– AUD and SGD lead selloff vs USD, Asian equities down 0.3-2.0%
– FOMC likely to embark on operation twist
– Euro zone PMI likely to print sub-50, leaving the euro vulnerable
What to watch for this week
USD: Fed watch. We head into this week’s two-day (Tuesday-Wednesday) FOMC meeting with elevated expectations for new action to support the struggling economy and fragile financial market sentiment. Expectations center on an announcement that the Fed will extend the duration of its Treasury portfolio, buying longer-dated notes in exchange for front-end paper. Our rates strategy and economics teams think the Fed will choose this route, and believe this will be an “active twist” policy where the Fed sells front-end paper outright to fund long-end purchases rather than simply relying on proceeds from maturities. More aggressive measures the Fed could take would include a cut in the interest rate it pays on reserves (“IOR”) from 25bp to perhaps 12.5bp, or an announcement of new outright securities purchases (QE3).
A decision in line with our own “twist” expectation should be generally supportive for the USD. Relief that the Fed did not opt for a more aggressive outright purchase strategy would likely see the USD bounce initially, and this bounce could be extended if risk sensitive assets were to react negatively to the limited nature of the easing. A decision to add an IOR cut to the twist announcement could mitigate any USD knee-jerk rally but seems unlikely to be substantially helpful for risk sentiment. A surprise announcement of new outright purchases would likely boost risk sentiment and hit the dollar broadly, with AUDUSD longs likely to be a preferred trade.
EUR: Weaker PMI. Our economists project a sub-50 headline for the September flash PMI on Thursday, the first since July 2009. While this would likely increase expectations of a slowdown in the euro area core, our economists note the data is likely to show a decrease in the marginal slowdown rate, in line with recent stabilization in US data. EURUSD will remain vulnerable to headline risk, especially as Finland starts to debate the ratification of the EFSF on 21 September. No vote is expected until 28 September.
CAD: Steady inflation. We expect August CPI core to remain subdued on Wednesday at 1.6%yoy, three tenths of a percent below the BoC’s projection. This would support our expectations of a neutral BoC stance. At current levels we remain neutral on CAD.
GBP: More votes for QE. We expect the Bank of England MPC minutes to show growing support for further easing in the UK. Given the deterioration in cyclical indicators and worsening in financial conditions ahead of the September meeting, we think more members of the committee will have joined Adam Posen in voting for more quantitative easing. Our economists point out that it’s possible that there were three votes for easing, given that in August “some” members thought easing would be justified if the downside risks materialized. The increased likelihood of further easing is likely to be viewed negatively for the GBP. However, we do not expect GBP to lose much ground versus the euro given the ongoing euro area fiscal concerns. Demand from reserve managers should continue to provide some degree of support for sterling.
NOK: On hold. We expect the Norges Bank to keep rates on hold at 2.25% at its policy meeting this week, in line with the consensus forecast. While the domestic economy in Norway is performing well, the external environment has deteriorated further since the August meeting. Against the backdrop of weaker global growth, we expect the recent strength of the NOK to deter the Norges from tightening policy. Governor Olsen has already expressed concerns about the currency strength becoming disinflationary and resulting in weaker growth. As explained in our FX Strategist: Scandis are not hedges to euro area risk, we doubt the ability of the NOK to perform well in the event of further risk liquidation and intensification of euro area stress. Our flow data show large net inflow into the NOK over the last several weeks, which increases the risk of position unwinding.
CHF: Focus on money supply growth amid SNB interventions. We think the market will focus on the money supply growth (Wednesday) in August, as the SNB adopted new measures to curb the CHF strength and flooded the market with liquidity. Although the latest inflation projections forecast deflation in most of 2012, we think the SNB will closely monitor nominal indicators. Any acceleration in credit and mortgage growth should be viewed as early signs of medium-term inflation building up. On the activity front, August trade data on Tuesday will shed light on whether Switzerland’s trade surplus continued to hold up amid the CHF strength and global slow down.
CE3: On hold. In Central Europe, we expect both the Hungarian National Bank (Tuesday) and the Czech National Bank (Thursday) to keep policy rate on hold at 6.0% and 0.75%, respectively, in line with market consensus.
NZD: Q2 GDP resilience? After the surprising strength of economic activity in Q1, our economists expect NZ GDP growth (Thursday) to moderate slightly, printing 0.5%qoq in Q2 according to the Bloomberg consensus, a touch below the RBNZ’s projection of 0.6%qoq. The RBNZ has conditioned the timing of future rates normalization on the impact of recent global turbulence on the NZ economy. Evidence of strong activity in Q2 together with fairly resilient leading indicators recently could point the markets to increase pricing for RBNZ rate hikes and support the NZD.
MYR: Inflation likely peaked. CPI inflation (Wednesday) likely moderated to 3.3%yoy in August from 3.4%yoy in July. We think Malaysia’s central bank’s concern over rising external risk means the FX policy bias is going to be against currency appreciation.
SGD: Elevated Inflation. We expect CPI inflation (Friday) moderated to 5.0%yoy in August from 5.4%yoy in July, slightly below the consensus forecast of 5.1%yoy. The robust August non-oil export growth and retail sales points to inflation remaining above 5%yoy over the next few months even as external risk to Singapore’s growth rise. We think Singapore’s central bank (MAS) will continue to maintain the SGD nominal effective exchange rate on an appreciating path. The worse case is that the MAS slows or halts appreciation, rather than depreciates the SGD as it has in past US recessions.
What happened overnight
European failure to make progress on Greece has returned markets to cutting risk. The USD is firmer and Asian equities have fallen 0.2%-2.0, with Japan closed for a public holiday. The AUD, IDR and SGD are leading currency weakness against the USD. EURUSD traded lower to 1.366 while USDJPY rose to 76.9. Greek Prime Minister George Papandreou is reportedly holding an emergency cabinet meeting to pass more stringent austerity measures so as to satisfy the IMF/EU requirement for the next tranche of aid. We continue to think that the highest probability is for the IMF to disburse the next tranche of funding for Greece, but we accept political discord in Europe makes having confidence in any view difficult.
The AUD is underperforming amongst the majors, falling to 1.024. AUDNZD fell to 1.244 amid mixed New Zealand data. New Zealand’s services PMI fell to 53.9 in August from 54.5 in July, while the Westpac New Zealand consumer confidence index was stable at 112 in Q3. EURGBP dropped to 0.87 amid a 0.7%mom rebound in September in the Rightmove house prices index.
The SGD is leading Asian currencies weaker vs the USD. Aggressive position reduction drove USDSGD 1.5% higher to 1.260. We estimate that the SGD nominal effective exchange rate (NEER) is just 0.2% above the levels before the April 2011 policy meeting at which the MAS announced a one-off upward recentering and steepening of the SGD NEER policy band. With inflation likely to stay around 5.0%yoy, we believe that the SGD is increasingly oversold. The MAS is unlikely to slow the pace of NEER trend appreciation more than what the market is currently pricing in given the inflation dynamics, much less depreciate the NEER, baring an outright US recession, in our view.
KRW: We understand that the BoK may have been intervening in the FX market to slow the up move in USDKRW to 1131 today.
US portfolio inflows remained lackluster in early Q3
TIC portfolio flow data for July show foreign appetite for US long-term securities remained lackluster heading into Q2. Net foreign purchases of long-term securities (adjusted for ABS/MBS prepayments and net of US purchases overseas) came in at $12bn, a rebound from net outflows of $22bn in June but well below the 12-month average of $41bn. The three-month sum of net inflows fell to just $21bn, which made this the weakest three-month period since Q1 of 2009. Selling of Treasuries by Caribbean-domiciled accounts (some of which likely reflects US money managed offshore by hedge funds) are part of the story here, as Caribbean accounts have sold a net $13bn in long-term Treasuries and T-bills over the three-month period. Still, even excluding Caribbean activity, the numbers are very soft and remain negative on a three-month basis.
– Foreign investors bought $16bn in long-term Treasury paper in July. This marks an improvement over the $5bn in net selling recorded in June but remains well-below the $43bn average of the previous 12 months. If we take activity in short-term T-bills into account, the month saw net selling of $18bn in Treasury paper. Most of the net selling reflects Caribbean activity, but even stripping out Caribbean activity yields net selling of $1bn. Together with the previous month, these are the first negative readings for total purchases of Treasury paper ex Caribbean since August 2007.
– Foreign liquidation of Agency and corporate debt continues. Flows into corporate debt (adjusting for ABS prepayments) were negative again for the second month running, improving marginally from -$13bn in June to -$2bn in July. Flows into Agency paper (both agency issuance and pass-throughs) were negative for the twelfth month in a row after adjusting for prepayments, though the scale of liquidation was smaller at just $2bn this month vs. $9bn in June.
– Foreign appetite for US equities collapsed in July, with foreigners selling $1bn of US stocks. This represents a deterioration from $4bn inflows in June and a peak of $17bn as recently as April.
– In contrast, US investor purchases of foreign securities remained strong in July. Purchases of foreign bonds dropped to flat after a strong June, but purchases of foreign stocks rose to $16bn, their highest since January.
Today’s July release follows confirmation of a poor Q2 for inflows in Thursday’s balance of payments data. The releases continue to highlight the USD’s vulnerability in more normal market conditions. Rising systemic concerns in Europe have kept the USD supported for now, but the data help explain why EURUSD has held up better than rate differentials and Euro credit stress might otherwise suggest.
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Credit Suisse
FIXED INCOME RESEARCH & ANALYTICS