Global Macro Brief
Basic fundamental – Borrowing is not the way out
The global downside risks towards the end of the year will be still the Euro Zone’s crisis development and the US fiscal cliff to constrain consumer spending.
Draghi and other EU policymakers’ comments helped bolster the risk assets once again. However, as we all know, the effect may soon fade away because that was what we saw in the past 2.5 years.
The Euro Zone’s problem will not be solved by just one or two comments from the policymakers or even a few summits. Budget deficit cut definitely doesn’t work well under the current currency bloc’s scenario and could make the story worse because those fiscal policies have slowed down the growth and problems become more severe because many negative consequences might follow such as rising unemployment and less government income.
On the other side, the balance sheet in the Euro Zone is too heavy, and the ECB has implemented 5 to 6 different measures along the 2.5 years of debt crisis, but I have not seen any improvement at all. More countries have lost the access to the credit market and struggling to seek the bailout.
Draghi has put his personal credibility on the dot because he has to deliver something at the ECB press conference this Thursday. But no matter what he is going to do is far from enough to settle the sovereign crisis.
In the US, the slowdown in Q2 GDP growth reflects cutbacks in consumer spending because a soft job market appears to have encouraged the household to save a bit more. The Personal Consumption Expenditures (PCE), ISM Manufacturing data and the NFP will be the top-tier economic releases this week, while the Federal Reserve (Fed) is also going to release its monetary statement in the coming FOMC meeting. As usual, I do not expect there will be anything new in this FOMC meeting and majority of the these key economic figures are expected to remain in a soft pace. I expect the PCE deflator stands at 1.6-1.7% y/y, ISM Manufacturing Index at 50.6-50.8, and the NFP to expand 99,000-105,000.
The BOE rate decision and MPC asset purchase facility are also due out this week. I do not expect that there will be any changes this time around although the UK reported a much weaker than expected Q2 GDP last week.
Euro Zone
Further rate cut unlikely; Is the European Central Bank’s (ECB) Securities Markets Programme (SMP) the next “bazooka”?
ECB council member Ewald Nowotny said there were arguments for giving the European Stability Mechanism (ESM) a banking license earlier last week, and later in the week, Draghi said “the ECB is ready to do whatever it takes to preserve the Euro dollar, and believe me, it will be enough .” From Draghi’s comment, the central bank would not only look at lowering the borrowing cost, but also aim to improve the negative impact on the financial sectors in the region. The central bank is also going to seek the stands from the Bundesbank next week before the ECB press conference.
Yesterday, the leader of the Eurogroup Finance Ministers Jean-Claude Juncker, who is based in Luxembourg, said the European Financial Stability Facility (EFSF) and the ECB were going to intervene to reduce the borrowing cost. However he did highlight that no details have been made yet and in what action to be taken will be discussed in the coming days because the currency bloc has no time to lose in his point of view.
The worse than expected growth projection and high uncertainties hinted by the central bank in the last press conference plus the new presentation from Draghi last week have put the ECB press conference this week in the center of the stage among all the economic releases.
The rate cut last month without other measures, to depreciate the common currency against the board could be one of the tactics by the ECB, and it looked like that they have made it. A further rate cut in the coming minutes will only show that the current mode is in a panic mode, and nothing positive. By referring to what he said last week, things might go worse.
A new Long-term Refinancing Operations (LTRO)? Last month, Draghi mentioned that it was still early to finalise the full impact of the previous stimulus (2 LTROs) on the economy, and credit activities such as Lending Survey was still stable. That means the liquidity is not a major concern that echoes Draghi’s comment in the last ECB minutes. Thus, the third round of the LTRO to happen is unlikely, either.
The question now is whether the ECB is going to reactivate its SMP programme or other bond purchasing programmes. There is a chance for this to be happen, be it at the ECB’s conference or on other days.
Source: Bloomberg
Click the image to enlarge
Source: Bloomberg
Click the image to enlarge
There are really too many similarities between last year and this year. Same time last year, the reactivation of the ECB’s bond purchasing programme had lowered Italy’s borrowing cost sharply from 6% to 5%, and what Draghi commented last week has pushed the bond purchasing possibility to another high. At least this is what the market expected.
You can argue Draghi’s comment in his last press conference that the ESM will have ample size to deal with emergency, but the tricky thing is that the ESM is still pending Germany’s decision and the outcome is expected to be released in the middle of September. Thus Draghi has more than enough reasons to convince the rest that such “SMP” is acting like a tool to fill in the window period if he really wants to do that. It is a bit contradicting to his usual view that “policymakers to act first”, but he has put his words on the table last week and the ECB is in a passive position at this time. No meaningful strategy, which seems that bond buying is the only choice, to be mentioned this week. All the gains in the risk assets and all the losses in the Euro Zone’s bond yield will be erased quickly.
Spain is going to release its preliminary Q2 GDP later in the day. I expect a further contraction figure to be released. However, the policymakers and Draghi’s statements made it “irrelevant” to the price direction. However, the austerity measures and deteriorating confidence in the country could force the country to stay in recession until late 2013.
United States
US Q2 Gross Domestic Product (GDP) not weak enough to trigger further stimulus from Federal Reserve (Fed)
The US Q2 advanced GDP grows at 1.5% q/q and it dampened the possibility that Fed is going to cheer those “pro-stimulus” investors in the coming FOMC meeting, although the employment expansion is still at the wrong side of the key 100,000 level.
Source: Bloomberg
Click the image to enlarge
There are two ways to gauge with the current inflation and Fed’s focus is in the PCE.
Source: Bloomberg
Click the image to enlarge
The June’s PCE will be released tomorrow and market expects a 1.8% y/y, which is still higher than the Fed’s preferred measure at 1.5% to add in more stimulus; however May’s PCE has fallen below the 2% inflation target, thus it has started to price in QE3 already.
Before the FOMC meeting, the ISM manufacturing and the Automatic Data Processing (ADP) private payrolls will be released as well. The 2 announcements are hardly going to affect the decisions by Fed this week. However, they are the best indicators for the coming NFP. The jobs growth is tough to improve towards the end of year because businesses are reluctant to expand due to the budget spend cut by the government and more people could lose their jobs.
Due to the struggling employment growth and “fiscal cliff” concern that constrained the household to spend more at this time, inflation could be stable and stay in a lower range, thus a possibly lower PCE and soft NFP that could increase the debate on further stimulus by Fed.
United Kingdom
UK Q2 GDP deteriorates further
Last week, UK released a much weaker than expect Q2 GDP, standing at -0.7% q/q, largely due to the Queen’s diamond holiday, terrible weather and explosion at North Sea Gas platform.
The construction sector has dragged the entire Q2 GDP lower and I estimated the extra holidays in Q2 could lower the total growth in Q2 by -0.3% although the National Statistics (ONS) has not released the statement regarding this.
Some weaknesses in construction have been factored in. Hence I expect the economy to continue to run at a similar underlying pace in Q3, but with a rebound in the Q3 output it is very likely due to the return to a normal working day mode and an Olympics effect could boost the growth in Q3.
UK Monetary Policy Committee (MPC) unlikely to change anything this week
The market focuses on 2 easing measures now:
rate cut
to buy more assets
In my point of view, rate cut is not preferred here at this time because the Funding For Lending Scheme (FLS) requires some liquidity to buffer, and the buffer might come from some large-scale deposit. With that said, a lower rate could make the banks suffer to build their capital. Most importantly, a rate cut can hardly lower the mortgage cost because many housing loans do not really track the benchmark interest rate when they track lenders’ base rate, unlikely in the Euro Zone. The worse is lender could choose not to pass the interest rate cut to the borrowers, and many of the loans also have the “floor rate”. A rate cut also hurts the banks’ margin indeed.
Thus if the BOE chose to ease further, it shall be further asset purchasing and I believe this is also what the market expects. I expect the next asset purchasing expansion should be incurred in Nov because the MPC members need to examine the Q3 growth. However, there will also be the possibilities that some non-standard measures to be announced since the BOE is always good at surprising the market.
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