by Tyler Durden
From Goldman Sachs
This past week’s EU Summit boosted risk sentiment materially, even if it failed to resolve in a definitive way some of the underlying problems facing the Euro zone. This was borne out in the price action this past week, where spreads on Italian and Spanish government bonds over Bunds narrowed around 20bp and 30bp on Thursday, respectively, but then gave almost all of this back on Friday, as market focus returned to Italy and the need for growth enhancing structural reforms. The Italian bond auction did not indicate a substantial improvement in investor sentiment either. EUR/$ on Friday traded with a softer tone, thought it held onto most of its gains from Thursday, underscoring the fact that EUR shorts remain sizeable even after the rally from 1.32 over the past month. In fact, when looking at our proprietary GS Sentiment Index, based on IMM positioning scores, risk reversals and bullish/bearish news commentary, EUR/$ short positions have increased to stretched levels (Figure 1). Among high-beta FX, the best performers last week were BRL, MXN, TRY, CLP, and ZAR (all against USD), while HUF was a notable underperformer against EUR (Figure 2).
Source: GS Global ECS Research
Source: GS Global ECS Research
In the big picture, the market continues to be torn between two conflicting desires. On the one hand, there is a need to remain nimble and keep any “risk-on” positioning light, given that a permanent solution for the Euro zone remains elusive and that US and global growth may remain slow as also indicated in our forecasts. On the other hand, in the wake of the risk sell-off in August and September the market, in our view, remains underweight risk, which was underscored once again this past week by the outsized rally following what was really a relatively tepid EU summit. In short, while substantial uncertainty remains, there is always a possibility this gets brushed aside into year-end.
Given this uncertainty, we monitor two things. First, the European policy process obviously remains key, and we will be monitoring developments into the Nov. 3-4 G-20 Summit in Cannes and the Nov. 7 Eurogroup meeting in Brussels closely. The former will be key in fleshing out any emerging market contributions to the SPV announced in the EU summit statement from this past week. The Eurogroup has been tasked with finalizing the implementation of EFSF leveraging and the SPV in November. Second, we are closely watching cyclical data in the US and elsewhere, and whether downside risks to growth are abating. In this regard, the coming week brings the global PMIs, including the all-important ISM and October payrolls, where at 75k, we are below consensus (95k). In terms of central bank meetings, we expect the FOMC to leave policy unchanged on Nov. 2. The official statement also likely requires only minor edits, although the improvement in market conditions and some incoming data could warrant an incremental upgrade in the discussion of current conditions. Fed Chairman Bernanke at the press conference may, however, discuss communication options under consideration—including an explicit path for the federal funds rate—but we do not believe the FOMC is ready for major changes at this time. Mario Draghi’s first policy meeting as President of the ECB will be important to watch on Thursday. We hold firm to our view that a rate cut will only come in December (50bp), and the market is pricing low odds for a cut this week.
With a lasting solution to the Euro zone crisis still elusive and uncertainty remaining over the pace of economic growth in the G-3, we remain focused on relative value FX opportunities. This past week, we went long SGD and MYR funding in equal parts out of EUR and USD. Funding out of EUR in addition to USD has the advantage that the correlation of this trade with risk appetite is close to zero, in line with our still cautious view overall. SGD and MYR have stood out in our analysis (see Figure 3) as having sold off heavily relative to other EM FX. On a one-week horizon and assuming that last week’s dollar and risk sentiment trends persist, currencies with a current account surplus and commodity exposure look particularly interesting, for example the CLP versus the USD.
Source: GS Calculations
Monday Oct 31
Taiwan GDP (Q3) We expect 3Q2011 GDP growth to slow to 3.5% yoy, down from 5.0% yoy in the previous quarter. The Bloomberg consensus forecast is at 3.6% yoy.
Euro Zone CPI (Oct) Consensus looks for a reading of 2.9% yoy, down from 3.0% yoy in September.
US Chicago PMI (Oct) Consensus is looking for a moderation to 59.0 from 60.4 previously. We are forecasting a reading of 58.0, below consensus.
Tuesday Nov 1
Global PMI’s We expect China’s official PMI to show a moderation in October. We believe despite the rebound in activity growth in September, the underlying growth momentum remains weak amid still tight domestic monetary conditions and weak external demand. Seasonally, the official PMI tends to fall in October as well though the seasonal factor may not be stable over time.
Indonesia CPI (Oct) We expect October CPI inflation to come in at 4.7% yoy versus 4.61% yoy in September. The Bloomberg consensus expectation is at 4.78% yoy.
Korea CPI (Oct) We expect CPI inflation to moderate to 4.2% yoy in October. That said, inflation moderation is likely to be slow in coming months due to the recent KRW depreciation and pent-up pressure for administered prices including electricity, natural gas, and public transportation tariffs.
Australia Central Bank Meeting Following last week’s benign CPI reading, our economists think a 25bp cut is all but assured. This is in line with consensus. The market is pricing a roughly 75% probability of a 25bp cut at this meeting.
UK GDP (Q3) We are significantly above consensus, looking for a reading of +0.6%-0.7%qoq (the median of economists polled by Bloomberg is just +0.3%qoq). Much of the growth that we expect reflects statistical distortions (in particular, the reversal of the royal wedding effect). It may be that the consensus forecast has taken insufficient account of these factors.
US ISM (Oct) Consensus is looking for a small rise to 52.0 from 51.6. We are below consensus and are looking for a reading of 51.5.
Wednesday Nov 2
US FOMC decision (see our discussion above)
Thursday Nov 3
G-20 Summit in Cannes
Euro Zone ECB rate decision This will be Mario Draghi’s first decision as President of the ECB, which will make the press conference especially important. Consensus expects rates to be on hold, as do we. We are expecting a 50bp cut only in December.
US Initial Claims (Oct. 29) Consensus is looking for a reading of 400k, relative to 402k in the previous week.
Friday Nov 4
G-20 Summit in Cannes
Australia RBA Statement on Monetary Policy
Global Services PMIs
US Non-farm payrolls (Oct) We forecast that non-farm payroll employment rose by 75k in October. The deceleration from a gain of 103k in September reflects the lack of a boost from the return of striking workers and still-moderate hiring activity. Consensus is looking for a reading of 92k. In line with consensus, we expect the unemployment rate to remain unchanged at 9.1%.
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