Signs grow that global output is slowing

Everyone has been talking about it for a while, but today there was hard evidence that a global manufacturing slowdown is taking place. PMI data from the Eurozone, the UK and China all moderated last month, and this is expected to continue when the US releases its ISM manufacturing report later this week.

The survey data showed that activity in Germany slowed to its lowest level since October 2010, the UK’s report was at its lowest level since December 2009, while China’s PMI is back to mid-2010 levels. The slow patch in growth last year in the US turned into QE2 and a commodity and stock price rally that saw the dollar tumble. So although the Fed is meant to end QE2 this month a bloodbath in today’s ISM would certainly increase the sceptre of further QE from the Fed, which might, perversely, cause risk to rally so watch out for volatile markets this afternoon.

Stock markets in Europe are fairly flat this morning as markets wait for ADP data and the ISM report. Likewise, the euro, pound, Aussie and Kiwi all remain well supported but are trading sideways as investors choose to wait on the side lines until after the US data releases.

Weak data out of the US is likely to keep pressure on the dollar. The close positive relationship between the ISM and US Treasury yields means that a poor print in the ISM could weigh on yields, which are already at their lows for 2011. This has constrained the dollar rebound, and until yields move higher we believe the greenback will remain under pressure.

Today’s data has also boosted safe haven assets and the Swissie and the yen are both stronger, interestingly, gold is following other commodities lower today as the dollar finds its feet.

The UK PMI figure was very disappointing and makes a rate hike less likely from the BOE. However, so much has been priced out of the UK yield curve already that Short Sterling futures in the aftermath of the report remained fairly static. The yield on the 3-month generic Short Sterling Futures contract is now back to October 2010 lows. The stabilization in yields is lending some support to the pound, which has had a strong run recently especially versus the dollar. However, if we get a spate of weak data this could signal a move lower in rate expectations and spur weakness in sterling.

The detail of the report is not yet known, but it is likely that there was a broad-based fall across all sub-sectors of the survey. However, since exports are needed to lead this recovery weakness in the manufacturing sector does not bode well. It is likely to cause further concern that the UK economy won’t be able to cope with the rate of deficit reduction the government is currently planning.

Elsewhere, apart from a German newspaper report that said the IMF would not extend the next tranche of bailout funds to Greece at the end of this month, it’s been fairly quiet out of Europe’s periphery. The cost to insure the debt of Europe’s most troubled nations has already moderated slightly, although it remains at high levels. Spanish bond yields are also lower today, which always helps to calm the market.

News that a large Irish Bank was planning to impose haircuts on the holders of subordinated debt didn’t cause a market impact. There are two reasons for this. Firstly, that the amount of debt that it applies to is extremely small, probably no more than EUR2bn, and secondly, a reduction in Irish bank debts means less debt for the state (and thus for the EU/IMF and ECB) since the Irish state has guaranteed all bank liabilities. As long as this doesn’t spread to sovereign debt then the markets are unlikely to be too concerned, however, markets remain extremely sensitive to rumours of default and restructuring, which could still cause risky assets to fall. So just because things have calmed down it doesn’t mean we are out of the woods yet.

The Aussie brushed off weak GDP data for the first quarter since growth is likely to bounce back later this year. Next week’s RBA meeting is the key event for the Aussie. The Kiwi is following risky assets higher but has retreated from fresh record highs of 0.8255/60.

Watch out for political news in Japan. Not only has its credit rating been put on downgrade watch, but momentum is building in Parliament to hold a vote of no confidence to try and bring down the government over its handling of the Tsunami and on-going nuclear crisis. Political instability is not new to Japan, but with its precarious fiscal position this is not a good time to change government. While the yen is fairly immune to what happens at home, we think that within the next year or so it will come under pressure especially if the government fails to get its public finances under control.

Also of note, the House in the US voted against a proposal to extend the debt ceiling yesterday. Not one single Republican voted to raise the limit, which is expected to be breached by August if the level is not moved higher. The Republicans have control of the House and it suggests there will be plenty of wrangling over the summer leaving the US’s solvency not necessarily a given. This could weigh on sentiment towards the dollar, and is unlikely to make overseas investors buy-in to the strong dollar story quite yet.

Source: Forex.com

01.06.2011