Abenomics Failed…Last Quarter

Abenomics failed
To increase GDP growth
Last quarter, at least

The dollar is firmer this morning, breaking its recent downtrend as the Asian session opened with news that Japan’s GDP grew a much less than expected 2.6% in Q2 (exp 3.6%). The yen weakened immediately and has retained those losses and the dollar has fared well against pretty much all currencies. In Japan, the ongoing debate remains about increasing the national sales tax, with a 3% rise slated for April 2014 followed by another 2% rise in October 2015. However, the weaker GDP numbers have called into question the country’s ability to withstand a tightening of fiscal policy at this stage, especially given the extraordinary focus on increasing growth and core inflation. Traders are starting to discuss the idea that there will be another round of easing by the BOJ as a response to the weaker data with yen weakness a natural outcome. While the timing of further stimulus remains uncertain, I am in the camp of believers that the BOJ will do more, and probably sooner rather than later. My sense is a rally back toward 98.50 or so is likely in the next several sessions.

Both the euro and the pound are also weaker this morning, although not falling nearly as much as the yen. The weekend press in Europe has been generally quiet due to the preponderance of summer holidays being taken right now, but in several places I have read about further concerns over Portugal and Greece. While Ireland seems set to make a tentative exit from its bailout requirements on a timely basis, Portugal is slipping on its commitments and Greece has never even come close. Despite some modest progress, both these nations are going to miss their budget deficit targets and require further financing. The problem is the Troika, or at least the IMF, seems increasingly unwilling to put up the cash. Greece remains in the worst shape of all with a budget hole of some €4.4 billion for 2014 and a larger one going forward. Growth continues to elude the nation and unemployment continues to expand. There has been no political will to actually dismiss government employees, one of the key measures required by the Troika. Asset sales have been de minimus and continue to lag the targets that were assumed as part of the financing package. In other words, virtually nothing of import has changed, so it can be no surprise that the country remains mired in a depression with a sense of hopelessness attached. I can see no situation where the Greeks repay their debt. It is simply a matter of time before the political cognoscenti in Europe see admit that as well. Perhaps after the German election we will see some views altered in public. While Portugal’s situation is not quite as dire, it too has been unable to generate the political will to make the changes required by the Troika. This has led to the government there losing key support and only a fragile coalition remains in place. These problems highlight the ongoing concerns in Europe, without even mentioning Italy’s increasing political difficulties. All in all, things in Europe remain quite problematic from a policy perspective. That said, it appears that the continent may be exiting its 6 quarter long recession as forecasts are for growth of 0.2% in Q2 (to be released Wednesday). While that would be a welcome outcome, it is hardly sufficient to change the monetary policy framework and we can continue to look forward to either no change or further ease from the ECB for now. All of this is a long way of saying that the euro has likely peaked after its recent modest rally, and I think it heads back toward 1.30 in the sessions ahead.

Looking ahead to this week, the data calendar is far more interesting than last week and some data has market moving potential. We will learn more about inflation and housing as well as the manufacturing situation in the Northeast of the country.

Today Monthly Budget Statement -$94.5B
Tuesday Retail Sales 0.3%
ex autos 0.4%
Business Inventories 0.2%
Wednesday PPI 0.3%
ex food & energy 0.2%
Thursday Initial Claims 335K
Continuing Claims 3000K
Empire Mfg 10.00
CPI 0.2%
ex food & energy 0.2%
Long Term TIC Flows -$10.0B
IP 0.30%
Capacity Utilization 77.9%
Philly Fed 15.00
Friday Nonfarm Productivity 0.6%
Unit Labor Costs 1.3%
Housing Starts 905K
Building Permits 948K
Michigan Confidence 85.3

While the Fed has clearly been more focused on unemployment than inflation, any surprises on the high side of CPI will almost certainly hit the bond market and are likely to support the dollar further. In addition, strong Philly or Empire numbers will be equally dollar positive.  After all, there seems to be a growing consensus that the Fed will begin to taper its QE come next month. So all in all, I think the dollar has reason to perform well this week. Not explosively, but certainly I expect it to be higher on Friday than it is right now.

Good luck