ESM jumps critical hurdle; rally stalls ahead of FOMC decision

GO Markets – FX Commentary

on September 12 2012 8:00 PM

After months of anticipation, markets finally received closure over the Europe's permanent bailout fund, the European Stability Mechanism, after attempts to derail the implementation at it's inception. As markets broadly anticipated, the court ruled the fund to be constitutional according to German law, but placed conditions on Germany's 190 billion euro portion of the fund, saying it cannot be increased without legislative approval.  This paves the way for German President Joachim Gauck to ratify the ESM, enabling leaders to tap the 700 billion euro rescue fund in efforts to secure stability in the region. Markets have of course responded in kind with the Euro first in line to receive the spoils. The Euro rose to highs of $US1.2937 in the ensuing period, but eased over the course of U.S trade with a break to the downside of 1.29.

Despite the favourable court ruling, U.S markets remained transfixed on Thursday's Federal Reserve Policy meeting which saw investors rebalance portfolios ahead of the critical decision.  The case in favour of QE3 has largely won over the market majority which expects the committee to unleash new asset purchases. It's clear Fed Chairman Ben Bernanke believes the pace of economic growth remains unsatisfactory, stating in his recent Jackson hole appearance "stagnation of the labor market in particular is a grave concern" which could "wreak structural damage on our economy that could last for many years." If the FOMC decide to hold off on further stimulus, the Fed may instead employ the tactic of forward guidance by extending their previous statement that 'interest rates will remain at record lows through to 2014.' Nevertheless, the merits of further asset purchases appear to be - for the most part -psychological as borrowing costs remain near to record lows. Despite Friday's poor jobs print, there's a valid case to be made the Fed may hold off for another month, implying significant value to the upside for the greenback should the Fed fail to appease. If this materializes we're likely to see the Fed-induced optimism unwound, which implies a material shift back in favour of the greenback.

The Aussie dollar mirrored Euro movements with initial break of 105 US cents changing course over U.S trade with price action consolidating around 104.5 US cents. After a period of downside for the local unit in recent weeks, a series of positive themes continue to underpin gains with hopes of further Fed stimulus at the top of the list of positive directives. This places the Aussie dollar at the mercy of this evenings FOMC policy decision, suggesting current levels are tentative at best and at risk of a steep correction should the fed fail to appease market expectations. Local economic feedback today will see the release of Sept. Consumer Inflation expectations. At the time of writing the Australian dollar is buying 104.65 US cents

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