The link between economic data and financial markets has been missing in the past two weeks. Indeed, the US economic data saw GDP revised down to -1.0pc largely due to inventories, which subtracted -1.6pc from Q1, compared to an initially reported drag of -0.5pc.
While on the bright side, initial claims fell -27k to 300k and the Department of Labor indicated there were no special factors impacting the data. When you think that yields should continue to normalize this year, US yields fell this week and the 10 year fell to 2.40pc. While the thesis that higher US yields were needed to lift the USD, the Dollar index closed above its 200 days moving average for the first time since September 2013 even if the greenback gave back some its gains, as positive risk environment helped emerging market currencies rally at the expense of the low yielding currencies.
In the UK, the Sterling Pound continued to struggle this week after UK economic data continued to disappoint with Lloyds business barometer plunging to +41 from +66 as analysts argued the positive correlation with PMI. In addition, Retail sales came at +16 in May versus +30 in April and +35 in March.
In summary, on the foreign exchange side, Markets closed the week with a relatively stronger USD against the low yielders. After reaching a high of 1.6882 on Tuesday, the Pound ended the week near the low of 1.6755. Euro on the other side behaved in a similar manner as investors refuse to buy the currency before any clarity from the ECB meeting scheduled for next week. The currency closed the week near the low of 1.3635.
In the commodities markets, investors remain confused as to the performance of Gold. Indeed, the metal continued its slide despite the thesis that higher US yields would hurt gold as the opportunity cost become too high. Some analysts noted May and June have been negative months over the last 3 years, not including poor performance seen so far this month. The arguments thrown is that investors are doubting the performance of gold in the lack of volatility.
Federal Reserve Bank of Atlanta President, Dennis Lockhart was reported saying that he was “not in a rush” for the central bank to end the era of loose monetary policy and begin raising rates. The US economy should rebound to a roughly 3pc growth rate after a rocky start to 2014 and put the Fed on track to raise rates later next year. On employment slack, he actually said that businesses were reporting conditions in some sectors that amounted to full employment. In fact, he highlighted that some industries in his own district had reported shortages of workers with certain skills and an inability to fill jobs. On the other hand, he said he feels there are many workers ready to take on more hours or new jobs as the economy strengthens. He added that he did not expect “dramatic” and rapid improvement in employment data, but that steady progress would likely put the Fed in position to begin raising rates in the second half of next year
The main event this week in Europe was a speech from ECB’s Draghi that pointed very much to the “package” approach. One that may fall short of full blown quantitative Easing at this stage. In terms of Draghi’s speech, reports that Draghi said that if the exchange rate, or market developments, result in an unwarranted tightening of monetary and financial conditions, “this would require adjustment of our conventional instruments”. Draghi also fleshed out what he called an “intermediate situation” in which constraints on credit interfere with the ECB’s monetary policy referring to the reluctance of some banks - particularly in the so-called periphery - to issue loans as they repair their balance sheets. “Term-funding of loans, be it on-balance sheet – that is, through refinancing operations – or off-balance sheet – that is, through purchases of asset-backed securities – could help reduce any drag on the recovery coming from temporary credit supply constraints,” he said. The comments suggested the ECB could deploy a long-term lending facility targeted at providing banks with funds to lend on to businesses and households, or else buy asset-backed securities to support the provision of loans.
In its bi-annual Financial Stability Review, the European Central Bank argued that investors’ pursuit of higher profits could be generating new price bubbles, which seemed ironic given ECB expectations. “As the search for yields intensifies, so do concerns regarding the build-up of imbalances and the possibility of a sharp and disorderly unwinding of recent investment flows,” The report noted main risks include “abrupt reversal” in global financial markets; weak bank profitability; “re-emergence of sovereign-debt sustainability concerns stemming from insufficient common backstops, stalling policy reforms, and a prolonged period of low nominal growth
The first comment came from an ECB official since the central bank concluded its annual gathering earlier this week. Media reported that the ECB is weighing up a package of easing options, and Executive Board member Yves Mersch confirmed that the policy meeting next week could yield a combination of easing measures to try and tackle the problem of low inflation and credit growth, a continuing problem highlighted by this week’s money supply numbers. When asked about the chance of a cut in the ECB’s main policy rates, Mersch said he assumes the differential between the rates will be maintained because narrowing the corridor could harm interbank markets, meaning that there could be a possibility of moving into a negative territory with deposit rate.
In Japan, more questions are being raised about whether we see more BoJ stimulus at some point later this year. indeed, newspapers suggested that the BoJ was quietly increasing its focus on how it will eventually exit from its current extraordinary monetary policy.
The Peninsula
