– Political risks result in a modest risk-off tone at the beginning of the week
USD strength continues to dominate as the market traded with a modest risk-off tone. The key catalysts behind the risk-off move include China-Japan tensions, uncertainty on whether Spain will seek external assistance, and a softer German IFO. This week the focus will be fixed on Spain when it releases its 2013 budget and reforms as well as the bottom up review of the Spanish banks on Thursday and Friday. Also, Spanish t-bill and Italian bonds auctions will be in focus today. The PBOC today announced CNY 100bn of 14-day and CNY 150bn of 28-day reverse repos at 3.4% and 3.6%, respectively, meeting market expectations for large reverse-repos to help smooth the tightness in the liquidity conditions ahead of quarter-end and golden week holiday. This action has proven positive for bonds with yields lowered by about 2 bp. Still, the 7-day repo remains at pretty elevated levels, but our expectations remain that liquidity conditions will ease post-golden week holiday.
– Greece comes back to the headlines
Besides Spain, Greece may also weigh on the EUR this week. The three coalition parties will continue their talks in an effort to reach a final agreement on the austerity package before 28 September when the government is expected to present the measures to the Euro Working Group. The government will then present the package to parliament for approval ahead of the Eurogroup meeting on 8 October when the Troika is expected to present its report on Greece. The Troika is pushing Greece as hard as it can before giving it any leeway. We believe that a deal will eventually be reached and Greece will be granted some flexibility under its austerity plan such as more time to adjust its balances and even some sort of relief from its debt to official creditors.
– ECB hints on rate cut vs. stress reducing measures eyed
Comments from ECB officials will be reviewed for any hints of the likelihood of a rate cut at the ECB’s next meeting on 4-5 October. Any further hints that rate cuts are less likely should reduce the chances that the EUR will fall on declining yield advantage. However, we judge that the response of the credit markets will be more important, and any further risk-reduction ahead of the Spain budget here could continue to see the EUR come off. Comments from ECB members Draghi (Tuesday, 1400 BST), Constancio (Thursday, 0:00 BST) and both Asmussen and Godeffroy (Friday, 12:30 BST) will be important. In comments over the weekend, the ECB’s Coeuré suggested that a rate cut would not be justified by current inflation developments, also alluding to the problems that a negative deposit rate would induce. It is worth noting that the Bundesbank’s monthly report for September highlighted that it expects the German economy to continue on its upward trend after a solid Q3, but added that signs of a slowdown are emerging, pointing to the slowdown in the labour market and the potential hit to exports. The slowdown in the German economy would sway the ECB in the direction of a rate cut.
– US consumer confidence and Canadian retail sales on the calendar for today
US consumer confidence for September is expected to show a solid increase on the back of a strong pick-up in stocks after the Fed policy announcement on 13 September. This should outweigh the negative developments on the labour market front as well as the rise in oil prices. With several FOMC members defending and reaffirming Fed policy last week, the stock markets should remain well supported. More Fedspeak this week should reaffirm the Fed’s commitment to their policy action and induce USD selling. We remain USD bears; and reiterate our long NZDUSD position targeting 0.8470. In addition to the recent bout of risk aversion, the NZD may see a setback on 25 September with the release of the trade data, which is expected to deteriorate. However, any decline in NZDUSD would offer a good opportunity to add to long NZDUSD positions. Also, the CAD may receive a boost today. Canadian headline retail sales are likely to receive a push higher on the back of the increase in gasoline prices, but underlying strength in real terms remains modest.
BNP Paribas