Are US equity markets bottoming and if so will this imply a shift of capital between asset classes? This is the question that is increasingly being asked by investors. Yesterday’s announcement of an 82% fall in first quarter earnings by computer chip maker Intel Corp, was greeted well by the market. This stemmed more from the fact that Intel predicted better second quarter earnings than analysts had expected, whilst indicating that business from computer makers improved in March. In addition, the ability of US equities to withstand a dire profit announcement by tech heavyweight Cisco Systems the day before was impressive and will be used a further evidence by stock market bulls that a bottom is finally forming. The response from Asian equities was positive, with the Nikkei rising by 4.4% overnight. This positive response is likely to be carried through to European and US equity markets over today’s session. Mutual fund activity is indeed reflecting a tentative return to equities, with AMG mutual fund data showing that inflows into US Equity funds, totalling USD 3.6 billion in the week ending April 11 billion was the largest since January 31. This contrasts with net cash redemptions of USD 9.7 billion reported in March and a first quarter when mutual fund investors were reported to have reallocated from equities to bond and money market funds. We remain skeptical of calling a bottom to US equities, especially as the first quarter earnings season moves into full swing, but if investors are indeed reallocating back to equities this bodes well for capital inflows to the US, a scenario that could give a strong benefitto the dollar. Following the recent improvement in equity market performance, demonstrated by last week’s 14% Nasdaq rally and more encouraging US data over recent weeks the sell off in the front end of the US curve has been sharp. The probability of an inter-meeting interest rate cut is now effectively zero, with the Fed funds futures only predicting a rate cut of 50 basis points by mid June. We remain skeptical about US economic and market prospects and expect at least another 100 basis points of easing by the Fed over coming months, but concur that there will be no inter-meeting move. With the stock market providing little pressure on the Fed to cut interest rates at present, the only source of pressure is coming from US manufacturers. Even though US industrial output posted a surprise bounce in March, the National Association of Manufacturers (NAM) urged the Fed to be prepared to lower interest rates to 4% “if conditions remain poor”. The NAM confirmed recent speculation of a meeting with Treasury Secretary O’Neill, but stated that rather than focus on the strength of the dollar, which they stated was overvalued, the meeting would focus on taxes. The de-emphasis of the dollar in the meeting contrary to recent rumours suggests that the dollar is likely to remain firm over the near term, especially if US equities bounce. The equivalent body in the UK, the CBI has also being demanding lower interest rates recently. Perhaps more significantly as their chief economist Kate Barker will join the MPC in June to replace De Anne Julius. Today, though, it is Julius who will remain the centre of attention with the release of the April MPC minutes (see in brief). The only real question in the minutes will be whether Julius and Wadwhani formally requested a 50bp cut or whether the issue of a larger move was simply discussed as in February. Events since then, though, have rather overshadowed the significance of the minutes. The upward spike in average earnings in February, albeit bonus driven, will certainly unsettle the MPC even though inflation data tomorrow is likely to show RPIX slipping toward, but not below the lower 1.5% tolerance range around their 2.5% target. Furthermore if expectations of another firm rise in retail sales in March are realised on Thursday this will only exacerbate MPC concerns about the strength of UK domestic demand. With the recent bounce in US equity markets perhaps easing concerns on the global economy, another firm reading on domestic demand may prompt a pause in the UK easing cycle until after the anticipated General election on June 7 th . In contrast to the EU12 given the signs of domestic demand are stronger and given the MPC have already eased rates by 50bp, any delay is unlikely to be viewed as negative for GBP. Indeed to the extent the UK economy is showing stronger signs of holding up against the weaker global environment than many economies in Europe and may even be viewed as a European “safe haven” currency as a consequence.
US trade balance (February): Weaker export and import growth is likely to result in a modest narrowing of the trade deficit in February. Exports of cars should rebound after two consecutive months of sharp contraction, while Boeing orders data point to a bounce in aircraft orders too. However the continued weakness of the NAPM export component and weaker export prices are still consistent with a 1% fall in export growth in the month. Imports will also be depressed by price affects as shown by the sharp 0.6% fall in import prices in the month, which was largely due to weaker natural gas prices. The fall in wholesale inventories in the month, meanwhile, continues to point to a further softening in the underlying import picture. We anticipate a 1.6% fall in import growth, which will be sufficient to narrow the trade deficit modestly to USD32.5bn.
UK MPC minutes (April): The statement that accompanied the decision to cut interest rates noted that the deterioration in the global environment, particularly the fall in global stock markets, had created downside risks for both business and consumer confidence. Although they noted that domestic demand remained firm and that the labour market remained tight, the statement concluded that the committee would continue to monitor the downside risks carefully. An indication perhaps of a readiness to ease further and a signal that some members, most probably Julius and Wadwhani who had voted for a 25bp ease in March, pushed for a larger 50bp cut. We expect that all MPC members voted for a cut this month, and if Julius and Wadwhani did not formally vote for a larger move, there should at least be a discussion of a 50bp move in the minutes as there was in February.