Market summary for April
After a negative start to the year, Sterling sellers finally enjoyed a sharp reversal of fortunes as Gross Domestic Production (GDP) figures acted as a catalyst for a Sterling rally that breached 3 month highs against the euro. Despite credit rating agency, Fitch, deciding to follow Standard and Poors in cutting the UK’s revered Triple A credit rating in April, the UK’s economic outlook has improved significantly over the last month. However, concerns remain regarding the sustainability of Sterling’s rally, with incoming Bank of England governor, Mark Carney, admitting that the “UK (is) still a crisis economy”.
In the Eurozone, concerns surrounding the Cypriot banking crisis have been replaced by concerns that the European Central Bank (ECB) may be about to introduce negative deposit rates for the first time. An interest rate cut from 0.75% to 0.5% by the ECB at the start of May was well received by the markets with many seeing the interest rate cut as honouring their previous commitment to do “whatever it takes” to promote stability for the eurozone. With economic data remaining weak throughout, the ECB face an unenviable task of providing support for peripheral European countries without ignoring the needs of Germany, which would lead to a deeper eurozone recession.
Signs that the US economic recovery is stalling continue to weigh heavily on the US dollar. Significantly improved non-farm payroll figures, showing the US economy added 165,000 in this sector in May compared to a below par 88,000 the previous month provided some short term relief for the US dollar. However deteriorating economic data maintain fears of further quantitative easing (QE) which would have a short term negative impact on the US dollar. Despite an undeniable slump in economic data from the US resulting in a Gross Domestic Production (GDP) annualised figures of 2.5% missing forecasts of annualised growth in the first 3 months of 2013 (Q1) of between 2.80% and 3.2%, the US economic recovery continues to significantly outpace its counterparts in the Eurozone and UK, with GDP growth in the UK forecast to fall below 1% for the whole of 2013.
The Great British Pound – Finally some sunlight through the clouds
Following a plethora of poor data releases, pessimistic forecasting and a general air of negativity surrounding the Great British Pound (GBP) this year, we have finally seen some positivity return to the market, albeit mostly centred on this month’s GDP figure. Recently, there has been a tendency towards adverse sentiment regarding Britain’s economic performance, but, when the facts are analysed, an upward trend is clearly visible. For example, the quarterly change in output has risen from a contraction of 0.1% in the fourth quarter of 2011 to a 0% flat reading in Q1 2012, followed by a return to growth of 0.1% (Q2 2012), 0.2% (Q3 2012), 0.2% (Q4 2012) and most recently 0.3% (Q1 2013). Although progress has been slow, we’ve seen some progress, most importantly.
Although the growth statistics in themselves are positive for Sterling as a currency and economic recovery in general, Sterling has also benefitted (and continues to do so) from the decreased likelihood of further QE being adopted by the Bank of England. The Funding for Lending Scheme has been extended to early 2015 and politicians are still emphasising the importance of increasing lending to small to medium enterprises (SME) to prolong the recovery. This type of monetary activism coupled with the positive GDP figure has meant QE is firmly on the back burner for the time being.
Elsewhere, we also witnessed a report showing UK manufacturing grew more than expected for the month of April, which has brought about a feeling of renewed confidence in the UK. Alongside this the UK construction PMI beat a forecast level of 48.0 coming in at 49.4 and a significantly better reading than 47.2 in March, also contributed to the belief that the UK economy is on the cusp of sustainable economic growth.
Despite this recent positivity, we are still being reminded by cautious economists that the UK continues to face a long and arduous task ahead, although optimistic tones are reverberating around the market.
What lies ahead for GBP
QE, in a simplified sense, is the method whereby central banks resort to printing more money to boost a country’s struggling economy. In the case of the UK and Bank of England, the Monetary Policy Committee (MPC) has chosen to allocate this money to bond purchases, keeping down the cost by which UK PLC can borrow internationally and reducing the currency’s buying power.
With the better than expected GDP figure announced on the 25th of April, the threat of adding more of this commonly used monetary stimulus has alleviated somewhat, as it appears the already printed pounds have induced the desired effect. GDP for Q1 2013 was expected to print at 0.1% growth; however, Sterling was boosted when the result was 0.3% for the quarter, and gained even further when previously dire GDP figures were revised slightly upwards.
Inflation is the other problem the UK faces, but with this coming slightly more under control of late, price growth poses more conundrums for the policy makers in the Bank of England and Government alike. Traditionally, the best way to lower inflation is to raise interest rates to encourage people to spend less and create slightly less demand, in line with creatng more of an incentive to keep money with the bank, while getting a higher return.
Currently, there is less chance of adding more QE, as the effects could be unnecessarily detrimental to the buying power of Sterling. However, as inflation staggers towards the Government’s 2% target, there isn’t any real possibility of an interest rate hike anywhere on the horizon. We will need to wait and see if the already implemented procedures continue to drive the UK back to the power it once was. A warning though: doing too much could be hugely detrimental. Realistically there are not many other options for the MPC to help tackle the economy other than what has already been used, so QE will not be far from the decision makers’ minds while we retain our sovereignty.
EUR and Europe’s hope for a revival
Over the course of the last month, we have seen the euro continue to suffer as attention turned from the banking crisis in Cyprus to the bigger picture of how the ECB is going to deal with reviving growth in the region. As a string of poor data flowed in from the eurozone, including euro powerhouse Germany, the markets geared themselves up for some action from the ECB. They duly obliged at the rate-setting meeting by cutting the benchmark rate to 0.5% - much as expected. What did surprise though were the comments from ECB president, Mario Draghi, who left the door open to negative deposit rates if the data deteriorates further. In his press conference, President Draghi said the bank is technically ready for negative deposit rates and noted downside risks to the economy. The ECB has kept a zero rate on deposits in an attempt to discourage banks to just keep money at the ECB and activate the lending market. A negative deposit rate would be a far more drastic measure and mean banks will actually have to pay the ECB for holding euro deposits, stopping them from hoarding funds, much to the “frustration” of Mr Draghi.
The rate cut itself is not anticipated to make much of a difference to the eurozone economy, which is still expected to languish in recession when first-quarter figures are published later in May. It is seen more as a gesture that the ECB will do “whatever it takes” but realistically the impact will be marginal. There is little evidence that the rate cut will result in lower borrowing rates in troubled peripheral countries where they have remained stubbornly high compared to rates in principal countries such as Germany, where lending is seen as a far safer bet by banks. The issue of juggling the vastly different needs of these countries is an art that the ECB will need to master going forward.
What lies ahead for EUR
The ECB has attempted to give the euro a boost with its move to lower interest rates in a bid to get credit flowing in the monetary union. The accommodative stance shows a much needed recognition of the deepening economic issues that face the European Union’s weakest members, further to accepting recent harsh austerity measures. The problem is that if you go back over five years to the start of the recession you will see that unemployment rates are still rising throughout the area. During this time government debt as a share of economic output has continued to grow, thanks in no small part to the shrinking economies in the region.
Whatever optimism investors can muster rests chiefly on the ECB’s pledge to do “whatever it takes” to hold the euro together. This effectively means buying government bonds in countries that are still taking steps to return to fiscal health. The EU’s definition of fiscal health is a government debt level of less than 60% of GDP, which looks an unattainable goal for a large portion of the euro region. If these peripheral nations fail to manage their finances accordingly, they will eventually have to default on their obligations. The subsequent losses could be disastrous and far outweigh what we have seen already in countries such as Greece and once again could again question the survival of the euro. Whatever measures are taken will require an element of risk and a loss of sovereignty that Europe’s leaders, particularly Germany’s, have so far spurned. If they don’t come around then there is a chance that the ECB’s assurances won’t be enough to keep the euro intact.
The US Dollar – Has the sell-off subsided?
In April, all eyes were firmly focused on the important US employment data that was released last week, although this time the figure was good.
For the majority of April, the dollar was seen as a SELL currency by traders pushing GBP/USD Interbank rates up from the low 1.50 mark to 1.56 and EUR/USD interbank rates from 1.2750 to 1.32 in the space of just four weeks. The main reason for dollar weakness in the past few weeks was the threat of further QE and that resulted in the biggest bearish dollar correction this year (since April 24th). Poor Q1 growth figures from the US were seen a few weeks ago, putting the dollar firmly on the back foot. The reading printed 2.5% annualised with the market consensus being 3.2% so quite a lot weaker than the expected. However, the dollar sell-off did finally come to an end (for now) after better than expected non-farm payroll figures were released last week. The report indicated that the US economy added 165,000 jobs in the month of April, with the market consensus being for an increase of 145,000, and we also had upward revisions to the figures released for February and March.
This bodes well for the US economy and coupled with the current issues in the eurozone, the dollar could recoup some of its recent losses as investors look for a safer bet.
What lies ahead for the USD?
Without sitting on the fence too much, it is extremely difficult to correctly predict which way the dollar will move from this point. On the one hand we’ve seen positive jobs data reversing the negativity from previous months. US growth, albeit down on expectations, was still showing a decent number by comparison to other major economies and the issues in the eurozone could cause a flight to safety. These are all strong arguments that could result in further dollar strengthening moving forward.
On the other hand, one set of good labour figures does not mean that the US economy is out of the woods just yet. Recent economic data before the non-farm payrolls has been on the poor side and the need for further QE continues to linger. So it wouldn’t come as a surprise if traders continued to sell USD.
In our opinion (not to be taken as advice), the dollar’s safe-haven capacity will come into play a bit more, adding strength to the currency. If we see EUR/USD break back through the 1.30 interbank level on the downside, then that too, may act as a catalyst for further dollar strength. Obviously, we could be completely wrong but one thing is certain - volatility will remain high.
A few things to look out for over the next few days - Federal Reserve Chairman, Ben Bernanke, speaking at the Federal Reserve Bank’s 49th Annual Conference on Bank Structure and Competition and the release of US unemployment claims, which will be closely monitored to see if they back up last week’s non-farm-payroll figure.