In yesterday's session we saw risk aversion dominating on the back of weaker global growth concerns as well as the renewed uncertainty in the Euro-zone sovereign debt situation. The catalysts were weak manufacturing data from China, the US and UK, as well as surging yields in Italy and Spain.
This morning in NY, things have calmed a bit, and that has helped higher yielders to stage a comeback against safe haven currencies like the JPY, CHF and USD.
In Europe, we are only 2 weeks removed from the EU Summit, but bondholders are getting panicky yet again, selling Italy's bonds, and causing the Prime Minister to address Parliament on the issue of the market.
European politicians thought they had bought themselves some time with the EU Summit, but it wasn't long before the waters got muddied by Germany, in regards to how the EFSF would be used to help stabilize secondary bond markets, and it became apparent that a template was set in which bond holders are going to take losses on their Greek holdings and that this same formula may be used in the case of other Euro-denominated debt. The best that EU leaders can do now is to say that the July 21st Summit decisions are implemented as soon as possible.
Still, we did have a few positive today from Europe:
- A stronger than expected retail sales report which showed sales up 0.9% for hte month of June, which beat expectations of a 0.5% increase, and helped pare most of the 1.3% decline we saw in May in the region.
- The final version for the Services PMI increased slightly from its 51.4 preliminary reading.
- Yields from Spain and Italy got a respite.
We await further word from EU and ECB leaders as they try and calm markets further.
In the UK, we had a positive Services PMI report. The index for July rose to 55.4 from 53.9, helping to take some of the sting out of the weak Manufacturing PMI report from Monday.
For more on the GBP/USD see today's Technical Update: GBP/USD Still Looks to Break 1.64 After the ADP Employment Release
The EUR got a boost from the surprise move by the SNB to lower interest rates and to strongly step up their rhetoric in regards to the recent appreciation of the Swiss Franc. It seems that the SNB is done waiting on the sidelines as the higher Franc is cutting into export growth and causing real pain to the economy.
A lower interest rate and more liquidity should help businesses and the economy to cope with the stronger Franc helping to undo some of the damage of the stronger Franc.
This is a net positive for risk sentiment.
See more on this story in our Fundamental Update: SNB Takes Different Tact from '09-'10 Intervention, Adopts ZIRP
The Bank of Japan meets on Friday, and market participants expect policy makers to undertake further liquidity measures in the form of more quantitative easing.
From Bloomberg: "The BOJ may move to ensure that the appreciating yen doesn't damp exports and derail the economy's recovery from the March earthquake and tsunami. Five of 14 economists surveyed by Bloomberg News said the central bank will increase monetary stimulus at its Aug. 4-5 meeting, while two said there's a possibility of it and seven said it will probably stand pat.
"The BOJ will likely announce an easing measure as soon as possible this time to respond to the strong yen and weak dollar caused by the U.S.'s slowing economy and worsening financial conditions," said Masaaki Kanno, chief Japan economist at JPMorgan Chase & Co. in Tokyo and a former BOJ official. "The Japanese economy has become less resilient to a stronger yen as competition from Asian companies has become more severe."
The central bank may provide further monetary stimulus this week, the Nikkei newspaper reported yesterday without citing a source for the information. Japanese officials are also preparing to sell the yen, the report said."
As we have seen recently, unilaterl intervention has not been successful in keeping the Yen from appreciating, and while multilateral intervention back in March helped to push the Yen lower, market participants have brought the currency close to those March lows.
Therefore, more quantitative easing may be the best option for central bankers. More stimulus is a positive for risk sentiment as it means that there is more support in the economy and that Japan's recovery can continue apace despite the stronger Yen.
In the US, futures are looking at a positive open for US stocks, following yesterday's plunge amid concern that the prospects for US growth are dimming.
- The private sector did add 114K jobs in July according to ADP, which was better than the 100K or so expected by economists. That was a small positive factor for risk sentiment, but the ADP has lost the trust of traders after it posted a 154K gain last month only to then see the NFP come in at a tepid 18K.
The US markets will focus on the ISM Non-Manufacturing report, which is expected to show a slight increase in July to 53.8 from 53.3 in June.
The weaker GDP reading, manufacturing report and no more avenues for fiscal help for the economy has opened the door to further quantitative easing by the Fed. While that may help the US recovery and would also be a positive for risk sentiment, a 3rd round of QE would put pressure on commodity prices and can create higher global inflation while the global recovery is starting to slowing. That consequence of Fed policy could just as easily make more QE from the Fed seen as an event that increases downside risks to the world.
Is Today's Rally the Eye of the Storm?
While it doesn't seem there is a single magic bullet that central bankers can use in coordination to calm markets, each is trying there own way to stem the problems in their countries. With the help of some positive data overnight, it seems to have worked enough stabilize markets following yesterday's turn towards panic, however the problems faced by the major economies remain unsolved.
- Europe continues to face a debt crisis, though its central bank is raising rates while providing liquidity to the regions banks.
- Japan and Switzerland are facing problems from their appreciating currencies and will try and use lower rates and QE to help stem appreciation of the JPY and CHF.
- In the US, concern revolves around the weak recovery, which appears weaker than previously though as well as the threat of a downgrade of its credit rating.
- In the UK, the country is grappling with a slow recovery amid austerity measures and high inflation.
Combining these factors together and we see that investors have plenty to worry about. We have some calm here as we may be in the eye of the hurricane prior to key risk events including Friday's Non-Farm Payroll. If it disappoints, we can have another lurch back into risk aversion and selling of higher yielders.
It's time for policy makers - both central bankers and politicians - to earn their pay, and convince the markets that they have a strategy for the way forward. The currency markets in the meantime will continue to remain volatile.
Chief Market Analyst