– Asian markets fell 2.0%-6%
– G7 pledged to support financial stability possibly with coordinated action
– ECB signals it will buy Italian and Spanish bonds
– FOMC to announce further policy measures on Tuesday
What to watch for this week
USD: New measures. We expect the FOMC to announce small steps toward further monetary accommodation on Tuesday. This will likely take place in the form of a maturity extension of the Fed’s existing Treasury holdings. Such a measure would not change the size of the Fed’s balance sheet but would still likely translate into increased downward pressure on the longer end of the Treasury yield curve. We also expect the FOMC to modify its “extended period” language to signal that monetary conditions will remain accommodative for even longer. Our economists note that one way to achieve this would be to tie “exceptionally low” policy rates to improvement in employment metrics. We think chances for a more aggressive “QE3” type announcement have receded after Friday’s better jobs news.
We expect risky assets to welcome the FOMC decision with a moderate relief rally, if the announced measures are in line with expectations. This said, we remain of the view that a sustained improvement in market conditions is unlikely in the absence of a firm commitment from the European authorities to address peripheral funding stress and further evidence that the recovery remains intact. Furthermore, some market participants might lament the FOMC’s decision not to commit to a program of additional asset purchases. As such, we would expect any relief rally to be short lived and expect the USD to remain bid against AUD, CAD, EUR and EM currencies in the near term and, barring intervention, to remain under pressure vs. the JPY and CHF.
The data calendar is likely to be mixed. We expect headline and core retail sales growth rose to +0.5%mom and +0.3%mom, respectively, but expect to see a plunge in the August preliminary Michigan consumer confidence to a 15-month low of 59.0.
EUR: A clearer picture of Q2 growth. French Q2 GDP data will be released on Friday and our economists expect growth slowed to 0.2%qoq from 0.9%qoq in Q1. Italian politics will also be in focus, as the Italian government stated it intends to pass a balanced budget constitutional amendment. This would require a two-thirds majority vote in both chambers of parliament. Any signs of resistance from the minority government party, the Northern League, or from the opposition would likely bring euro zone funding pressures to the forefront, with negative implications for EURUSD. We remain short the pair in our cash model portfolio with a 1.345 target and a 1.454 stop loss.
GBP: More dovish. Our economists expect the Bank of England Inflation Report on Wednesday to signal a slightly more dovish bias. Although market expectations for policy rates have eased somewhat, there are several factors likely to lead the MPC to lower its inflation forecast on a two- to three-year horizon: 1) distress in European bond markets, 2) evidence of slow growth in the first half of the year, and 3) weaker cyclical indicators pointing to poor activity in the second half of the year. That may provide further evidence that the committee’s bias is moving towards contemplating further easing. The business surveys at the end of Q2 suggest downside risks for June industrial production on Tuesday. These lead us to expect UK yields to remain negative for sterling. However, with the ongoing euro zone peripheral issues, we do not favor expressing GBP shorts versus the EUR. Instead we prefer GBPUSD shorts given our bearish EURUSD view.
AUD: Employment to add only marginal support. The consensus forecasts that July employment rose 10k and the unemployment rate remained steady at 4.9%. Our bias would be to expect an above-consensus reading, given that total hours worked held up well in the past two months. Better employment is unlikely to support AUD in the current risk-off environment, in our view, and we expect AUD to remain vulnerable to deteriorations in global risk appetite. Nevertheless, good data could push AUD higher vs. NZD and CAD.
NOK: Unchanged. Our economists expect the Norges Bank to keep rates on hold at 2.25% on Wednesday vs the consensus forecast for a 25bp hike. At the last meeting, the executive board pre-announced a hike for this month on the back of a better assessment of the economy. While domestic data flow since the June meeting has been supportive of further tightening, the external environment has deteriorated significantly. This has pushed front-end interest rate differentials in favor of the NOK as markets have cut expectations of monetary policy tightening elsewhere. In the unlikely event of a rate hike, it will likely be paired with a dovish statement, in our view. We think that the NOK is vulnerable to an intensification of the euro area peripheral stress and further risk liquidation.
CE3: In central Europe, market focus will be on the July inflation statistics. The Bloomberg consensus forecasts are for July inflation to move sideways – Poland (4.3%yoy), HUF (3.5%yoy) and Czech Rep (1.8%yoy). We think the CE3 currencies are most vulnerable to a systemic fiscal and liquidity crisis in the euro zone, given their heavy reliance on liquidity from European banks (see FX Strategist – EM FX Sensitivity to Global Financial Crises, 5 August 2011). The sovereign risk in CE3 has risen sharply amid the euro zone funding stress, close to the levels last seen in June 2010. In addition, weaker-than-expected growth in the euro area would weigh on the CE3 growth outlook further, in our view. Among the CE3 currencies, we think the PLN is most vulnerable to a further risk sell-off, followed by the HUF and the CZK.
CNY: Resilient growth, still elevated inflation. China reports July CPI, industrial output, fixed assets investment data and retail sales on Tuesday. We expect industrial production growth to remain robust around 15%yoy and retail sales to print above 17%yoy. Inflation is likely to moderate but remain at an elevated 6.3%yoy, according to our economist. We also expect trade data out on Wednesday to show robust export growth of 17.2%yoy in July, driving a slight widening of the trade surplus to $27bn from $22bn in June. Data in line with our estimates would point to growth moderating, not a “hard landing”, and would support our expectation of continued PBoC policy tightening. We expect USDCNY to continue drifting lower and remain short USDCNY via the 3m NDF.
TWD: Slowing exports. Taiwan reports trade data today. Our economist forecasts export growth fell to 9.5%yoy in July from 10.8%yoy in June, slightly higher than the consensus forecast of 9.1%yoy. With inflation surprising lower to 1.3%yoy in July, the Taiwanese central bank (CBC) is likely to remain dovish and will continue to resist TWD strength. A further slowdown in exports will allow the CBC to keep USDTWD trading in a range, in our view.
KRW: BoK on hold. We expect Korea’s central bank (BoK) to keep policy rates on hold at 3.25% versus the consensus forecast for a 25bp hike. While CPI inflation surprised higher in July, we think the continued stress in the euro zone and US means the BoK is likely to tighten policy gradually, with a hike in September more likely. We think the central bank is likely to allow the large $7.2bn trade surplus to translate into gradual FX appreciation to help curb imported inflation in the meantime.
INR: Slowing production. Industrial production growth likely remained sluggish around 5.4%yoy in June. The slowing growth profile and still elevated inflation are likely to discourage equity inflows. But we think the aggressive central bank rate hikes have re-established its credibility. This should be particularly positive for flows from overseas Indians given money market funds and fixed deposits offer interest rates of over 9%. We have turned bullish and target USDINR at 43.5 in three months.
What happened overnight
The Asian session started on risk aversion mode. Equities sold off on the back of the weekend announcement by S&P of the downgrade of its US credit ratings to AA- from AAA. Our US interest rates strategy team expects minimal market reaction today. Markets have also seemingly read the G-7 statement as underwhelming. We think the G-7 statement increases the probability of coordinated policy actions to support markets. The ECB announced after an emergency meeting over the weekend that it will intervene decisively in the markets to respond to the escalating debt crisis. We think the ECB is signaling that it will buy Italian and Spanish bonds when markets open (see our conference call replay: Credit Suisse views on the US debt downgrade and weekend ECB meeting). EURUSD traded lower to 1.432 after opening high at a high of 1.443.
The USD weakened vs the CHF, JPY and European currencies, but has pared back some losses. USDJPY opened lower and traded flat around 78.0 while CHF opened at 0.756 before grinding higher to 0.760. EURGBP is unchanged around 0.872 despite the UK employment outlook as reported by Lloyds falling to -53 in July from -50 in June. The Antipodeans are underperforming amongst the majors. AUDUSD traded lower to 1.033, weighed by a decline in the volatile ANZ jobs adverts by 0.7%mom in July from +3.8%mom in June.
Asian currencies are mixed vs the USD. Most USD/Asian crosses opened lower but have pared back much of the gains, with the PBoC’s decision to fix USDCNY at another record low of 6.4301 helping sentiment initially. USDSGD drifted higher from the opening low of 1.21 to 1.217 currently and we understand that the MAS may have been buying USDSGD around 1.2120 initially. The KRW and INR are underperforming, weighed by losses in the equity markets. USDKRW traded to a 6-week high of 1,079, while USDINR traded above 45.0 for the first time since 28 June. Asian equities are down 2.0%-6% today.
What to read today
USD: Growth outlook revised down. Our US economic team expect just 1.5% real GDP growth in Q3 from a previous forecast of 3.3% and 2.2% growth in Q4 from 3.1%. Next year’s forecast has been reduced to 2.2% on a Q4/Q4 basis from 3.1%. Our economists expect the Fed to undertake further monetary accommodation at the August 9 FOMC meeting. This suggests that the USD will continue to struggle against the JPY and CHF, barring any FX intervention. See report here.
What to do
Worst-Of Option – EURUSD put, EURCHF call, EURPLN call
– Two-month expiration
– EURUSD 1.4059 put (1.00% OTMS)
– EURCHF 1.0638 call (2.00% ITMS)
– EURPLN 4.0669 call (1.00% OTMS)
– Premium 0.31% of EUR notional
Note that the EURCHF leg is struck 2% in-the-money spot. Average offered price of three vanilla options is approximately 2.46% while the cheapest option (EURPLN call) is offered at roughly 1.52%. The buyer of the option receives the worst of the three payouts from each of the individual options. The risk of the trade is a complete loss of premium if one of the underlying options is out of the money at expiration.
For details please see FX Strategist – EUR Worst-of Option.
Click here to read the full report:
http://www.easyforexnews.net/wp-content/uploads/2011/08/document-804294540.pdf
Credit Suisse
FIXED INCOME RESEARCH & ANALYTICS