The Global Investment Climate

There are five main characteristics of the global investment climate: 1) the Federal Reserve has begun a protracted exit from the extraordinary monetary policy; while 2) other major central banks are not ready to follow suit.  This is encouraging 3) an unwind of structural positions, that were predicated on low US interest rates, and 4) the replacement of the dollar as funding currency, which is leading to 5) portfolio adjustments away from fixed income, emerging markets and some commodities, including precious metals.    The dollar, US and Japanese equities are favored by investors.

The end of the US payroll tax holiday and the sequester, while Europe relaxes its austerity drive in de jure as well as de facto meant that US fiscal policy was the tighter.  Now the Federal Reserve has signaled that barring new signs of weakness in the economy, it will likely slow its asset purchases this year and conclude them next year.  

A Reuters poll after the stronger than expected jobs report included 17 of the 21 primary dealers.  Eleven now look for the tapering to being in September, up from 7 in late June.  The poll found the median expectation that the first slowdown in purchases is $20 bln.  Most Primary dealers expect the first hike in the Fed funds rate in 2015, but the Fed funds futures strip suggests the market is discounting a move in late 2014.  

Fed officials appear somewhat surprised by the sharpness of the rise in interest rates and have tried to allay fears that tapering is tightening.  This warns that the FOMC minutes that will be released on Wednesday will likely be more hawkish than the subsequent soothing rhetoric.  The market will scrutinize Bernanke's speech the same day and Plosser, Bollard and Willams comments on Friday for clues into Fed thinking. 

The US earnings season kicks off with Aloca on Monday.  According to Thomson Reuters, the ratio of negative to positive pre-announcements appears to be the largest since 2001.  This lowers the bar of expectations, which makes positive surprises more likely.  At the same time, the US Treasury will sell $64 bln worth of securities, starting Tuesday.  

The euro area economy has contracted for six consecutive quarters through Q1 13, and recent data suggest the pace may be lessening.  Industrial production figures due this week will likely support the view.  However, the unexpected weakness in industrial orders (-1.3% v 1.2% consensus), following a 2.2% decline in April warns of downside risks for Germany industrial output.  Recall the June manufacturing PMI slipped to 48.8 from 49.4 and has not been above the 50 boom/bust level since February.  

Politics may trump economics in the euro area.  Greece's next tranche payment is front and center. The Eurogroup meets on Monday and will likely sanction a compromise worked out over the weekend. The easing of the acute phase of the crisis has not alleviated the need to reach a compromise. Moreover, the rearguard action to minimize the impact of the backing up of US rates on Europe will prove for naught if there is a renewed crisis in periphery. 

It is also understandable why Germany would prefer an uneventful few months in the run-up to its election.  Circumstances may be favorable for this.  The risk that Portugal's government will collapse has receded with a new compromise between the coalition partners, making S&P's cut of Portugal's credit outlook to negative from stable due to "growing political uncertainties" ahead of the weekend look rushed.  There may be near-term scope for Portuguese stocks and bonds to outperform others as the situation normalizes. The Italian government's willingness to delay the VAT hike also appears to buy time for the grand coalition.

Japan reports its May current account balance on early Monday in Tokyo.   The reason it is in surplus is not because of the trade account, which remains deeply negative, but because of its investment income balance.  However, exports are recovering and the 10.1% year-over-year rise in May's merchandise exports (reported in mid-June) is the fastest pace since December 2010.  

The Bank of Japan is the only major central bank to meet in the week ahead.   It is highly unlikely that there will be change in policy, but the BOJ is expected to upgrade its economic assessment.  Japan appears to enjoy the fastest growth among the G7 in Q2.  

Through last week, the Australian dollar has depreciated by 12.8% this year, second only to the 14.2% decline of the Japanese yen, among major currencies.  The RBA is not satisfied yet and further currency depreciation is anticipated.  Two pieces of data, employment data due on July 11 in Sydney and the inflation data on July 23, will likely solidify expectations for an August rate cut.  In five of the seven months through May, Australia has lost jobs.   The Bloomberg consensus calls for a flat report, but a tick up in the unemployment rate to 5.6%.  

China's money markets have nearly normalized after the squeeze last month.  However, the underlying issues do not appear to have been addressed.  In fact, the higher interest rates appear to have attracted even more funds into the wealth management products that have an inherent maturity mismatch (investors get long-term interest rates in a short term investment product).  Press reports suggest that a record number of investment plans were sold by 70 banks over the past two weeks, a 50% increase from the previous two week period. China's Minsheng Banking Corp, China's first privately owned lender, for example, sold a 35-day wealth management product with a annualized yield of 7%, according to reports.  

Separately, China is expected to report inflation and trade figures in the week ahead.  Inflation is expected to have ticked up, helped by a rise in pork prices.   Headline CPI has been fairly steady in the 2.2%-2.4% range (3, 6 and 12 month averages), but the consensus calls for a 2.5% reading in June.  

China is also expected to report its June trade figures near mid-week.  It surplus is expected to rise from $20.4 bln to $27.8 bln.  Export growth is expected to have accelerated after a 1% increase (year-over-year) in May.  Imports had unexpectedly fallen in May, but are expected to have rebounded smartly in June (6.2% vs -0.3%).   This may lend some support to the numerous countries for whom China is their top export destination.  

The Chinese yuan appreciated about 1.9% against the US dollar from late February through late May.  The dollar has stabilized in a CNY6.12-CNY6.15 range.  Given the dollar's broad based strength, it should not be surprising to see the dollar rise toward the upper end of this range in the days ahead.  

There is host of central banks from emerging markets that meet in the week ahead.  Only two, Indonesia and Brazil are expected to hike rates.  The others, including Korea, Malaysia, Thailand, Russia, Chile and Mexico are expected to stand pat.  A 25 bp increase in key rates is expected by Indonesia's central bank.  A 50 bp hike by Brazil is widely expected, though there is some speculation of a larger move.