Macro View

Holiday in Tokyo and London are making for a quiet start to the week.  The US dollar is firmer, though gains are mostly minor, with two notable exceptions.  The greenback's gains against the yen in the second half of last week have been extended to ~JPY99.45, a new 8-day high.

The Australian dollar is the weakest of the majors, though, completely retracing its pre-weekend gains in response to disappointing retail sales data (-0.4% in March vs +0.1% consensus forecast).  Among the emerging markets, the Malayasian ringgit jumped 1.8% after election victory for the ruling coalition and the local equity market rallied 3.4%.

The Chinese yuan posted its biggest decline of the year.  Yesterday that State Administration of Foreign Exchange (SAFE) announced new regulators that will curb the banking system's ability to short the US dollar (or other currencies for that matter).

Specifically, the quota for individual banks to short foreign currencies linked to their currency loan and deposit situation.  Banks are given until the end of next month to comply.  Previously SAFE simply set the quotas.  Essentially, the Chinese banking system is seen having more foreign currency loans (short) than deposits (long).  This would imply a need by local banks to buy foreign currencies, especially the dollar.    The dollar has fallen 1.5% against the yuan since late Feb.  This policy shift likely signals the end to that move that has seen the dollar drop to 19-year lows.

There were two important economic reports from the euro area today.  The first is the service PMI.  At 47.0, it was an improvement over the 46.6 flash reading, but remains well below the 50 boom/bust level and would still be consistent with continued contraction into Q2.  German and French reports improved from the flash readings and Italy surprised on the upside (47.0 from 45.5).  Spain was disappointed with a 44.4 reading, though impact may have been mitigated by a larger than expected 46k decline in the April unemployment rolls. 

In addition to these developments, there are five issues that are shaping the investment climate:

1.  State of the US economy:  The weekend media heralded last week's jobs data.  The Financial Times headline of the weekend edition proclaimed "US jobs report eases economy fears".  This is an exaggeration.  It is true that non-farm payrolls rose 165k and the revisions to the back two months added an additional 114k jobs.  The unemployment rate did fall because more people were working rather than from a decline in the number of people participating in the labor the force. 

Yet the signs of weakness are unmistakable.  The pace of job growth in March and April below the 6-month average and while it is tempting to blame the sequester, government sector jobs losses have not accelerated.  In addition, the number of industries adding jobs, captured in the BLS diffusion, has trended lower from 61.7 in February to 56.2 in March to 53.9 in April.  More importantly, the 0.2% decline in hours worked is significant.  Given 135 mln workers, a 12 minute reduction in the average work week translates into the loss of around 500k full-time equivalent positions.  This will translate into less output, less income and less consumption.   While first estimate of Q2 GDP may be revised higher from the initial 2.5% estimate, the jobs report is consistent with the marked slowing to something on the magnitude of half the pace in Q2.  

2.  Policy in the euro area:  There have been changes to the monetary policy stance of the ECB and the trajectory of fiscal policy.  The ECB delivered a 25 bp cut in the refi rate, held open the possibility of additional measures, such as effort to  help rebuild the market for non-financial asset backed securities, ostensibly as a way to encourage new lending to the small and medium size businesses that face tight credit conditions.  It promised full allotment of the refi operations until at least the middle of next year  The ECB has indicated for some time that it was technically prepared for a negative deposit rate and Draghi reiterated that, but added that he was open-minded about it, suggesting that it may be more likely.  Due to what we expect would be disruptive consequences of such a move, we think the odds are very low that the ECB would sanction this.  

In terms of fiscal policy, the tide continues to move away from the austerity path that the euro area has been on since the crisis.  EU Economic Affairs Commissioner Rehn signaled that three of the euro area five largest economies (France, Spain and the Netherlands) would be given more time to reach the 3% deficit target.   That France was given two more years (like Spain) was a surprises insofar as France requested only a single year delay, and some at Bundesbank had objected to any delay (for France) on grounds that it would undermine the credibility of the fiscal pact.  

Yet, the German government appears to have agreed to the delay and tomorrow the France's finance minister and central bank chief will meet their German counterparts.  The bilateral relationship has reportedly fallen on difficult times.   Even if France was economically stronger and able to offer a clear alternative to the ordo-liberalism of Germany, the fact of the matter is that Merkel supported Sarkozy nearly as much as any German chancellor could support a French presidential candidate--and clearly augers poorly for the relationship between the two pillars of Europe.  

3.  Two major central banks meet this week.  The Reserve Bank of Australia decides on rates tomorrow and the Norway's central bank meets Wednesday.   The risk of an RBA move have increased in the past week or so amid soft Q1 inflation reading and general disappointing global (China) data, including today's HSBC service PMI which fell to new 2-year lows.    The OIS has about a 60% chance of a cut priced in, but if the RBA does not move now, expectations will likely simply shift to the June meeting.  Friday's monetary policy statement may be used to expand on the message of the statement that follows the RBA's decision.  

Norway's Norges Bank has already signaled that a rate cut this year was likely.  With the ECB and Denmark cutting already, this is an opportunity for Norway.  However, we suspect that decline in the krone gives the Norges Bank more time.  

4.  Data:  Once past this service PMI reports, the data stream this week is light.  The highlights will include German industrial production on Wednesday, which will help economists fine tune forecast for Q1 GDP, due May 15.  The weekly US initial jobless claims fell to new cyclical lows last week and any additional decline would be encouraging.  Also Thursday, Japan reports March trade and current account balance.  Japan's current account is expected to be nearly twice February's JPY637 bln surplus.  Seasonal factors are distorting.  Adjusting for them, the current account is expected to swing into surplus from the minor JPY100 mln deficit in February.  The consensus expected a seasonally adjusted JPY480 bln, which would be the largest since last August.   Lastly, Canada reports its April employment figures at the end of the week.  Canada lost about 26k jobs in Q1.  It is expected to have recouped a little more than half of these in April.   Note that the G7 meet on Friday and Saturday.  We do not expect fresh initiatives.  It may simply endorse current measures and renew pledges.  

5.  Geo-politics:   The civil war in Syria has two new features.  First are reports of the use of chemical weapons.  The use of which is thought to trigger a greater international (and US response), though there are conflicting reports over which side used them.  Second, Israel has struck targets inside Syria in recent days to reportedly stop the shipment of missiles headed for Hezbollah.

In Asia, China seems more annoyed with Japan over Abe's nationalism, which extends beyond the dispute islands and involves amending its constitution to weaken the prohibitions of building a military presence, than about the depreciation of the yen.  South Korea and China appeared to protest Japanese officials support for the Yasukuni Shrine by boycotting the ADB meeting and sending junior ministers to the ASEAN+3 that met at the end of last week.