What happened overnight
– EUR and equities rally modestly ahead of the FOMC
– FOMC may deliver “twist”; a cut in IOR remains a possibility
– BOE minutes likely to show more votes for new QE
– Norges on hold
The USD has recouped early losses as markets hunker down to wait for the FOMC result. EURUSD traded higher in Asia but held below Tuesday’s 1.3745 highs and has now settled lower below 1.37, while AUDUSD has traded sideways below 1.03. Price action in equities markets is mixed as well-the S&P future is up slightly after gains in most Asia markets, but European bank stocks have taken another turn for the worse and the DAX is down 1%. Italian and Spanish bond yields are stable.
Reaction has been muted so far to news that the Republican Congressional leadership have urged the Fed to refrain from additional easing. Markets likely view the letter as unlikely to dissuade the Fed from the limited policy measures being considered at today’s FOMC meeting. However, the letter will likely add to perceptions that the hurdle for more aggressive action is high, which could prompt the market to maintain more pricing for recession tail risk if data were to deteriorate further.
Meanwhile, markets remain subject to a degree of uncertainty with respect to EU and IMF plans to disburse the next tranche of Greece assistance. While comments following yesterday’s conference call suggested progress in discussions has been good, there seems unlikely to be finality on this question until early October. The Greek Finance Minister has said there are plans to continue discussions with IMF officials during the G20 meetings on Friday and the IMF meetings this weekend. The IMF mission now seems scheduled to return to Greece next week. Of course, even eliminating the near-term prospects of Greek default will still leave questions about the capacity and willingness of EU institutions to support Italy.
We remain medium-term constructive on the prospects for a rebound in risk sentiment but, as our Global Strategy team note in our weekly Strategy Snapshot published early this morning, it may well be mid- to late-October before key uncertainties on Europe and US growth dynamics have been addressed sufficiently to see markets exit from “panic”. The implication in currency markets is that the pro-USD and pro-JPY momentum trades which have begun to materialize likely have further to run.
EURCHF remains well-supported this morning amid market discussion that Swiss National Bank may announce an increase in its floor level to 1.25, perhaps as a response to recently weaker-than-expected trade data. An academic adviser to the SNB was quoted in the press this morning (Reuters) indicating that he considers it is possible that the floor could be raised. We do not have a strong view on this, but note that our original estimates suggested that a floor between 1.25 and 1.30 would represent an attractive trade-off of reducing overvaluation while ensuring enough disinflationary pressure to prevent a policy conflict until 2013 at the earliest.
Bank of England MPC minutes showed a shift in the direction of new QE although the voting pattern remained unchanged. All members voted to keep rates on hold and only Posen voted to extend QE, as last time. But most members judged the probability of QE has increased and some thought that conditions seen over the past month would be sufficient for an action at the next meeting. We remain bearish on GBP and continue to recommend expressing this view vs. the USD via GBPUSD put spreads.
Asian central bank resistance to FX weakness intensified today. Central banks in Indonesia, Korea, Malaysia, and the Philippines all sold USD. This was more aggressive in Indonesia and Korea and lighter, aimed at smoothing, in Malaysia and the Philippines.
Japan’s trade balance surprised weak, with a deficit of ¥775bn in August. Expectations were for a ¥300bn deficit. Exports grew only 2.8% yoy, much less than the 8.0% yoy expected mainly due to weakness in Asia, while import growth surprised strong at 19.2% yoy largely due to higher volumes of energy imports.
Westpac’s Australia Leading index rose 0.5% in July, a second consecutive rise and the strongest for five months. Additionally, the chief executive of the world’s third largest miner of bulk commodities tempered concern about some Western customers delaying orders by noting that demand for iron ore and coal from China remains strong. The net effect has been continued unwinding of long bond and bond futures positions sparked by yesterday’s more hawkish than expected Reserve Bank of Australia minutes. Australian yields are up about 6 – 7bps across the curve. Other news was less constructive. The DEWR internet skilled vacancies index fell for a third consecutive month in August. One of Australia’s mortgage insurers reported the percentage of mortgagees experiencing stress rose to 25% in July from 21% in June even as rental vacancies fell.
New Zealand’s current account deficit was NZ$921mn in Q2, larger than the NZ$671mn expected. The reported share of GDP was smaller than expected however at 3.7% in Q2 vs. expectations for 4.0%. More important, the weighted average for dairy product prices fell 2.1% at Fonterra’s latest auction, a seventh consecutive fall to the lowest level since August last year. Although prices are off their highs they remain high in absolute terms.
What to watch for today
USD: Fed watch. Our rates strategy and economics teams think the Fed will announce an extension of the duration of its Treasury portfolio, buying longer-dated notes in exchange for front-end paper. This would be an “active twist” policy where the Fed sells front-end paper outright to fund long-end purchases rather than simply relying on proceeds from maturities. More aggressive measures the Fed could take would include a cut in the interest rate it pays on reserves (“IOR”) from 25bp to perhaps 12.5bp, or an announcement of new outright securities purchases (QE3).
A decision in line with our own “twist” expectation should be generally supportive for the USD. Relief that the Fed did not opt for a more aggressive outright purchase strategy would likely see the USD bounce initially, and this bounce could be extended if risk-sensitive assets were to react negatively to the limited nature of the easing. A decision to add an IOR cut to the twist announcement could mitigate any USD knee-jerk rally but seems unlikely to be substantially helpful for risk sentiment. A surprise announcement of new outright purchases would likely boost risk sentiment and hit the dollar broadly, with AUDUSD longs likely to be a preferred trade.
NOK: On hold. We expect the Norges Bank to keep rates on hold at 2.25% at its policy meeting this week, in line with the consensus forecast. While the domestic economy in Norway is performing well, the external environment has deteriorated further since the August meeting. Against the backdrop of weaker global growth, we expect the recent strength of the NOK to deter the Norges from tightening policy. Governor Olsen has already expressed concerns about the currency strength becoming disinflationary and resulting in weaker growth. As explained in our FX Strategist: Scandis are not hedges to euro area risk, we doubt the ability of the NOK to perform well in the event of further risk liquidation and intensification of euro area stress. Our flow data show large net inflow into the NOK over the last several weeks, which increases the risk of position unwinding.
What to watch for today
Global Strategy Snapshot: Our interest rate strategists expect core bond yields to make new lows, our credit strategists remain wary of financials, and in FX we expect the JPY to continue appreciating and the USD to remain firm. (see report here)
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http://www.easyforexnews.net/wp-content/uploads/2011/09/document-914607241.pdf
Credit Suisse
FIXED INCOME RESEARCH & ANALYTICS