Growth Optimism is the Story

At the risk of exaggeration, there is only one story today and it is growth. The story began on Friday with the Q2 GDP showing a smaller contraction than most expected, and more importantly, the unexpectedly sharp decline in inventories, has even the likes of Alan Greenspan recognizing the risks of the strong bounce in the economy in this quarter. The Bloomberg consensus for US growth has firmed in recent weeks to 1.0% and this is likely to be revised sharply. Greenspan himself mentioned 2.5% and there is at least one investment house forecasting 3%. Most US officials that hit the weekend media also were relatively upbeat. This has been followed by today’s better than expected European purchasing managers surveys. The euro zone came in at 46.3, a bit better than the 46 flash and the 42.6 reading in June. It is the best in 11 months. The magnitude of the rise itself is the second biggest in the 12-year history. Output and new orders gained and near 50. Outside the euro zone, there were notable upside surprises by the UK and Sweden. The UK surprised with a 50.8 print. The consensus was for 47.7 after 47.4 in June, which was originally reported at 47.0. New orders were particularly impressive; rising to 55.9 from 49.9, the highest since late 2007. Turning to Sweden, recall that at the end of last week it reported a flat Q2 GDP (quarter over-quarter) defying expectations of a contraction. Today it reported its PMI rose to 54.3 in July, up from 50.5 in June and well above expectations of 51.5. Lastly, we note that Switzerland’s PMI was reported at 44.3, up from 41.8 in June. Output was just below 50, though new orders.

To be sure, the price action is not following the news very tightly. The Swedish krona, for example, is under-performing today, though it may be understandable given not only the pre-weekend advance, but the nearly 8% gain against the euro since the middle of July. In fact, the krona is challenging the yen for the dubious honor today of being the weakest of the majors against the dollar. On the hand, sterling is the strongest. Even with the upward revisions to the US growth outlook that are likely to crystallize, the dollar itself lacks any traction. This is consistent with the recent pattern. The piece of the jigsaw puzzle that has yet to fall into place for our intermediate term constructive dollar view is the interest rate differentials. Ten and five year US rates are above Germany, but the more crucial shorter tend has yet to switch. Germany, for example, offers 15-16 bp more than the US at the 2-year tenor and even the Euribor and Eurodollar spreads for June next year still favor Europe (marginally). We suggest that a rise in US rates relative to Europe’s is a necessary pre-condition for the dollar bull market to resume and then with a little lag.

There are two other developments to note. First, following last week’s disappointing employment data, Japan today reported that cash wages fell more than twice the consensus expectations. The 7.1% year-over-year contraction is the 13th consecutive decline and the steepest on record, as bonuses were slashed 14.5%. Although industrial output and a pick-up in Japanese exports will help, the weakness in the weakness in labor and wages reflects the weakness of the domestic demand. Second, the IMF indicated that it may upward its economic forecasts for Poland later this year. The zloty is not simply waiting and rallied to new 6 ½ month highs against the euro and continues to lead the regional currencies higher. We have expected the zloty to outperform both the Czech koruna and Hungarian forint. Today Poland reported its July PMI rose to 46.5 from 43 in June. The consensus had called for a more modest increase to 43.6.
Growth Optimism is the Story Growth Optimism is the Story Reviewed by Marc Chandler on August 03, 2009 Rating: 5
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