Daily Commentary

At face valve, yesterday’s durable goods report followed the generally weaker than expected pattern to incoming US data in recent weeks. However, the underlying details of the report were better, with the weakness concentrated in the volatile defence and aircraft categories. Our preferred measure of non-defence capital goods shipments ex. aircraft is up 15.8% in Q2 compared with Q1 (annualised) – a healthy pace of gains which bodes well for business investment in tomorrow’s Q2 GDP print. However, the market response centred on the weakness in the headline numbers, with the US S&P 500 finishing the session down 0.7%. Indeed, the general theme remains whereby fears over the economy are overshadowing the by-on-large better than expected corporate earnings.

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Upbeat messages on the UK retail sector from the CBI distributive trades survey have provided support for sterling on the exchanges. The UK unit has firmed against both the euro and the dollar over the past 24 hours or so. Eur/Stg is back to around 83.5p (from over 84p yesterday morning), while GBP/USD is maintaining its upward trajectory against a generally softer dollar; it opens at a 5-month high of over $1.56.

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In contrast to the recent tendency for US housing data to surprise on the downside, yesterday’s June new home sales numbers were much better than expected as sales jumped by almost 24% last month. But even after last month’s improvement, sales remain at extremely low levels though at least the surprise was in a positive direction for a change.

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In contrast to the general pattern of recent US economic data, euro area and UK numbers again surprised on the upside on Friday. However, the real focus of markets was on the results from the European bank stress tests. Markets were not expecting anything dramatic, as there had been plenty of leaks to suggest that they would lack credibility. In the event, there were no major surprises, with a mere 7 of the 91 banks tested failing. Despite concerns surrounding some key features of tests, the market reaction has been favourable so far, with European equity markets opening in modest positive territory and Eur/USD moving higher to around the $1.2950 mark. However, as we have discussed previously the main issue is the degree to which the stress tests are credible enough to restore confidence in the medium-term health of the European banking system.

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Given the ongoing market concerns about the prospects of a double dip in the global economy, yesterday’s euro zone and UK data helped to soothe at least some of these worries. While the risk of renewed weakness remains, in particular the euro area periphery given the need for tough fiscal consolidation, European debt markets have shown signs of stabilising. In this regard, the release of the much-anticipated European bank stress test results will be key today. In the run up this, markets will have plenty of food for thought, with the release of the first estimate of UK Q2 GDP and the German IFO.

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US equity markets took a hit overnight, and Asian and European markets are playing catch-up this morning, with Bernanke’s testimony to the Senate knocking some of the recent optimism out of risk appetite. Bernanke acknowledged that the economic outlook was “unusually uncertain" and that the Fed was "prepared to take further policy actions as needed". The market reaction would indicate that the main focus was on such comments, or perhaps there was also some disappointment that there was little else to show that the Fed has any appetite for further stimulus measures. The testimony has also contributed to a further move downwards in Eur/USD, which is trading at around $1.2750 presently.

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The euro has given back some of its recent gains against both the dollar and sterling. Its rally began to peter out yesterday morning and it then sold off gradually over the remainder of the day, with Eur/USD back to $1.29 (from over $1.30) and Eur/Stg back to 84.3p from an intra-day high yesterday of around 85.3p. In truth, there wasn’t any obvious catalyst for the sell-off so it perhaps was more a reflection of the upmove simply running out of steam. It may also be a case that the market is just that bit more wary about buying the euro ahead of the results of the bank stress tests.

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The euro continues to forge higher. Eur/USD ticked up through the $1.30 level overnight, while Eur/Stg traded above 85p at one point late yesterday. The position-unwinding story may still be playing out here, as the prior sharp sell-off gets partially reversed in the face of a lot of bad news having been priced in.

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A particularly weak reading of consumer confidence on Friday afternoon (sentiment among US households slipped to its lowest level in eleven months) meant that the trading week ended on something of a sour note as early-week stock market gains were reversed. The S&P closed with losses of 2.9% on the day resulting in a fall on the week of 1.2%.

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Eur/USD consolidation has given way to renewed upward pressure over the past 24 hours. Eur/USD has pushed notably higher to get as high as $1.2950 overnight (its highest level since mid-May) from sub $1.2750 yesterday morning. But this is not really about a stronger euro; rather it is more about dollar weakness and the greenback has been under pressure against other majors too, including sterling which hit an 11-week high of over $1.5450 in Asian trading.

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