FBS Quarterly Report
Wednesday, April 4, 2012 - 10:00
Q1 Review
Traders will remember Q1 2012 for mixed economic data. On the one hand, US economy kept improving. On the other hand, we got some disturbing news from China and the threat of recession in Europe. Geopolitical risk (Syria) and sovereign debt worries (Europe) were also among the main drives of the global financial activity in the first quarter.
American stock markets rallied aiming to return to the levels seen before Lehman Brothers collapse (NASDAQ was up by 18%, S&P was up by 14%). Brent crude oil price remains in the area of 125 dollars per barrel. On the upside oil prices are affected by the Iran, on the downside – by the talks about the potential release of strategic petroleum reserves. Higher prices harm global demand hurting the developed economies.
Let’s begin our analysis with a look at how the economies of United States, euro area and China have been performing since the beginning of this year.
The United States
US GDP growth accelerated from 0.4% (q/q) in the first 3 months of 2011 to 3.0% in the final quarter of the last year.
Source: Bureau of Economic Analysis, U.S. Department of Commerce
Activity in US manufacturing and services sectors is resilient, and manufacturing output has been gaining pace for the 3 months to March. The situation at US labor market has also improved. By March jobless claims have reached a 4-year minimum, while the nation’s economy has been adding in winter over 200K jobs per month, and unemployment rate fell from 9.0% in September, 2011 to 8.3% in January and February, 2012.
However, even in the United States not everything is so bright. First of all, America isn’t isolated from the rest of the world, so China’s landing – soft or hard – and euro zone’s problems will surely affect its state. Secondly, inflationary pressures in the US are slowly picking up, trade deficit is widening, while the housing market is still in trouble.
Note that trying to predict the market’s sentiment is a tricky thing. US investors seem to think that American economy may stay away from the issues elsewhere and keep growing. As the global markets represent a really complicated mechanism they may even be right: China’s slowdown does not pose systemic risks for markets in a way the credit crisis would. If it leads to weaker commodity prices, this could ultimately be a positive factor for future growth.
Europe
Euro zone’s economy contracted in Q4 by 0.3%. Moreover, it’s necessary to note that about a third part of the EA17 nations have already entered recession which is defined as GDP contraction during 2 consecutive quarters.
The region’s manufacturing sector suffered a poor March: Manufacturing PMI of the currency union came in at 47.7, a 3-month low and the eighth month in row in which output has shrank. The unemployment rate across the euro area jumped to 10.8% in February, the maximal level in at least 14 years.
China
Chinese Premier Wen Jiabao cut 2012 growth target to 7.5% from the 8% goal which was in place since 2005 as officials seek to shift the economy toward more consumption. Last year Chinese GDP increased by 9.2%. The Bank of China, however, claimed recently that China’s economic growth will be able to remain over 8% for the whole of 2012.
China posted the largest trade deficit in February in at least a decade of $31.5 billion as import growth exceeded that of exports in more than 2 times. The deterioration of China’s trade balance may be explained by lower demand from the euro area which is suffering from the debt crisis as Europe accounts for 20% of all Chinese exports. Taking into account reduced overseas demand it’s possible to expect China’s exports to stay weak at least for the next few months.
At the end of March the nation’s PMI data made investors experience mixed feelings: while HSBC Manufacturing PMI was below the critical mark of 50, the official index of purchasing managers turned out to be above this level. Official figures helped to lighten the market’s mood, though the concerns about Chinese slowdown haven’t faded and will likely continue haunting investors’ sentiment.
Currency majors in Q1 2012
New Zealand’s dollar was the best performing G20 currency this quarter, rising more than 5% against the greenback. Japanese yen performed the worst, falling more than 7% versus US dollar.
American currency lost to all its major counterparts except yen (due to monetary stimulus by the Bank of Japan). The greenback was weakening in January and February and then retraced some of its losses in March.
Q2 prospects
Euro
European policymakers have finally started showing real efforts in combating the crisis in the first quarter. There was the Greek restructuring deal, approval of the second bailout to Greece and expansion of the anti-crisis firewall.
However, significant risks still exist. Among them one may cite the risks of/that:
- Potential euro zone’s economic slowdown and recession;
- Defaults of other indebted European economies;
- The size of the bailout funds may turn out to be insufficient;
- Of implementation associated with the European rescue and reform packages.
The first risk seems to be the most severe. As the so-called PIIGS countries have to conduct severe austerity measures, it becomes more and more difficult for them to restore their competitiveness that is leading to social unrest. Combined with the electoral cycle in these countries, the political landscape is shifting to right wing nationalist parties. If these parties are successful, the implementation risks surrounding these austerity programs will be escalated. French presidential elections on April 22 and May 6 could also be a catalyst for intensifying trouble.
As a result, despite the political progress made so far it’s really hard to find in Europe some drivers which are capable to trigger the growth of the single currency in the medium term.
US dollar
One may say with high certainty that the greenback’s performance will depend primarily on further actions of the Federal Reserve. The main question remains the same: will the Fed launch QE3 to promote economic growth or not?
In March the Fed’s Chairman Ben Bernanke acknowledged the US economic improvement, but underlined that the option of more quantitative easing should be left open, because the economy isn't strong enough to continue quickly reducing unemployment. Bernanke doesn’t expect jobless rate to keep declining. The policymaker warned that the recent signs of improvement at the labor market may be the result of statistical errors.
Some experts also note that the market has began expecting too much from US economy and, consequently, may be easier disappointed if the actual data fails to exceed the forecasts which tend to get higher and higher.
Another important development is that the inverse relationship between US dollar and investors’ risk appetite started to fade. Never the less, don’t hurry to take risk. We see steady growth for American currency possible only if QE3 is completely taken out of the Fed’s agenda and that isn’t very likely in Q2.
In addition, US GDP growth may have slowed in the first quarter. Don’t forget about the negative effects of higher oil prices which may increase inflationary pressure and the fact that tax cuts are set to expire by the end of the year.
British pound
UK economy is still having a lot of problems and consumer sentiment is weak as high unemployment and weak wage growth don’t encourage British to spend.
At the same time, there are some positive things ahead: Diamond Jubliee and Olympics will certainly support the nation’s economy. UK inflation is also expected to decline further which would make consumers feel better. In addition, Britain’s Manufacturing and Construction PMIs posted the readings above 50 in March beating the forecasts pointing at the expansion of these industries.
If GBP/USD manages to steady itself above the 200-week MA, its chances to continue growth will significantly increase. Remember, though, that Britain is strongly affected by the situation in the euro area, its main trading partner, so the downside risks still seem considerable.
Japanese yen
Japanese yen has weakened versus the greenback in Q1 as the Bank of Japan has given in to political pressure increasing in February its asset-purchase program by 10 trillion yen ($128 billion) and setting an inflation target at 1%. The greenback on its part was driven by the rising yields in the United States (10-year Treasury yields added 27 basis points).
USD/JPY has managed to break above its long-term downtrend leaving the range within which it was trading in the second quarter of 2011. The pair consolidated above 100-week MA. We’ll get a bullish signal if the weekly Ichimoku Cloud switches upward.
Note though that April has been traditionally a good month for the yen because domestic investors tend to transfer funds abroad the start of the fiscal year after the March repatriation. However, this year the demand for yen wasn’t that high as Japanese importers were selling large amounts of the national currency –
Japan has to import much nowadays (energy resources). So, yen’s expected to weaken modestly due to the BOJ’s loose policy, weak fundamentals and an increase in risk appetite – the factors which don’t encourage demand for yen as a safe haven.
Swiss franc
Although euro zone sovereign debt crisis hurts Swiss exports, Switzerland may avoid contraction with the help of relatively resilient domestic demand. Swiss fundamentals remain very strong: the nation has balanced the fiscal account, public debt is declining and government bond yields are lower than in Germany and the US.
The nation’s economy has regained some strength: investors’ confidence rose for the third month in March. Foreign sales, adjusted for inflation and seasonal swings, increased by 9.2% in February (m/m). The Swiss National Bank raised 2012 GDP growth forecast from 0.5% to 1%.
The SNB’s EUR/CHF floor at 1.2000 helped to stabilize Swiss franc. Market participants expressed enough confidence to this level and we have seen the pair’s trading range narrow to the levels between 1.2000 and 1.2100.
At the same time, deflation remains a considerable threat which could push Swiss economy into recession. If deflationary pressures intensify in the coming months, the SNB will likely opt to raise the currency floor, though with oil prices rising steadily year-to-date, the likelihood of such outcome has diminished. Swiss consumer prices rose by 0.3% in February after decreasing by 0.4% in January.
Australian dollar
Australia is heavily influenced by China’s business cycle. Speculation that China may experience a harder landing than expected weighted on the Aussie dollar this quarter and will likely continue to do so.
Many economists expect the Reserve Bank of Australia to cut rates in May. The central bank itself decided to take a “wait-and-see” approach intending to take into account the first-quarter CPI data (released on April 24). In March the nation’s consumer prices rose by 1.8% (y/y) showing the slowest pace since October 2009.
In addition, Australian annual budget is released on May 10. If the signal from the budget is deep fiscal cuts, the RBA will likely be forced to ease monetary policy to accommodate tighter fiscal conditions.
Canadian dollar
Canadian economy grew in line with forecast at 0.1% in January. Although the nation’s GDP growth has slowed from the last quarter of 2011, its economic outlook seems optimistic as it gains from US growth and higher oil prices.
As Canada released the spending plan with a goal to balance the country’s budget in 2014-2015 and achieve surplus in 2015-2016, S&P confirmed Canadian top credit rating – the factor which makes Canada stand out among G10 nations. As a result, loonie has all chances to continue gradual appreciation.
Forecasts from major banks
Data was submitted on March 30, 2012.
Source: FX Week
FBS Quarterly Report // FBS Markets Inc.
