Forex Market Analysis provided by eToro
The financials lead the markets lower this week as news that the US attorney’s office was investigating Goldman Sachs for potential criminal misconduct created uncertainty. This news on top of the downgrades earlier in the week by S&P, Moody’s and Fitch, put pressure on the broad equity indexes. The S&P 500 finished the week down 30 points or 2.5%.
Greek bailout
Calling what is taking place a “Greek bailout” is a misnomer. The funds that the European governments and the IMF are going to make available to Greece are not going to stay in Greece. The money will used to service Greece’s debt, of which something close to 70% appears to be in foreign hands. With various spending cuts, wage cuts and job losses, it is hard to see how Greece itself is being bailout out. Instead of Athens that is being made whole, it is Greece’s creditors that are getting so-called bailed out and essentially another bank will transfer (European) government funds to European banks. Greece is merely an intermediary. While other bond markets in southern Europe are benefitting from strong ideas that Greece will be given funds in time to avoid problems with the May 19th maturity and coupon payment, it is far from clear that investors will be satisfied for long. News Friday that Spanish unemployment rose to 20.1% in Q1 from 18.8% in Q4 09 illustrates the kind of economic headwind the periphery of Europe faces. This was a larger rise than economists expected and is around 7 times the EU average. Consider that since joining the euro zone Portugal has average less than 0.5% growth a year or that S&P expects Spain to average around 0.7% annual growth through 2016. It is difficult to see how the European/IMF package is scalable or how it really gets ahead of the curve of expectations or shows any appreciation for the fact that underlying the debt/deficit issues is really a competitive issue.
During the week, S&P downgraded Spain one notch to AA from AA+ and kept a negative outlook. Greece was cut a full step (three notches) to BB+ by S&P from BBB+ previously, moving it into junk status. Negative outlook was kept in place. This is a very, very aggressive move, but the rating agencies are clearly trying to play catch-up after missing the boat on this earlier. Right before the Greece downgrade, Portugal was cut two notches to A- by S&P, who kept the negative outlook. This too was a very aggressive move. Fitch cut Portugal in March to AA- from AA previously, but it is clear that both it and Moody’s remain well behind the curve, as Portugal is clearly not a double-A credit. Moody’s and Fitch still have Spain as a triple-A credit. This will probably not last, and there will probably be multiple downgrades ahead for Spain. When those other two move into double-A range, they will likely cause even bigger ripples than today’s S&P move. Indeed, Spain is the 800-pound gorilla in the room. Greece and Portugal are small countries, but Spain is about five times their size concerning GDP.
The Euro consolidated during the ladder half of the week after pushing through support at 1.32.
Japanese data, inflation still a thorn
Japan released a slew of economic data at the end of the week, none of which was particularly inspiring. Unemployment ticked up to 5.0% from 4.9% in January and February. The job-applicant ratio rose to 49 from 47, but it is still dismal (49 job opening for every 100 applicants). Industrial output rose 0.3% in March. The market had expected a 0.8% increase after a 0.6% decline in Feb. The MOF survey picked up expectations of a further decline (-0.3% rather than -0.1%) in April’s manufacturing output, but a large rise in May (3.7%). Core inflation fell for the 13th month in March with little change in the pace of decline and in fact deflationary forces strengthening in Tokyo in April. New BOJ forecasts were largely in line with expectations, their GDP forecast was revised this year to 1.8% from 1.3%, but next year’s forecast was shaved to 2.0% from 2.1%. Core CPI, which excludes fresh food, is expected to fall 0.5% this year before rising to 0.1% next year (previously was -0.2%). Bottom line here is that pressure is likely to remain on the BOJ to take additional steps to spur lending and arrest deflation.
Crude Oil Remains Strong
Crude oil and products look to be continuing their move higher, as the easing of EU sovereign debt concerns have helped the market overcome high storage levels. At 357.8 million barrels, U.S. crude oil inventories are above the upper limit of the average range for this time of year. Currently it is interesting to note that the only area of the oil complex not close to new highs for the move are the front two months in WTI crude oil, as the supply glut in Cushing, has kept them down. With expectations for increased summer driving activity seen as a reflection of US economic recovery capacity, any sort of sustained drawdown in crude stocks could send prices towards new highs for the year, particularly as this does not take into account sustained demand from China and the rest of the world. Additionally news of higher a-float oil supply this week is not undermining oil prices. Floating storage is reported to have increased from 21 million barrels to 47 million barrels as traders profit from cash and carry storage plays. Crude oil has broken out on a daily chart, breaking through trend line support.
US Growth
First quarter GDP was largely in line with expectations. The 3.2% annualized pace was slower than the 5.6% of Q4 09, but everyone recognized that the prior pace was not sustainable. Although growth seemed solid, price pressures eased, further underscoring the lack of inflation risks. Despite the slightly above trend growth for the second consecutive quarter, the Fed remains securely on the sidelines. Consumption rose 3.6% after a 1.6% advance in Q4. It contributed about 2.5 percentage points to the GDP figure. Inventories added about 1.6%. Business spending on equipment increased 13%, but its spending on structures fell 14%. For first time in three quarters, house construction fell. The core PCE deflator, among the Fed’s most cited indicators of inflation, fell moderated to 0.6% from 1.8% in Q4. This is smallest increase in the core PCE deflator since the time series began in the late 1950s. In year over year terms, GDP rose 2.5% in Q1 compared to 0.1% in Q4.
The difference between the US economic optimists and the pessimists seems to be the difference between 1.5% growth this year and 3.0%. Both recognize that fiscal policy will be less supportive for the economy as the stimulus spending runs its course. Government spending in the preliminary Q1 estimate shaved 0.4% off GDP growth. That is to say, it has already turned from a tailwind to a headwind. That headwind is likely to grow in the coming quarters.
However, that drag may be offset by improvement elsewhere. Job creation is the key and so is the workweek to boost incomes, consumption and output. The drag from non-residential structures is lessening, even though it was off 14% in Q1, which represents the smallest decline since Q4 08. A turning in the second derivative should continue. The government does not have the full set of trade and inventory figures for the quarter and this is where economists will focus on for potential revisions, which historically are frequently statistically substantive. The US consumer and business investment may be the key to growth going forward. The inventory cycle still appears incomplete and could still contribute to GDP over the next couple of quarters. Net exports are not so much a function of US growth as rest of the world’s growth.
Next week’s economic calendar is full of data releases. On Monday the US PCE and Personal income and spending leads off followed by construction spending and the ISM manufacturing report. On Tuesday, the RBA makes its interest rate decision. The market is expecting a 25 basis point hike to 4.5%. On Wednesday, EMU retails sales are the headline for Europe, which is followed by the ADP private employment figures in the US. On Thursday, the ECB makes its interest rate decision. On Friday, the entire market will be watching the US employment figures.
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