After Friday’s spectacular leap in the prices of risk assets, the inclination of traders overnight was to take some profits. The euro, which was near 1.27 at the start of the Asian trading session, has slipped back to 1.2620, with the Aussie down at 1.0225 from 1.0270 earlier. News that the HSBC China PMI dropped to a 7mth low of 48.2 in June partially contributed to the more contemplative mood.
Today’s final PMI figures for June out of Europe will also make for depressing reading. In addition, there is awareness that the EU unemployment data due out later this morning will likely show a continued worsening of labour market conditions. Thursday’s ECB meeting will probably see the ECB lower the refi rate by at least 0.25 percentage points.
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Despite these immediate hurdles, Friday’s EU Summit surprise is still being extensively debated. Permitting the bailout funds to buy Italian bonds, and removing the requirement that official creditors are treated as super-senior when lending to Spain’s troubled banks, are concessions that many did not expect Germany to make. As always, the devil is in the detail. Germany may permit these initiatives, but the strings attached will likely be similar to the cordage on a large oil tanker. It would be a mistake to suddenly believe that Germany was either going soft, or shutting its eyes to southern Europe’s financial indiscretions.
Commentary
BoJ easing still on the cards. Notwithstanding last night’s better than expected June quarter Tankan reading, there is still a strong likelihood that the BoJ will increase its asset purchases at the next meeting on July 11th-12th. Encouragingly, large manufacturers are signalling that they are prepared to raise capital spending in coming quarters, after previously being much more reluctant. The mood was helped by lower commodity prices, especially the significant reduction in the oil price – Japan remains hugely dependent on oil imports for industrial production, even more so since its numerous nuclear reactors were closed down. Motor vehicle manufacturers are especially buoyant, aided by subsidies for fuel-efficient cars. With the economy apparently dealing with weaker foreign demand and a strong exchange rate relatively well, the yen may well attract some additional buying interest.
A critical week for the Fed. Fed policy-makers will be pouring through this week’s catalogue of US economic data with a fine-toothed comb to decide whether additional monetary action is required. First up is the manufacturing ISM for June, which is likely to show that the pace of activity continued to slow last month. Worryingly for manufacturers, both foreign and domestic demand has been weakening over recent months. Last week’s very soft Philly Fed survey provides a prelude to what we can expect from the various sector surveys to be released over coming days. The US consumer has definitely lost interest – auto sales in June were probably the weakest month for the year-to-date, and overall spending is unchanged in nominal terms since the end of February, despite much lower prices for petrol on the forecourt. Given’s Bernanke’s increased focus on labour market conditions (more generally) and jobs growth in particular, Friday’s June payrolls will be closely scrutinised. Some of the partial jobs’ indicators released recently suggest there was very little job creation last month.
PMI data key for sterling. The UK manufacturing series plummeted in May, from 50.2 to 45.9, a three-year low and the sharpest one-month fall since November 2008. If the weakness is sustained, then the perception will be strengthened that the recession in the UK economy will be deeper and more sustained than otherwise believed. An announcement of further QE from the Bank of England this week looks almost certain after recent comments and the split vote at the May meeting, with a further GBP 50bln of bond-buying likely to be announced. Whilst sterling has benefitted from the woes in the eurozone, EUR/GBP continues to struggle to make a sustained break below the 0.8000 level, with last week’s moves below having been unwound by the euro-buying into month-end and after Friday’s post-summit statement.
Bridging the divide in Europe. Whilst Friday’s trading day was relatively positive for the euro, it’s not easy to split out just how much was down to month and quarter-end flows vs. the market’s positive reading of the EU summit statement. On the latter, it boils down more to the split between those measures that can be put into the category of fire-fighting and those that can be classed as rebuilding. Furthermore, the longer a move towards a meaningful resolution is left, the bigger becomes the gap between where the eurozone is positioned (teetering on the edge) and where is it needs to be (sustainable debt and common bonds with appropriate conditionality) that has to be overcome. A move to a structured form of debt-mutualisation two years ago would have been manageable because, Greece aside, Europe was not seen as insolvent. At this moment in time that’s not the case and just how we bridge the gap between the two states, without restructuring beyond Greece, is the question that leaders dare not speak of, let alone consider tackling.
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