1 September 2010
Global Strategy
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Research Team
Global Strategy
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Global Views
The View Ahead: Not enough buffer
It has been a choppy morning in Europe as the market awaits the first of this
week's big data releases; ADP and ISM. Clearly this will set the tone going into
NFP so the choppy range trading seen thus far today should come as no
surprise. We have, however, had some interesting data out of Europe. The euro
area PMI came in at 55.1 just 0.1 above the flash estimate, showing continued
resilience but the UK and Norwegian PMIs both fell much more than expected. I
think a few months ago as the euro area crisis was kicking off you would have
been hard pressed to find anyone who would say that the euro area would be
outperforming the UK and (especially) Norway in late Summer so where does
this resilience come from? Partly of course it is the currency but that has now
stabilised in the high 1.20s and so will be less of a marginal boost in coming
months. More generally, however, I think it just shows the natural lags that exist
between core Europe and the global economy given the former's reliance on
exporting to the latter. To that extent, euro area data should be seen as a lagging
or coincident indicator at best, so buying EUR/USD on the back of stronger
European data is a dangerous game.
While we are discussing the Euro, worth looking at EUR/GBP and my simple
correlation with bank share prices and 1y swap rate differentials. Using this little
model the recent stabilisation / bounce in EUR/GBP is entirely justified, and
indeed fair value for the pair is a touch above current levels at 0.8350. However,
with the RBS view that the stress tests have failed to ring fence the euro area
banking system from peripheral worries, I would expect a risk that the relative
bank share prices part of the model starts to push in favour of EUR depreciating
against GBP in coming weeks and months.
The only other thing that matters over the next few days is how the data comes
out and market sensitivities to it. As a strategist it is the latter that interests me
and I loved a comment that our US economist Michelle Girard made when
talking about NFP (though the same applies to ADP) that given the volatility of
the series, there is not enough of a buffer between expectations and the 0k level
to be confident that we can avoid a negative number. Let's say that this
afternoon's number for ADP, expected +15k, is 25k out (the average miss so far
in 2010). I am pretty confident that the market reaction is bigger to a -10k print
than to a +40k print, because of the psychological importance of the 0k level.
And of course the same applies to NFP but on a bigger scale. The data will be
what the data will be, but be aware of this potential skew to reactions. Andy
Chaytor
Ahead today
US ADP employment change, Aug (8:15 EDT): ADP employment should post a
small 15K rise, though down from last month’s 42k rise.
US ISM, Aug (10:00 EDT): We expect a further moderation in the August PMI,
with the composite falling to a still more than respectable 56.8.
The Royal Bank of Scotland

Central banks: 10:45 EDT Fed’s Duke speaks; 13:40 EDT Fed’s Fisher speaks
on the economy; 17:15 EDT Fed’s Evans speaks

Global Strategy | 1 September 2010

G10 data calendar
EM data calendar

Overnight news

UK Manufacturing PMI, Aug: tumbled to 54.3 in from 56.9 in July, the lowest
outturn this year and way below forecasts of 57.0. The output balance fell back
to 56.0 from 58.2 but remains an elevated level. Major concern is the collapse in
new orders to 52.0 from 58.5, the lowest outturn for over a year. The employment
sub-index remained in positive territory, indicative of ongoing job creation.

Australia GDP, Q2: The economy picked up steam in Q2 as GDP growth rose a
sharp 1.2% after an upwardly-revised 0.7% gain in Q1. Surging exports as well
as strong consumer spending drove the result, although housing and public
spending were also strong.

German retail sales, Jul: consumer demand disappointed falling by 0.3%

against a consensus of 0.5% rise expected. This was followed by upward
revision to June’s print to -0.3% from -0.9% previously. The annualized rate fell to
+0.8% from +4.7% in June.

Swedish PMI, Aug: Swedbank PMI fell to 60.6 (adjusted for seasonal swings),
below market expectations. This was a pull back from last month’s print of 64.2.

Norwegian PMI, Aug: big disappointment in manufacturing segment. The index

fell to 49.2 from last month’s 55.2, in the contractionary territory, lowest levels
since Dec-09. This was primarily due to slowdown in global recovery hurting
exports.

Euroarea PMI, Aug (Final): final estimate broadly in line with flash estimate, PMI
fell to 55.1 from 56.7 in July.

China PMI, Aug: The HSBC PMI improved from 49.4 to 51.9. The official PMI
beat expectations, rising from 51.2 to 51.7. The data suggest that the
stabilisation in heavy industry is taking place as expected. The details show new
orders rising 2.2 points to 53.1, even as finished goods inventory fell 3.0 points to
46.9. The combination of higher orders and lower stocks is constructive for the
outlook, although August's exports will be important.

Today’s views

FX: Data/events come thick and fast from now on. Disappointment from UK and
Nordic PMIs suggest slowdown in global recovery is having an impact. In UK,
with government spending cuts still to come, recently established GBP longs will
be trimmed. Short GBP/CHF. The most important release today is the US
manufacturing ISM. Any signs of cooling will make the case for a broad based
US slowdown even stronger. EUR/USD will remain in skittish mood ahead
of tomorrow’s ECB meeting as it will include an announcement on the extension
of the fixed liquidity measures through the end of this year. While an extension is
expected, confirmation will only underscore the fragility of European banking
sector. Hence I maintain my strategic sell on the EUR. USD/JPY will continue to
test the BoJ patience. Decent Chinese PMI and Australian Q2 GDP data
overnight play to theme of divergence between Asia (and countries supporting
the Asian growth) from the G4. This, along with relative stability in global
equities will support Asia's policy 'tightners'.
2
The Royal Bank of Scotland

Commodities: Bellwether metal copper has begun September trading at its

highest level in over 4 months. The red metal took comfort from the Chinese
manufacturing PMI for August which indicated that economic stabilisation is

Global Strategy | 1 September 2010

taking place for the world’s biggest consumer of copper. The PMI rose to 51.9
from 49.4 in July with new orders rising 2.2 points to 53.1. Three month copper
surged to US$7,580/tonne (US$3.44/lb), its best price level since end April. In
addition, I am heartened by copper’s price resilience over the seasonally weaker
summer months. LME copper inventories declined for the 6th consecutive month
in August shedding nearly 15,000 tonnes. Remember that LME copper
inventories hit an over 6 year high of 0.555mt in February this year and have now
been eroded by a handsome 28% or 0.156mt. Indeed, copper inventories
normally rise in August and the drop this August was only the second time in 25
years that LME copper inventory did not rise in August. Macro issues do remain
and high flying copper would be vulnerable to poor upcoming macro data from
the US. I am forecasting a Q4 copper price average of US$7,400/tonne and a full
year average of US$7,160/tonne (US$3.25/lb), 40% higher than the dismal 2009
average of US$5,163/tonne (US$2.34/lb).

Emerging markets LatAm: RBS expects the Brazilian BCB to keep rates on
hold at 10.75%, finalizing the tightening cycle that started in April-10 for a
cumulative 200bp in hikes. We believe that the policy rate at this level is
compatible with the neutral rate, which in our view would suffice to guarantee the
attainment of the inflation target next year, although inflation expectations are
currently at 4.87% and the output gap remains in the positive territory. In our
view sub-par world economic growth along with tamed inflation abroad should
give a hand to the CB while the output gap slowly moves towards normality.
Moreover, the recent downward surprises in inflation as well as in activity might
have led to a reduction of CB's inflation forecasts for 2011, although they might
remain above the mid-band target, while the Committee is likely to see lower
risks to this forecast, meaning an improvement in the balance of inflations risks.

Emerging markets CEEMEA: It’s the time for PMIs in this region (Turkey, S.
Africa, Poland, Czech R, Hungary and Russia). August PMIs are all above the
expansion line (50). Turkey and Hungary are down on the previous month,
Russia, Poland, Czech and S Africa are up on the previous month (this is back
up above the expansion line). With EC and GE August PMI also out this morning
and remaining in expansion territory, this bodes well for CEEMEA FX in an
otherwise jittery market.

Emerging markets NJA: Robust Aug China PMIs and Australian Q2 GDP
growth buoyed risk sentiment. Asian currencies strengthened, led by the KRW.
Exports growth and CPI inflation out of South Korea continued to paint a healthy
macro picture, against which the KRW should remain supported. IDR saw some
relief buying after the August CPI came in slower than market expectation. The
MYR IRS curve shifted 3-4bp lower ahead of Thursday's policy meeting where
the central bank is widely expected to stand pat. We remain long 10Y MGS and
recommend extending duration further out the curve. KRW front-end rates traded
5bp higher following the introduction of the term deposit facility on Tuesday. We
view the move as a confirmation that the central bank is preparing to accelerate
the pace of policy tightening and recommend paying 1y KRW IRS (see Trade
idea | KRW IRS | New BOK term deposit facility). Separately, the central bank
began its 2Y MSB buyback operations this morning, buying back KRW400bn
worth of 2Y MSBs this morning against KRW630bn worth of offers submitted.
Note, however, that the intention here is to smooth out the current maturity profile
of the outstanding MSB stock and for that the central bank will be issuing
shorter-dated MSB to offset the buy-backs. In Indonesia, we expect IDR recap
bonds to retrace part of its recent losses after the August inflation print came in
lower than expected at 6.44%.

3
The Royal Bank of Scotland

Media

US Tax Cuts Weighed to Spur Economy - WSJ

Global Strategy | 1 September 2010

Currency Trading Soars - WSJ
Japan's Ozawa Pledges Forex Intervention - WSJ

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