Risk assets continue to outperform, but euro lags and dollar hangs on to its gains

Tom Tong20/Αυγ/2012Currency Updates

The absence of news from the eurozone and mildly better than expected macroeconomic data out of the UK and the US buoyed equities and commodities worldwide last week. Sovereign risk premia in the European periphery continued to drop, and the absence of bond issuance from Spain and Italy (as is traditionally the case in August) means that these lower levels have not been tested yet. The MSCI World index is now up about 12% from its June low; a remarkable move. Even more remarkable is the failure of the euro to get a lift out of this relatively benign risk environment, and last week was no different: it actually dropped moderately against both the dollar and sterling. This validates our view that the main support for the common currency has been the extreme bearish positioning among investors. This positioning has been now largely unwound, and therefore the euro finds little support from short covering.


Sterling had a positive week amid a spate of better than expected macroeconomic news. Retail sales, employment growth, and (less positively) inflation all surprised on the upside. Hiring continues to post stronger-than-expected numbers. The contradiction between decent job numbers and negative GDP data is becoming one of the key features of the British economic landscape after The Great Recession, and we confess to being somewhat puzzled by it. Confidence surveys (PMI and Markit) still point to labour market contraction through the end of 2012, but there is no doubt that relative strength in the UK job market is one of the pleasant surprises of 2012. Strength in retail sales confirms this labor market outperformance. Unsurprisingly, sterling performed strongly in the week, rising against both the euro and the US dollar. Moving forward, we will be nudging our estimates for GBP higher next week, as we revise our FX forecasts for G10 currencies.


News was thin last week out of the eurozone. German GDP growth surprised slightly to the upside, while Finland and Portugal surprised sharply to the downside. Overall, the 0.7% QoQ saar contraction was roughly in line with consensus. However, the miserable Portuguese performance (Ireland does not publish its data until next month) and Greece’s Government request for a two-year extension of its austerity «plan» provide further evidence of the disastrous impact of austerity policies in the periphery. As mentioned above, the euro is not keeping pace with the generalized risk asset rally, a sign that its main support was the record short position among traders. Now that this position has been mostly squared up, we expect the downtrend in the common currency to resume in September.


Another spate of better than expected news out of the United States last week. Retail sales came out much stronger than expected. Industrial production and housing data also showed healthy gains. It is true that retail sales and industrial production come on the heels of negative surprises in the previous months, but nevertheless this week’s numbers increase our confidence in our forecasts of 1.5-2.5% GDP growth for the remainder of 2012. The recovery in the housing sector from the very depressed levels of late 2011 continues apace, and we expect this sector to provide a moderate lift to US growth over the next quarters. This positive data buoyed the dollar, and the trade-weighted index rose moderately in spite of the risk appetite revival, an environment that is usually negative for the greenback. We are pleased to see the dollar follow the generally positive trend we have pencilled in.


Written by Tom Tong

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