The US dollar is little changed here at the start of the second quarter, as European markets remain on holiday. Short-covering is making the yen the best performing currency today. The dollar traded below JPY93.50 for the first time March 6. The next level of support is seen near JPY93.00.
The yen's gains came in conjunction with a 2.1% drop in the Nikkei and a 3.3% slide in the Topix. No sector escaped the carnage, but health care, utilities, financials and basic materials were hit the hardest. We note that in the options market, the premium for downside insurance (puts on the Nikkei) is trading at the largest premium (over calls) in eight months. This is a sign that the longs are getting nervous and paying up for protection.
The Nikkei closed below its 20-day moving average for the first time since late February and the 5-day moving average may fall below the 20-day average late this week for the first time since mid-November, just after elections were called and an Abe victory anticipated. There seems to be some growing skepticism of the impact of Abenomics, along the lines we have outlined.
There are three sets of drivers in the week ahead: central bank meetings, economic data and the ongoing heightened state of anxiety in Europe.
I. Four Central bank meetings:
The Reserve Bank in Australia is the first to meet. Practically no one expects a resumption of its easing cycle. Recent economic data has been a bit firmer than was the case at the March meeting. However, we suspect there is sufficient uncertainty about the economic outlook, with appreciation of the trade-weighted currency, to deter the RBA from declaring an end of the cycle. The statement to leave the door ajar to additional rate cuts, which we expect to materialize in late Q2 or early Q3.
Bank of Japan: The long awaited first BOJ meeting with the new management team will conclude on Thursday. The market has a good sense of what is going to happen. The BOJ is expected to bring forward from next year the beginning of opened-end QE. It will likely combine the monthly rinban operations with its asset purchase program. The former includes buying JPY21.6 trillion of long-term government bonds a month. The latter includes purchases of JPY44 trillion of JGBs up to 3-years of duration. The BOJ is also expected to suspend its self-imposed constraint that limits its JGB purchases to bank notes in circulation. Given the extreme market positioning, we suspect that Kuroda & Co have to shock and awe investors, otherwise the risk of a short-covering yen bounce would seem to increase.
Bank of England: Governor King has been outvoted at the past two MPC meetings, with the majority refusing to renew the gilt purchase program, in part, the recent minutes revealed, because of concern it would lead to fresh sterling weakness. Chancellor of the Exchequer Osborne formally endorsed the MPC's flexible inflation targeting. We suspect the BOE wants to avoid pre-committing Carney, who becomes governor in July, especially given the decisions on forward guidance to be decided in August. This means that the window to resume gilt purchases, assuming a three-month period, is closing after this week's meeting.
European Central Bank: With the regional economy showing no compelling signs of bottoming and price pressures easing, a case can be made for easier monetary policy by the ECB, and we suspect some board members will advocate a cut in the 75 bp repo rate. However, on balance we expect the consensus to lean against a move at this stage. A repo rate cut will have little bearing on the key overnight rates, which continue to trade a few basis points above the zero deposit rate. A repo rate cut is largely symbolic, and we suspect that the consensus will find a repo rate cut now would be sending the wrong signal. Half a year ago, the ECB unveiled the Outright Market Transaction facility. It was not intended to be a panacea, but rather, to buy time for European officials to act. They have not moved in the direction the ECB desires. Cyprus and other regional banking issues will likely be featured in the Q&A of Draghi's press conference.
II. Economic Data:
In Asia, Japan's Tankan survey and several PMI reports were released earlier today. Japan's Tankan survey generally showed modest improvement in sentiment, though among the large manufacturers, the pessimists still outnumber the optimists (-8 from -12 in December). However, news that capex was expected to fall 2.0% after a 6.8% increase in the Dec survey and expectations for a 5.0% pace is troubling. The recent string of economic data shows little impact from a weaker yen. Exports continue to fall. Industrial output is weaker than expected and the grip of deflation has not slackened. Separately, Japan reported that vehicle sales fell the most in six quarters (9.4%). The end of the government's subsidy for fuel efficient cars last September continues to impact activity.
China's official manufacturing PMI saw a modest increase to 50.9 from 50.1. This was just below expectations. The HSBC reading was stronger at 51.6, matching expectations. Of note, new orders, output and exports all increased, while price measures moderated. Separately, we note that over the weekend, Beijing and Shanghai imposed new restrictions aimed at curbing activity in the housing market. The US dollar has been gently easing against Chinese yuan and a new marginal 19-year low was recorded today. To keep this in perspective the yuan has appreciated by about 0.35% against the dollar thus far this year.
South Korea's PMI rose to 52.0 from 50.9 and is at the highest in a year. However, this news was not sufficient to offset the disappointing export growth (0.4% vs expectations 1.8%) in March and a soft inflation report (-0.2% in March for a 1.3% year-over-year rate). Today's data likely brings forward measures to ease monetary policy to compliment the fiscal stimulus the government will unveil later this month.
Separately, Taiwan's PMI rose to 51.2 from 50.2. India's slipped to 52.0 from 54.2, which is the main exception to the data that is generally showing modest improvement in the region.
In Europe, the PMIs are featured and the risk is to the downside. Greece reported its manufacturing PMI today. At 42.1, it showed deterioration from the 43 reading in February. Output, orders, inventories and employment fell. The day before the ECB meets, the preliminary March consumer inflation report for the euro area will be released. Price pressures have been falling and a new 2 1/2 year low is expected (1.6% vs 1.8% in February). Like the PMI reading, the risk to inflation is also on the downside.
The US employment report is the main feature. The consensus expects private sector employment to have expanded on par with the 200k seen on average over the last three and six months. The improving tone of the labor market appears to be a reflection of a slowing in lay-offs rather than an increase in employment.
The US auto sector is an important driver of manufacturing, consumption and business investment. US auto sales are expected to remain near 5-year highs, with domestic producers continuing to pick-up market share. Given market positioning (long US dollars mostly), and the fact that analysts appear to have adjusted their forecast to reflect the resilience of the economy, there is scope for disappointment or buy the rumor sell the fact type of activity.
Canada reports employment figures at the end of the week as well. A repeat of the 50.7k job growth posted in February is unlikely to be repeated. A minor uptick in jobs is expected. At the same, Canada is expected to report its first trade surplus since last March.
III. European Crisis
The fallout from Cyprus will continue to command attention. The capital controls will be reviewed at the end of the week. The optimists are thinking the duration will be measured in weeks, while the pessimists are thinking of months, if not years (as is the case in Iceland). In addition, the sharper the economic contraction, the greater the likelihood that Cyprus will require more aid.. The market will also watch developments in Slovenia closely as it appears to have become the favored candidate to succeed Cyprus in needing assistance.
Separately, Italy's political situation is entering a new phase now that PD's Bersani has formally failed to cobble together a government. Over the weekend, Napolitano had seemingly used a resignation threat to up the ante. He named ten senior statesmen and politicians to a committee that will see if there is a limited agenda that can be agreed upon by all the key stake holders. Another technocrat government may be coming at a poor time.
The shallow roots of democracy have been laid bare by the fact that the Cypriot parliament is not needed for the terms of the assistance program, but the Germany parliament must agree. There is still a sense that EU officials were responsible for Berlusconi's exit in late 2011. Even now Draghi's call to Napolitano over the weekend is read (by some) as reflecting nefarious intent of unduly influencing Italian politics by dissuading him from resigning early to make way force new elections. We suspect that Napolitano's threat of resignation was a tactical ploy to force higher level negotiations,
