Market Movers ahead

• In the US the FOMC meeting is the main event next week. We believe that the speculations about further monetary easing are premature, but that the assessment of the current economic situation will be downgraded. We expect US July retail sales to increase 0.5% m/m after a weak H1 2010.
• For the euro area, the key event next week is expected to be the release of Q2 GDP data. We expect to see robust growth, but at a rather uneven pace. Germany is expected to stand out as the top-performer.
• UK inflation report on Wednesday is expected to weigh on GBP and support Gilts.
• In Scandinavia focus turns to inflation numbers out of Denmark, Sweden and Norway. The monetary policy meeting in Norges Bank will not attract much attention. Unchanged rates are widely expected.

Global Update

• Over the past month the euro area has been the main provider of good news while US data have disappointed. The German Ifo index, German factory orders and Euro PMI all surprised to the upside, while US data covering housing, business and consumption have all been weak.
• The relative stronger numbers out of the euro area relative to the US and less PIIGS concern have pushed EUR/USD above 1.32.
• Wheat prices rise strongly on Russian drought and subsequent export ban. A new food crisis cannot be ruled out if the export ban spreads to other countries like we saw in 2008. However, global wheat stocks are in fact plenty and other grains prices are not rising to the same degree.

Market movers ahead

Global

In the US the FOMC meeting is the main event next week. Recently, speculation of further easing has intensified. However, we believe that it is premature for the Fed to announce new easing measures at the upcoming meeting. That said, it is quite certain that the assessment of the economic situation will be downgraded following a range of disappointing economic data. Hence, the Fed will continue to communicate that yields will remain exceptionally low for an extended period. It will be interesting to see if Plosser votes against the extended period language again. If not, it will be a dovish sign.

July retail sales will provide important information about the trend of consumer spending after downward revisions and soft data in the first half of the year. We expect improvement with a 0.5% m/m increase in overall sales. Car sales already reported for July have been solid and rising gasoline prices will contribute positively as well. The underlying pace of spending is likely to improve at a healthy 0.4% m/m following a weak reading in April and May, but a better one in June. Michigan consumer confidence is released Friday.

Finally, the July CPI data will be released. We expect core inflation to remain very low with a 0.0% m/m reading consistent with an unchanged annual rate of inflation at 0.9%. The headline will be boosted slightly by higher gasoline prices to 0.2% m/m up from -0.1% m/m.

For the euro area, the key event next week is expected to be the release of Q2 GDP data. We expect to see robust growth, but at a rather uneven pace. Germany is expected to stand out as the top performer. We expect German GDP to have expanded 1.3% q/q in Q2, up from 0.2% in Q1. French GDP is expected to have advanced 0.7% q/q during Q2. PIIGS countries are expected to have seen very limited growth. For the euro area we expect robust growth at 0.7% q/q, which compares with a mere 0.2% q/q in Q1. It is mainly exports that support increased activity while private demand remains sluggish. Q2 is expected to mark a peak in growth and we expect momentum to decline during H2 2010, although Q3 should produce growth above trend too.

In the UK, BoE’s Inflation Report due Wednesday will be the one to watch next week. Despite CPI being at 3.2% y/y and annual price increases having been above BoE’s target of 2% in 41 of the past 50 months, the BoE isn’t particularly worried about price pressures at present. We think projections will show that inflation will edge lower on the medium-term horizon and economic growth will be revised downwards, i.e. the Report will be GBP negative. Nationwide’s consumer confidence index is likely to edge lower on Tuesday night. GBP is expensive according to our short-term models and we see only limited scope for additional gains against the euro.

In Asia there will be extra focus on the Chinese data for July given the recent signs of slowdown. Industrial production is expected to weaken as signalled by the decline in Chinese PMI in recent months. Retail sales should stay fairly robust though with growth rates above 18% y/y. Next week also brings data on the trade balance, fixed investments and house prices which should give a further clue of how much the tightening measures of the Chinese authorities are cooling activity. In Japan focus is on the Bank of Japan meeting. Data have softened somewhat recently and JPY is trading at record strong levels against USD. This is not what you want to see when you are dealing with deflation and it clearly puts Bank of Japan in a tight spot. We could soon see further QE from Bank of Japan.

Global Update: Euro shining – for now

German locomotive picking up speed

No one expected it. But it probably had to happen sooner or later. Over the past month the euro area has been the main provider of good news while US and Asian data have disappointed. The German Ifo index, German factory orders and Euro PMI all surprised to the upside. And in financial markets we have witnessed considerable improvement in PIIGS bond markets with especially Spanish yields coming down – see Monitor: Euro debt crisis watch published yesterday.

This is clearly good news, but we would strike a word of caution. The question is whether this is a sign of renewed European strength or whether it just reflects the usual lag in the business cycle to the US and Asia, i.e. the strength in the euro area is a consequence of the boom seen in the US and Asia in the beginning of the year. We tend to believe so and expect to see some slowing of euro area growth towards the end of the year as a reflection of the slowing in the US and Asia currently.

On the positive side there are signs that euro area investment growth is picking up, but this is mainly due to the improvement seen in the industrial sector on the back of strong exports. So investment is to a wide extent also driven by external demand. Looking at the euro area consumption growth things are still not looking too good. We expect consumption growth to pick up somewhat as the labour market is improving, but in the end the business cycle in the euro area is likely to be governed by the global business cycle as is usually the case. So it is unlikely that the euro area can continue to shine unless the global recovery stays on track. There are increasing signs that global growth will slow down in coming quarters, which is likely to be felt in the euro area as well- see Business Cycle Monitor: Asia leads the global slowdown.

ECB: Too early to declare victory

The ECB meeting did not bring any surprises and the press statement included only minor changes. The ECB kept its refi rate unchanged at 1.0% and did not renew any nonstandard measures. The market reaction was limited. Trichet emphasised that the recovery was strengthening in Q2 and that available data for Q3 were better than expected. But he also repeated that it was too early to declare victory and that growth would likely slow in the second half of 2010. We expect the ECB to stay cautiously on the exit path and we still anticipate a first hike in H2 11 – see Flash Comment: Trichet will not declare victory yet.

Another food price crisis brewing as wheat prices shoot higher

Wheat prices have shot markedly higher over the past weeks as a severe Russian drought is limiting supply. Prices spiked further on Thursday as Russia announced a ban on wheat exports, which is starting to have a spill-over effect on other soft commodities such as soybeans and corn. This should be watched closely in the near future as it could spiral into another food price crisis if the price rise continues. A rise in food prices acts as a tax on consumption and could put a further brake on the world economy, which could be critical as growth is already facing headwinds and showing signs of slowing..

In 2007-2008 food price inflation rose to 6-7% in both the US and the euro area. As food weighs 15% in US and 20% in the euro area this had a considerable effect on inflation. The impact is even higher in emerging markets where food has a much higher weight in the consumption basket.

US recovery continues to lose pace

Over the past couple of months, incoming US economic data have been surprisingly weak, a sign that the recovery is losing pace into H2. Overall the weakness has been widespread: housing, business and consumption data. This trend has continued throughout July, but with a few exceptions.

Housing data continue to be very soft as the effect from the expiration of the first time home buyer tax credit ripples through the housing market. Recent evidence suggests that the weakness continued into July, with June pending homes declining to a new record low. While the current housing data probably seriously understate the true trend in housing, the magnitude of the post tax-credit setback has surprised us. If home demand does not begin to recover soon, home prices could face another setback, which could hit the financial sector. In any case there is little doubt that residential construction will be a negative for growth in Q3 and will probably not contribute much positive in Q4.

The softening in both hard and soft business indicators had been expected, but has been somewhat deeper than expected. We suspect that the financial turmoil in late spring and early summer created by the euro debt jitters has led to extraordinary caution in the business sector. Both orders and hiring have simultaneously slowed. However, the recent ISM reading adds some comfort as the manufacturing index slowed much less than feared and the non-manufacturing index surprisingly rose. In our view this might be the first sign that some of the recent weakness has been amplified by the euro crisis and that this might reverse in the coming months.

Until last Friday the available economic data showed that consumption had expanded by 3.0% q/q AR in Q1 and close to 2.5% q/q AR in Q2. However, with the release of the advance national accounts, the picture changed dramatically. Q1 consumption growth was revised lower to 1.9% q/q AR and Q2 consumption printed a much lower-than-expected 1.6%. The bad news is that the slower pace of consumption growth makes the US recovery look less resilient, as we need final consumption to be strong enough to feed investment and job creation.

The bottom line is that the flow of data in the recent month leaves us with a slower pace of growth and lesser degree of resilience in the US economy. Hence, not only is our current 3% H2 growth forecast probably a notch too high, but the risk of a sharper slowdown has also increased as the economy is more sensitive to adverse shocks. The good news is that financial conditions have substantially improved given the sharp decline in bond yields and the recent rebound in risky assets. This might reverse some of the front-loaded slowing caused by the turmoil in the spring.

Clear signs of slowing in China

It is increasingly evident that the Chinese economy is slowing. The HSBC PMI new orders index for July decreased again to 47.9 after falling below the 50-line already in June. Import growth has also shown some signs of moderation recently. Tightening measures from the Chinese authorities are starting to take effect. The Chinese central bank said on Sunday that it would stick to its credit target of CNY7500bn in new loans this year and strictly implement the tight credit policies it adopted. A campaign to close energy-inefficient businesses has also contributed to a slowdown in heavy industry. Although the slowing in China should be watched closely, it is important to stress that China still has fiscal and monetary room to manoeuvre. It can thus ease policy if needed to sustain growth at robust growth levels. To some extent the slowing is also needed in order to stem inflationary pressures.

There are other indications that growth in Asia is cooling off. Japanese industrial production has stalled in recent months after seeing significant gains earlier in the year. Japanese PMI also declined in July to 52.8 from 53.9 in June. It is still above the long term average and thus signalling growth above trend.

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