One Month Too Early?
With two major policy decisions due over the next 36 hours, FX investors were cautious in expressing any directional conviction, though the dollar was slightly soft heading into today’s FOMC meeting. The euro dropped 20 pips after Bundesbank chief Weidman said governments are overestimating the ECB’s possibilities, and the ECB must not overstep its mandate. These comments should not be taken as a surprise however, as it is clear that the ECB will only act within its clear guidelines. The euro also took a brief leg lower when German Economy minister Roesler said he backs Merkel in rejecting a banking license for the ESM bailout fund. He adds that reducing the rate pressure on the Eurozone stragglers means reducing the pressure on them to reform. Again, this is a clear position however so any initial euro weakness was understandably faded as the US session approached. Overnight, the official China PMI came in at 50.1 (cons. 50.3) overnight, barely an expansion but it appears markets were not overly concerned in light of signs the local economy is basing. The Eurozone composite manufacturing PMI was revised down to 44.0 from 44.1 preliminary, from 45.1 in June. Swedish data continues to show resilience however and EURSEK pushed lower after the manufacturing PMI printed an above-consensus 50.6. The AUD held in a decent range as other factors are in play, such as G3 monetary policy. As such, all eyes are on the FOMC, though our view is that any further easing is far more likely at the September meeting, when we will see the new Summary of Economic Projections and a press conference by Chairman Bernanke. In the interim, the Fed will have two additional months of employment data to peruse, and the Jackson Hole conference at the end of August will provide Bernanke with a timely opportunity to prepare the market for any easing decision. As highlighted earlier this week, our economists are looking for a US-style emulation of the UK’s FLS scheme, and it would be possible for the Fed to provide some early hints of policy innovation in the coming weeks, though today’s decision may yet prove somewhat early. If, on the other hand, the phrasing of the statement only points towards conventional asset purchases, the dollar could respond adversely per the market’s usual reaction function. However, we note that QE trades such as short USD vs. JPY and commodity names have already done well in recent weeks and appetite to add to these positions may be limited. The wider growth environment globally is far different compared to 2009 and 2010, while there is renewed skepticism over the efficacy of asset purchases when loan demand is an issue – precisely a new form of discount window action may be designed to address specifically. On the other side of the Atlantic, markets will be looking to Thursday’s ECB decision before deciding on their next steps. ECB President Draghi is expected to formally endorse bond purchases in some form – most likely through a reactivation of the SMP. Nonetheless, comments from German Finance Ministry and Bundesbank officials suggest that SMP reactivation is not a done deal, let alone the contentious issue of granting the ESM a banking license. On Tuesday, the positive US data surprises (May house prices up 0.9%; July Chicago PMI up to 53.7; July consumer confidence index up to 65.9) had little impact, with the focus clearly on the FOMC.
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UBS Investment Bank