Macros In Focus

Over the past week, US assets have outperformed the others in G10. The dollar has risen against all the major currencies, except the Japanese yen. The US 10-year yield has fallen 23 bp compared with 13 bp decline in German and UK 10-year yields and a 1 bp increase in the 10-year JGB yield. The US S&P 500 had generally outperformed going into today’s session.

Since Friday’s disappointing employment report, but driven home over the past 24-hours, investors have become more concerned about the trajectory of the world economy. The string of poor economic data continued today. The 1.6% rise in machinery orders in Japan was less than a third of the gain the market expected after a 9.1% decline in May. These orders are now contracting on a year-over-year basis. China’s data was largely in line with expectations showing a modest easing in industrial production, retail sales and urban fixed investment. The pace of increase in producer prices eased (4.8% from 6.4%), but consumer prices accelerated (3.3% from 2.9%). The UK has been hit with a barrage of soft reports—from the collapse in the Nationwide consumer confidence measure (-7 from 49), only a 3.8k decline in the claimant count for unemployment (vs consensus of -17k) and unfavorably revised the June figure (to -15.9k from -20.8k) and culminating in the quarterly inflation report that saw the BOE revise down growth and kept the door open to additional QE if necessary.

The euro has been pushed below its 20-day moving average for the first time since July 1. Hourly technical indicators are over-extended and the euro will probably stabilize in the North American session. There is a band of support in the $1.2960 area. A break of this area would make it the deepest correction since the euro bottomed in early June. The combination of the shifting market focus back to growth concerns and the deteriorating technical tone, both themes we have been anticipating in the recent commentary, warns that euro losses could extend toward $1.2750, at least initially.

Sterling’s technical and fundamental backdrop has also weakened. Initial support in the $1.5660 area is being tested and a break could spur another 1% decline. A break of $1.5440 would be ominous.

Meanwhile Japanese MOF officials appear to be ratcheting higher their verbal attempts to stabilize the yen. Even though we often employ the imagery of an escalation ladder, we recognize one of its weaknesses: There are nearly an infinite number of rungs of verbal intervention. There seems to be several reasons why Japan has not intervened. The case for intervention must be more than undesirable price action. Currently, the dollar-yen rate is not very volatile-3-month implied volatility at just below 12% is lower than the 50 and 100 day averages. Nor is this necessarily as one-sided as the yen’s strength may appear. The premium the market pays for yen calls over yen puts (risk-reversals) and at the lower end of where it has traded over the past few months. Japanese verbal intervention may escalate and while it may make the market more cautious it is unlikely to force the market to reverse course.

In this macro context, the US trade figures may take on greater significance than usual. It is the last piece of significant economy data that economists will use to fine tune expected revisions to Q2 preliminary GDP estimate of 2.4%. Currently, given the recent inventory and consumption data, Q2 GDP looks closer to 1.5%. There are some reasons to suspect the risk of an upside surprise. For example, Boeing has indicated an increase in civilian aircraft exports and shifting import and export prices also look favorable (though the GDP contribution uses inflation adjusted—real—figures). Note that net exports took a little more than 2.75 percentage points off Q2 GDP, after only shaving Q1 about a third of a percent. On the other hand, one consideration that may be skewing US imports (and Chinese exports) is the end of some export subsidy for Chinese companies in the middle of July. There may have been some effort to “beat” the deadline and China-based companies may have frontloaded their exports.