The Brits finally lose the ratings battle ... we need that Churchill spirit now more than ever it seems!
Week commencing Monday 25th February 2013
Overriding Market Themes
The UK lost its top credit rating by Moody’s Investors Service, which cited weakness in the countries growth outlook and challenges to the government’s fiscal consolidation program. The rating on the U.K. was lowered one level to Aa1 from Aaa, and the outlook on the nation’s debt changed to stable from negative. The agency cited the U.K.’s high and rising debt burden and the deterioration in the government’s balance sheet is unlikely to be reversed before 2016. This will increase the already gargantuan political pressure on Chancellor of the Exchequer George Osborne, with the Labour party already calling on him to scale back his fiscal squeeze as the recovery struggles to gain momentum. We doubt he will change course however, as many believe opting for a ‘plan B’ would be more politically damaging for the conservatives than retaining the already unpopular policies embedded in ‘plan A’. The pound fell after the downgrade in the last half-hour of trading during the New York session, dropping 0.6 percent to $1.5163. Sterling has depreciated 5.6 percent this year, the second-worst performer after the yen amongst the 10 developed-market currencies. In my mind, the downgrade comes as little surprise, especially as the UK has a similar gross debt to GDP ratio as both France and the US, both of which has lost their AAA’s recently.
Pressures against the Pound were also not helped last week as Bank of England Governor Mervyn King indicated he backed more economic stimulus. King, Miles and Fisher were outvoted by the remaining six members of the MPC, the minutes of the 7th February meeting showed, surprising many economists who had predicted only one policy maker voting for more quantitative easing.
In more upbeat news for the UK however, it seems that the Bank of England is one step closer in negotiations with its Chinese counterpart on a deal likely to boost trade between the UK and China in the Yuan. The Bank and the Peoples Bank of China as currently engaged in talks to crease a three year currency swap arrangement, pushing the UK closer to becoming an international trading centre for the renminbi. The agreement will allow both central banks to swap currencies and can be used by both banks and large corporates to settle trade in local currency rather than in US dollars, since China’s currency is still yet to be convertible. A similar agreement between China and Brazil has generated almost 30 billion US Dollars for the South American economy. Let us hope it can do the same for dear old England!
Italian notes dropped for a fifth week amid speculation that parliamentary elections will result in a hung parliament, derailing economic reforms in Europe’s biggest debt market. The country’s two-year yields climbed toward the highest level since the start of January as the latest polls before the vote tomorrow showed front-runner Pier Luigi Bersani is unlikely to gain enough seats to govern without a coalition. Former Premier Silvio Berlusconi was in second place. German bonds rallied on the back of this, with yields dropping the most since December, as a euro-area report showing manufacturing and services shrank boosted demand for the region’s safer assets.
GBP This Week
We start the week with the second estimate GDP release on Wednesday. GDP is one of the most important fundamental releases, and often affects the movement of sterling pairs. After posting a string of declines, the indicator improved nicely in the third quarter of 2012, posting a respectable gain of 1.0%. However, the markets are bracing for a weak reading in Q4, with the first estimate of -0.3% likely to remain. We then turn our sights to Friday morning’s Manufacturing PMI release, which no doubt will stoke up market volatility. This PMI has managed to pull above the 50 level for the past two releases, indicating slight expansion in the British manufacturing industry. The markets are expecting another release in positive territory, with a forecast of 51.0 points.
I remain bearish on the Pound’s chances of an imminent recovery, having lost a staggering 11 cents against the US Dollar since the beginning of the year. The UK economy continues to struggle due to its proximity to the Eurozone and fiscal consolidation, and the credit rating downgrade will only add insult to injury. The pound has not been able to stem the steep decline so far, and we could see the downward momentum continue into next week.
USD This Week
CB Consumer Confidence starts off the week, and with the implementation of new payroll taxes lowering confidence in economic outlook, a small rise to 60.8 is forecasted now. We then move to Ben Bernanke’s speech at the central bank’s semi-annual monetary policy hearing and provide answers on his aggressive monetary policy actions and on US recovery. After the relatively hawkish FOMC meeting minutes, Bernanke is likely to remind us that the doves are still in control, and that QE isn’t going away too quickly. Moving to Wednesday, we look forward to Pending Home Sales, which recently saw sales down due to short supply of available homes. This trend is expected to continue in the coming months. A reduced gain of 1.9% is forecasted this month.
US GDP is then due out on Thursday, and should be the highlight of the week. The initial release of GDP for Q4 2013 was a big disappointment as the economy contracted by 0.1%, mostly due to a sharp fall in government spending. As the strong growth in Q3 was probably overstated, the first report for Q4 was probably understated. A smaller trade balance deficit and other factors raise the expectations and an upwards revision to 0.5%, which we now expect. Finally, we are watching US Unemployment Claims and estimating a slight decline to 361,000 against last weeks above market reading of 353,000.
We remain bullish on the Dollar, and whilst things are not all shiny in the world’s biggest economy, at least it still experiences some form of growth and markets continue to have some faith that the Federal Reserve might begin tightening again, despite the dovish control of late.
EUR This Week
The overriding news from the Eurozone this week can only be the Italian Parliamentary Elections. The zones third largest economy has already gone to the polls and results are expected out today at 15:00. There is a close race between current center-leaning PM Mario Monti, center left leader Pier-Luigi Bersani, center-right PM Silvio Berlusconi and also the alternative candidate Beppe Grillo of the 5 Star Movement. There are fears that Berlusconi will fare well, and could return to his former job, whilst fears of a hung parliament also dominate markets. The best scenario for the markets is a strong outcome for Bersani and Monti, that would form a government together and continue the current stance on fiscal consolidation. Last ditch efforts to win over undecided voters compelled former prime minister Silvio Berlusconi to offer easing measures in IMU housing tax as well as remission on penalties for tax evaders. These attempts were strongly criticized by other opponents such as the former Prime Minister Mario Monti, who introduced the IMU tax to battle the debt crisis left behind by Berlusconi’s government. After this event, we have a array of manufacturing and services PMI data releases from individual member states before Mario Draghi’s speech at the Katholische Akademie in Bayern on Wednesday.
We remain relatively bearish against the Euro, especially with a hard-to-call election and real economy recessionary pressure effecting all but one of the nation states. A election focused upset could realistically send EUR/USD back towards the 1.30 levels, and perhaps even give Sterling a reason to appreciate for once, opening up the 15’s once more.
In Other News
After England's sluggish 23-13 victory over an improved yet still weak France, the words 'Grand Slam' are out in the open and setting the English rugby community alight. Of course, we still have to face Italy at Twickenham in a fortnight, and the all-powerful Welsh a week later, but it takes a particularly pessimistic man to think a return to the glory days is not upon us. Infact, this was a good weekend for home grown rugby as the Scots slammed in a much needed victory against the Irish at Murreyfield. Although sloppy, a victory is a victory in my books, and keeps Scotland just beneath the Welsh in third place.
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