In what can only be described as a remarkably candid assessment, China’s Ministry of Industry and Information Technology overnight claimed that both domestic and external conditions were still ‘grim’ and that the economy was likely to endure further downward pressure. Companies in China are confronting growing operational difficulties, including much higher prices for energy and substantially higher wages. Interestingly, there has been little response in Asia overnight to this report, with equities becalmed ahead of tonight’s FOMC decision and Friday’s BoJ meeting. In foreign exchange markets, even the Aussie ignored the warning, which is unusual because it is invariably extremely sensitive to changes in China’s economic outlook. Instead, it appears that more attention was paid to Premier Wen Jiabao’s promise to stimulate the economy through additional policy measures if required. More stimulus from Beijing cannot be far away because it is clear that the economy needs it to achieve the growth targets set by policy-makers.
Japan goes further
It seems like some time ago now that Japan threw everything, including the kitchen sink, at the deflation problem. Now they are ripping out the plumbing and anything else they can find to try and escape the deflationary slump which the economy has been suffering from for the best part of the past fourteen years. The latest meeting has seen the Bank of Japan expand its asset purchase-program by a further JPY 10trln (to JPY 40trln). It also chose to extend the maturity of both government and corporate bonds to be purchased under their QE program. It now has an inflation target of 1%, which it remains confident of reaching “in the medium to long term”, but that is a long time in central banking terms and markets hold little faith in such a forecast, largely through the bitter experience of recent years (and not only in Japan).
Seeing red
Yesterday proved to be a fairly tumultuous day in markets, in stocks especially. For Europe, it was a combination of the economic and political that conspired to put pressure on investor sentiment. Events in both France (a likely change in president) and the Netherlands (a backlash against austerity) impacted sentiment, as did the softer PMI data for both France and Germany. For now, it appears that the factors that were supportive for most of Q1 (ECB 3Y money, Greece inching back from the brink and better US data) are waning, but suitable replacements have yet to be found. For FX, this is seeing a stronger return to ‘risk-off’ moves into month-end, so the dollar is firmer against most (the yen excepted) and the Aussie is suffering the most, helped by softer inflation data overnight.
Cautious optimism from the Fed
The Fed decision last night was not expected to rock the boat, but the subtleties cannot be ignored given the reliance of many asset markets upon the Fed’s continued easy money stance. There was a subtle upgrading of the Fed’s growth outlook, the statement acknowledging an improvement in the longer-term picture. Although the Fed’s commitment to keep “exceptionally low levels” for rates until late 2014 remains, the charts released with the statement show a notable proportion of the non-voting members are looking to raise rates earlier. This is ensuring that the debate remains healthy at least. Markets proved relatively resilient to the Fed Chairman’s remarks, although the dollar does stand modestly softer against most major currencies since the meeting results. In a relative sense, the US continues to stand out from the pack in the developed non-Asia world, especially in light of the UK GDP numbers yesterday and the likely weakness in Q1 eurozone data in the coming few weeks.
Cautious pessimism
During April, markets have displayed a far more cautious tone to that seen through most of the first quarter. FX markets were earlier than most to adopt this tone, with high-beta currencies turning at the start of March, much earlier than most equity markets. As we enter the last full week of April, this approach seems set to continue. The first round of voting in the French presidential election campaign has strengthened the view that Sarkozy is unlikely to see a second terms and markets are slightly nervous regarding his likely successor, Francois Hollande. The US Federal Reserve also meets this week, but all the signs are that it is unlikely to satisfy those hoping for a fresh round of quantitative easing, despite the ongoing underlying weakness of the economy. Furthermore, the latest PMI data from China (HSBC manufacturing series) increased to 49.1 (from 48.3), keeping alive concerns about the extent of the slowdown currently being seen in China. Finally, the latest producer price inflation data in Australia appear to have further cemented the case for a fresh rate cut next month. Cautious pessimism is likely to remain the theme as we head into month end.
Commentary
Another eurozone leader set to bite the dust. The first round of the French presidential campaign saw the incumbent Sarkozy win just 27% of the vote yesterday. His socialist rival François Hollande took nearly 29%. Whilst this may not seem like a huge divide, there is a strong feeling that the second round will see Hollande take the majority of support from the minor parties that received votes from those disaffected with Sarkozy. Hollande has softened his rhetoric as the campaign has progressed, but nevertheless markets are naturally nervous. He has thrown out hostile words towards the ECB, the ‘fiscal compact’ and other budgetary measures in recent months. As most new leaders have found though, the numbers are the same whoever is at the helm and whoever wins will face the same tough budgetary battles to retain the full faith of bond markets in the months ahead.
The pound’s purple patch. Friday’s better than expected retail sales figures make it even more likely that the UK economy avoided falling back into recession last quarter. In the three months to March, the volume of retail sales rose by 0.8%, quite a respectable performance. Moreover, apart from sluggish demand for clothing and footwear, growth in consumer demand in the first quarter was broadly based. Naturally, the month of March was aided by a surge in fuel sales; it being the warmest March for 55 years also helped. Also, preparedness by retailers to offer keener pricing has encouraging spending on a more general level – for the March quarter the retail price deflator rose by just 0.4%. Indeed, in non-store retailing, significant price deflation was apparent in the most recent quarter. Placed alongside firmer house prices, stronger employment growth and decent anecdotes emerging from both the services and manufacturing sectors, it is clear that the UK economy did better in Q1 than expected. Indeed, MPC perma-dove Adam Posen was moved to opine that the economy is actually stronger than the official data will show. In response, cable moved is at 1.61 and EUR/GBP has fallen to a new 20-month low of 0.8177. GBP/AUD has jumped through 1.56, a four-month high.
The risks in Germany. The key Ifo data on Friday was modestly above expectations, but in the current environment that was enough to give the single currency a lift to the European session highs above the 1.3165 level. Following the decline in GDP in the final quarter of last year, there has been a strong focus on the pace of momentum of the German economy and specifically questions as to whether that was a brief blip or the start of a more sustained slowdown. The Ifo data, together with other survey releases, are erring towards the latter, although they are not suggesting that the economy saw a strong reversal upward during the first quarter. But the central issue is the extent to which the German economy can continue to grow despite what is going on in the European banking sector. The data last week from Spain has reminded us that the situation is primarily a banking/credit bubble rather than a sovereign crisis (though this is of course a by-product). The main risk in Germany is that this bubble manifests itself in a further contraction of lending through the year, more aggressively impinging on the German economy. The eurozone already experienced a sharp fall in lending towards the end of last year and the YoY pace of lending to households risks falling into negative territory over the next couple of months. Such a trend will impact Germany, but less so than other nations, so the divide between the core and the remainder will continue to grow.