ECB Press Conference, Fed Action (?), European Data

The ECB press conference is the key event of the remainder of today’s 24-hour session. There are three key issues.

First, are the stress tests on European banks. Most observers seemed to share our preliminary assessment that the stresses being tested for were not particularly onerous. Although the details remain somewhat sketchy, reports suggest, for example, that the stress test will see how banks cope with a 17% draw down on Greek bonds. The recovery swaps market is pricing consistent with a 40% recovery rate—a 60% loss in a default or restructuring. It may not be politic for Trichet to say much about the stress tests, but he is likely to be asked. Note that he will be meeting with the CEOs of the top banks a couple of days prior to the July 23 stress test results are published.

Second, there has been a significant rise in money market and other short-term interest rates in the euro zone. Trichet will likely be pressed on this issue a bit more than on the stress tests. That said, the ECB is not poised to provide more liquidity now, but maybe Trichet will try talking rates down.

Third is the potential for collateral rules changes. Back in April, Trichet seemed to suggest some decision this month. However, a press report yesterday suggested the announcement may come later in the month, when the member central bank governors meet. On balance, the market still seems inclined to buy euros on pullbacks. That said, many participants are monitoring the downtrend line drawn off last Nov’s highs and mid-April highs. It comes in near $1.2760 today, falling about 5 ticks a day.

There is a Washington Post story that will likely be a talking point today. The article suggests that, given the fiscal impasse in the US Congress, the Federal Reserve may consider other measures to support the fragile recovery, which recent data suggests has lost momentum. A number of possible courses are discussed, including hardening the wording of their “extended period” guidance, cutting the rate on excess reserves (now 25 bp) and maintaining its mortgage book by replacing maturing securities with new purchases. The report seems largely speculative and comes on the heels of comments from a couple Fed officials (Fisher and the FOMC dissenter Hoenig) suggesting the Fed has done what it can. US rates have fallen over the past month and the narrowing interest rate differentials, as we have noted, are part of the story behind the liquidation of long dollar positions (against the euro) in recent weeks. Separately, but related; note that the IMF has updated its GDP forecasts and the US appears to be the only country/region that the IMF upgraded in both this year’s forecasts and next. US GDP forecast was revised to 3.3% form 3.1% and next year to 2.9% from 2.6%. The fact that it did not cut the euro zone’s GDP forecasts this year of 1% is not surprising and underscores the point that despite the rhetoric Europe’s austerity is more a 2011 story and beyond than a 2010 story—except on the periphery. The IMF did cut its 2011 GDP forecast for the euro zone to 1.3% from 1.5%.

The IMF lifted Japan’s 2010 GDP forecast to 2.4% this year from 1.9%, but then shaved next year’s to 1.8% from 2.0%. Separately, the BOJ raised its economic assessment on 8 of the 9 regions. Yet earlier in the Asian session, news that machine orders fell 9.1% in May, a three-times larger decline than the consensus expected suggests that Japanese businesses may not be as optimistic as some survey data suggests on the outlook for exports and domestic demand. Orders from manufacturers were off 13.5%. Lastly, the latest polls ahead of the weekend upper house election show Prime Minister Kan’s support rating has slipped to 43.4%, down from 58.8% in June.

The UK reported a 0.7% rise in May industrial production. This compares with a consensus estimate of 0.4%. However, the magnitude of the April revision form a gain of 0.4% to a decline of 0.7% gives it’s a weaker cast. Sterling has fallen to 12-day low against the euro as the single currency rebounds. Germany, on the other hand reported much better than expected May industrial production figures, all the more impressive after yesterday’s reported weakness in orders data. The 2.6% rise in Germany industrial output compares with expectations for a 0.9% gain and the April series was revised to show a 1.2% gain rather than 0.9%. Strong export figures (9.2% vs expectations for 4%) drive home a message about German competitiveness.