Bank Research Consensus Weekly 05.17.10
Review and Preview
Ted Wieseman, Global Economics Team, Morgan Stanley
Treasuries ended fairly narrowly mixed over the past week as initial hopes that the massive EU/IMF support programs for fiscally strained eurozone members would halt the European crisis proved too optimistic and flight to safety into Treasuries resumed in a big way late in the week. Peripheral European debt spreads narrowed very sharply in response to the support plan, but worries about the euro area seemingly just became more diffuse and less focused on the recently most strained peripheral countries, and this was vented through a big further drop in the euro. After a brief partial improvement early in the week, funding pressures also worsened over the course of the week, and the biggest strains continued to be in dollar markets, notwithstanding the seemingly euro-focused nature of the current crisis. The FX swap lines that were re-introduced over the weekend initially at least were offered at rates so far above market levels - 100bp over expected fed funds at the initial one-week operations Tuesday - that demand was non-existent in the UK and Switzerland and light in the eurozone. Actually that there was any demand at all at the ECB operation at a 1.22% one-week rate was taken as a negative sign as dollar Libor continued moving higher and forward Libor/OIS spreads approached the highs hit May 6. While Treasuries didn't move too much on net for the week, modest short-end gains and long-end losses did combine for a significant steepening of the curve.
More EUR Weakness Ahead - But the Worst is Likely Behind
John Hydeskov, Senior Analyst, Danske Bank
In several issues of FX Forecast Update we have written about the risk related to the debt situation in the PIIGS countries. Admittedly however, we did underestimate the impact on the FX market – not least on EUR/USD. We revised our 3M EUR/USD forecast lower on 28 April to 1.27, see FX Research: The good, the bad and the ugly EUR scenario, but as EUR/USD is currently trading below 1.24 – a level not seen since the beginning of 2006 – the revision was obviously too modest. See the grey boxes below for a detailed insight into EUR/USD going forward.
The EU/IMF/ECB rescue package announced on 9 May resulted in a short relief for the euro. European solvency concerns returned and the CDS market continues to price a high probability of a sovereign default in southern Europe. In our view, the package did address a lot problems and ought to remove some of the current risk-premium attached to the euro. Perhaps most importantly, no country is allowed to default on liquidity constraints and ECB has shown its commitment to step in as buyer of last resort in the European sovereign debt markets. The latter should mitigate contagion from Greece to other PIIGS countries in respect of the interest rate level and secure the ability to issue debt in the market at a manageable price. The interventions are expected to be sterilised, i.e. the monetary base will not be expanded, and are therefore not euro negative by construction. Furthermore, the re-opening of the dollar swap-lines has eased the USDshortage in the money market even though the price for dollar liquidity seems surprisingly high. Finally, the package also showed a strong political commitment, intended to dampen “euro break-up” risks.
Despite Euro-zone Uncertainty, the U.S Economic Recovery Is Still on Pace
John E. Silvia, Ph.D. Chief Economist, Wachovia
Economic indicators released during the week were mixed, but continue to suggest the recovery is under way. The nominal U.S. trade deficit for goods and services widened slightly in March to $40.4 billion with broad-based increases in both exports and imports. Both increases reflect the economic recovery that is occurring in both the U.S. and the global economy.
While trade data released this week continued to support an upward trend in exports, some market participants suggest turmoil in Europe and dollar strength will likely be deleterious for U.S. exports in the long run. Indeed, slow growth in Europe will result in somewhat slower growth in U.S. exports, but at around 20 percent of the total market share, it is simply not large enough to change the upward trajectory in U.S. exports if the rest of the world continues to grow.
United States - Moseying Along the Road to Recovery
James Marple,, Economist, TD Bank Financial Group
Volatility remained center stage this week, following the rollercoaster ride of late. More details about European debt restructuring plans prompted markets to rebound strongly early in the week, but sober second thoughts took away some of the gains as the week closed out. As of writing, the S&P 500 was up almost 2.0% from its close the week before. In other good news, another key source of uncertainty – who would lead Great Britain – was alleviated this week with a coalition government formed between the first and third placed parties in the May 6th election.
Amidst the malaise across the pond, economic data out of the U.S. showed an economy moseying along the road to recovery. The key to a stable rebound is a transfer of the drivers of growth from government stimulus to private demand. This week returned signs that this transition is taking place. Retail sales data showed a 0.4% rise in the month of April, which after an outsized (and upwardly revised) 2.1% gain in March, is nothing to shake a stick at. Given that consumer spending is still close to 70% of the U.S. economy, a continued rebound in this sector bodes well for the overall pace of economic growth.
Budget Deficit is Focus of New UK Government
Trevor Williams, Chief Economist at Lloyds TSB Corporate Markets
The focus of the new coalition government – the first in over 70 years - has been made crystal clear: lowering the budget deficit and reversing the rise in debt. The parties agreed that tackling the deficit is the best way to ensure economic recovery, so there needs to be: ‘a significantly accelerated reduction in the structural deficit over the course of a Parliament with the main burden of deficit reduction borne by reduced spending rather than increased taxes’. This clearly lays out the new government’s position on this. We estimate that the structural budget deficit is around £70bn, see chart c. With an 80:20 split for reducing the deficit in favour of spending to tax, this suggests total spending cuts over the next five years of £56bn and additional tax rises of £14bn.
Emergency Budget to be held in 50 days There will be a Budget in 50 days, in other words by the end of June 2010. In an echo of the formation of the MPC in 1997, a new Office for Budget Responsibility (OBR) has been set up. A new Spending Review has also been set in motion and will report in the autumn. The problems of Greece – a highly indebted economy with a Budget deficit close to that of the UK but with outstanding debt of 120% of gdp (well in excess of the UK’s 60% of gdp) - highlights the risk to countries of funding large debt positions. Doing nothing would lay the UK open to the same sort of selling pressure on government bonds and hence severe funding problems, even if its financial position is in reality stronger than that of Greece.
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