Markets Trying to Stabilize Despite Official Rattle

Between Federal Reserve Chairman Bernanke and Bank of Japan Governor Kuroda, they have unsettled investors and injected volatility into the capital markets that has not been seen for some time. The markets are trying to return to some semblance of stability ahead of the weekend, but the ripple effects are still evident. 

The Nikkei initially retraced some of yesterday's steep losses, before selling off more than 3.5% through yesterday's lows and then recovering to finish 0.9% higher. The stock market and the yen have not been the subject of BOJ concern as much as the JGB market. Purchases of another JPY900 bln of JGBs (five year maturities and longer)coupled with yesterday's JPY2 trillion money market injecting helped stabilize the bond market, but the 8 bp day's range shows that volatility remains highs and the market's unsettled.

Emerging Markets: What Has Changed

(from my colleagues Dr. Win Thin and Ilan Solot)

This is what has changed in the EM space in, our view.

1) In Brazil, government finances are back in focus and sparking calls for faster hikes

2) The Philippines government takes action on FX, more is coming

3) FX measures are also coming in Thailand

4) PBOC resumes CNY appreciation

5) Social-political tensions continue to mount in South Africa

1) In Brazil, government finances are back in focus and sparking calls for faster hikes. Some houses are calling for 50 bp hike at the May 28/29 meeting. We think that the BCB should use stronger language to convey to markets that inflation remains a priority, especially with the fiscal situation deteriorating, but we doubt they will deliver a 50 bp hike. The curve is now pricing about 40 bp of tightening for the May meeting. A new round of fiscal concerns was sparked by news that the PT is up to their usual accounting tricks. The government is selling some $15 bln of debt linked to future revenue from the Itaipu hydro-plant, up to 10 years – i.e. impacting the next 3 presidential terms. 

Japanese Corporates Not Yen Bears (Any More)

Japan's Economics Minister Amari had initially suggested a few days ago that the correction to the yen's strength had been corrected. Reports suggested that under criticism from his cabinet colleagues, he softened his comments, now indicating that correction was ongoing. The dollar proceeded to recover and made new multi-year highs yesterday. 

Amari was not talking off the top of his head.  A Reuters survey of 400 Japanese businesses, half of which were manufacturers, released on Tuesday, shows that almost half the businesses said the yen's decline has been sufficient and more than a third would like to see the yen recover somewhat.  Only 15% of the respondents sought further yen depreciation.  

Market Responds Dramatically to Bernanke

The global capital markets have been thrown into a tizzy by comments from Federal Reserve Chairman Bernanke.  US bonds and equities sold off yesterday on ideas that Bernanke was signaling a tapering off of QE.    The knock on effect was seen in Asia, even before the disappointing the flash China PMI from HSBC that showed the first sub-50 reading in seven months (49.6 vs 50.4 in April, with a fall in new orders and new export orders).  

Japanese government yields, which have been rising in recent days, initially jumped to 1.0% on the 10-year yield, almost triple the rate seen on the day before the BOJ announced its massive easing operation in early April.  The bond market recovered as the stock market tanked  The Nikkei lost 7.3%, essentially cutting in half gains over the past month. 

Great Graphic: Five Different Measures of US Inflation

This Great Graphic was posted on FT Alphaville and it comes from Credit Suisse.  It shows different measures of inflation.  The Fed's preferred measure is the core PCE (deflator).  However, it is sensitive to other measures as well. 

Perhaps it is like the different measures of unemployment.  There is no true or right measure of unemployment.  There are different measures and each has a different use.  It turns out that the commonly used U3 measure follows the guidelines established by the International Labor Organization and allows for more meaningful international comparisons.  

Fed officials have largely played down the drift lower in prices.  Bernanke himself suggested that he was not worried as inflation expectations remain anchored near 2%.   This is perhaps one of the benefits of QE--namely helping to underpin inflation expectations that is among the least commented consequence.  

The Fed may be right to play down the decline in the measured inflation, though a couple more soft reports could make it become more salient.  Given the monthly increases seen in Q2 12, it is possible that as these drop out of the year-over-year comparisons, core PCE still drifts lower.  However, the second half will be a different story.  In the second half of last year, core PCE rose by a cumulative 0.3%.    Core PCE rose 1.1% on a year-over-year basis through March, the most recent data, but in Q1, the annualized pace was 1.6%.  

Bernanke and the majority of the Federal Reserve say that a few more months of data is before deciding if it should taper of the long-term asset purchases.  Because the economy did not enter a self-sustaining growth phase, it can be judged that QE1 and QE2 ended prematurely.  Bernanke and Co don't want to make the same mistake a third time.  

Two Misunderstandings about Japanese Trade

Japan reported April trade figures earlier today. Given the decline in the yen and the positive contribution of exports to Q1 GDP, it is a closely watched report. However, there are two profound misunderstandings that distort how the media and some other observers comprehend the data. 

First, the decline in the yen does not automatically translate into lower prices for foreign purchasers of Japanese goods. Second, Japan is not nearly as reliant on exports as many suggest. It services foreign demand primarily, though not exclusively of course, on building and selling locally. These foreign sales still bolster Japanese corporate earnings. 

Central Bankers' Day

The US dollar is firmer against most of the major currencies, but is more mixed against the emerging market currencies. Although the US reports April existing home sales (consensus +1.4%), the focus is on Bernanke's testimony and then the FOMC minutes. 

Essentially we expect the Federal Reserve Chairman to say essentially three things: First, that the Fed has made progress on its thinking of the QE exit strategy. Second, that there will be no imminent tapering off of purchases of long-term assets and that the decision is dependent on the trajectory of prices and the labor market. Third, that fiscal policy and weakness in Europe are headwinds for the US economy and that the Fed cannot yet be assured that economic growth is sustainable. We suspect some late dollar longs are vulnerable if Bernanke hits these points.

Cool Video: How Tornadoes are Formed

This Cool Video was posted on The Atlantic and originally comes from NASA.  It explains the origins of tornadoes.   In a little less than four minutes you will have a better understanding of complex weather phenomenon.

Two Issues for the Fed: How and When

Federal Reserve Chairman Bernanke testifies before the Joint Economic Committee of Congress tomorrow. The market is anxious for the Chairman to weigh in on the recent comments suggesting that even some like-minded regional presidents like Chicago's Evans seems to be warming to the idea of tapering off purchases.

It is one thing for the more hawkish members, several of whom have never felt comfortable with the latest iteration of quantitative easing, to talk of slowing purchases, but it is another thing for some of the more dovish members to talk in this vein. Yet we suspect there is less than meets the eye. With the stock market extending its advancing streak to near 200 days without a 5% pullback and what Bernanke has called "the reach for yield" has driven the industry index of below investment grade yields below 5% for the first time; it is incumbent on Fed officials to demonstrate their vigilance.

Sterling and Yen Aren't Waiting for Tomorrow

The US dollar remains largely in a consolidative phase, awaiting Federal Reserve Chairman Bernanke's testimony before the Joint Economic Committee of Congress tomorrow. There has been much talk about tapering asset purchases and Bernanke's views are critical. 

However, comments by Japan's Amari, seemingly trying to soften yesterday's comments, after reportedly being criticized by cabinet colleagues helped lift the dollar back toward JPY103. Separately, soft UK inflation figures sent sterling back to the base it build last Friday and yesterday near $1.5165. Against the emerging market currencies, the greenback remains bid.