* EUR Short covering remains the big driver
The big driver in FX continues to be short covering of EUR positions on anticipation of a strong ECB response to lower sovereign debt yields; yesterday’s news that ECB Draghi won’t be attending the Jackson Hole conference on account of a busy schedule play to this. Today, the meeting between Germany’s Merkel and Italy’s Monti (13:14 BST) will be eyed in terms of whether politicians are any closer to seeking aid so that the ECB can proceed with any response. From Spain, PM Rajoy continues to maintain that Spain was not in talks with Europe regarding conditions for a possible bailout and reiterated that he was waiting for the ECB for details on what they intend to do to support the sovereign debt markets. Given that Spain’s EUR 20bn bond redemptions are not due until the end of October, it will likely drag out asking for a bailout. However, pressure may increase on Spain by the eurozone in the coming September meetings. We remain long EURUSD, targeting 1.28 and EURJPY targeting 101.63.
* German CPI to remain on the softer side, leaving room for further cuts
On the data front, German CPI this morning is expected to show a rise in headline inflation (to 2.3%y/y from 1.9%y/y) on the back of the surge in oil prices. However, core inflation is actually softening and as the summer season draws to a close, we expect core price declines and a slight moderation in energy prices to bring the annual headline inflation back to 2% in August. Thus, with inflation very well contained, hawkish members of the ECB should feel at ease with current policy and less reluctant to loosen monetary policy further. We continue to expect a 25bp cut in the refi rate in September in tandem with downward revisions to ECB staff growth and inflation projections. While this may have a negative impact on the EUR, we believe that sovereign risk premia will dominate the price action in the EUR.
* Norges Bank meeting likely to drive NOKSEK higher
Even though eurozone stresses have abated, EURCHF has barely budged off the 1.2000 floor. Swiss sight deposits, which serve as a proxy for FX reserves, continue to rise, suggesting that the SNB intervention persists in an effort to maintain the EURCHF floor. Given the economic weakness in the eurozone, Swiss data remains weak, and today’s KoF Swiss Leading Indicator will only confirm this. While we expect a slight decline, it reasserts the SNB’s resolve to uphold the floor. If the SNB’s intervention continues at such a pace, then the rally in EURSEK may be slower. The rise in Swiss sight deposits has correlated well with EURSEK weakness. Even if the SEK continues to outperform the EUR, we expect NOKSEK to forge higher. The rally in NOKSEK should be accelerated by the Norges Bank meeting today. With domestic economic conditions strengthening in Norway, the Norges Bank is bound to recognize the improvements in the domestic data. However, we do not expect the bank to hike rates this year. We remain long NOKSEK targeting 1.1700.
* Fed Beige Book and US Q2 GDP due out today
While the focus this week remains on Fed Chairman Ben Bernanke’s Jackson Hole speech, the Fed Beige Book may likely highlight the uncertainties about the broader economic outlook and the weaker growth in the manufacturing sector. The second estimate of Q2 GDP, due out today, will be revised slightly higher to 1.7%q/q (saar) from 1.5%q/q (saar) on the back of the revisions in net exports. With growth well below trend our economists’ expect QE3 to be announced at the September FOMC meeting. We remain bearish on the USD, and expect commodity currencies to benefit on the back of this. After being stopped out of our discretionary long AUDUSD trade, we established a long AUDUSD trade, targeting 1.0545, based on the BNP STEER model. The model showed that the recent decline in AUDUSD is not justified by underlying fundamentals.
BNP Paribas