At this stage as most earnings are in Euro's.
The Euro Pound rate is the most important, and that is in Medify;s favour, as actually the Uk is in a far worse shape that the U.S which may sound difficult to believe. Ive added a monthly currency comment I do at the bottom and only the Kiwi is in a worse stae than sterling. The EuroDollar rate is the most diffilcult to call in the short term, but in the long term the Us Dollar has big structural problems and will weaken against the Euro. Again as Medify;s earnings are in Euro's thats in your favour as it will take less Euro's to buy dollars.
All in all a win win if I'm right.
If your a European with a large holding ( not british), at some point you should consider hedging the exposure.
Euro
The emphasis last month was that the Euribor market was still behind the curve in terms of rate rises, and that once this was perceived as true, the Euro would benefit. This was certainly bourn out, as the Euribor market slid further, but the impact on the currency was far more muted. It did rise against Sterling and the Yen, but was largely unchanged against the Dollar.
On the economic front, the components of the Ifo, that had previously shown very positive expectations, where transferred last month into the current situations index, as the indicator hit a 15 year high. Manufacturing Pmi posted its highest level since 2000, and the services component was strong as well. Loan growth continues to move upwards, with M3 up 8% y/y.
Inflation remains benign, with the rise in oil having a greater impact in the trade balance deficits. As is usual with the Ecb, Mr Trichet caught the markets by surprise, by more dovish comments at the last meeting, but the Euribor market and Bunds continued to slide aggressively. Whilst there is little doubt that the immediate economic outlook is rosy, without wage growth, the possibility remains that the peak in the economic cycle is close. This is especially true, if subscribing to the prospect that the rising yields in America will cause the housing market to fall further. The lack of political will to make real change as shown in Italy and France in recent days, combined with high government deficits, the outlook for politically induced change is unlikely.
Therefore in contrast to last month, the Euribor curve is possible pricing in too many rises. Once the market realises this, the Euro should retrace, although the longer term outlook against Sterling still looks promising, not with standing the recent false break out of the long standing monthly triangle formation.
UK
The contrast between the UK’s economic performance, compared to other economies, provides a stark realisation of the problems the country faces. Whilst other trading blocs post new highs in many statistics, this economy is barely growing, and if the rest of the world merely coughs, it is probable that the Uk will catch bird flu.
The only area of comfort is in the housing market where prices rose 1.1% m/m, with Halifax index signalling a rise of 7.4% y/y. Equity withdrawal has also been strong, and the drop in mortgage approvals is probably explained by the shockingly bad weather. M4 lending continues to rise.
It is in other areas of the economy where the worries lie. Manufacturing Pmi is barely above 50 and the Services Pmi component is also falling. The extremely tame inflation readings are testament to a lack of pricing power across the whole economy.
Of real concern to Sterling is the exorable rise in deficits. The core goods number is now at £6.3 billion and goods and services at £4.8 billion. Whilst the Short Sterling market is following the lead of other interest rate futures and pricing in rate rises, this seems misguided. Plays on calendar put spreads and back month calls look appetising. Rates are now higher in America than the Uk, and as the country loses its traditional high interest rate status, the possibility of an extended slide in Sterling is a distinct possibility. The large amounts of takeovers of British companies has provided a boost to Sterling’s inflows, as has the Ftse 100’s mutation into a mining index, but with long terms yields still very low, this is just another negative for the currency. As stated many months ago, no Labour Government has avoided a Sterling crisis. It is not too late for this one either, and appears the only reason that rates could go higher.
USA
In a similar vein to the Yen comment, focus was concentrated on the long term yields, which were at an important juncture. Any move beyond 4.65% on the 10 year note would see price entering a new distribution, and a break out of the huge sideways congestion dating back to 2000. Any break out was likely to underpin the Dollar, although in the long run the ultimate destination was lower, once the cycle of hikes was completed.
Rates did indeed break up, and have already moved beyond there first target of 4.97%. The next major level is at 5.49%. With the Fed still making hawkish noises, a move to here cannot be ruled out and this is reflected in the interest rate futures.
However, in a similar way to Europe, whilst the current data is strong, there remain doubts about whether this can be sustained. The question is; are we reaching the top in the cycle? Certainly for the stock market there are serious concerns. Profitability is at its highest since 1966, but this suggests that there is little room for further growth. The analogy with 1987 is clear with rates rising sharply, with the added problem of soaring commodity prices and high personal debt. The potential for the housing market to slide further cannot be ruled out, which could mean the economy suddenly turning around, and the fed being forced back into an aggressive accommodative stance. Whilst the hurricane season is still some months away, the unleaded gas market is already showing signs of strong upward momentum. The problem is not oil supplies or stocks per say, as they are at very high levels, but the inability for this oil to be refined.
Beginning with housing, new home sales were down 10.5%, but existing home sales up 5.2%. However, with the overhang of supply and inventories still climbing, it is difficult to see how house prices can stabilise. The recent rise in rates does not bode well. Inventories are at there highest since 1995, and the 4 week average of mortgage applications hit a fresh low. This was reflected in prices, as the median house sale value dropped 7.2% m/m, and was the biggest fall since 1990. Existing home sales have also fallen 2.2% on a 3 month basis.
As has been the trend for some time, this weakness has not transferred itself to retail sales. They rose 0.6% m/m and the 3 month to 3month average is at its highest since 1991. However, with earnings growth still sluggish at 0.2% m/m, and with the consumption deflator up only 1.8% y/y on a core basis, this highlights how the economy may not be as strong as the Fed believes, or moving forward.
Therefore, the current rising interest policy seems fraught with danger and the Fed would have been better served by pausing, and seeing how the next few months evolve. Whilst current policy favours the Dollar, with the 3m/3m non oil deficit making new lows, the downside risks remain. They do not appear as urgent as the stock or bond markets. If subscribing to that view, In a similar vein to the UK, Eurodollar interest rate put spreads and back month calls look an interesting proposition.
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