G3 Recap 5-23-11

Main Items:

  • Chicago Fed National Activity Index declined to -0.45 in April vs 0.2 expected and 0.26 previously. It is the lowest print since last August.


  • EU PMI Manufacturing dropped to 54.8 in May vs 57.5 expected and 58.0 previously. PMI Services declined to 55.4 vs 56.5 expected and 56.7 previously. French Services was the only data series which beat expectations, but still fell MoM.
  • Italy’s Rating Outlook was revised to Negative by S&P, signaling a one in three chance that ratings will be lowered in the next 2 years. S&P said that the decision came because the government’s debt reduction plans for 2011-14 may fall short of the mark in light of weaker growth and possible ‘political gridlock.’
  • In Spain, the ruling Socialist party lost control of a number of regions and municipalities, while the conservative Partido Popular party looks poised to govern in 11 of 13 regions and many of the municipalities. The Socialists are expected to remain in power over the next 10 months with the support of one of the small nationalist parties.
  • Fitch cut Greece by 3 grades to B+
  • China HSBC PMI decreased to 51.1 in May vs 51.8 expected


  • As noted earlier and better elsewhere, it appears that the macro picture for risk assets is poised to turn darker.
    My own take on the macro picture thus far was that we would likely go through a period of consolidation before the underlying cycle reasserts itself via higher risk asset prices. In particular, I had hoped that US economic data would be stabilizing by now, 2 months after the March headline shocks, which would offset the likely deceleration in Europe. This clearly hasn’t happened. The likely upcoming scenarios and current market expectations suggest that there is a dichotomy that will mostly likely be resolved via somewhat lower risk asset prices.

    Consider that current expectations for 2Q and 3Q growth in both the US is basically unchanged over the past few months, despite 2 months of economic data that has continued to come in below expectations:

    EU growth expectations have actually increased against that backdrop, though EU data has admittedly been better until today:

    Against these rosy expectations, we have the following sources of risk:
    1) End of QE2. Maybe the effect won’t be negative, but we can probably all agree that this isn’t positive for risk assets
    2) US budget battle. The fight over 60bn was resolved at the last minute. There is a strong possibility that it will be the same this time or worse. Republicans are likely to ‘hang tough’ on budget cut demands because of broad public support for them as well as the fact that they will be able to blame then resulting economic slowdown on Democrats in the 2012 election cycle. The effects of a budget shutdown today are much worse than the mid-90’s government shutdown because the budget deficit is 10% of GDP today. An extended government shutdown today will tip the US into a recession.
    3) Greece & the EU periphery. The ECB, France, and Germany appear unable to agree on the next step, even as all parties involved agree that an immediate default is not an option. Furthermore, continued financial assistance to Greece is predicated upon an agreement between the Greek government and the ECB, EU and IMF. The longer it takes to reach a compromise, the wider PIIGS CDS will move and the greater the perceived risk of contagion.
    4) EU data is now softening. The May EU PMI Composite surprised on sharply on the downside today, and given the prior high levels, we are likely to see a further slowing in the rate of growth. Based on the money supply analysis done here and elsewhere, this is not unexpected and is likely to continue for at least a few more months.
    5) US PMI also appears to have peaked
    6) Negative seasonal effects

    Let’s be clear: all of these risks will most likely be resolved in some way or other, and the most likely path continues to be of continued global growth. However, the likely upcoming surprises relative to expectations will most likely be on the downside going forward, which has negative ramifications for risk assets in the coming months. This general thesis is supported by multiple trend and support line breaks across major asset classes today:

    Against this backdrop, some risk assets will be more vulnerable than others. For example, as noted before, extended long positioning in EUR/USD suggests further downside. Long gold also looks attractive given the list of risks above.

    NB: There will be no recap tomorrow.


3 thoughts on “G3 Recap 5-23-11

  1. with the exception of the US$ dollar holding in there, i coulda sworn market is starting to behave as if expectations of QE3 are starting to be priced in ..? maybe another ECB rate hike whilst leveraging up its own balance sheet? or how about the BOJ being polically forced to expand its balance sheet further?

    1. With 2yr tsy yields at 50bps, certainly feels like it. Broker color definitely sounds like a year ago. Heard the terms ‘fixed income asset shortage’ several times. Citi’s bank letter also suggests that mid to small sized banks are suffering from high cash balances and yet low loan growth.

      Perhaps the market is looking for a catalyst…

      1. money market yields zippo pushing folks out the money market curve so also somewhat technical but at least rates market behaving in line with data … or not seeing through it whereas rish does seem to be.

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