Global Investment Climate: Pieces falling into Place

Investors learned last week that the US created 1.38 mln net new jobs in H1, the most for a six-month period since 2006. They learned that US vehicle sales in June also reached an 8-year high. For its part, the ECB emphasized that the TLTRO facility could inject around 1 trillion euros into the banking system for loans to businesses and households. It also announced that the rules of engagement will allow banks that already work closely together to tap the TLTRO facility collectively.

In Japan, the Tankan was mixed as sentiment among large businesses deteriorated a little more than expected, but capex plans increased. Separately, data showed that overall household consumption collapsed in May, warning that the impact of sales tax increase, coupled with base wages and return on savings not keeping pace with inflation, may have compress demand longer than Japanese officials may appreciate.

These developments were not game changers. The dollar remains within the two yen range (JPY101-JPY103) that has largely confined the price action since early April. It recovered into the middle of that range with the help a 10 bp net increase in US Treasury yields. At 207 bp, the US premium is at its 200-day moving average. The dollar managed to resurface above its 200-day moving average against the yen (~JPY101.80) and finish the week above it.

The euro has been confined to a two cent range ($1.35-$1.37) for the past six weeks. The decline from near $1.40 appears to have be participants anticipating the June rate cuts. The euro was actually stronger against the dollar before the ECB's July meeting than it was at the June meeting.

If last week's developments were not able to break the dollar out of its ranges, the events in the week ahead are unlikely to either. The May industrial production reports from the largest euro area countries will likely confirm the general impression that investors already have. Germany has lost some momentum. Spain is performing well. France and Italy are struggling.

The main release from Japan will be its May current account figures. There are two key components. The trade balance and the investment income balance. The former is in deficit, despite (or because) the significant decline in the yen. The latter is in surplus and sufficiently so that it should overcome the trade deficit and put the external account into surplus.

US data cycle is also at a low ebb in week ahead. The JOLTS data on the labor market may receive more attention by economists given that Fed Chair Yellen has referred to it. However, it is not a market mover. It follows on the heels of a national survey and is unlikely to dissuade investors and policy makers that the Fed is drawing nearer its mandates.

The FOMC minutes rarely provide market moving material either. Note that the minutes often give air to a wider range of opinion that the Fed's statement following the meetings, as non-voters also participate in the meeting. Yellen's willingness to play down the recent upticks in inflation and play down risks to financial stability are not necessarily universally shared. As QE3+ will be wound down in a few more months, discussions of the Fed's toolkit to manage policy, such as reverse repos, are bound to increase, and there is plenty of scope for difference of opinion.

The heuristic point we make is worth repeating in this context.  Yellen and Dudley (and we expect Vice Chairman Fischer to join them) generate the important policy signals. It is not that the others do not have important things to say, far from it. However, when trying to discern the signal from the noise, Yellen and Dudley (and Fischer) can be counted on for the signal.

The consumer credit report is unlikely to move the markets either, but it nevertheless offers important insight. Most of the household consumption that has taken place during this cycle has not been financed with revolving credit (that is credit cards). The bulk of the credit that has been extended is for auto and student loans. However, in April, revolving credit rose by $8.8 bln, which is most in seven years. To put this in perspective, consider that even including it, the 12-month average growth in revolving credit is a little less than $1.7 bln. The May report will lend credibility to this turn or show it as a fluke. We are more inclined to expect the former, which is to say that the de-leveraging of the American household may have very well run its course.

The Bank of England meets, but for investors, this is a non-event. It is too early to look for a rate hike. The minutes will not be published until July 23. Although some members see conditions that may soon justify a rate hike, no one seems prepared to pull the trigger now. Expect a unanimous decision to keep rates on hold.

Separately the UK reports industrial production figures for May. Recall that the May manufacturing PMI edged lower to 57.0 from 57.3. Barring a significant surprise, it should be consistent with the preponderant of evidence indicating the UK economy continues to expand at a robust pace (just shy of 1.0% quarter-over-quarter pace)

The combination of the growth differentials, strength of sterling and some structural factors has contributed to the UK's large external deficit. The visible (goods) trade balance is expected to be near the six month average of GBP8.8 bln. The overall trade deficit (including services) is expected to have narrowed sharply to GBP1.6 bln (six-month average is GBP1.66 bln deficit) from a GBP2.54 bln deficit. 

It is a big week for Chinese data, but the general sense that with the aid of targeted government support, the economy has stabilized is unlikely to change. The inflation China is experiencing is concentrated in foodstuffs. Goods and service price inflation is running below 2.0%, and producer prices are still falling (albeit at a slower pace). Official efforts to rein in the shadow banking activity likely means that yuan bank loans should account for a larger share of aggregate social financing.

Arguably the most interesting data will relate to reserve growth and trade. In Q1, reserves jumped $126.8 bln on a Q1 trade surplus of $23.1 bln. Reserve growth then outstripped the trade surplus by a factor of 5. This is a prima facie case that the reserve growth was more a function of sterilizing the capital inflows than recycling the trade surplus.

Assuming a $37 bln trade surplus in June, as the consensus forecasts, that would bring the trade surplus to about $91 bln in Q2. Export growth may have accelerated (consensus is for around 10% increase after 7% in May). Imports fell 1.6% in May and are expected to have risen by around 5.5% in June. Reserves are expected to have risen by about $30 bln. Such results would be consistent with capital outflows from China in Q2.

The IMF's models suggest the yuan is near fair value. The US Treasury recognizes the large reserve growth as evidence that it is not. Treasury officials have it made it clear. It would rather China buy US goods than buy Treasuries. The next round of Strategic and Economic Dialogue talks will be held on July 9-10 in Beijing and Secretaries of State, and Treasury (Kerry and Lew) will lead the US delegation. A Deputy Secretary of Defense will also meet his counterpart.

In light of the economic and political context, some yuan appreciation would not be surprising, within, of course, a limited framework. In fact, the dollar's peak against the yuan was two months ago (April 30, almost CNY6.27). It finished last week near CNY6.2050. The dollar could ease into the CNY6.15-CNY6.18 range.

The Swedish krona and Norwegian krone are the weakest of the major currencies against the dollar last week. The krona's 1.6% decline brings its losses for the year to almost 6%. It is the weakest of the majors. The 50 bp cut by the Riksbank last week was more aggressive than the market expected. Moreover, that the Governor and First Deputy were outvoted (4-2) creates some uncertainty. At the same time the large move renders the coming data, including CPI, less important. The krona can continue to under-perform.

Norwegian krone lost 1.0% to essentially double the year-to-date loss. The losses were mostly in sympathy with its neighbor, but there has been a more dovish shift in the central bank’s stance. The krone weakness buys the central bank time for inflation to fall, it which case it can cut rates, or for the economy to pick up. It should outperform the krona.