Our base scenario continues to pan out, with the risk trade still on, which is positive for EURUSD. Investors feel comfortable with the fact that monetary policy in the US, EU, UK and Japan will remain extremely loose. On the other hand growth projection remain intact, even if subdued, with a combination of better than expected numbers in Europe since June ( we saw positive PMI’s above 50 in Italy and Spain in November ) and retail sales in the US which should show growth of 3% for the current quarter.
The debate continues on when the Fed will begin “tapering” and what effect it will have. The general view seems to think that this could now take place in February, but the effect on the financial markets will not be as pronounced as in the May –June period.
Two things come to our mind:
1) Inflation remains at its lowest point in Europe and the US. Fears of disinflation remain strongly in the minds of G-3 central bankers
2) Anything that will halt the US recovery in US real estate prices is to be avoided at all cost.
The bond market seems to agree with this assessment, as after the initial sell off due to the strong US employment report, prices recovered rapidly.
In the EU, the ECB press conference was not well received, as no change was announced. The new forecast for 2015 foresees annual real GDP declining by 0.4% in 2013, before increasing by 1.1% in 2014 and 1.5% in 2015. The risks surrounding the economic outlook for the euro area are assessed to be on the downside. Inflation is expected to remain in the 1% level.
The most important message was that the ECB has many possible tools available in case of a major shock, but none are justified at present. President Draghi took great length to explain the collateral damage that each of them could have. In this sense the message is clearer than the one of Fed.
We wonder how the bank’s asset review will come out in Q1 2014. Circumstantial evidence regarding the German Landesbanken continues to suggest that many toxic assets have not been written off properly (if at all).
We expect investors to continue to invest in EU peripheral bonds, as they expect spreads to narrow, especially in Spain and in the Easter European countries.
In Japan, the Tankan report on December 16 should give us some idea if Abenomics has succeeded in getting Japanese corporations to start investing in Japan again. The September Tankan showed a somewhat better sentiment in employment and capacity utilization, but equipment spending is still weak. The government announced a JPY 5.5 trillion fiscal stimulus package last week, to offset the impact of next April tax hike, so there is a good chance that corporate sentiment does improve.
We remain positive on the Japanese real estate sector. Loans to property developers are particularly interesting. The gain in loans to that sector nearly equals that to all industries. At the same time, the decline in urban office rents is coming to a halt and there is an uptick in the number of contracts being signed for condominiums. If the market improves, financial institutions will step up their lending because property is used as collateral for bank loans, which should start a virtuous circle.
On China , we remark that Premier Xi has taken control of power faster than expected historically , a positive point. The reforms towards a more balance economy will certainly take place, but the impact will only be felt in two to three years. We believe the credit problem will be addressed faster and we reduce our expectation of a financial crisis for next year to less than 20%. Retail sales remain strong. The index should remain in lackluster territory, simply due to the fact that it is dominated by the banking sector.
A note on Brazil.: We have been negative on the country for the last two years and will continue to be so in the foreseeable future. From Lula to Dilma Roussef , all government levels have passed in the hands of the PT and corruption/ incompetence seems to be seen at all levels. GDP, which had a slight rebound in 2013, will most probably decelerate in 2014. Given the lack of reforms, it will continue to disappoint. A downgrade of the debt is in the cards.
The situation in Ukraine is going to put a serious strain between Russia and the EU. Roughly half of Ukraine is of Russian origin and or pro Russian, dating from the ruthless invasion that took place in 1922. The other half hates Russia, for rather good reason. Putin want Ukraine and has used all means, short of sending in his troops to achieve his goal. This is one of various geo-political situations that might upset investor’s complacency in 2014.
Technically , the trend for EURUSD remains intact. We never broke the 1.35 level in the last two weeks. . The Dec. German Bund has rebounded weakly from its support of 139.75. and could test 139.
As said before, if there is demand above 1.38, the 1.40 level should be challenged. Above starts Draghi’s worst nightmare.
Weekly Pivot on Dec. Futures
PP 1.3633, R1 1.3734, R2 1.3809, R3 1.3985
S1 1.3563, S2 1.3457, S3 1.3280