Risk asset rally and mixed news out of the US drag Euro higher

admin15/Apr/2013Currency Updates

Risk assets generally rallied last week, and a select group of those deemed more likely to benefit from ongoing QE efforts (US and Japanese equities, primarily) did so to new cycle highs. The dismal macroeconomic background and relative lack of central bank action weighed on European assets and credit. In FX markets, the absence of market moving news either on the policy or the macroeconomic front, together with weaker than expected retail sales in the US, left the euro to weakly track the asset rally upwards, and the common currency rose about 1% against both sterling and the US dollar. The most volatile of the major currencies lately, the Japanese yen, flirted with the floor of 100 to the US dollar, but rebounded later in the week to close above 98.50. However, the relentless rise in the EUR/JPY cross rate continued last week. We expect some political noise regarding this from European politicians very soon, which should provide a temporary lid on euro appreciation.


Data out last week from the UK were fully consistent with our expectation of zero growth in the economy in the first quarter, and in fact the risk of a negative print has increased. Construction output rose just 5.5% m/m from January to February, which amounts to a serious drop in seasonally adjusted terms. This sector in all likelihood will have a significant negative contribution to the overall GDP number. More bad news came from the external sector, with a further 2.8% drop in exports from January to February. Trade will also be a drag on the GDP number, driven down by the dismal economic situation across the channel. Given the slightly better news that we are seeing in retail sales, we maintain our call for 0% growth, though the downside risks increased this week. In this gloomy backdrop, we are now firmly convinced that the majority of MPC members will swing to another increase in the Gilt purchase target at the May meeting. We expect that to have a negative effect on the pound, temporarily against the euro, and more durable against non-European currencies.


It was a very slow week in terms of macroeconomic data or policy news, and the euro rose moderately, as it usually does in such weeks. On the policy front, the Eurogroup agreed to a longer-than-expected seven-year extension of the maturity in the official loans to Portugal and Ireland. This is positive at the margin, but we point out that the problem is not the timing of the repayment, but the unsustainability of public debt loads in the context of Europe’s perma-cession. More negative news came out the banking union process, were Germany signalled that it is not ready to make significant progress any time soon. This will not dispel worries about the status of peripheral bank depositors spooked by the Cyprus haircuts.

Macroeconomic news were gloomy, as usual. Though February industrial production rose slightly from January’s dismal levels, this was entirely the result of a weather-related surge in energy production. It is clear that the goods sector contribution to first quarter growth will be negative. As inflation in Europe continues its downward march (to 1.7% in March), we remain thoroughly puzzled by the ECB’s refusal to make use of any of the monetary levels at its disposal, and expect that, at the very least, dissent within its ranks will become more obvious over the next few weeks.


Macroeconomic news out of the US have turned weaker with the Spring, as they have for the past couple of years. March retail sales were down 0.4%, and the previous two months saw significant downward revisions. This report calls into question our view that the 2013 tax hikes had had little effect in consumer spending, and introduces some downside risk to our forecast of 3% growth for this quarter, and 2-3% for the full 2013 year. We are sticking with our forecast for now, as stronger-than-expected contributions from housing and business investment are likely to keep growth on track, but are paying very close attention to the recent weakening in labour market and consumer spending news. USD did in fact react quite negatively to the retail sales news, and most of its weekly loss against the euro occurred late Friday after the report’s release.


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