Weekly Focus: Worries Are Intensifying

Market Movers ahead

• Market focus is likely to remain on the US economy in the coming week. The minutes of the most recent FOMC policy meeting could reveal important information about the Federal Reserve's decision to reinvest the proceeds of its MBS portfolio in Treasuries. There have been rumours that several FOMC members were in doubt about the decision. In addition, the ISM will give us an update on the pace of the slowdown in the US manufacturing industry. We expect the ISM to decline to 53.6 in August. The August employment report will finish off a hectic week on Friday. Early labour market indicators are pointing towards a weak report, with private employment set to grow a meagre 20,000.
• In Europe, the key event of the week will be the ECB Governing Council meeting on Thursday. While policy rates are likely to remain unchanged, a key question is whether the ECB has become more worried about the effect of the increasingly disappointing US indicators on the European growth outlook. Another important question that might be addressed at the policy meeting is whether the ECB will extend the full liquidity allotment - we believe this is likely. In Sweden, we expect the Riksbank to hike policy rates by 25bp to 0.75%.

Global Update

• The flow of weak economic indicators out of the US continued in the past week. Home sales have plummeted following the expiry of the tax credit for homebuyers. This has raised concerns about the strength of the underlying trend in home sales. Also, durable goods orders have called the strength of business investment into doubt. However, the reduction of weekly jobless claims was a positive, with initial jobless claims retreating to 473,000.
• The weakness in US indicators is likely to feed through to the European economy. In fact, new export orders in Europe's manufacturing PMI weakened. The European economy, led by Germany, should nonetheless be able to continue delivering abovetrend growth in Q3. However, although it has remained strong so far, Germany's Ifo manufacturing activity index is also pointing towards slowing growth.

Market movers ahead

Global

Market focus is likely to remain with the US the coming week, as it is heavy on US data and events. Firstly, the FOMC minutes will reveal details about the discussion at the latest FOMC meeting, and the reasoning behind the decision to reinvest the proceeds from Fed's MBS portfolio in treasuries. A WSJ article this week said that several FOMC members were in doubt about the decision. It will also be worth keeping an eye on the many Fed speeches scheduled for next week.

Secondly, ISM for August will give us updated information about the pace of the slowdown in the manufacturing sector. The regional surveys received so far have been bleak, suggesting that the slowdown could be more pronounced than our fundamental models predict. Taking both signals into account, we expect the ISM to decline to 53.6 in August.

Finally, the August employment report is likely to add to the round of depressing data received from the US economy recently. The unfavourable turn in initial jobless claims combined with the fast slowdown in economic activity in recent months, points to a weak trend in private employment. We expect a meagre increase of 20,000 in August. The termination of temporary employment for Census will continue to distort headline payrolls. We expect a drag of 150,000 from Census which will take overall employment to -130,000 in August.

The major economic event in the euro area next week is the ECB Governing Council meeting. Policy rates will remain unchanged, but there will be plenty of other signals to look for. Will Mr. Trichet be as happy as he appeared at the last meeting? We think not - US data have deteriorated a lot since the last meeting, and it can only be a matter of time before it begins to drag on European growth. Will the ECB prolong full allotment? We think it will - at least until the end of the year. The ECB will also have to revise its staff growth forecast upwards due to the better than expected outcome in Q2. The inflation forecast is likely to remain unchanged. The simple conclusion is that the ECB is not going to hike rates for a long time.

Switzerland is heading for a quite interesting week. Attention will focus particularly on the Q2 GDP numbers due out Thursday and the August inflation numbers due Friday. We expect healthy GDP growth of 0.75% from Q1 to Q2 (2.6% y/y), driven not least by consumer spending and exports. Moving on to the inflation data, we expect another decline in the inflation rate from 0.4% y/y in July to 0.2% y/y in August. With inflation approaching zero and no signs of major inflationary pressures in core inflation measures, we see a risk of the first rate hike from the Swiss central bank, SNB, being pushed back a little further than December 2010, which is our current forecast. The likelihood of a later-than-expected initial rate hike is supported by growing fears recently of another downturn in particularly the US economy. Moreover, it is worth keeping an eye on Monday's PMI data for August and Thursday's retail sales numbers for July.

In Asia focus next week will be on the manufacturing PMIs released across Asia. We should pay attention to China's two manufacturing PMIs in particular because over the past two years China has led the rest of Asia (and the rest of the world for that matter). In our view the Chinese manufacturing PMIs will bottom out in the coming months. This view is supported by some recovery in domestic steel prices. We expect China's official NBS manufacturing to improve slightly in August, both because it has shown most signs of stabilisation recently and it tends to go higher seasonally in August. On the other hand, the HSBC/Markit will probably decline slightly, but we expect it to show signs of stabilisation.

Outside China we expect manufacturing PMIs to continue to decline in August as they have recently lagged China. This includes Japan's Nomura/JMMA manufacturing PMI where not least the strong JPY weighs heavily. We only expect industrial production in Japan to have edged marginally higher in July following the - 1.1% m/m drop in the previous month, underlining that the manufacturing recovery has slowed substantially. In addition, everybody's eyes will be on Bank of Japan (BoJ). There has been some speculation that BoJ could soon call an emergency meeting to discuss what to do about the strong JPY. We do not expect intervention in the FX market, but think it will step up its quantitative easing further, but most likely not until its next scheduled meeting on September 6-7.

Global Update

Stress is on the rise

The past week offered no relief to worries about the global recovery. US data were very weak and equities have now given back most of the gains seen over summer. Strong data in Germany did not get much attention in the markets. PIGS countries have also come under renewed pressure - not least Ireland which got downgraded one notch to AA- by S&P.

Bond yields in core Europe have fallen steeply, increasingly driven by the long end. This points to some pain in the pension sector as lower bond yields lead to rising liabilities for pension funds with guarantees. As equities fall this eats into reserves and increases the need to hedge against further decline in equities and bond yields.

Overall the signs of stress have been on the rise this week and should be watched closely. Data on US ISM and non-farm payrolls next week will clearly be important for the slowdown fears.

A tsunami of bad US data

The tsunami of terrible data from the US economy continued this week.

The implosion in home sales following the expiry of the first-time-home buyer credit continued. New home sales dropped to a new all-time low, while existing home sales reached cycle low. The recent data raise serious questions about how weak the underlying trend in home sales actually is. While there is little doubt that the current level exaggerates the weakness, it is also reasonable to believe that the underlying trend is much weaker than we earlier believed. Given the current level of data residential construction is set to decline about 30% q/q AR in Q3. Moreover, it raises concern that prices could resume declining.

Businesses also showed more discomfort in July, as the durable goods orders embedded much worse details than expected. Core capital goods orders - which is usually a good proxy for future CAPEX spending - declined 8% m/m from an upward revised 3.6% m/m, while shipments dropped 1.5% m/m. This put equipment and software spending on track for a softer pace of growth. In combination with the housing data it adds some downside to our 2% q/q AR Q3 growth forecast. However, note that these data are notoriously volatile and subject to big revisions. Further, the setback arrives following some very solid months. Hence, before getting too concerned about this, we would like to see if the trend is sustained.

Weekly claims data stand out as the good news this week. Initial claims declined to 473K following several weeks of upward trending, which we believe reflects a seasonal distortion from the lack of shutdowns in the auto sector. If claims data manage to hold this level, it will be a sign that the job recovery continues - albeit at a moderate pace.

While the continued flow of bad data is increasing the pressure on the Fed to step up its QE a WSJ article this week revealed large disagreement about this issue within the Fed. Apparently several members had been very reluctant about the Fed's decision to re-invest principal payments on its mortgage portfolio. This indicates that the bar for further QE is relatively high. We will hopefully get more information on this topic from the Jackson Hole grape vine and the minutes, but for now the markets may have read too much into the recent Fed statement.

Euro zone: Strong confidence, but growth is set to slow

PMI data indicated that the US slowdown is beginning to drag on euro area growth. Manufacturing PMI new export orders point to a notable decline in export growth. The slowdown is also affecting the rest of the euro area economy. Both composite PMI and the new orders index indicate slowing growth.

The German Ifo index showed that the rebound in Germany is intact for now. The evidence is thus mounting that Germany will post above-trend growth in Q3, though not as spectacular as Q2. Ifo expectations points to a slowdown in German industrial production growth. At the same time, sub indices indicate that we can see a strengthening rebound in retail and services, which helps to put the recovery on a more sustainable path. Indeed German Q2 GDP details showed that private consumption increased 0.6% q/q in Q2 and construction increased an impressive 5.2% q/q. The weather-related dip in Q1 was less pronounced than previously thought as construction growth in Q1 was revised up from -3.8% to -0.7%.

The ECB's monetary data showed a mixed picture with annual loan growth improving, M3 annual growth unchanged and monthly loan flows deteriorating. It is not evident from the monetary analysis that the euro area recovery is getting much traction.

Asia: BoJ likely to move soon

In Japan growth is without doubt slowing, but so far we do not believe it will be a "double dip". The economic data released during the past week have actually been slightly encouraging. While exports month-on-month in July declined slightly in current prices for the third month in a row, export volumes increased a healthy 2.4% m/m. Hence, so far it appears that the strong JPY has mainly hurt companies' margins. In addition the unemployment rate in July unexpectedly declined from 5.3% to 5.2% - the first drop in the unemployment rate since January 2010. In addition, the jobs-to-applicants ratio continues to improve. In our view this is a more reliable labour market indicator and contrary to the unemployment rate it suggests that the labour market has continued to improve since December 2009. So the overall picture in our view is that the Japanese labour market continues to improve, but the pace of the improvement will slow and could start deteriorating if growth slows more than expected.

In the past week everybody's attention has been on the strong JPY and on possible intervention in the FX market to stem the recent appreciation of JPY. In our view there will be no direct intervention in the FX market, but we expect Bank of Japan (BoJ) to step up its quantitative easing most likely in connection with its next monetary meeting on September 6-7 when BoJ will probably downgrade its view of the economy for the first time since early 2009, see Flash Comment - Japan: BoJ move to stem strong yen is imminent. The move should be able to create a more solid floor under USD/JPY. However, unless BoJ delivers aggressively, we are unlikey to see JPY weaken significantly until the financial markets regain confidence in global growth.

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