(Insider Stories) - The following is an extract from a Capital Daily report by London-based research provider Capital Economics.

-    US new home sales probably posted another decent gain in June (15.00 BST)

-    Spain’s economy not faring quite so badly

-    China’s “flash” manufacturing PMI may have stabilised in July (02.45 BST)

 

Key Market Themes

We do not think Tuesday’s decision by the Turkish central bank to tighten the monetary screws signals the onset of widespread policy tightening in Emerging Europe. Central banks in the region are generally likely to start raising rates later than those in Emerging Asia and Latin America. Indeed, the Hungarian central bank actually cut rates on the same day (see below). Although the outlook for monetary policy could provide greater support to local currency government bonds issued in Emerging Europe than to those issued elsewhere, this may be offset by a less favourable shift in credit spreads.

 

We think rates in Emerging Europe are generally likely to remain low and stable over our forecast horizon for three reasons. First, growth should remain lacklustre and below its historical trend, partly because of the region’s close proximity to the troubled euro-zone. Second, inflation is set to stay subdued, not least because of ample economic slack. And third, central banks in this region will probably take their cue from the ECB, which is likely to tighten policy much later than the Fed.

 

By contrast, we expect an upward trend in rates in Emerging Asia to emerge next year amid concerns about strong credit growth and an improving global economic outlook, while we think rates in Latin America will generally follow suit in 2015 less aggressively. (There are, of course, exceptions at the country level.)

 

Admittedly, one risk to our view is that other Emerging European central banks tighten monetary policy to counter currency depreciation, should the latter arise from growing concerns about the Fed’s monetary policy.

 

But most currencies in Emerging Europe (the Turkish lira and Russian ruble aside) proved relatively resilient to the recent sell-off in emerging market assets. Instead, it has generally been countries outside of Emerging Europe that have sought to counter currency depreciation by hiking interest rates – such as India and Indonesia in Emerging Asia. (Brazil’s recent tightening of monetary policy was driven more by above-target inflation.)

 

In any event, countries that have sought to tighten monetary policy to counter the impact of Fed-led currency weakness are probably exceptions to the rule. QE tapering is generally likely to have only a small impact on emerging market central bank policy for three reasons. First, its economic implications for emerging markets should be limited. Second, the historical relationship between policy rates in emerging markets and the Fed funds rate is not strong. And third, emerging market countries on the whole now have much lower levels of external debt than in the past, making them less vulnerable to a reversal of capital inflows. (For more, see our Emerging Markets Economic Update, “What will a tapering of QE3 mean for EM interest rates?”, published on Tuesday.)

 

Although we generally expect monetary policy to be looser than most expect over the next few years across the emerging world, the relative outlook for monetary policy may turn out to be more supportive for local currency government bonds issued in Emerging Europe than for those issued in Emerging Asia and Latin America.

 

After all, there is a strong relationship between market expectations of short-term interest rates (using 2-year interest rate swap rates as a proxy) and the “risk-free” components of 10-year local currency government bond yields.  (See Chart 1.)

 

Nonetheless, the evolution of credit spreads will also determine the fate of local currency government bonds. And on this score, we think Emerging Europe is rather more exposed than Latin America and especially Emerging Asia to a renewed waning of investors’ appetite for risk – primarily due to Russia’s vulnerability to a fall in oil prices and Turkey’s onerous external financing requirement. (Jessica Hinds & John Higgins)

 

What to watch for today: North America

US new home sales (15.00 BST) rose strongly in May and the forward indicators point to another decent increase in June. Admittedly, data released on Monday showed that existing home sales fell in June, perhaps as the recent hike in mortgage interest rates started to dent sales activity. Given that new home sales are measured at the contract signing stage and are therefore timelier than the existing home sales data, which count contract closings, higher mortgage rates may have had a larger impact on new home sales. But with the NAHB current sales index still rising strongly, we have pencilled in an increase in new sales from 476,000 in May to 485,000. (Paul Diggle)

 

Meanwhile in Canada, the 1.9% m/m gain in retail sales volumes in May, together with earlier reports showing strong increases in manufacturing and wholesale trade, suggest that the economy grew by as much as 0.4% in that month. (David Madani)

 

Continental Europe

The composite PMI (09.00 BST) may have edged up again in July to around 49.0, although it should still point to small falls in GDP. In June, the composite PMI rose from 47.7 to 48.7, while the new orders component ticked up again, boding well for this month’s reading. Although recent hard data have disappointed a little, more forward-looking sentiment indicators have improved over the last month. (James Howat)

 

On Tuesday, the Bank of Spain estimated that GDP fell by 0.1% in Q2, rather better than the 0.5% drop in Q1 and the best performance since Q3 2011. This figure is only an estimate – the official figure will be published on Tuesday 30th July. But the Bank’s estimates have tended to be a reliable guide in the past. Encouragingly, the business surveys suggest that the economic situation may continue to improve over the summer. Given these developments, we have revised up our GDP forecasts slightly. We now expect the economy to contract by about 1.7% this year, compared to our previous forecast of a 2% fall. Nonetheless, we continue to think that the consensus forecast for GDP growth of 0.3% in 2014 is much too optimistic and we still expect GDP to fall pretty sharply next year, perhaps by as much as 1.5%. (Ben May)

 

Japan

June’s external trade data (00.50 BST) are likely to show strong y/y growth in the value of exports but even stronger growth in imports, reflecting adverse base effects (imports were particularly weak in June 2012) and the impact of the fall in the yen on the prices of imported commodities. This in turn may well result in the first June deficit (before seasonal adjustment) in more than 30 years. In any event, the adjusted trade balance should remain deeply in the red.

 

Meanwhile, Japan’s formal entry into negotiations on the Trans-Pacific Partnership (TPP) on Tuesday was only the first step on a long road. The talks are likely to drag on well into next year, and perhaps beyond. Any sign of backtracking on the TPP, notably in the face of opposition from the powerful agricultural lobby, could still undermine the credibility of “Abenomics”. But the more immediate risk is the decision on whether to press ahead with the consumption tax hike planned for April 2014. Officials suggested on Tuesday that this decision would not be made before the G20 summit in early September. The linking of the two events is curious and raises the worrying possibility that the government might use any G20 call to rein in fiscal austerity as cover to delay the tax hike, even if the Q2 GDP data due in mid-August are still strong. However, for now at least we assume that the government will raise the tax as planned, albeit with some offsetting fiscal stimulus if the economy softens in the meantime. (For more discussion see our latest Japan Economics Weekly.) (Julian Jessop)

 

China

Today sees the release of the flash estimate of the manufacturing PMI (02:45 BST) for July from HSBC and Markit. Credit growth slowed last month, due to the cash crunch and associated spike in market rates. But the full impact will probably be felt with a lag, and the pace of credit expansion is still strong, more than twice as fast as economic growth. Accordingly, we expect the headline PMI to stabilise near its June level. (Qinwei Wang).

 

Other Asia-Pacific

We think inflation in Australia (02.30 BST Wednesday) will come in at 2.4% y/y in Q2, just slightly below the 2.5% recorded in Q1. Although a range of supply-side factors have pushed up inflation in recent quarters, their effect is now waning. Looking ahead, currency weakness should put upward pressure on import prices, but falling global commodity prices should help to offset currency depreciation. On balance, we think inflation will level off around the mid-point of the Reserve Bank of Australia’s 2-3% target range, leaving room for further policy rate cuts later in the year. (Krystal Tan)

 

Key Data and Events

Wed 24th    00.50  Jpn  Merchandise Trade Balance (Jun) Unadj.

            00.50  Jpn  Merchandise Trade Balance (Jun) Adj.

            00.50  Jpn  Merchandise Exports (Jun)

            00.50  Jpn  Merchandise Imports (Jun)

            02.30  Aus  CPI (Q2)

            02.45  Chn  Flash HSBC Manufacturing PMI (Jul)

            03.00  Sri  Repurchase Repo Rate (Jul)

            09.00  EZ   Flash Manufacturing PMI (Jul)

            09.00  EZ   Flash Services PMI (Jul)

            09.00  EZ   Flash Composite PMI (Jul)

            09.00  EZ   ECB Bank Lending Survey

            11.00  UK   CBI Monthly Survey (Jul)

            11.00  UK   CBI Quarterly Survey (Q3)

            13.58  US   Markit Manufacturing PMI (Jul Prov.)

            15.00  US   New Home Sales (Jun)

            22.00  NZ   Interest Rate Announcement (Jul)

              -    VN   CPI (Jul)

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