Europe's industrial
production still disappointing
Europe's industrial production does not confirm PMI trend
In spite of continuing improvement in the overall, as well
as manufacturing, PMI index, industrial production is not picking up in Europe.
The fact that it is not picking up is, however, not surprising. First of all,
industrial production, unlike the aggregate gross domestic product, is a very
volatile indicator. Second, for industrial production to pick up consumption
must pick up in a more sustained manner. In other words, we would like to see
at least a full semester of consumption picking, before industrial production
increases. Thus, given the only very slow speed at which many EU countries are
recovering out of the crisis, it does not make sense to expect too much out of
industrial production for the next few months.
Growth in any case likely to remain subdued
In addition, it should be kept in mind that even in the
United States, where the economy has been more resilient, growth has remained
confined to a few sectors such as the residential sector and, to some extent,
the automobile sector. What really matters, however, is that across the
Atlantic growth is likely to remain below its long-term trend. In the United
States this means 2% real growth versus close to 4% real growth. In Europe this
means that real growth is too stick around 1% yearly at best. The investment
implications of this dire scenario is that tapering is going to be far more
modest than the market has been discounting, and also the ECB is going to
dilute its latest "green shoots" rhetorics.
Japan prepares itself
for its first sales tax rise since 1997
Green light from growth figures for sales tax hike
By early October, Mr Abe will have to decide what is his
position on the first phase of a sales tax rise. This increase, which has been
voted under the previous legislation, should lift the current 5% levy to 8% in
April 2014 (first phase) and to 10% in October 2015 (second phase). To keep
things into perspective, a value added tax (VAT) at 5% is a record low among
advanced economies that have a VAT, whereas the average stands around 19%. The
upside revision of GDP figures for the second quarter, one of the key indicator
that Mr Abe has linked to its decision, seems to leave little excuses not to go
ahead with the voted schedule.
Stimulus to be launched to protect the economy.
The opponents of a rise fear that a sales tax hike would
derail the still fragile Japan recovery. It is true that a reduced consumption
would hurt growth as it represents roughly 60% of its GDP. On the other hand,
any perception that Japan's fiscal management is undermined could also have
some negative effects on bond prices and ultimately jeopardise the recovery.
The Bank of Japan (BoJ) has already warned Mr Abe's government that any tax
plan change could lead to a spike in interest rates caused by a loss of confidence
among investors in Japan's commitment to meet its debt obligation. Furthermore,
the BoJ upgraded its assessment of the Japan economy (recovering moderately),
the strongest language used by the Bank since March 2008. Finally, the BoJ
stands ready to increase its monetary stimulus should the tax increase
significantly deteriorate growth. Barring negative figures from a survey of
business sentiment on October 1, recent developments seem to indicate that Mr
Abe will indeed let the rate hike goes as planned but will launch an economic
stimulus to cushion the negative effects of the sales tax increase. The
stimulus, that could be as much as ¥5tn (half the size of the stimulus launched
in January), would also allow him to manage public support as he will need it
to implement his growth strategy (third arrow).
Potential stimulus
favour short-term JPY weakness
Implication for the forex market
The increase in the consumption tax is a step towards fiscal
austerity, even if the expected economic package used as a cushion should erase
a large part of the gains made by the tax hike in its first year. Therefore it
should act as a potential lift to the value of the Japanese yen in the medium-
to long-term. However, as we expect this austerity to be associated with the
launch of an economic stimulus from the Japanese government, and potentially
also from the BoJ, the short-term effect should lead to a devaluation of the
JPY. Looking at the charts, the short-term stimulus followed by the medium-term
austerity favour the test of long-term resistances on the major yen crosses
(110 in USD/JPY, 139 in EUR/JPY and 163 in GBP/JPY) but any sustainable moves
above are unlikely. On the other hand, any delay in the sales tax hike would
likely be perceived as a lack of commitment to address Japan's debt issue. The
expected rise in yields would lead to a stronger yen in the short-term.
However, a persistent rise in yields would increase the cost of the Japanese
debt and, with the BoJ as the main buyer of new government-debt issuance (70%),
it would likely bring closer the spectre of a sovereign debt crisis with
long-term damaging effects on the vale of the yen. Overall, as the first
scenario is the more likely, we favour a weaker JPY in the short-term. However,
we would not be too greedy close to the aforementioned key resistances.
The financial markets
do not read Mr Carney's lips
Housing prices and unemployment favour tighter monetary bias
The Bank of England (BoE) has tied its monetary policy to
the level of unemployment through its forward guidance. Even though a decline
of the unemployment below 7% will not automatically lead to a rate hike, an
improving UK labour market suggests that the start of a tightening cycle is
getting nearer. Furthermore, the recent sharp rise in housing prices
(especially in London), fueled by low rates and stimulus such as the
"Funding for Lending" and "Help to Buy" schemes, favours
more restrictive rules to credit access, especially with a still highly
leveraged private sector. All these factors have helped to lift the value of
the British pound.
Is there more upside for the British pound?
On 12 September, Mr Carney reaffirms the view that
unemployment should not fall to 7% until mid 2016, indicating that the start of
the tightening should not start before the second half of 2016. On the other
hand, market expectations favours a first hike in late 2014 or early 2015,
possibly earlier than in the US. With about 75% of the interest rates relating
to the BoE's benchmark, we believe that the GBP strengthening is starting to be
overstretched. From a technical point of view, GBP is close to major key
levels. In GBP/USD, the break of the resistance at 1.5752 is bullish. However,
given the underlying downtrend since April 2011 and the overextended rise since
the low at 1.4814 in July, we see a limited upside potential. Furthermore, the
bigger deleveraging in the US make them more ready for a rate hike than the UK.
In EUR/GBP, the support near 0.8411 is challenged. We would favour a further
medium-term decline toward 0.8225, possibly 0.8082 (see page 7). In GBP/JPY,
the break of the resistance at 156.77 opens the way for further rise towards
the strong resistance at 163.09. Finally, GBP/CAD remains technically very
attractive especially should the strong resistance at 1.6474 be broken.
EUR/GBP remains a
sell considering market positions
The International Monetary Market (IMM) non-commercial
positioning is used to visualise the flows of funds from one currency to
another. It is usually viewed as a contrarian indicator when it reaches an
extreme in positioning.
No major changes in positioning has occurred in the week
ending on Tuesday 3 September (IMM data cover a week ending on Tuesday).
Euro has seen some reduction in its long positioning before
the ECB meeting on 5 September. Given the very cautious stance of Draghi
concerning the Eurozone recovery and the potential for lower rates should money
market rates be unwarranted by the ECB's medium-term outlook, further EUR long
positions could have been reduced. However, from a pure positioning point of
view, the gap between the positions in Euro and British pound remains wide and
favours a medium-term bearish stance in EUR/GBP.
The Australian dollar remains thus far extremely short. The
recent batch of positive news relative to Australia (see our last weekly
report) could force investors to close some of their short AUD bets. Therefore,
even though our medium-term stance remain negative on AUD/USD, we would not be
aggressive sellers of AUD/USD in the short-term.
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