The week's top news in world financial markets from Maximus Capital

  • 2009-06-10
USA
After two quarters of steep contraction, the economy is declining much less rapidly in the second quarter of the year, and a move into positive growth in the third quarter is still expected. The coming weeks should bring a much slower pace of decline in payrolls, coming off an increase in the ISM manufacturing new orders index to above 50 in May. A continuation of the recent stability in consumption and home sales is an important part of future developments 's these two areas are losing some of the supports that bolstered them recently. An important test of the recovery forecast will be whether these sectors can keep holding up when the supports fade. Overall home sales have been stable at low levels over the past six months; one helping factor has been low mortgage rates. Now that mortgage rates have moved higher, a natural question is whether home sales will go back into freefall. Currently it doesn't seem that will happen. Home sales in the housing downturn have not been primarily driven by rates. Rather, the first stage of the downturn was brought on by speculators leaving the housing market, while another leg down came from the virtual elimination of subprime and Alt-A mortgage availability, and more recently the sharp deterioration in the labor market. Home sales have stabilized mainly because of improved affordability. This was partly due to a fall in interest rates, but also because housing prices have dropped much more than incomes. Most analysts do not expect the current level of rates to cause a renewed downturn in home sales, but if rates begin to shoot much higher, there will clearly be a more significant threat. Moreover, the Fed is expected to ramp up its treasuries purchases if it senses the housing market recovery is threatened by rising rates.

Eurozone
The recent surge in Japanese industrial output in April, combined with very strong gains projected by the MITI survey, have fueled speculation that the eurozone industrial sector might experience a similar positive burst. If this happened, it would certainly be a big surprise for the ECB. Indeed, it does appear that Spanish industrial output grew a surprising 2 percent in April (on a calendar-seasonally adjusted basis), though this does follow particularly severe weakness in previous months. However, a look at industry-level statistics for autos and steel in Germany, combined with other analysis, would suggest that any surge in industrial output is unlikely to be seen with the April data. Indeed many analysts are pessimistic about industrial output changes for Germany, France and Italy, in the data due to come out during the next seven days. On the positive side, industry data suggests that on an adjusted basis, German auto sector output rose about 6 percent month on month in April (after a gain of 22 percent month on month in March) and will rise about 15 percent month on month again in May (road vehicles have a 10 percent weight). Looking ahead, the ultra-low level of finished goods inventories cited by respondents to the Markit PMI survey suggests that the change in inventories, which subtracted 1 percentage point from the quarterly change in the first quarter GDP, will become positive going forward.

Central and Eastern Europe
Market concerns regarding Latvia's currency intensified this week. This was fueled by the Swedish Riksbank's financial stability report 's which highlighted the risks in the Baltic region for Swedish banks 's and a failed Treasury auction on the following day. The seemingly indifferent attitude of Swedish banks toward a potential devaluation in public comments seemed to further withdraw support for the peg. However, while the much-repeated argument holds that banks' balance sheets would deteriorate either way 's slowly through rising loan losses over time or upfront through a one-off devaluation 's the size of the potential devaluation has never been specified. Clearly, avoiding a disorderly collapse of the peg remains in the interest of all parties involved: the Swedish banks (for the sake of their balance sheets), the EU (to avoid regional contagion and to protect the euro adoption framework) and the IMF (to defend its funds and reputation). An agreement next week hinges mainly on government measures to contain Latvia's ballooning fiscal deficit. Recent public comments by the EU and ECB seemed to indicate that an agreement can be reached. If a deal can be struck, it would, in turn, open the gates for combined disbursements of up to 1.7 billion euros from the EU, IMF, World Bank and other bilateral and multilateral agencies.

*** Written using materials from Bloomberg and Reuters Research