- Market rallies on story of an expansion of EFSF which was later denied
After a breadth of negative euro news resulting in risk-off trade for much of Tuesday, the market sharply turned around on a UK Guardian report that France and Germany agreed to boost the EFSF to EUR2trn. The EFSF would become an insurer rather than a bank. Chancellor Merkel has already said that leveraging the EFSF via the ECB is not an option. This is in line with what the ECB has repeatedly vocalised. The Guardian story also suggested that Germany and France agreed that banks would be recapitalised to meet the 9% capital ratio that the EBA is demanding. The deal would be endorsed as soon as this weekend’s EU Summit. The story triggered a EURUSD rally from 1.3650 to nearly 1.3820 and US equity markets to close on a positive note. However, the story was later denied, forcing EURUSD to retrace some of its moves. But the bad news did not end there. After the US equity market close, Moody’s cut Spain’s government bond rating two notches to A1 with a negative outlook. While Moody’s was behind the other two ratings agencies, it is now one notch below its competitors. In addition, Apple earnings, which rarely disappoint, fell short of expectations, pushing S&P futures lower. The price action in the markets overnight continues to highlight the vulnerability of the market to headlines. We continue to see downside risk on the EURUSD ahead of this weekend, even if German officials in particular have done a good job this week of managing down market expectations.
- BoE minutes to justify accommodative policy while US CPI may further scale back QE expectations
Fed chairman Bernanke offered little policy insight in his speech, but reiterated the importance of the central bank in ensuring financial stability. While further monetary easing from the Fed may be a hard sell with high inflation, US core CPI later today is likely to moderate further. Headline inflation is likely to increase 0.3%m/m and 3.9%y/y in September, but we do believe that this will be the peak in y/y inflation due to base effects. But even if we see a rise in inflation, we are unlikely to see Governors Rosengren and Lockhart water down their dovish tones. The Fed Beige Book may indicate a more pessimistic outlook on the US economy than the recent data. In addition, the housing market – the US economy’s Achilles heel – may show a slight improvement in housing starts after a decline in August. Meanwhile, the BoE minutes should provide further insight on the BoE’s decision to restart asset purchases. With September inflation in the UK above 5%, albeit as they had expected, the BoE’s credibility is on may be on the line. But a combative BoE Governor King on Tuesday argued that the UK economy is at risk of stalling without stimulus and that ‘significant’ stimulus is in fact appropriate. UK retail sales Wednesday is likely to confirm the weakness in the consumer sector with headline sales forecast to fall by 0.1% (consensus 0.0%). The weakness in the UK economy further coupled with aggressive monetary easing from the BoE justifies our weak GBP view. We remain short GBPCAD.
- Norges bank to remain on hold for now; economic conditions point to a hike next year
Despite recent strong data out of Norway, we expect the Norges Bank to remain on hold. In fact increased uncertainty regarding the economic outlook will force the central bank to delay the next rate hike to Q1 next year. The bank will also publish its new Monetary Policy Report including an update of its economic forecast. Q2 domestic economic conditions remained robust. We remain bullish on NOK in the medium term given its relative economic performance in the G10 space and would look for buy NOKSEK on any dips. The key risk to a long NOKSEK position is a rally in risk as SEK tends to perform better in a risk-on environment.
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BNP Paribas
Corporate & Investment Banking