Is Europe Beginning to Grow?

Is Europe beginning to grow?
Economists claim that they know
It’s nearly two years
That growth’s in arrears
But now it’s moved up to so-so

The dollar continues its rebound from last week’s depths with the yen suffering the greatest fall, but most currencies declining. The Japanese story was a combination of better than expected data (Japanese Machine Orders grew 4.9% in the past year compared to expectations of 2.6%) and a story that in order to offset the potential fiscal tightening of the increased national sales tax, PM Abe is considering a cut in corporate tax rates to help stimulate growth. This was sufficient to bring out the yen sellers and spot has jumped more than 1.6% as I write. From the charts I think there is still room for a bit more upside, but barring any further news from Japan, I think 99.00 will certainly cap this rally. Of course, the opportunity for further news of this nature remains quite significant as Abe is struggling to get Japan back to its former glory. If he perceived this has had a salutary impact, look for another announcement of some newly tweaked policy in the near future. But not today.

In Europe all the discussion is on the narrowing gap between German Bunds and the yields of Italian, Spanish and Portuguese debt. The claim is that expectations of a resumption of growth in the Eurozone (Q2 GDP is expected at +0.2% tomorrow) will lead to a further reduction in any tensions with the peripheral nations. In fact, there are some who are expecting these nations (excepting Greece) to start to show positive GDP numbers by the end of the year. While nothing is impossible, the trajectory of Eurozone growth has not been such that I feel that is likely. Remember, the two key elements that started all these problems were the massive sovereign debt loads and the extremely weak banking sectors of these nations. And to the best of my knowledge, neither one of these issues has been even remotely resolved. While banks are trying to raise more capital, their loan portfolios continue to deteriorate, and all of the peripheral nations continue to see their debt/GDP ratios growing rather than shrinking. Many very serious problems remain in Europe and the political will to actually address them has yet to be found. I don’t think we will see too much activity ahead of the German election next month, but if we do see something, the likelihood is that it will be a negative event. So the euro remains little changed this morning near 1.33 but I think a slow drift lower is the most likely short term path. As I said yesterday, 1.30 is the target, but it will be a gradual move.

In the EMG space, ZAR has been the biggest loser, falling about 1% after unrest at some mining sites has raised the specter of a repeat of last summer’s activities. The rand can ill afford more problems like the striking that was seen last year given the alternative investment opportunities, not least of which are US Treasuries with a much higher yield, than last time this occurred. ZAR has already fallen more than 18% since the beginning of 2013 and all indications are that there is more to go. Meanwhile, MXN is weaker this morning after the market registered disappointment over President Nieto’s ‘reforms’ of PEMEX and the oil industry. This is one of the great tragedies of Mexico, the slow collapse of its energy infrastructure because of the nationalism that is attached to the issue in the country. The inability of PEMEX to even utilize the expertise of the international oil community to help improve its output has reached a point where it is on the political agenda. But the initial proposals were minimal, and the peso has suffered accordingly. While we are nowhere near the lows seen back in June, given the dollar’s underlying strength and no reasons to believe that further policy changes are forthcoming, a move toward 13.00 seems a reasonable bet here. Finally in this space, HUF has fallen some 0.75% after releasing softer than expected inflation numbers. This has the market talking about further rate cuts by the central bank there, with the natural currency response being a decline.

For one day at least, it seems there has been some logic in the FX markets. However, I wouldn’t get used to it.

This morning we will see Retail Sales (exp 0.3%, 0.4% ex autos) and then Business Inventories (0.2%) at 10:00. Equity futures are higher this morning after a recent weak run and Treasuries have fallen a bit with the 10yr yielding 2.66% right now. While market conditions remain relatively light due to holiday schedules, I continue to look for marginal USD strength, especially if we see a strong Retail Sales number. That said, there is no reason to look for a significant move today barring some Fedspeak or other comments out of the blue.

Good Luck