Drivers in the Week Ahead

This will be an eventful week.  The highlights include four central banks meetings (Reserve Bank of New Zealand, the Bank of Canada, Sweden's Riksbank and the Federal Reserve).  The first estimate UK and US Q3 GDP will be released, while the euro area flash October PMI will be reported alongside Germany's IFO.  

The RBNZ and the BoC are likely to soften their stances, even though the chances of a outright policy shift are slim to none.  The fact that the Federal Reserve had previously announced an open-ended MBS purchase plan and the proximity of the election means the FOMC is on the sideline.  That leaves Sweden's Riksbank as the most likely candidate to surprise.  Recently the governor of the central bank squashed speculation of a rate cut, fueling recovery of the krona, even this did not stop some of the dovish members from pressing their case.

The euro zone flash PMI expected to confirm that contractionary conditions persist here at the start of Q4. However, the real sector data has generally been reported better than the survey data has led economists to forecast.  Even though the German economy has lost its momentum since H1, the IFO will point to its general resilience.  

Both the US and the UK economies are likely to report better Q3 performance than Q2.  The UK economy after all has contracted in three consecutive quarters beginning in Q4 1.  It was interrupted in Q3 and the Bloomberg consensus is for a 0.6% expansion.  We see scope for disappointment, but still expect positive growth.  The consensus in the US is for a 1.8% annualized pace in Q3, a bit faster than Q2's 1.3% pace. However, here too the risk seems to be on the downside. 

In addition to these new impulses, the market will be digesting a few developments that happened last week and will still be on investors' radar screens this week.  

The most important decision from the EU Summit was not when the bank supervisory function would be established or operationalized, but it's scope.    Here the position of the creditors seems adamant.   Legacy assets of the banks would not be covered by the ESM.  Even though many investors did may not have seen the significance, Spain, most directly impacted, did.  The headline in El Pias read "German Prevails, Spain Loses Banking Union Battle".  

Ireland may have appeared to have also been disadvantaged by the position of Germany and the other creditors and this is the way the local press took it.  However, on Sunday Irish PM Kenny and Germany's Merkel made a joint statement suggesting that Ireland may be treated as an exception.  

At the end of last week, after the markets had closed, the Canadian government blocked a state-owned Malaysian oil company (Petronas) from purchasing Canada's Progress Energy Resources for C$5.17 bln.   This was a surprise in and of itself, but intentionally or not, it injects an element of uncertainty in China's CNOOC's C$15.1 bln offer for Canada's Nexen.   In turn, this may have broader implications on the premium some analysts see in Canada's resource sector due to the underlying foreign interest.  

This comes at the same time that the Bank of Canada has signaled it is in less of a hurry to "remove accommodation" and the Finance Minister indicated that enough has been done to cool the housing market. This points to less fundamental support for the Canadian dollar, which dovetails nicely with the deterioration in the technical outlook.  

Before the weekend the Hong Kong Monetary Authority intervened for the first time in three years to lean against the upside pressure on the Hong Kong dollar.  HKMA announced the purchase of $603 mln, absorbing flows that were attracted to the Hang Seng, which has rallied more than 13% since early September, and the local property market. 

More broadly, according to EPFR Global data, emerging market equity funds saw their sixth consecutive weekly inflow and has taken in $28 bln year-to-date.  Of note, Chinese shares have moved higher for three consecutive weeks now, which is the longest streak in six months, and has lifted the Shanghai Composite to seven-week highs. 

There have been two talking points about China recently.  The first was the capital outflows and the second was the yuan's appreciation, which caught many observers by surprise.  The most recent data suggests capital inflows returns in September after outflows were experienced in July and August.  Chinese financial firms reportedly bought CNY130.7 bln of foreign currency in September (converting it to yuan) last month, which is the second highest monthly figure this year. 

The yuan has appreciated 1.9% against the US dollar over the past three months an 0.8% over the past month.  Conspiracy-enthusiasts and some partisans have suggested that China's is responding to Romney's more confrontational rhetoric.  While this is possible, it strikes us as unlikely.  We note that in 2008, Obama's campaign had been critical of the Bush Administration for not being tougher on China and early on Geithner accused China of manipulating its currency.  During the run-up to the 2008 election, China did not allow its currency to appreciate.  

A more likely interpretation recognizes the resumption of capital inflows into China and that the yuan trades against a basket.  During this time, the euro has also trended higher against the dollar and the euro and yuan tend to move in the same direction (though different magnitudes ) against the dollar.

The yen has been the weakest G10 currency over the past month and week and this holds today as well as the greenback approaches JPY80.   There are several factors weighing on the yen.  S&P's warning about Japan's credit rating hit an already weak yen market.   The BOJ is under strong pressure to ease further.  Not only will it recognize that its inflation target is nowhere near being reached, when it releases its report next week, earlier today it announced a cut in the economic assessment in 8 of 9 regions.  Since the July upgrade, there appears to have been an abrupt and widespread deterioration of economic conditions.

Prime Minister Noda, who continues to see his support erode, has signaled interest in additional fiscal stimulus, but as this would come out of the existing budget and is seen to be about 0.25% of GDP the effect seems minimal at best.  Some observers continue to play up the risk of material intervention.  We continue to believe that intervention is not likely and if it does materialize, it will be unilateral and criticized by other G7 countries.

Separately, Japan reported a JPY558.6 bln trade deficit in September.  While it was a little smaller than the consensus forecast, what weighed on sentiment was the 10.3% year-over-year decline in exports, the fourth monthly decline and a sharp acceleration from the -5.8% pace seen in August.