Yesterday proved to be a fairly tumultuous day in markets, in stocks especially. For Europe, it was a combination of the economic and political that conspired to put pressure on investor sentiment. Events in both France (a likely change in president) and the Netherlands (a backlash against austerity) impacted sentiment, as did the softer PMI data for both France and Germany. For now, it appears that the factors that were supportive for most of Q1 (ECB 3Y money, Greece inching back from the brink and better US data) are waning, but suitable replacements have yet to be found. For FX, this is seeing a stronger return to ‘risk-off’ moves into month-end, so the dollar is firmer against most (the yen excepted) and the Aussie is suffering the most, helped by softer inflation data overnight.
Aussie rate cut now a done deal. The inflation figures for the first quarter fell by more than expected, shifting the debate in Australia to how much the central bank is likely to cut rates by next month, rather than whether it will do so at all. On the trimmed mean measure, inflation fell to 2.2% from 2.6% in Q4. The RBA’s preferred measure fell even more sharply, from 3.1% to 1.6%, the lowest for two and a half years. Not surprisingly, the Aussie weakened on the news, down to a near two-week low around the 1.0250 area on AUD/USD. Parity, which has not been seen since mid-December, is now not looking that far away.
The new crisis within Europe. The political and financial crisis experienced in many eurozone countries over recent years is now engulfing the Netherlands. Geert Wilders’ Freedom Party withdrew its support from the coalition on Saturday because of disagreements over the thrust of fiscal austerity being pursued by the now former Dutch Prime Minister, Mark Rutte. Budget talks have been ongoing since early March, with Rutte determined to deliver a package of measures designed to reduce the fiscal shortfall to 3% of GDP, as demanded by the fiscal compact. Rutte’s Liberal Party will now appeal to parliament to pass its budget, although passage is unlikely to come cheap. For instance, the opposition Labour Party is prepared to allow the package through but only so long as Rutte calls fresh elections for September. Unsurprisingly, Dutch bond yields have widened significantly yesterday, the 10yr yield out by 10bp vs. Bunds to 77bp this morning. This political uncertainty is undermining Holland’s AAA rating – three months ago S&P warned that the rating was under threat should the economy deteriorate further. Just this morning, a survey of Dutch business confidence suggested a further deterioration last month. German Chancellor Merkel will be increasingly alarmed by the situation, not just in the Netherlands, but also in France. As might be expected, the single currency is on the defensive this morning while Bunds are attracting a renewed safe-haven bid.
Reasons not to be cheerful. The provisional PMI data for the eurozone provided sobering reading yesterday, adding to the opening downside pressure on stocks and giving the dollar a lift. There was interesting contrast in the readings between Germany and France. For the former, it was the manufacturing sector that was notably weak in April, the series falling from 48.4 to 46.3. Export orders were particularly hit, with evidence of weaker demand from the peripheral eurozone nations. In contrast, services held above the 50.0 level for the seventh consecutive month. In France, it was the other way round, with services sentiment much weaker than expected at 46.4 (from 50.1). There were other reasons to be less cheerful though, and in Italy especially where consumer confidence fell to the lowest level since the series began back in 1996. This is perhaps not that surprising given the pressure Monti is putting on the economy with his austerity drive. Furthermore, the Bank of Spain has estimated that GDP contracted 0.4% in the first quarter, which would put the country back into a technical recession. Again, no real surprise, with the European Commission forecasting a 1% contraction this year, but this coming before the latest Spanish budget announcements, so a decline in the 2-3% area is now looking far more likely. Further afield, overnight data for China (PMI) and Australia (producer price inflation) have both added to the more sombre tone. The reaction in FX markets reflects that we are seeing a ‘risk-off’ move, the dollar firmer vs. most majors apart from the yen, with USD/JPY nudging through the 81.00 level.