Sentiment recovers as expectations of ECB response persist; USD hurt
A more risk positive tone has come through today with european equities higher with financials outperforming, the catalysts being good Spain bill auctions (much lower yields) and a UK Telegraph story putting more weight behind yesterday’s story the ECB was looking to target peripheral yields (more below). For FX, this has seen a broad based USD sell off, with four currencies (NZD,CHF,AUD,EUR and SEK) gaining close to 0.60% vs. the USD. Today, we would keep an eye out for comments from Fed Lockhart later today (13:45 BST) and whether he feels the need to undertaken further stimulus given the current evidence. His comments will provide useful information given he is one of the members in the centre of the committee who is probably still unsure about whether or not the Fed should take action in September. Our economists’ call is for QE3 in September. USD could face downside risks especially against both EUR and the commodity currencies (AUD) heading into what could be a dovish set of FOMC minutes tomorrow.
EUR recovery to be tested this week; Risks still for EUR short covering rally
Looking ahead, towards the weekend, there are risks to the current EUR recovery with Germans, French and the Eurogroup meeting with Greece. Here, the staunch commentary from a number of German officials suggesting that any leniency or a third Greek programme will not happen suggests potential market unfriendly commentary and perhaps a pick up in volatility. But we continue to remain constructive on EUR on a multi week view and hold our long EURUSD recommendation targeting 1.2800. Yesterday’s disappointment after the ECB’s denial (that bond buying to cap debt yields) has already tapered off. Today, UK’s Telegraph says it “confirms” such a plan is being “studied” by ECB technicians which will then be presented to the ECB council outlining the pros and cons to such a plan. This plays to the view that the ECB is at least looking at ways to indirectly target “convertibility risk” (one reason why peripheral yields are so high), thus consistent with Draghi’s August 2 big picture message. According to our work, EURUSD, EURGBP and EURJPY remain most prone to a short-covering rally. The current trajectory of compressing sovereign CDS is eerily similar to that seen after the December LTRO, and it took about 5-6 weeks (after the bottom in credit prices) before EUR/G4 crosses based and moved higher (See chart). We remain comfortable holding our long EURUSD recommendation targeting 1.2800.
Keep an eye on Lockhart; FOMC mins tomorrow could test USDJPY rally
There isn’t much on the calendar today, but we would keep an eye on comments from Fed Lockhart today. The next major US market sensitive event could be Wednesday’s FOMC minutes release (for the Aug 1 meeting). Last month’s FOMC minutes (for June 20 meeting) resulted in a risk-off tone with the USD gaining ground. The reason was the minutes did not provide the smoking gun for QE3 (some members believed more stimuli was necessary, others felt it depended on the economy weakening further). Tomorrows release will be more revealing as members would have over the month seen a sub-100k NFP number (3rd straight reading), contractionary ISM and very weak retail sales data. If the minutes sound more dovish, it could take some of the steam out of the recent USDJPY (as the US 10Y pauses for breath below key levels). Still, the multi-week USDJPY bias remains to the topside, with a reversal only likely to come into September.
AUD rallies after RBA mins & PBOC liquidity injection. Thursday China HSBC PMI next catalyst
This morning we had AUD positive events. First up, the RBA meeting minutes which suggested (a) a rate cut was not discussed at the last meeting, (b) RBA view that AUD was high, but not yet hampering policy and (c) confirmation of SNB demand for AUD. Second, some relief Chinese policy makers are looking for alternatives to ease policy (if not via RRR cuts). The PBOC conducted a very large cash injection (reverse repo operation). Thursday’s China HSBC PMI for August will be the next major input, and a number closer to or above 50 (last figure 49.3) would support AUD further..
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