Weekly Focus

Market Rates Set to Head Upwards

Market Movers ahead

• In the US, the coming week will be relatively quiet on the data front, although durable goods orders could give us an important indication of whether investment activity has turned the corner, broadening the overall economic recovery.
• In Europe, the focus is still on Greece and the coming week's EU summit could bring news about the readiness of EU leaders to help Greece out. It will also be interesting to see if forward-looking indicators continue to signal an accelerating recovery.

Global Update

• Risk sentiment is still improving in spite of Greece's debt problems. Equity markets are pricing in an increasingly significant economic recovery - the downside is a greater risk of disappointments.
• The FOMC signalled that US rate hikes are still some way off. This was confirmed by US inflation numbers, with core inflation on the soft side. Nonetheless, we expect market rates to move upwards going forward.

Focus

• We expect China to resume the gradual appreciation of its currency within a few months to contain inflation.
• The market reaction could be negative for equities in the short-term, as a stronger CNY will put a dampener on Chinese GDP growth. On the other hand, CNY appreciation will stimulate growth outside China. A stronger CNY could reduce China's currency reserves, which would be slightly negative for US bonds.

Market movers ahead

Global

In the US, the coming week will be relatively quiet on the data front. The calendar is dominated by housing market data with new and existing home sales and the FHFA monthly home price index due. We look for a further decline in existing home sales but a rebound in the sale of new homes. Further, it will be worth watching durable goods orders. Business CAPEX showed a significant rebound late last year and we believe that this was the beginning of a long-term investment cycle in equipment and software. We will get an indication of the current trend in business investments with the durable goods orders release the coming week. Finally, the consumer remains in focus and the final release of the University of Michigan consumer confidence and the weekly jobless claims are worth keeping an eye on. Bernanke will testify to the House on the Fed's exit strategy. On top of this there is a range of other Fed speeches during the week; most important will be those by Kohn and Warsh.

In Europe, flash PMI and IFO releases are the most interesting data next week. The EU summit held in Brussels on 25-26 March is however likely to get most headlines. The ongoing bargaining game between Greece and the EU this week intensified as Germany toughened its stance towards Greece. The Greek PM wants further clarification about the facilities the EU has to offer. Germany does not want to decide to help Greece without a formal request for aid, which Greece has not made. The summit next week is key for further negotiations. Will EU “show“ Greece the money, will the idea of IMF support get traction among EU leaders? These questions and many more are likely to be addressed in a week that could turn out to be very interesting.

A number of quite interesting data releases will come up on Wednesday. Flash PMIs are released in Germany, France and the eurozone. Lately manufacturing PMIs have risen in the eurozone, especially in Germany, indicating rising orders and production in early 2010 albeit from a low level. We expect PMIs to rise a little more, but the trend is likely to be more flat in the coming months. Further, our models indicate that the IFO expectations could rise somewhat reflecting the strong pull from Asia.

The CPI numbers and retail sales are going to be the most closely-watched numbers out of United Kingdom. We expect annual headline inflation to decline below BoE's upper comfort level of 3% and to continue lower in the coming months. Retail sales for January fell short of analyst expectations but we think that the February numbers will be much better. The pound has recovered nicely in the past week but short-term dynamics remain weak and we think it is too early to turn bullish on the pound.

In Switzerland, the SNB has allowed EUR/CHF to reach record-lows despite saying just last week that it would address excessive movements. We think the SNB hasn't forgotten how to intervene and believe that it will prevent a too strong franc as promised. The flow is however still for a stronger franc and our 6M EUR/CHF forecast of 1.42 might be reached earlier than previously anticipated.

In Asia the calendar will be light in the coming week. In Japan CPI for February will be released on Friday. We expect CPI inflation in February to edge slightly higher to - 1.2% y/y from -1.3% in the previous month. Deflation has got a lot of attention recently in Japan, with the DPJ-government continuing to press Bank of Japan to step up its fight against deflation. Measured on the headline inflation number deflation has already eased as seen in the chart, with headline inflation currently close to 0% 3M AR. Measured on core consumer prices, deflation remains more resilient although improving wage growth suggests it should start to ease.

In addition Japan will release foreign trade data for February. Export data for February released in China, South Korea, Taiwan have so far been strong and suggest the recovery in Japan's exports has continued in February. However, we cannot rule out there could be a temporary negative impact from Toyota's recall of autos.

No major economic releases are planned in China the coming week. In our view Peoples Bank of China (PBOC) can raise the reserve requirement for commercial banks anytime and a hike in the leading interest rates is not far off. However, we do not expect PBOC to hike until mid April.

Global update

Risk sentiment continues to improve despite Greece

Overall the improvement in risk sentiment appears to continue despite Greece continuing to dominate headlines. Standard & Poor's reaffirmation of Greece's BBB+ rating at least temporarily calmed nerves on Greece. However, with Greece now trying to force a some sort of solution in connection with the EU summit later in March, we could be in for a bumpy ride in the coming week. Data continues to suggest a gradual recovery, and a Fed statement with only few changes and further easing from the Bank of Japan suggest policy rates will remain low for an ‘extended' period.

Fed statement close to status quo

Hoenig remained the lone dissenter at this week's FOMC meeting. The growth language in the statement was slightly more optimistic, but there were no changes to the inflation outlook. The key phrase about rates remaining low for an extended period was retained, suggesting that hikes will be off the agenda for at least the next six months. That said, we expect the Fed to gradually step up its language to prepare markets for the first rate hike, which will likely arrive in November. Further, we expect the Fed to continue the normalisation of monetary policy over the coming months. Particularly we believe that a further widening in the discount rate spread is likely to come very soon.

The FOMC is likely to move gradually though, as the huge slack in the economy is keeping inflation pressures in check. Indeed, the disinflationary trend in the economy was confirmed by February CPI which came in on the soft side with a 0.053% m/m increase in core prices following a -0.13% m/m reading in January.

Activity data has been mixed with the Empire manufacturing index showing a surge in all of the forward-looking sub indices, suggesting that the ISM index could post an increase in March. However, this was countered by the weakness in the Philly Fed index and on balance the two surveys point to an unchanged ISM. Further, one of the most timely indicators of developments in the labour market - the weekly release of jobless claims - showed a further decline. However, the slow pace of improvement is a bit worrying and at current levels the claims data points to only a stabilisation in job growth. However, other indicators are more positive and overall point to an underlying trend in job growth of around +50K.

A weak spot continues to be the housing market. The NAHB housing market index fell back again in March and housing starts showed a continued decline in February. That said, the decline was smaller than expected as the weather in February was extraordinarily unfavourable for construction activity.

Germany no longer ruling out IMF solution for Greece

It has been an eventful week for European markets. Not so much in terms of data releases, but rather in terms of the ongoing discussions about whether Greece needs to be bailed out or not and who will pay for a potential financial lifeline. Let's start with the data releases. The most important piece of data this week was the release of the ZEW indicator for March. German ZEW expectations fell for a sixth month in a row. The financial sector sentiment is still burdened by concerns about the fiscal sustainability in the region, but good news in January with respect to industrial production probably lifted the assessment of the current economic conditions. We take some comfort from the current conditions index, which has moved higher for more than three quarters now, reflecting improved economic activity. (See Flash Comment - Germany: ZEW current conditions improve, 16 March 2010.)

Market attention however was more focused on the ongoing bargaining game between Greece and the EU countries. From Greece's perspective, the week got off from a decent start. The Euro Group and ECOFIN yet again welcomed the steps taken by Greece, and it was indicated that technical arrangements for a potential bailout had been clarified. S&P later removed its CreditWatch on Greece, thus removing the immediate risks of a Greek rating downgrade and markets reacted positively (see Flash Comment - Greece: moving away from the abyss, 17 March 2010. But then, sentiment had changed for the worse, as Germany toughened its stance towards Greece, saying that the troubled country should seek the IMF for assistance rather than the EU. Finland backs this view, as do the Netherlands and Italy. However, French President Sarkozy and ECB Governor Trichet are strongly opposed to allowing the IMF to bail out an EMU country, as they think it would prove that the EU cannot sort out its own problems. Greek PM, George Papandreou, said that Greece wants some clarification at the EU summit in Brussels next week on whether it can expect support from the EU. (See Flash Comment - Greece: The bargaining game continues, 18 March 2010. The bargaining game continues and we should know more next week. Uncertainty remains high and we expect volatile Greek markets next week.

Bank of Japan eases further

At the closing press meeting in connection with the National People's Congress this weekend, the Chinese Prime Minister, Wen Jiabao, talked tough and said that he did not believe CNY is undervalued. In addition, he said that “China would continue to reform the exchange rate system while basically keeping it stable and balanced.” The market's expectations of China resuming appreciation of CNY eased a bit on the back of Wen's comments. In our view, these comments should largely be seen as a rebuke of the recent increase in international pressure - not least from the US - for China to revalue its currency. Wen's comments allow for considerable flexibility and we maintain our view that China will resume appreciation in Q2 - more specifically in May. Nonetheless, Wen's comments underline the risk that increasing political tensions between China and the US could derail the solution that ultimately is the best solution for everybody, if it becomes more important for the Chinese leadership to demonstrate that it does not give in to external political pressure.

The Bank of Japan (BoJ) decided to expand the size of its non-conventional easing slightly at last week's monetary meeting. Specifically BoJ will increase the amount of liquidity provided through its three-month fixed rate operation started in December last year from JPY10trn to JPY20trn. The interest rate on this facility is 0.1% and was introduced in December. At the moment BoJ's main strategy is to try to push money market interest rates lower. This is the main purpose of the three-month fixed rate operation. We believe that BoJ prefers this strategy to stepping up purchase of government bonds - first because BoJ does not want to give the impression that it is bailing out the government, and second because it might believe there will be a greater impact on JPY from lower interest rates. Although this week's easing move was modest, it underlines that, unlike most other countries, Japan is far from starting to exit its nonconventional easing measures and might even ease further. Hence, contrary to last year, relative monetary policy should now really start to move in favour of a weaker JPY.

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