Optimism Tempered
The euro was broadly softer overnight as investors are starting to digest the implementation issues surrounding Europe’s latest efforts to resolve the crisis. The breaking news over the weekend was from the El Economista newspaper, which claimed that Spain may wait until after regional elections on Oct 21 before making a formal application for EFSF aid. If true, this would mean there is little prospect of ECB bond purchases via Outright Monetary Transactions anytime soon, given the ECB’s insistence on conditionality. In addition, new challenges have been submitted to the German constitutional court arguing against the ESM. The latest came from a German lawmaker which asked the judges to block ratification of the ESM or postpone a ruling scheduled for Wednesday. The court said it would likely issue a release on this tomorrow. Although observers do not believe the court itself will block the ESM in its entirety, scrutiny over minute details in the Treaty may yet cause renegotiation of the Treaty itself and this would be a tail event which could damage current expectations. Headline risk aside, investors also have global growth issues to contend with and the news from China is still troubling. The country’s trade surplus was wider than expected, but imports contracted by 2.6%, and this (along with news of an Australian coal mine closure) did nothing to boost sentiment towards the Australian dollar. Weaker imports are often cited as a sign of a consumption slowdown, which will not help hopes for rebalancing in the economy. In Japan meanwhile, Q2 GDP was revised down. In theory this raises the risk of further BoJ easing when the policy board next meets on Sept. 19, although what the Fed announces on Thursday will likely be a far more crucial factor. In the wake of Friday’s soft payrolls report, our US economists now think the Fed will announce another round of asset purchases this week, of at least $500bn, and will also extend the commitment to keep the Fed funds rate exceptionally low into 2015. We consequently expect the dollar to trade heavy as Thursday’s FOMC meeting approaches, though with the constitutional court ruling and the Dutch elections out beforehand, the euro itself may also find upside drivers somewhat lacking. EURUSD traded 1.2771-1.2812 and USDJPY 78.19-78.33 overnight.
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UBS Investment Bank