Disappointment Reigns

In some ways, today is about disappointment. To be sure, it is not that the disappointing news is surprising, but it is disappointing nonetheless.

Yesterday the FOMC statement seemed to downgrade growth a notch and characterized underlying inflation as “trended lower” following exceptionally poor housing data. This follows the disappointing jobs data at the beginning of the month, followed by poor retail sale figures. Fed Chairman Bernanke recently acknowledged that he could not rule out a double dip to the economy, and although the FOMC statement’s very first sentence recognized “…that the economic recovery is proceeding…” there seems to be growing concern about growth in H2 10 and into 2011. Despite the federal stimulus in Q1, the cuts by the state and local governments made the overall government contribution a drag on GDP. Federal stimulus is expected to wane, while the drag from the states and local governments are likely to continue.

In Europe, the adoption of austerity programs is the source of some of the anxiety about the economic outlook. Weakness today in the April euro zone industrial orders (+0.9% vs consensus forecasts of 1.6%) does the outlook few favors. At the same time, European officials are walking a tightrope. On one hand they want to convince investors that they are serious about restoring fiscal credibility. On the other hand, they are responding to criticism of moving pre-maturing by playing down the near-term cuts and emphasizing the broader commitment.

S&P was also a source of disappointment. While Moody’s and Fitch have made generally supportive comments about the UK’s budget and the status of the country’s AAA rating, S&P was more circumspect. It said it was too early to assess the impact of the budget on the UK’s ratings and while the budget was an important first step, more action is needed.

The threat to the UK economy, which former BOE’s Blanchflower is playing up today in an article in the New Statesman, and the anticipation of lower gilt supply has pushed UK 10-year yields to new lows (since last April) near 3.4%. Short-sterling futures are flat on the day but remain near contract highs. Sterling is the only major currency to have largely kept pace with the yen this week. The 1.6% rise against the dollar has brought it to the $1.5000 level. Sterling has traded through there, but is struggling to sustain the upside momentum. The $1.5050 area may prove sufficient to contain for at least the near-term.

The performance of the Australian dollar is disappointing. Its new Prime Minister Gillard quickly indicated she was open to negotiations about the controversial resource tax and while key mining company shares did well, the Australian dollar disappointed. Initial gains were reversed and it is not clear that a low is in place. Risk aversion and weaker commodity prices seem to negate the positive developments. In a larger sense, a new prime minister in Australia is part of a common theme. New governments are in place in two G7 countries (the UK and Japan), while two euro zone countries are trying to form governments (Netherlands and Belgium, the latter assuming the rotating EU presidency on 1 July). Other governments in the G7 are strained. Some polls, for example, indicate that US President Obama’s approval rating is at the lowest of his presidency. There continue to be press reports about the infighting within the German government. This political weakness coupled with uncertainty over financial reform/regulation is also not positive for the general investment climate.

China is also disappointing many who had expected the weekend’s announcement to produce significant results. Despite some minor gains in the spot market (0.38%), the 12-month NDF implies a 2% pace of appreciation over the next year, which is the least that has been priced in since the announcement. Chinese officials may have hoped that the announcement would steal some thunder from the G20 meeting, but it is not clear this will be really the case. Look for discussions over pace and magnitude of yuan appreciation.