The relief rally in equities continued yesterday, with Wall Street welcoming a better than expected Chicago Fed National Activity Index. Given that last week’s Philly Fed survey has destroyed confidence, Wall Street managed to close slightly up on the day, ending last week’s rout. Asian stocks rallied by over 1% and European bourses should rally by a similar amount at the open. Using conventional measures such as price-earnings ratios, equity markets look cheap in historical terms, which have been reflected in a flurry of ‘buy’ recommendations from strategy teams.
Sterling continues to benefit from its ‘safe haven’ status for now. Cable continues to trade over $1.65 against the greenback, whilst euro-sterling remains around £0.8740. Given that 10-year gilt yields remain around 110-year lows of 2.4%, interest rate differentials would point to a lower value for the pound. However, it has been the foreign flow of capital into the UK seeking solace from eurozone sovereign debt fears that has kept sterling at elevated levels. The effective exchange rate has risen by around 5% since the start of July, which will undoubtedly cause more questions as to how the UK will be able to rebalance its economy.
The front Brent crude contract rallied overnight rising back to $109 per barrel from the $107 it had consolidated around yesterday. The Libya inspired rally petered out as markets recognised not only the time scale needed to restore production, but also the fact that other OPEC producers would start cutting production in order to keep prices at current levels. A further slowdown in global growth would push Brent towards $90. But we would need to see clear evidence in Q3 GDP data, which will start to become available in October for that to happen.
Today is dominated by survey data, with the flash estimates for French, German and eurozone PMIs due. The market is expecting some slowdown in August, which seems only fair. The sovereign debt crisis and ECB tightening should all have some adverse impact on activity.
We also get the ZEW survey of economic sentiment for both Germany and the eurozone. The ZEW survey tends to be much more volatile than the IFO release as it covers the investment community rather than businesses. The market is looking for a sharp fall in German sentiment, which would take the index back to its lowest level since January 2009. We take more interest in the current situation index, which correlates much better with German GDP. A decline back to 85, would leave it at its lowest level since January, but would still point to solid growth in the third quarter, keeping the German economy on track to grow by around 3% or so this year.