The US dollar's recovery last week may not get the kind of fundamental support that medium and long-term investors would like to see to raise the confidence that the two-month correction has run its course.
Owing to a greater deterioration of net exports and a smaller than expected inventory build, Q1 GDP is likely to be revised sharply lower. The 0.2% expansion may turn into a 0.8-1.0% contraction. Although it is backward looking, especially given that the second quarter is two-thirds when the revision is announced, it does have an important implication.
It means that rather than raise rates in June, as many of us had previously anticipated, the Federal Reserve will have to cut its GDP growth forecast for the entire year. In March, the Fed's central tendency forecast, which excludes the three highest and three lowest forecasts was 2.3%-2.7%. It is possible that growth in the first half is flat or barely positive. This means that even if growth in the second half averages 3%, GDP for the entire year would be about 1.5%. To reach the current Fed forecast, the economy would have to expand by close to 5% in H2.
The projection for growth in the current quarter could edge higher if the details of the April durable goods orders report on May 26 is firmer. The headline activity may slip on the back of lower aircraft orders. Boeing reported its April orders slipped to 37 from 39 in March. However, orders, excluding defense and aircraft and shipments of the same, which are inputs for capex and GDP forecasts, should both be above Q1 averages.
Separately, the Richmond and Dallas Fed manufacturing surveys, and the Chicago PMI and Milwaukee ISM will also likely boost confidence that the world's largest economy is not recession-bound. Whereas the Atlanta Fed's GDPNow suggests the US economy is tracking 0.7% growth in Q2, we expect the incoming data to gradually lift this estimate. The increase in aggregate income (~5% year-over-year) and the increase in savings (~$125 bln in Q1) will likely provide the fuel for stronger consumption going forward.
The economic data is one thing, but how the markets respond to it is a different matter. For the better part of the past two months, disappointing, though not always weak, US data sparked dollar selling. At the same time, the dollar was not rewarded for good news. This was broadly consistent with the dollar's downside correction after recording one of the strongest quarterly performances in many years. How the markets respond to the new fundamental news may be more revealing that the economic data itself.
The Bank of Canada is the only central bank that meets during the last week of May. There is little doubt that policy will remain on hold. The economy has generally performed in line with the Bank of Canada's expectations. Speculators shift to a net long positions in the futures market, for the first time since last September strikes us a premature. We suspect that this net long position was established at the end of the Canadian dollar's two-month upside correction.
The economic highlight from the eurozone will be April money supply data. M3 has been trending up for a year. It is expected to have accelerated on a 3-month year-over-year basis to 4.5% from 4.1%. It had bottomed at 1% in April 2014. More importantly, credit extension is accelerating a well. This is important because this is the last data point to set the condition for the TLTRO that will be available in the middle of June. Lending to households had turned positive recently and now lending to business is expected be turn up too.
The unresolved Greek crisis continues to hang over the market. No doubt it will be a point of discussion at the G7 meeting being held in Dresden on May 27-29. Just like there has been greater progress since Greek Prime Minister Tsipras reigned in his finance minister, is it really beyond the pale to suspect that if Merkel would reign in her finance minister (who has recently appeared to advocate referendum and a parallel currency for Greece), it would also be helpful? What Europe has to convince its G7 partners of is that is it not turning a broken state into a failed state.
The immediate problem is that Greece owes the IMF about 1.6 bln euros spread out over four payments in June. Recall that the last payment to the IMF was made possible only because the Greek government borrowed from a reserve account held by the IMF itself. If that reserve account is not repaid in a few weeks, the IMF will begin another set of procedures against Greece. It is true that Greece has cried wolf many times, saying it would not make a debt payment, but then somehow, miraculously, found the means to make the payment.
Greece was the proverbial canary in the coal mine in 2010 and Syriza is performing a similar function five years later. The political push back against austerity is not isolated to Athens. Today's local elections in Spain will offer a test for Podemos, which shares many beliefs of Syriza. Prime Minister Rajoy has staked his political future on the improving macro-economic conditions. The strategy has not yet yielded positive results. The local elections will also be a test for the new center-right alternative to Rajoy's PP, the Ciudadanos.
Three non-EMU European countries will report Q1 GDP figures in the week ahead. The UK is expected to revise up its preliminary estimate of 0.3%. Industrial output and construction figures for March were stronger than the ONS projected. Sweden, where the central bank has set a negative repo rate and is engaged in a bond-buying program is likely to have grown just less than 1% after growing a little more than 1% in Q4 14. Switzerland's growth is expected to have slowed to 0.3% from 0.6%.
Turning to Asia, there is a Japanese economic report every day in next week. The picture that is likely to emerge from the data is an economy that is picking up after losing some momentum as Q1 wound down. Retail sales, overall household spending, and industrial production are expected to have improved. However, if the main thrust of the aggressive monetary easing was to fuel an increase in inflation, it has been considerably less successful. With last year's sales tax increase dropping out of the base effect, core inflation (which excludes fresh food) is expected to be around 0.2%.
Lastly, before the weekend Chinese officials confirmed the long anticipated mutual recognition of mutual fund listing between the mainland and Hong Kong (SAR) will begin July 1. This represents a new era for asset managers. Previously foreign asset managers accessed Chinese savings by partnering with local mutual fund companies. The mutual recognition will allow Hong Kong domiciled funds to sell directing into China and allows China-based fund managers to sell their product in Hong Kong. The initial quota will be CNY600 bln (~$97 bln) evenly split between the two. This is seen as enhancing the case to include Chinese "A shares" into the MSCI indices and demonstrating the liberalization that may see the yuan included in the SDR later this year.
