Thoughts on the Week Ahead

There were several important developments over the weekend that may influence the activity at the start of the new week.  

First, the Australia drove out the Labor government, with its largely self-inflicted wounds, and gave the Liberal/National coalition what appears to be the largest parliamentary majority since 1996.  The new government is committed to cutting spending and taxes, especially the carbon/mining levies.    

This potential coupled with what many see as the shift in the central bank's stance is creating an attractive opportunity for investors.  The calculus for direct investment in the mining sector may change and the rise in interest rates is creating interesting carry opportunities.  The 1-year note offered the best yield in nearly two months  (~2.5%) on the eve of the election and the Australian dollar had its highest close since August 9.  The speculative community is short, leading scope for a further short squeeze.   

Second, China reported a larger than expected August trade surplus of $28.6 bln (vs consensus estimate of ~$20 bln).  Exports rose 7.2% from a year ago (vs consensus estimate of 6%), while imports rose 7% (vs consensus 11.3%).   Export strength as seen in electronics, textiles and machinery.  Exports to ASEAN countries rose 30.8% (year-over-year).  Exports to the US rose 6.1% (compared with 5.3% in July).  Exports to the EU rose 2.5%, roughly the same as the July pace and consistent with the modest recovery seen in the PMI data.  On the other hand, exports to Japan slowed for the seventh consecutive month.  

Many economists slightly raised their forecasts for China's growth year over the past week or so. They will likely see confirmation in the trade report, though the softer than expected imports could be a sign of weakness in domestic demand, or alternatively, the crackdown on fictitious imports used to disguise capital flows.  

This is an important week for China data, but the new optimism that the world's second largest economy will avoid a hard landing is unlikely to be challenged.  Before the markets open on Monday, China is expected to report consumer and producer price indices.   Producer prices have been falling on a year-over-year basis since early 2012 and this is continuing.  Consumer prices continue to be inflated, as it were, by food prices.  Non-food inflation in China running below 1.5%.  

China reports retail sales, industrial production and fixed asset investment in the coming days.  The market, like officials, will likely closely watch the new yuan loans and the aggregate social financing.  The difference between the two is a rough and ready estimate of the activity of the shadow banking sector.   That gap is expected to have more than doubled to CNY220 bln in August from CNY109 bln in July.  

Third, the results of the Moscow election were not known at the time of this post, but all indications point to a victory by Putin's candidate Sobyanin over the reformer Navalny.   It is the first direct election of the Moscow mayor since 2004.  

On one hand, the intensity of Navalny's campaign, who has been a vocal critic of the corruption of the government and state-owned businesses, says something important about the democratic forces in Russia.  On the other hand, his defeat is will reinforce the crackdown on the opposition that has intensified over the past year or so.  

Fourth, Japan was awarded the right to host the 2020 Olympics.  This is too far away to be a significant market factor, but some observers argue that this will reinforce the risk-on impulses which are seen as yen negative.    Although on Friday the dollar traded above Thursday's highs before finishing below Thursday's low, in what is technically a bearish key reversal, we recognize that important support levels held.  In addition, the US premium over Japan on 10-year bonds remains near its recently set 2-year highs, despite the pullback in US yields.  This is also a supportive factor for the greenback.  

Early Monday in Tokyo, Japan will most likely report a sharp upward revision to Q2 GDP figures. Quarterly growth may be nearly double the government's first estimate of 0.6%.  This will further solidify expectations that the government will go ahead with the retail sales tax hike on April 1. 

Separately, Japan will report July current account figures.  The headline is expected to have increased from JPY336 to JPY507, but that may be misleading.  Seasonal factors distort month-over-month readings.  

On a seasonally adjusted basis Japan's current account surplus will be halved toward JPY313 bln from JPY646 bln.   The take-away point is that it is not yet clear that Japan has reversed deterioration of its current account despite the yen having peaked against the dollar in late 2011 and a nearly 25% depreciation on a trade-weighted basis.  

The key determinant of the investment climate though remains the anticipation of Fed tapering later this month.  US employment data disappointed.  One simple way to capture this is to note that with the downward revisions, the US job growth have average 180k this year compared with 183k all last year.   Many observers had argued that the tapering decision was data dependent and though the disappointing data had a limited impact on expectations.    Perhaps the greatest impact, was on the level of conviction, but this is more difficult to ascertain.    

A CNBC survey found that nearly three-quarters of their survey respondents expect the Fed to taper in the Sept-Oct period (43% and 30% respectively), up from 60% in the July survey. Expectations of the size of the Fed's tapering has also been, well, tapered.  The consensus has scaled back from the initial step being $20 bln + to now around $12.5 bln.   Indeed there is more talk now of "tapering-lite" among the commentariat.   Our analysis has tended to emphasis the risks that market expectations were disappointed.  

The only central bank from a high income country that meets in the week ahead is the Reserve Bank of New Zealand.  It is widely recognized to be on hold.  However, this will be an opportunity for the central bank to lean against the idea seeming put forward by the Finance Minister that the decline in the currency may be 'good enough'.  This is to say the risk is for the central bank to recognize that the currency is still significantly over-valued (15% by OECD's measure of PPP).  

Norway holds parliamentary elections at the start of the week.  There has been a gradual drift to the right of the Norwegian political spectrum for many years.  The new government is likely to be led by the Conservatives and Progressives (with the Christian Democrats and Liberals).  It has campaigned on more public investment, less mortgage regulations and cuts in income and wealth taxes.  The Progressive Party may be the second biggest in the coalition and represented an anti-immigration current.  

Note that on September 15, the German state of Bavaria holds its elections a week before the national contest.  Many will see it as a bit of a litmus test for the national election.  Bavaria, is for all practical purposes a one-party state.  The CSU has run state government since the end of WWII.  It saw its fortunes wane in the last election in 2008, but is now running strong in the polls and is likely to regain its outright majority.  A strong showing by the CSU and by the Free Democrats will spur ideas that the center-right can avoid a grand coalition on the national level.  

The manufacturing PMIs in the euro area are generally trending higher.  This has bolstered official and investor confidence.  ECB President Draghi has even referred to them.  However, the real sector data has not always aligned.  Already for example, Germany, Spain, Portugal and Ireland have reported disappointing industrial production figures for July.   The Netherlands, France and Italy will ahead of the aggregate figure on September 12.  It appears that a large part of June's 0.7% rise was reversed in July.  

The UK's August jobs data and July earning's data will be released at midweek.  Any strength, especially a decline in the unemployment rate, which Carney's BOE has adopted as a threshold for policy review, will likely underpin sterling and weigh on UK rates.  The December 2015 short sterling futures contract implied a yield 60 bp higher than when Carney protested the implied interest rates at his first BOE meeting in early July.