Risk assets, Euro rally again, as investors pour money into stocks
14/Jan/2013 • Currency Updates•
Last week saw another healthy rally in credit, equity and commodities, while risk-free bonds managed to hold their own.
Negative real rates in developed countries, coupled with monetary authorities unwavering commitment to reflation, are driving investors to switch out of the miserly yields in safe assets and into reasonably valued equities.
In FX markets, sharp rallies in the commodity currencies (AUD, NZD, MXN among others) also pushed up the euro, which managed to close the week at a nine-month high.
As generally expected, the Bank of England left both its it target interest rate and asset purchase levels unchanged last week.
Outside of monetary policy, it was another week of generally weak data out the United Kingdom. Manufacturing output in November added a 0.4 % drop to the 2.4% fall over the previous three months. The Markit report on labour market sentiment displayed a sizeable drop, admittedly from quite high numbers. It went from 56 to 53.2, still in expansionary territory, but perhaps an early sign that the dichotomy between the relatively strong labour market and dismal production figures in the UK is starting to be resolved.
Sterling continued to move independently of domestic data, and has firmly reverted to form as a low-beta version of the euro, rising by 1.5% against the dollar but dropping against the common currency and most other currencies except the yen.
The big event of the week was the first monthly meeting of the ECB on Thursday. Rates were left unchanged, but this time the decision was unanimous. Markets understood this as a signal that the ECB has become more sanguine about prospects for the European crisis, and enthusiastically agreed with this view by sending peripheral yields sharply lower and the common currency higher against the dollar and sterling.
The ECB is (wrongly, in our view) focused for now in the easing of financial conditions, rather than in the (so far) complete lack of pass through to the real economy. The latter remains extremely weak, even in the core countries. German industrial production is expected to decline by double digits in the fourth quarter of 2012, and an overall GDP print below 2% contraction would not be surprising. The French contraction is expected to be 1.5%, and Italy and Spain will also post declines.
FX markets, however, chose to focus on the ECB optimism rather than the dismal macro news, and the euro surged against both the dollar and sterling.
News turned somewhat more negative last week in the US. The November trade data was worse than expected, as the trade deficit surprised to the upside on surging imports. This should negatively impact fourth quarter GDP growth to the tune of a few tenths of a percentage point. We do think that these negative news will be overshadowed by the decent recovery in both the labour and housing markets.
Given the single minded focus of the Federal Reserve on labor market recovery, we expect that the next meeting of the FOMC will see, for the first time, a significant forward revision in the date at which most members expected rates to start rising, from 2015 to 2014. We do not think the markets are quite prepared for this shift, and therefore think that the meeting on Janaury 24th and 25th bears close watching.