Weekly Focus: Fear of Double Dip Intensifies

Market Movers ahead

• In the US we expect to see a drop in both new home sales and existing home sales. Moreover, we expect that the durable goods report will give an indication of how strong the upward trend is, notably if it has been losing pace. Furthermore, we expect a considerable downward revision of second quarter GDP.
• The most important release in the euro area is the August flash PMI indicators. We expect PMI levels to drop a bit across the euro area as a consequence of the recent signs of slowing in the US and Asia.
• The data calendar for next week is light in Asia. Most notably Japanese trade data will give some more input to how Japanese exports are coping with the strong JPY and how much Asia is slowing at the moment.
• In Denmark attention will be on the Danish government’s draft budget proposal for 2011 and the accompanying economic forecast.

Global Update

• With another round of weak economic data out of the US late this week, the fear of a deeper slowdown has intensified. Due to continued weakness in activity data we have decided to revise the growth forecast, but we continue to believe that the risk of an outright recession is limited.
• It has been a calm week in the euro area. In Germany the ZEW expectations index showed some weakness.

Focus

• Sovereign spreads in the euro area periphery have widened considerably during the past two weeks. We will take stock of the attempts to bring public finances back on a sustainable path. Our primary concern is that public support for necessary reforms may falter.

Market movers ahead

Global

The data release calendar for next week is somewhat light in the US. We will have a few Fed speeches, most notably Bernanke speaking on Friday. In light of the recent weak housing figures, we expect to see a drop in both new home sales and existing home sales, where the latter is expected to fall by 12.8 % m/m. A continued contraction in the housing figures adds to fears of real weaknesses in the US housing market, along with the prospect of declining house prices.

Moreover, we will get data for durable goods orders for July. Business capex has rebounded rapidly over the past months, indicating a positive movement in domestic demand. The durable goods report will hopefully give an indicator of how strong the upward trend is, notably if it has been losing pace. Next week we furthermore expect a considerable downward revision of second quarter GDP, as both trade figures and inventories have proven much weaker than expected. On the upside we do expect domestic demand to show continued strength.

The August flash PMI indicators will be the most important release in the euro area. It is our expectation that growth momentum in general has peaked. There are signs of slowing in the US and Asia, and this should push PMI levels a little lower across the euro area. We however still expect that the surveys will show above-trend growth during Q3 – at least in Germany. We also expect to see further evidence of stabilisation of the majority of labour markets. German Ifo is also released next week. On the back of signs of slowing in the US and Asia in combination with a strong move upward in the past months, we expect expectations to decline a little. Finally the ECB sends out its monthly report on monetary developments, which we expect to show some improvement in credit conditions.

GDP data for Q2 are likely to take centre stage on Friday in the UK. Markets are going to focus on whether consumption also slowed in the last quarter and if the trend in net exports was as frightening as earlier numbers showed. GBP still trades closely in line with USD movements but we expect this correlation to fade over the coming months.

Switzerland will be releasing several interesting numbers in the coming week. The leading growth indicator KOF usually attracts considerable attention – and especially at the moment, as there are a number of signs that economic growth has either peaked or is close to peaking in several countries. Given that it is a small, open economy, Switzerland is unlikely to be any exception and we therefore expect to see a minor decline in the KOF index from 2.23 in July to 2.20 in August. A nascent easing in the KOF index will hardly come as a surprise for the central bank (SNB), and indeed the level of the KOF still indicates decent growth in the Swiss economy and in no way clashes with the approximately 2% growth in GDP that both the SNB and we expect to see this year. The KOF numbers will be released on Friday. Otherwise, it may be worth keeping an eye on Monday’s M3 money supply figures for July and Thursday’s Q2 employment numbers.

Only limited data out of Asia next week. Japanese trade data will give some more input to how Japanese exporters are coping with the strong JPY and how much Asia is slowing. We look for a bit further moderation in export growth. Japanese CPI will give an indication of deflationary pressures. CPI was -0.7 % y/y in June.

Global Update

A deeper slowdown

With another round of weak economic data out of the US late this week, the fear of a deeper slowdown intensified and also hit equity markets, which had been holding up fairly well throughout the recent weeks’ continued downward trend in bond yields. We have also taken the consequence of the continued weakness in data and have revised our growth outlook for the US down.

US growth forecast revised down

US economic data have weakened consistently during the summer. Over the past weeks we have flagged downside risks to our Global Scenarios June 2010 forecast of slightly above-trend growth in 2010. Due to continued weakness in activity data this week we have decided to revise the growth forecast (see Research US: Deeper slowdown but no recession). The change in the growth outlook also increases the likelihood of further Fed QE as the central bank will find it hard to accept high and stable unemployment.

US GDP growth is now expected to remain below trend in the coming three quarters and payrolls will average below +100K per month for H2. The weaker labour market improvement implies that the decline in the unemployment rate will stall and will only resume its fall gradually in 2011.

Local PMI surveys now indicate a more accelerated path of decline in the ISM. While we cannot fully explain this, it might be the negative confidence effect from the euro debt crisis and the following market turmoil, which causes businesses to switch to a more cautious inventory management. We expect the ISM to decline faster than suggested by our fundamental analysis and reach 50 by year-end.

We continue to believe that the risk of an outright recession is limited as there are very few – if any – excesses left in the economy. Inventories are low, construction spending is at record low, house prices are less overvalued and financial leverage is much lower than before the financial crisis. While the risk of a ‘slump’ scenario with sub-par growth for several years has increased, we think that the most likely outcome remains a mid-cycle slowdown.

High growth and low yields in Germany

This has been a calm week in the euro area. The German ZEW expectations index declined to a 16-month low reflecting concerns in the financial market about the scale of the slowdown in the US and Asia. ZEW current conditions advanced strongly and thus signals that the strong momentum in the German economy continued into Q3. The Bundesbank adjusted its German growth forecast upwards to around 3% from around 2% in June. The Bundesbank said that evidence was mounting that the German upswing was becoming increasingly self-sustained.

German yields continued even lower this week and after Thursday’s dismal US data the yield on German 10-year government bonds stood at a record low 2.3%. Government bond spreads widened further until mid-week and then narrowed slightly on renewed buying interest

Japanese growth slows

Japanese GDP growth for Q2 disappointed, yet another sign that the economy is slowing down. GDP grew only 0.1% q/q versus consensus expectations of 0.6% q/q. Especially domestic demand was weakening.

The downward pressure on USD/JPY continued this week with continued disappointing US data and declining US bond yields. Japanese authorities continue with verbal intervention, but it is not doing much to alleviate the strengthening pressure. New stimulus efforts are being debated, but with an already very high debt and budget surplus the room for manoeuvre is highly limited. The large savings in Japan are with the private sector so the government needs to find out a way to lure out some of those savings for spending.

China took more steps this week to liberalise its capital flows in a long and gradual move to make the yuan more global. China will allow foreign financial institutions including central banks to participate in China’s interbank bond market. Foreign banks can participate to the extent that they are involved in settling trade denominated in yuan. Although a small step, it should in the long run help spur more trade transactions in yuan.

Full Report in PDF