After last week's turmoil, the markets have bounced back. Equities are higher today and the FX markets have been fairly stable. Markets were looking oversold last week, so a pullback is perfectly normal as bargain hunters take their pick of stocks. However, in the current environment a prolonged recovery in stocks seems unlikely and we believe that markets will bide their time until Fed Chairman Bernanke gives his Jackson Hole speech on Friday.
Some of the recovery in stocks has been mirrored in FX. The dollar is broadly being sold off today, EURUSD is above 1.4420 and GBPUSD is hovering close to 1.6490. There has been some volatility in USDJPY this morning, it spiked back above 77.00 spurring rumors of intervention from the Japanese authorities, however it has since fallen back and at the time of writing USDJPY is back around the 76.70/80 mark. Japan's Finance Minister Noda warned today that FX moves are becoming one sided, however, this verbal intervention seems to be having limited effect on the yen.
It seems like the tale of two Swissies right now. USDCHF is still at a low level, whereas EURCHF continues to hold onto recent gains after successive rounds of intervention. EURCHF is currently above 1.1300. This makes more extreme measures like a euro peg or a currency floor less likely in the near-term. If the SNB was to employ this type of action right now then it would be locking in the Swissie at high rate and thus harming the economy over the long-term. We think the Swiss and Japanese authorities will re-evaluate the situation post Ben Bernanke's speech on Friday at Jackson Hole, a year on from his announcement of more QE that spurred a dollar decline and a rally in risky assets.
This week will be dominated by speculation about Bernanke. A fair share of people believes that QE3 is waiting in the wings. We believe that more policy stimulus is not a done deal at this stage. US inflation is 1 per cent higher than it was back in 2010 and closer to the Fed's 2% target. Inflationary fears, combined with political opposition especially from some parts of the Republican Party could stymie more policy stimulus just as the US economy is heading south.
The problem for investors is that the growth outlook remains unclear at this juncture. That is likely to keep markets volatile but essentially range-bound, as we have seen in the major FX crosses in recent months. The only currency that is trending is gold. It reached another high today and it may experience further upward pressure especially if speculation gathers that the Fed is about to announce another round of QE, thus flooding the market with more dollars and reducing its value. If the US were to take the plunge for a third time global central bankers may follow suit. Thus, in this environment gold's attractions are even more enhanced since it cannot be printed or manipulated by any central bank. Although we would note that there is an enhanced risk of an increase to margin requirements when gold continues to crack fresh highs, which may cause some volatility.
Europe also remains in focus this week. Last week there were some ominous signs of pressures in the banking sector. Not only did overnight inter-bank lending rates spike, but the amount of money European financial institutions were depositing with the ECB, rather than lending to others in the industry, also rose sharply. This stress could last for some time. Although a quick, credible solution to the sovereign debt crisis would undoubtedly ease tensions, European banks are undercapitalized relative to their US counter-parts and raising capital in the current environment is a long-term project that will be more difficult to achieve.
The sovereign debt crisis continues to bubble. The Eurobond idea that is currently gaining traction in the markets as the only credible solution to the debt crisis continued to be criticized by Germany this weekend. The French Prime Minister also added his reservations saying that it would raise borrowing costs for France and thus threaten the countries' AAA credit rating.
There are a few new issues in the currency bloc that could distract the market from its relief rally this week. Firstly, there are concerns that the new bailout plan for Greece and changes to the EFSF plan won't be in place before the September deadline when Greece's next tranche of bailout funds come due. This was reiterated by the ECB's Nowotny earlier. Also, the news that Finland had secured collateral agreements with Greece before providing second bailout loans has led to a warning from credit rating agency Moody's that it could be credit-negative for Greece and that the pursuit of such agreements could delay its next tranche of bailout funds. So yet again, we could be on the brink of another default crisis for Europe's most indebted nation.
Later today we will find out the extent of the ECB's bond-buying program for last week. Spanish and Italian bond yields have been extremely stable in the past couple of weeks, so the expectation is that the ECB have been big purchasers of debt in recent days.
Ahead today there is a limited amount of data, but this week PMI data from Europe will be key to determine the extent of the downturn.
United States 13:30BST/ 0830 ET Chicago Fed Nat Activity Index (Jul) index n/a -0.46 -0.48
Euro Area 14:30/ 0930 ET ECB Announces Bond Purchases EUR22bn last
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