Highlights for the Week Ahead: Central Banks Dominate

The week ahead promises to be eventful.  Three main items stand out: service sector purchasing managers surveys, five major central bank meetings, and the US employment data.

These will take place in the context characterized by a) lingering uncertainty over the direction of Italy, where there is still two weeks before parliament will sit in; b) uncertainty over the impact of the end of the US payroll savings tax holiday and the new spending cuts required by the sequester; and c) a generally strong dollar, which rose against all the major currencies last week and has begun the new week on a firm note.   The net speculative position in the currency futures is now short all the major currencies--the euro, yen, sterling, Swiss franc and Canadian dollar (though not the Australian dollar or Mexican peso).

For most countries, the service sector purchasing managers surveys will likely confirm what the market already knows.  Europe, outside of Germany, is struggling.  The does appear to be some stabilization of the contraction in most countries, with Italy being a notable exception.  The UK may also be of somewhat greater interest as recent data has been disappointing, warning that the stagnation may be giving way to new contraction. The construction sector PMI, released today points in this direction.  It slumped to 46.8 from 48.7.  It is the fourth month below the 50 boom/bust level and is the lowest since October 2009.   It may be noteworthy that sterling was not able to extend the pre-weekend losses; tested and held the $1.50 level. 

In addtiion, the fact that BOE Governor King wanted to resume gilt purchases last month and was outvoted, makes this week's MPC meeting of particular interest.  King and two others (Fisher and Miles) wanted to increase gilt purchases by GBP25 bln.  It is possible that when it decides to move, which could be as early as this week, the MPC may decide to buy GBP50 bln.   The data has deteriorated since last month's meeting, the EC revised down its estimate of euro area growth to now show a contraction this year, the impact of the Funding-for-Lending Scheme appears to be waning and more MPC officials seem sympathetic. 

The ECB meeting is also going to attract attention.  In the face of poor economic news and the disruptive fallout from the Italian elections, there has been increased talk of an ECB rate cut, with at least one investment house predicting it.  We are less sanguine.  While the economic data has been soft, the ECB had anticipate weakness early in the year.  New staff forecast will be provided and this will help shape interest rate expectations for Q2, where we suspect a rate cut is more likely.  

In addition, we note that the passive tightening of monetary conditions was not as much as had looked likely as banks have thus far been reluctant to return much of the borrowings from the second LTRO.  Over the past two years, the ECB has responded to political developments that it feels goes contrary to austerity and reform not by offering greater accommodation, but rather it does nothing to offset the market pressure brought to bear.  Thus, it seems misguided to expect the ECB to cut rates in response to the new anxiety spurred by the Italian election.

The other three central banks that meet are also unlikely to change stances.  This is especially true for the Bank of Japan and the Bank of Canada.  It is Governor Shirakawa's last meeting and is unlikely to take any fresh initiatives.  At the previous meeting, the BOJ adopted the 2% inflation target and announced plans to expand QE a little in net terms (after accounting for the maturing issues) starting next year.  The recent economic data has prompted the government and BOJ to upgrade their assessments.  Next month, when the new BOJ team is in place, we expect it to announce increased JGB purchases, perhaps under the rinban operations.  

The Canadian economic data, in contrast, has been disappointing.  The Bank of Canada still has a tightening bias though it has pushed out in time when fully capacity will be reached.   The Bank is likely to formally recognize the economy is weaker than its earlier forecasts anticipated.  A more neutral statement is likely; a change in rates is not.  

The Reserve Bank of Australia is still in an easing cycle, but appears not to be in any hurry to deliver the next cut. There is, as RBA Governor Stevens has noted, stimulus that has not worked its way through the system.  We suspect the next cut will come in May, after the Q1 inflation read in late April.  

The US jobs data may be the more important economic report.  It will set the tone for the economic data for the remainder of month, including industrial production, construction spending and personal income and consumption.   While performing better than most of the other high income countries, we suspect the US economy has downshifted into a slower gear and anticipate the employment data will reflect this.  The US has created a net 208k private sector jobs over the past three months and 181k over the past six months.  In February, the consensus expects about 166k net new jobs were created, almost identical with the number private sector jobs created in January, which of course is subject to revision.  

A decline in the unemployment rate and/or an increase in the average hours worked would come as a surprise  Note that an increase in average hourly earnings may sound supportive for consumption, but to be meaningful, earnings have to increase in real, or inflation adjusted terms.   Consumer prices appear to have ticked up in February after a flat January.  

Several emerging market central banks meet in the coming days.  They include Indonesia, Malaysia, Poland, Brazil and Mexico.  Poland is the only one that we expect to deliver a rat cut, though the surveys suuggest market expectations are divided.    Brazil is not, but the statement is likely to be important for shaping expectations going forward.  It seems early to us to expect a Mexican rate cut now, but we see increasing risk of a rate cut in late Q2 or early Q3.  There are some forecasts for as much as a 50 bp cut. 

Chinese shares plunged, led by the property sector, following moves by the Chinese cabinet to to curb rising house prices, which include increase in down payment requirements and stricter enforcement of a 20% tax on capital gains.  The Shanghai Composite fell 3.65%, effectively wiping out this year's gains.  It had a cooling effect on the region and most bourses were lower, with the MSCI Asia-Pacific Index off almost 1%.

The Nikkei was the major exception as it responded to the weaker yen and dovish statements by the nominated-BOJ team.   One of the implications of this new action to curb house prices is that speculation of a increase in required reserves or an outright hike in key rates should ease.  Comments over the weekend by a PBOC advisor supports such an interpretation, hinting at a easing of price pressures in March. 

Separately, China reported a decline in the official service sector PMI to 54.5 from 56.2 in January.  Due to the economic disruption of the lunar new year, Chinese data, including the trade figures which are to be released toward the end of the week, will, arguably, be more noisy than usual.  The National People's Congress begins its session on today and this is a forum in which new government initiatives have been announced in the recent past.