle to extend those gains in North America today. Japan’s Tankan Survey disappointed, showing no improvement from the December report (large manufacturers diffusion index -4), with softer capex plans (1.0% vs 1.4% in December) and expectations of a firmer yen (JPY78.14 vs JPY79.02 in the December survey).
There are several policy implications from the recent data reports. First, the rise in China’s official PMI supports the idea of a soft landing in the world’s second largest economy. This would seem to reduce the urgency of easier monetary policy. Second, it also has knock-on effects for the outlook of tomorrow’s Reserve Bank of Australia meeting. Speculation seen last week for a cut has been largely, even if not wholly, reversed. Of the central banks that meet this week (RBA, BOE and ECB), Australia still is the most likely to surprise, although we now expect it to wait a bit longer to move. The Bank of England will leave its rate and asset purchase program unchanged and, with indications that the UK economy expanded in Q1 (and stickier prices, which were also evident in today’s CIPS report), the MPC doves – Posen and Miles – are unlikely to have found much support for further easing measures.
The ECB is in a more difficult position. March was the eighth consecutive month of a sub-50 PMI reading. Moreover, the forward looking new orders component gives no hope for optimism of stability. It stands at 45.4 from 45.6 in the flash report and down from 47.3 in February. The euro zone also reported another increase in the unemployment rate—10.8% in February from 10.6% at the end of last year and 10.0% in February 2011. Yet interest rates are not the main obstacle to growth. Instead, austerity and deleveraging are the main culprits. Ironically, in the current environment, weaker growth will force some countries to increase their austerity efforts and/or overshoot their fiscal targets.
We note another budding problem in the euro zone. We have commented previously on the diverging collateral rules within the euro zone and noted last week that the Bundesbank has decided not to accept debt from countries receiving aid as collateral. It appears poised to extend this further in May. Moody’s noted earlier today that this has negative credit implications. At the same time, S&P reminded that it has 14 of 17 euro zone members on negative watch and one on selective default.
The Bank of Japan is likely to come under more pressure to ease policy as soon as next week’s meeting. While stepping up its asset purchase program is one option, we suspect the BOJ could increase its fund provisioning measures to stimulate business sentiment instead. The dollar spiked to JPY83.30 in response to the disappointing Tankan, but has since retreated and is may retest the bottom of its two-week trading range around JPY82.00.
For its part, the euro has tested the $1.34 area several times and remains in a sideways pattern near –term. Of note, the 3-month implied volatility is near its lowest level since August 2008. Implied volatility has come off as the euro recovered in Q1. We suspect that the decline in volatility is like a coiled spring, warning of the increasing risk of a large spot move in the offing. Sterling is trying to establish a beachhead above $1.60 and if successful, would signal near-term potential toward $1.62.
There is a US economic report every day this week. The key reports are the auto sales and the employment report. We expect some moderation in both. Feb auto sales were at a four-year high and, with rising gasoline prices, we suspect the risk is for a pullback from the 15.03 mln unit pace. Non-farm payrolls are also likely to have moderated. During the March survey week, there was little improvement in the weekly jobless claims compared with the February survey week. In addition, the warmer winter meant fewer layoffs and the payback should mean less hiring in the spring.
Elsewhere, Moody’s raised the outlook for South Korea’s A1 credit rating to positive. The Kospi rose 0.75%, making it the second best regional performer behind Indonesia (1.1%). Note that in Q1 South Korea saw foreigners buy $9.6 bln worth of shares for a 1411% increase from Q1 11. Separately, Poland’s central bank meets on Wednesday and is expected to stand pat 4.5%. The head of the central bank, Belka, appears more dovish than many members on the MPC.