What happened overnight
– Euro area manufacturing PMI revised lower
– German unemployment rises
– Greek cabinet approves plan for referendum
– EFSF delays bond issuance plan
– Australian building approvals weaker than expected
The USD is broadly weaker as risk sentiment manages a few hours of tentative stabilization ahead of today’s FOMC result. EURUSD has bounced back to levels around 1.38 while AUDUSD has tested up to 1.0428. The yen has remained better bid though, with USDJPY holding around 78. Price action in equity markets is more tentative, with the S&P future and most European indices essentially flat. Peripheral credit markets are stable, with the Italian 10-year yield down 3bp to 6.14%.
Greece appears to be moving forward with plans to hold a referendum. The cabinet backed the prime minister’s proposal, which he said would provide a clear mandate on Greek membership and participation in the euro. Reports have indicated voting could occur as soon as December, but the disbursement of the next aid tranche due in November remains in doubt as does finalization of private sector participation. The government seems more likely to survive its confidence vote at the end of this week, but uncertainty will remain elevated. The EFSF delayed a planned auction today citing market conditions and indicated it would come to market over the next two weeks. Markets appear to be looking to today’s FOMC meeting for support, suggesting vulnerability in the event the meeting yields no major changes.
Meanwhile, European data have brought more evidence that uncertainty and damage to confidence are impacting activity. The euro zone October manufacturing PMI was revised a touch lower to 47.1 from 47.3 flash and 48.5 in September. In core countries, French PMI was revised lower to 48.5 while post revision, German PMI confirmed its first month below 50 since September 2009. In periphery, Italian manufacturing PMI recorded its sharpest fall to 43.3. Similar weakness was found in Greece while Spanish PMI moved sideways at very weak levels. Exhibit 1 summarizes the October manufacturing PMI releases over the past two days. In other data, German unemployment unexpectedly rose by 10,000 in October, the first increase since June 2009.
Australian building approvals fell 13.6%mom in September, the first decline in three months. The weakness in the Australian housing market supports the RBA’s move to ease policy to neutral. A major Australian bank has announced a cut in the interest rates it charge on variable mortgage rate by 20bp, less than the RBA’s 25bp cut. This should help to provide some support to the housing sector. While we do not agree with the market pricing that the RBA will cut interest rates aggressively, our rates strategist is expecting a 25bp cut in Q1 2012. However, the AUD is likely to remain vulnerable to developments in Europe in the very near term.
The IDR is leading slight weakness in Asian currencies, with USDIDR just a shade below 9,000. We note that Bank Indonesia resisted IDR depreciation beyond 9000 aggressively in late September and early October. Similarly, the recent fall in the SGD nominal effective exchange rate (NEER) is beginning to create attractive risk-reward, in our view. We estimate the NEER is 1.7% above its October intraday low when market uncertainty about whether Singapore’s central bank (MAS) was easing policy was at its peak, but about 3.3% the top of our estimate for MAS’s policy bands. China’s central bank fixed USDCNY only 7 pips higher to 6.3297. We estimate that this would push the CNY NEER up 1.3% compared to yesterday’s fix. We note that Chinese policymakers have allowed sharp CNY NEER appreciation as we head into the G20 meeting.
Bank of Korea seems to have resisted won appreciation in late October. FX reserves data released today show that headline FX reserves in Korea rose $7.6bn to $311bn in October. After adjusting for valuation changes, we estimate that Korea’s FX reserves rose by $4.7bn. This suggests to us that the Bank of Korea may have been resisting recovery in the KRW versus the USD down to 1100 in late October. With inflation having moderated in October, this implies that Korean policymakers are likely to fade aggressive won appreciation pressures. In contrast, Indonesian FX reserves fell by $0.5bn in October or down $1.5bn after adjusting for valuation, according to our estimates.
– USDCNY was fixed largely unchanged at 6.3297.
What to watch for today
USD: More guidance from the Fed. Our economists believe that the Fed is moving towards making future policy decisions more contingent on the progress towards its inflation and employment objectives and may signal accordingly in today’s policy statement or press conference. However, we think explicit medium-term inflation and unemployment thresholds are not likely in light of the Fed’s limited capacity to directly control employment. It is also probably premature to look for the Fed to signal a new round of asset purchases, despite recent comments suggesting Fed thinking is moving in that direction.
In general, we would expect the USD to lose ground on a deepening of the contingent commitment or on indications on asset purchases. An unchanged statement would likely contribute to more pressure on risk positions, benefitting the USD. USDJPY shorts would seem to offer the best risk-reward heading into the decision, with the JPY likely to gain vs. the USD if policy initiatives push US yields lower or if a steady message adds to pressure on risk positions. We continue to favor selling USDJPY on intervention-driven rallies to 79.30, and published a bearish USDJPY seagull recommendation this week.
The FOMC statement will be released at 16:30 GMT (12:30 EDT), followed by a press conference with Fed Chairman Bernanke at 18:15 GMT (14:15 EDT). For more details on our economists’ preview on the FOMC.
On the data front, the consensus forecast is for another 100k gain in ADP payrolls in October. Numbers in line with consensus should reinforce perceptions that the US slow-growth recovery is intact.
What to read today
EUR: Greek referendum. Our European economics team think new elections in Greece are more likely than the Greek prime minister’s call for a referendum on the second aid package.
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FIXED INCOME RESEARCH & ANALYTICS