EUR Attempts Rebound
The EUR had a rather volatile overnight session, generally trending lower before a rather well-received EFSF auction prompted a rebound towards 1.23. For FX markets though, the main news was SNB’s reserve allocation figures, which showed that as of the end of Q2, EUR holdings were 60%, up from 51% in Q1. This suggests that diversification had slowed, though whether it represents a permanent shift in allocations remains to be seen. The pace of accumulation in the second quarter has been significant, and significant selling in EURUSD may have exacerbated price action in a currency which was already trading heavily and the SNB did not wish to be seen as disruptive and causing a vicious cycle in EUR performance, which would have made its own policy execution far harder. Nonetheless, the rise in allocations in the ‘others’ category suggests the central bank had been an active buyer of currencies including AUD, SEK, DKK, SGD and KRW, as listed by the central bank. Although their purchases may not explain all of the outperformance in currencies like the SEK and AUD, it may have encouraged other market participants to join the rush for high-quality assets. Elsewhere, our economists have changed their view on Fed policy and now we expect a further easing programme in September. However, our economists do not expect this to come in the form of Large-Scale Asset Purchases (MBS or Treasurys). We
now expect the Fed to ‘undertake an easing program within the discount window facility’, ‘which provides bank with access to even lower cost funding – even at zero – to banks with certain lending or possible debt forgiveness targets’. Given the discount window is collateralized, and any programme would be subject to restrictions, the sense of ‘debasement’ is probably less palpable and markets would need to find a new reaction function with respect to the dollar. Given investors’ recent tendency to reward policy innovation, we do not expect immediate challenges to the dollar, but are cognizant of the fact that this represents new territory for the dollar itself and the market may take its time to factor in the implications. In the US, Core PCE, consumer confidence and housing numbers are out. EURUSD traded 1.2249-1.2303 and USDJPY traded 78.10-78.30.
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