Thoughts on the Week Ahead

There are many events and economic reports that can roil the market in the days ahead.  Yet, just as importantly, there are already forces at play that will shape market developments.  Here are 8 thoughts about what to expect.  

1.  The US employment data failed to have much impact on expectations the timing of the Fed's tapering.  A recent news wire poll found a median expectation for it to begin in Oct and by about $20 bln.  The key issue is whether the appreciation of this is sufficient to stabilize long-term US interest rates.  It does not appear to be, which means, barring a significant surprise, US yields do not appear to have peaked yet.  The 10-year yield can rise into the 2.25%-2.40% area.  This need not be supportive of the dollar against the other major currencies, if it is part of a larger unwind of positioning.  

2.  The interest rate on a 30-year fixed rate mortgage has risen from 3.6% to 4.1% in recent weeks.  It is first time its is above 4% in a year.  Yet, the impact on the housing market may be mild.  Rates are still not high, by nearly any metric.  Activity has been lifted by participants, like institutional investors, that are less sensitive to marginal interest rate changes.  Moreover, the real hindrance has not been the cost of credit, but the access.  If lenders have greater confidence of a self-sustaining recovery, then perhaps they would increase their willingness to lend.

3.  After testing 1600 last Thursday, the S&P 500 gapped higher on Friday.  It extends from Friday's opening and low print of the session (1625.27) to Thursday's high (1622.56).  Although there are several different types of gaps, this one appears to be one of  two kinds. The first kind would be filled over the next day or two and that would suggest a near-term set back.  The second kind will not be filled in the near-term and it is a type of break-away gap.  After retreating by 5% over two-weeks, the gap signals the end of that move, which means new advance is at hand.  We are inclined toward the latter and anticipate it will lead to new highs for the index.  

4.  The S&P 500 peaked on May 22, the day before the Nikkei.  The Nikkei has slumped 21%, which brought it within spitting distance of a 50% retracement of its gains since the election was called in mid-Nov '12.  The pre-weekend rally in the S&P 500 and the recovery of the dollar against the yen following the US employment report, points to a likely recovery of Japanese shares.

5.   The key political event of the week is the German Constitutional Court ruling that is expected Tuesday or Wednesday.  As has been done with other measures that are forging greater European integration, there is a legal challenge to the ECB's Outright Market Transaction program.  It could side step the issue and refer the ECB powers to European courts, claiming perhaps that it does not have the authority to rule.  It could agree with the complainants and find that the ECB has encroached on a right that belongs to the German people through the parliament.   It could find that the OMT is not an infringement on Germany sovereignty and use the case as another opportunity to draw conditions or lines that need to be respected, which is what we expect.   

6.  The Bank of Japan and the Reserve Bank of New Zealand meet in the week ahead.  The BOJ concludes on Tuesday.  There may be some minor operational tweeks and it could announce a new longer-term repo facility (2-years) as a possible way to help stabilize the JGB market.  The RBNZ meets on Thursday and we see it in no hurry to raise interest rates, though that is the direction of the next move in rates.   The New Zealand dollar has dropped nearly 10% against the US dollar since early April, though has gained 1.5% against the also falling Australian dollar.   The central bank, which has begun intervening in the foreign exchange market, no doubt welcomes the weaker currency.  

7.  There are several economic reports that offer headline risk in the days ahead.  At the start of the week, in Japan, a small upward revision in Q1 GDP is not great shake, but April's current account will be scrutinized.  The increase in bank lending is expected to continue, bolstered by reconstruction efforts and foreign investment.  Machinery orders are likely to have been set back at the outsized March jump.  A rise in corporate goods prices reflects higher cost imports, including energy, and this has been aggravated by the weakness of the yen.  Weekly MOF portfolio flows have taken on greater interest of late.  It is a light week for European reports, but the focus will be on industrial production reports (including the UK and Sweden).  The UK also reports on the latest labor market conditions.  The euro area reports CPI figures at the end of the week.   The two economic highlights for the US will be the retail sales report on Tuesday and industrial production on Thursday.  The consensus looks for a 0.4% and 0.2% rise respectively in the headline figures, while the retail sales measure used for GDP calculations is expected to rise 0.3% while manufacturing is expected to have risen by 0.2%.  Risk seems asymmetrically distributed to the downside of both reports.  

8.  There are several central banks in the emerging markets that meet, including India, Korea, Philippines, Chile and Russia.  None are expected to cut key lending rates, though there is some expectation for the Philippine Central Bank to cut its special deposit rate by 25 bp (to 1.75%), which it has done three times this year to try to curb the short-term capital inflows.  Brazil's markets will also be closely watched after last week's lowering (technically not abolishing) the tax on foreign purchases of Brazilian bonds to zero and S&P put the country's ratings outlook on negative watch.  South Korea may also be interesting after 3 nuclear reactors last week were suspended indefinitely for using forged safety certificates.  At the end of last year 2 other pans were closed for similar reasons.  With seven other reactors out of service due to routine maintenance, the country has lost about a third of its electricity capacity.  The government warned of "unprecedented shortages".  This may be another headwind for the South Korean economy that could last the better part of the summer.