Macro Overview

The global capital markets continue to adjust to ideas that monetary policy is loosening again.  Of course the Bank of Japan's announcement last week is important, but the also consider that the ECB left the door open to a rate cut as early as next month and, in a few months, Carney takes over the helm at the BOE with an apparent mandate to ease.  Meanwhile, the weak batch of data keeps the Fed buying $85 bln of long-term securities.

The market has picked up where it left off before the weekend.  Unexpectedly, in the wake of the Cypriot agreement, European bonds have rallied.  French, Dutch, Belgium and Austrian bond yields are at record lows.  Spanish and Italian bonds have extended their rallies as well, and of note the Spanish 2-year yield is slipping below the 2% threshold.   

Japanese stocks have continued to rally as the yen has weakened.  Other Asians shares were lower, though the 3.3% rise in the Topix was enough to lift the MSCI Asia-Pacific Index by 0.4%.  This also means that emerging equity markets remains under pressure after recording 4-month lows last week.  Just as the market appears to have been caught off guard by the large rally in European bonds, the continued weakness in emerging market equities is unexpected. 

European shares are mostly higher, with the Dow Jones Stoxx 600 up 0.5% led by consumer services and oil and gas sectors.  Portugal is under-performing, both in the bond market (where the shorter end is under pressure) and in the equity market, where losses are being led by the financials (while industrials actually advancing by more than 1%).  We note problems with the NBG-Eurobank tie up in Greece are weighing on Greek shares.  Lastly, Slovenia's CDS remains firm, but off the high set last week.

There are several considerations shaping the investment community in the week ahead. The first and most important is the BOJ's decision last week to create bank reserves at an unprecedented rate.  It seeks to do in two years what took the Federal Reserve five years to achieve.  The scale of its monthly operations will be roughly twice the Fed's.  Under Shirakawa, the BOJ's balance sheet was roughly 21% of GDP.  The current plan is to bring to it about 40% by the end of 2014.

Some observers are suggesting that this is a new strike in the currency wars.  The US and IMF do not see it that way.  Some in the Chinese media have expressed concern and it would not be surprising if a few other countries, like South Korea, were critical.  However, it seems that the main channel by which monetary policy (ie., the manipulation of balance sheets of the central bank and financial sector) is to arrest and reverse deflation is through inflation expectations. 

The Ministry of Finance weekly data has been unambiguous, Japanese investors have responded to the prospects of a weaker yen or higher inflation by stepping up their purchases of foreign financial assets.  While some may dismiss the selling of foreign bonds last month as repatriation ahead of the fiscal year end, it seems bigger than that.  Japanese investors have been net buyers of foreign bonds three times (weeks) this year.   Although some investment houses and media were claiming that the carry trade was dead (killed by QE) a few months ago, the leveraged community appears to be the main sellers of the yen, using to fund purchases of developed and emerging market bonds.

Earlier today Japan reported its first current account surplus in four months.  The trade deficit of JPY677 bln, was more than offset by the JPY1.4 trillion investment income surplus.  These are the two biggest items on Japan's current account. 

The weakness US job creation in March will influence policy expectations and may very well undermine the significance of the FOMC minutes that will be released this week.  Recall that Q1 data, prompted upward revisions to GDP forecasts, and some Fed officials, including most noteworthy San Fran Fed's Williams, talked about tapering off asset purchases around the middle of the year.  The jobs data spurred a sharp swing in the pendulum of market psychology, with some economists now suggesting of the risk that the Fed increases the pace of its purchases.

This is an exaggeration to one month's data.  Moreover, it seems that the market's judgment maybe more severe than the Fed's.  The Troika at the Fed (Bernanke, Yellen and Dudley) have cautioned against getting to excited by some short-term acceleration in the data and warned that it needs to see the data sustained to have a policy impact.   Bernanke's speech later today on financial stability is likely to show that the high frequency data has not impacted the Chairman one way or the other regarding the $85 bln a month in asset purchases.

While no doubt disappointing, there were two elements of the jobs data that were encouraging.  First, the 61k upward revision to the Jan and Feb series would put the new job creation at 149k, which was in line with what we had identified as the whisper number following the disappointing ISM and ADP reports.  Second, and more importantly,  current employees are working more hours and this is understood to be a possible prelude to future hiring.  The index of hours worked increased by 0.3%, just above the 6-month average.  The average work week is the longest in five years.

The 20k decline in retail trade jobs was unexpected, but we think it is likely coincidental that the retail sales report (Friday) the most important US data of the week, will show weakness (though the Bloomberg consensus is for a flat report).  We suspect the headline will be weighed down by 1) a 3.5% fall in gasoline prices, 2) poor weather which may have limited building material sales and 3) a moderation after February's 1.1% gain, a five month high.  The component used for GDP calculations will likely do better than the headline as chain store sales have been steady and the drop in gasoline prices may have helped spur other purchases.

There will be economic and political developments in Europe this week.  The economic data features the industrial production of the euro area and the UK.  Germany reported industrial orders twice as strong as the market expected and this pointed to the upside risk to today's industrial production report.   The 0.5% February rise was indeed more than the consensus, but the sharp downward revision in the January series (-0.6% from unchanged) negated the impact.  France reports its figures at mid-week and the euro area as a whole at the end of the week. The first estimate of Q1 GDP will be released on April 25. The optimists are hoping for a flat number, while the risk seems clearly on the downside.

There are several political developments to note in Europe.  First, given the Portuguese court ruling at the end of last week that found several austerity measures to be unconstitutional, there is some thought this could destabilize the government as new spending cuts are sought to fill the gap (Brussels appears to have rejected the suggestion of making a payment to workers and pensioners in T-bills).   Second, Italian President Napolitano's commission that is to derive an consensual platform to resolve the political logjam, is to report around the middle of the week.  

Meanwhile, there are reports suggesting some weakening of the cohesion of the 5-Star Movement, potentially making a political agreement of sorts more likely.  Third, the European finance ministers meet at the end of the week.  There are several agenda items, including Cyprus, Greece, Portugal as well as possibly extending the maturities of Portuguese and Irish EFSF/ESM loans.   Fourth, we note that Norway appears to be headed for an strike that may idle 20% of its oil output and have knock-on effects on shipyards, construction and public transportation (and breweries).

China data deluge for March starts off with consumer and producer prices tomorrow. The CPI is expected to moderate to a 2.5% pace from 3.2% in February and 2.6% in January-February.  New yuan loans will be reported sometime during the week, expected at CNY890 bln vs. CNY620 bln in February. Trade will also come out during the week.  Exports and imports likely moderated from February levels. Exports are expected to rise 12% (year-over-year) after 22% jump in February.  Imports likely rose around 6% after a 15% increase in February. Official and HSBC PMI readings for March both point to continued expansion in manufacturing.

Perhaps of more immediate concern is the outbreak of H7N9 virus in China.  The slow release of information from China appears is worrisome.  In addition to the human contagion, there are reports that there has been a culling of swine and poultry.  

Finally, we note that the flash point of geopolitical concern has shifted from Iran and Syria, to some extent, to North Korea.  There is new leadership in China, North Korea and Japan.  The US has made a "pivot" to Asia and appears to be realigning its trade and security interests.