Beware of Particularly Challenging Week Ahead

It is never easy, but the week ahead may be particularly difficult for market participants. It will first have to respond to weekend developments.

First, the front page of the NY Times on Saturday was a report that the Saudi Arabia warned the US if a bill making its way through Congress that would allow it (Saudi Arabia) to be held responsible in American court for the terrorist strike on 9/1, the sheikdom would forced to sell its Treasury holdings, and other US assets, which otherwise could be frozen. Apparently there have been talks along these lines for several weeks between top Obama Administration officials and Saudi officials. The issue re-emerged into the public space with the help of a television news show (60 Minutes) that discussed a classified report that is thought to contain some linkage between some parts of the Saudi government (even if not the highest levels) and the terrorists.

Earlier this year, press reports highlight that while the US Treasury's TIC data estimate holdings of US assets on a country basis, it groups together of OPEC. The implication is that the holdings of Saudi Arabia, with what appears to be the third most reserves in the world, remains unknown to the public. The NY Times story cited the Saudi foreign minister saying that $750 bln of US Treasuries and other assets" may be sold in the bill is approved.

Obama will be abroad in the week ahead. His trip to London, in which he is expected to press for the UK to remain in the EU was a talking point among investors last week. Obama has to be careful, even though US interests seem clear. Imagine another foreign leader, say Russian President Putin, going to the UK and support Brexit. No doubt many would cry "foul."

However, given the NY Times revelation, Obama's trip to Saudi Arabia may take on greater significance, even though the press report suggests some uncertainty whether this will be on the agenda. Still formal or otherwise, it is a subject that it is difficult to see how it can be avoided.

The market will also have to respond to the outcome of the Doha meeting between many OPEC and non-OPEC oil producers. Ideas that a freeze could materialize is one of the factors that have helped oil prices recover 20% off the low seen earlier this month. The tentative agreement struck in February, was conditional on wider participation, and in particular Iran. Moreover, any agreement should be held to the Reagan Criteria: Trust but verify. There is not much of the former and the latter proves difficult in the short-run.

We have argued from the get-go that Iranian participation could not and would not be secured. The Iranian had just agreed to surrender (or postpone) their nuclear development in exchange for the lifting of the embargo, which had crippled its energy sector. If it would now agree to a freeze in output, it would have made significant concessions for nothing.

We had surmised that the astute Saudi officials understood this and had used the prospects of an oil freeze to put a wedge between its rivals Russia and Iran, and deflected the blame for cheap oil among oil producers from itself to Iran. For the Saudis, we argued it was a political maneuver and not an attempt to relieve the economic pressure stemming from the drop in oil prices, which led to Fitch to cut Saudi Arabia's credit rating last week to AA- from AA. Fitch's rating is now the same as Moody's (Aa3) and above S&P, which is at A+. All have stable outlooks.

Nevertheless, Russian officials have been playing up the possibility of a freeze even without Iran. Here too we have cautioned clients against accepting this at face value. For Saudi Arabia to participate without the Iranians means to lose market share to their rival, who they are confronting in various fronts, directly and through proxies.

After the markets close for the week, press accounts indicated that Prince Mohammed bin Salman, who is thought to be an important driver of the country's strategy, was unequivocal: Saudi Arabia would not restrain production unless other major producers, including Iran, also froze output.

We warned that to the extent the advance in oil prices reflected investors anticipating a freeze in output, we cautioned in the middle of last week that expectations may be disappointed. Oil prices retreated in the last three sessions, ending with a 2.75% slide before the weekend.

The recovery in oil prices, especially since February 11 has coincided with the recovery in equity prices, emerging markets, and dollar-bloc currencies. A reversal in oil prices may inject fresh volatility into the capital markets.

This volatility could complicate the choices for Japanese officials. The yen had pulled from its multi-year lows set on April 11. The US dollar recorded its low just below JPY107.65 and made it to almost JPY109.75 before reversing lower ahead of the weekend.

Initial press reports from the meeting between US and Japanese officials seemed to have emphasized a rough agreement that there was no need for intervention. BOJ's Kuroda was quoted by the news wires recognizing that the yen's strength had been partially corrected, implying reduced pressure for intervention.

However, other accounts, like this one in the Wall Street Journal that was published after the markets closed on April 15, suggested greater discord. Japanese Finance Minister Aso apparently pushed for agreement intervention under the G7, and G20 accords that accept that "volatile" and "disorderly" markets may necessitate official action. We suspect that European officials were also not particularly sympathetic to Japan's desire to intervene. Press reports suggest little support for the Japanese intervention at the G20 meeting.

Ironically, Chinese officials may be among the more supportive. First, the strength of the yen has limited the yuan's decline against the dollar, which is more significant for its trade. In fact, the yuan bottomed against the US dollar on January 7, roughly six weeks before the claims of secret agreement in Shanghai to avoid additional weakness, and has appreciated by about 2% against the dollar through last week. Second, intervention by Japan makes it somewhat harder to criticize Chinese intervention with appearing to apply a double-standard.

The economic data to be reported in the week ahead are unlikely to spur change in policy expectation or significantly alter the information set investors currently possess. The US reports housing data while is expected to show strength in new home sales and softness in the larger existing home sales market. Weekly initial jobless claims, which last week matched the cyclical low, will cover the same week as the survey for April nonfarm payrolls and may garner slightly greater attention.

The flash PMI readings for the eurozone will be released. They are expected to be little changed. Many observers, and perhaps many policymakers as well, are failing to appreciate that eurozone growth now is fairly steady and matching the average pace of growth that was experienced between 2001-2005. The eurozone is expanding near its customary modest pace, with still high levels of unemployment and for all practical purposes, price stability (which in the modern jargon is called lowflation).

The ECB meets, but there will be not change in policy. Aggressive action was taken last month, and all of the measures have not been implemented. For investors, the important information to be looking for from the ECB is more details about the corporate bond purchases. Draghi may also warn of against further euro strength and how it can be counter-productive in prematurely tightening financial conditions.

The UK reports March employment and retail sales. Soft retail sales are expected for the second consecutive month. While this is consistent with the modest slowing of growth seen in other data, it also needs to be understood within the context of the surge in January sales. Headline retail sales leapt 2.7% in January and 2.3% excluding gasoline. The UK job growth remains strong, and the unemployment rate is likely to be steady at 5.1%. Earnings, with are reported with an extra month-lag and are also expected to be little changed in the three-month period ending in February.

Separately, the UK will report its March budget position, which ends the government's fiscal year. In February, the government was around GBP1 bln from its deficit target. Therefore, the risk is for an overshoot. Stepping back and above the ideological narratives, it is interesting to compare the UK with the US in terms of budget deficits. The deficits peaked as a percentage of GDP in 2009. The UK at 10.4% and the US at 10.1%. Last year, the UK deficit was 4.4% of GDP. The US deficit was 2.6% of GDP.

It may not help Japan's case to intervene in the foreign exchange market when it starts the week by reporting what is expected to be its largest trade surplus in more than five years. The median forecast is that Japan's trade surplus widened to almost JPY820 bln in March from JPY242 bln in February. When seasonally adjusted, the surplus will be smaller but is still expected to post a multi-year high.

Two points need to be quickly added. First, a wider surplus does not mean stronger exports. Specifically, the median estimate is that exports fell 7.1% in March (year-over-year) after a 4.0% decline in February. Imports fell 14.2% in February and expected to have fallen around 16.5% in March. Second contrary to allusions to Japan's reliance on exports note that as a percentage of GDP, its exports are roughly the same as the US; 13%-15%, not the 40%+ of some European high income countries.

Sweden's Riksbank meets. It is likely to stand pat, with an exceptional ease stance of negative rates and bond purchases. The deflationary forces that the central bank is battling have not hobbled the economy. The economy is growing among the fastest in Europe (3.8% in 2015 and is projected to expand at a 3.5% pace this year). It enjoys a large current account surplus of almost 6% of GDP. It monetary policy stance seems an exaggerated response to what appears to be price stability. The CPI was zero in 2013, -0.2% in 2014 and -0.1% in 2015.

Canada may report weak February retail sales, which is part of the payback for the 2.1% jump in January. March consumer prices may rise sharply on a month-over-month basis, but seasonality plays a large role. The year-over-year rate is likely to ease on the headline level as well as the core. Minutes from the recent meeting of the RBA will be published. Look for the focus to be on the labor market and inflation. There will be an opportunity to voice concern about the strength of the Australian dollar.

A few emerging market central banks meet. Turkey's may cut the upper end of its rate corridor. There is risk that South Korea cut its key seven-day repo rate that stands at 1.5%, but the base case is against a move. The central banks of Israel and Indonesia meet. Both are expected to stand pat. Brazil's lower house will vote on the impeachment of the President. Even if there are sufficient votes, closure does not look likely for some time. The upper house will have to vote on it, and the entire process can take several more months. Before the weekend, the President of the Organization of American States issued a statement that argued that after its own detailed analysis, it concludes that Rousseff's action did not rise to the level of an impeachable offense.

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