The Week Ahead: Eight Observations

1.  Important and sustained trends are in place.  The dollar has appreciated against the yen for twelve consecutive weeks, which appears to be the longest streak in the floating exchange rate era.  The euro has risen for six months against the dollar, the longest advance in nearly a decade.  The six-month advance against the yen is the longest since 1999.  

2.  The ECB meeting is important.  There has been a tightening of monetary conditions in the euro area.  There are some calls for the ECB to cut rates, but we do not think it will.  The first line of defense is moral suasion.  The reduction in the ECB's balance sheet, which is now the smallest in about a year, is a symptom not of undesirable developments, but the improved access to private sector funding.   Draghi is likely to calm market anxiety.  

3.  There is one way that can reconcile the weakness in Q4 US GDP and the upward revisions to US employment growth (now 201k a month, rather than 151k):  a drop in productivity.  Q4 productivity most likely fell for the first time since 2009.  In turn, the drop in Q4 productivity means that unit labor costs increased.  However, the real signal is that the US economy is enjoying some momentum going into the March 1 sequester deadline.


The Jan manufacturing ISM is a nine-month high.  The Jan ISM services is expected to remain near the 10-month high seen in Dec.  Auto sales remained strong in Jan, with the sales of domestic producers making new cyclical highs. This combined with the wealth effect of the rising stock market and the continued recovery in house prices may help blunt the impact of the increase in the payrolls saving tax.  

4.  The Bank of England meets, but this will be a non-event.  There is a more important development on Thursday, the day the two-day MPC meeting concludes.  NIESR will report its rolling three-month GDP estimate.  A small positive reading is likely, though this may be anticipated if the Jan services PMI on Tuesday pops back above the 50 boom/bust level, which it dipped below for the first time since Dec 2010.  Note that in Jan 2011, the services PMI snapped back well above 50.  Also on Thursday, the next BOE Governor, Carney will appear before the Treasury Committee in parliament.  He is likely to show a more activist, which in current circumstances means more dovish.   December trade and industrial production may pose some headline risks, but are too dated, given that Q4 GDP has been released, to contain much new information.  

5. Japanese rhetoric about the yen is likely to be more tempered in the run up to next the upcoming G20 meeting.  Japanese officials will still defend recent price developments as an unwinding of the yen's excessive strength, but will likely refrain from specifying comfort levels.  Japan is expected to report a small current account surplus for December, where the income from past investments offsets a a little more the increasingly persistent trade deficit.  Separately, there does appear to be a recovery in the industrial sector taking place and we expect this to be reflected with an increase in core machinery orders.  

6.  The Reserve Bank of Australia meets with a decision early Tues in Sydney.  Most do not expect a rate cut and see a move in March more likely.  An earlier move, though, should not be that surprising.    Data out earlier today--building approvals and job ads--were weaker than expected, suggesting the economy is still losing momentum.  As we noted in our review of positioning in the futures market, there appears to be substantial long speculative positions that are vulnerable.  There is asymmetrical risk associated with the employment data at midweek.  A weak report, especially a loss of full-time jobs, which would be the third consecutive decline,  would be likely bolster expectations for a March cut.   On the other hand, a strong report would not necessarily negate such expectations.  Meanwhile, we note that over the weekend two senior ministers resigns and PM Gillard support is falling and allies of Rudd are seeking revenge.  

7.  There was a divergence last week between the official Chinese manufacturing PMI and the HSBC measure.  The former fell and the latter increased.  The Chinese official services PMI ticked up ever so slightly to 56.2 from 56.1.    The Jan yuan loan report may be issued late in the week and this is important.  The Dec report was disappointing and this fed into doubts about the sustainability of the economic recovery in China.  A strong report will bolster sentiment   Trade figures may also be released late in the week.  The consensus is looking for strong gains in import and exports.  We are skeptical, and if true, may be distorted by the rush before the Lunar New Year.  The Shanghai Composite has risen by nearly a quarter in the past two months and is at it highest level since last May. 

8.  Two central European central banks meet.  Poland is expected to cut rates by 25 bp.  This will not be a surprise and we expect limited market reaction.  We generally like the zloty and the recent setback appears over and may provide a lower risk opportunity to increase exposure.   The Czech central bank meets and is expected to leave the repo rate at the record low 5 bp set in November last year.