The Monday Edition: Global Macro Talk (US, China & ECB)

By Yaser Anwar, CSC of Equity Investment Ideas

This week I’d like to discuss 1) Conflicting US Economic Data (weak ISM but strong wage growth) and 2) China’s Fuel (18% savings rate), ECB hike (likely in June) & report International Money Market positions (in FX markets).

Conflicting US Economic Data

• Recently, the US Q4 growth came in at 2.2% vs. 3.5% expected. The ISM non-manufacturing index fell to 54.3 in February vs. 59 in Jan. The softening in non-manufacturing index, (representing a significantly larger portion of the economy than manufacturing) showed the lowest reading in four years.
• However, unit labor Costs surged at a 6.6% annualized rate in the Q4 thanks to an 8.2% annualized rise in compensation. So you see, at one hand we have sluggish growth but on the other we’ve got employment and wages which are not so sluggish.
• Furthermore, the USD is highly dependent on capital flows, a risky position as problems in housing and mortgage markets threaten to spill over into growth. Tightening by overseas central banks is right on track, and the dollar will lose further ground once the Fed drops its neutral bias (if you look at the TIC data, you’ll see foreign buying of US assets has been weak, is it possible the hawkish comments are also used to keep the USD from dropping? I think so).
• But will it? Not anytime soon. On Friday, Fed’s Kohn said that inflation expectations were "critical" and criticised the notion that actual inflation trends lead inflation expectations. Fed’s Lacker (a non-voting member) said that it was questionable whether current inflation expectations were anchored enough for price stability.
• While Fed officials keep up the hawkish rhetoric, the US consumer retail spending (is telling a slightly different story) in 07 has been flat, and February’s release will likely show a continuation of a below-trend pace to spending.
• Even with the correction on Feb 27th, the markets are higher than a year ago, and may well defer the need for any near-term tightening, alongside cooling the speculative exuberance in the global markets, which have been a concern to policy makers (not only in China but Korea, Vietnam to name a few Asian tigers). The reserves of foreign central banks are sufficient enough to cushion any correction.

Global Macro- China’s Fuel, ECB & Int. Money Market positions

• China– The Chinese government’s unwillingness to see the yuan appreciate rapidly & the average savings growth remaining in double digits (has averaged around 18% annually, it is quite possible these savings could flow into the stock market, more so now given EPS growth of 16% EPS growth, and stocks trading at 14x 07 earnings with 2.4% dividend yields.
• ECB– The ECB is still in tightening mode, with wages the current concern. Industrial production across the EU is at 4% above year ago levels in the latest report. Germany will be hit by the VAT increase (as talked about two weeks ago), but its IFO index remains not far from its recent 15-year high, and February saw a significant drop in German unemployment.
• This week the CPI comes out (and the ZEW) which is expected to climb. The M3 has remained high around 7% (surged to 9.8% in Dec. 06) well above the ECB’s 4.5% estimate for what would be consistent with price stability. Hence the market is right to price in a June hike and the Euro will keep trading at top end of the range in the FX markets.

IMM: Carry-trades unwinding

• IMM data released on Friday pointed to a reduction in carry positioning by the speculators. Short yen positions fell to -56k vs. -103k the week prior, while long AUD positions collapsed from +102k to +41k. Meanwhile, short CHF positions fell to -17k from -42k, while long EUR positions fell from +116k from 132k. Long GBP positions were also cut back to +36k from +83k. Finally, short CAD positions were extended to -73k from -54k. (Source: Bloomberg)

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