All eyes on central banks as market summer lull set to end
03/Sep/2012 • Currency Updates•
Financial markets in general closed the month of August on a relatively calm note, as equities and risk assets retreated a touch from the lofty levels attained in the month. No dramatic news came out of the European periphery, and the ECB has apparently committed sufficiently to unconventional measures to assuage the short-term fears of the markets. Problems are a long way from being solved, however. The global macroeconomic backdrop varies from lacklustre (China, the United States) to grim (eurozone). Markets’ expectations for central bank activism have been raised to perhaps the highest level since the Lehman crisis. In addition to the ECB, the Fed, the Bank of Japan and the People’s Bank of China have all hinted to a greater or lesser degree to further unconventional easing measures. By far the most important date will be this Thursday, when the ECB meets and is expected to articulate a concrete strategy for lowering peripheral Government yields from their currently unsustainable levels. Any failure to deliver on market participants’ high expectations could be very negative for both the euro and financial markets in general.
Very little news from the UK in late August, as is usually the case. Such data that came out (CBI and BCC surveys, mostly) were consistent with our view of a mildly contracting economic environment. Unlike most of its peers, neither the consensus nor ourselves expect any action from the Bank of England in its September meeting this Thursday. The latest increase in Gilt purchases is still being executed, and MPC members have generally expressed reluctance to cut rates further from 0.5%, citing concerns about the functioning of money markets. Much more important will be the release of the PMI business confidence indicators, also on tap for next week. However, given the low likelihood of any action or statement from the Bank of England, we expect sterling to trade mostly in response to foreign developments as a low beta version of the euro.
There was more negative macroeconomic news last week out of the eurozone. Concerns about both Spanish and German growth have intensified after the former revised downward its estimate for GDP growth over the last three quarters; all three have negative growth now, and given the certainty of further contraction this quarter, that would extend the Spanish double dip recession into a full year. As for Germany, the PMI business survey surprised to the downside. The composite index is now at 47, consistent with outright contraction. The grim news shows no sign of letting up. In this context, the ECB faces a crucial test when it meets this Thursday. Markets are expecting a clear road map for unconventional measures to guarantee sustainable Government yields in the eurozone, and proof of the ECB’s willingness to execute them in the form of outright purchases of peripheral bonds, most likely Portuguese. Failure to deliver on either of these fronts would be very negative for the euro. At any rate, while it is positive to see the ECB and eurozone officials in general starting to acknowledge realities, the question is whether this turnaround is coming too late in the game to save the peripheral economies. Expect significant volatility in the common currency and markets in general on Thursday morning.
GDP growth for the third quarter was revised up slightly, in keeping with the latest raft of slightly better-than-expected macroeconomic news. Overall, the numbers are consistent with our call of growth in the range of 1.5%-2.5% for the remainder of 2012. As always, we will revise this figure if the critical payroll numbers on Friday diverge significantly from expectations. More important than the backward-looking GDP revision was Bernanke’s speech at Jacksonhole, Wyoming. The Fed chairman struck a distinctly pessimistic tone about the US economy, and in particular the slow pace of job creation. He made it clear that the Fed will not hesitate to use and expand its set of unconventional tools to redress the problem. The consensus now expects a further expansion of the balance sheet at the September meeting, and we do not disagree. In fact, we expect to see some other type of unconventional policy tool announcement at the meeting; possibly, direct lending facilities following the Bank of England experiment.