Risk sentiment steadies post-Jackson Hole

As we suggested last week, Fed Chairman Bernanke failed to deliver any new measures to support the economy and instead voiced optimism the pace of recovery would still improve into the end of the year. We find it difficult to share his optimism, but markets thought otherwise and turned disappointment into a surprising rebound in stocks and commodities. All in all, however, major markets remain in consolidation mode after the large sell-off earlier in the month. Heading into the last week of the month, we still think risk assets remains vulnerable and we will be watching for a resolution (break-out) of the current consolidation range, especially around the US Labor Day holiday on Monday Sept. 5.

Grasping at straws on QE3

Some analysts have suggested that the resilience in risk assets is due to Bernanke hinting that additional Fed policy measures, including QE3, could still be adopted. He pointed to the Sept. 20 FOMC meeting as being lengthened and that all policy options would be discussed. If so, markets may be grasping at straws, hoping that another round of asset purchases will somehow revitalize the economic outlook, even though QE2 seems to have done little for the real economy apart from spawning a nice rally in stocks. By the way, that rally has now retraced by 76.4% since the April highs. Markets may also be reacting to the notion that Bernanke did not warn of a potential double-dip, encouraging investors to think better of the outlook. However, we think the headwinds in the US are gathering force rather than waning. With the Fed increasingly ineffectual, that leaves Congress as the sole source of any fresh stimulus. Given the political gridlock there, we are not optimistic over any new initiatives coming out of Washington anytime soon. Perhaps Pres. Obama may generate some optimism when he unveils his jobs plan after Labor Day, but if any of it requires Congressional action, such as extending the payroll tax break, we would expect it to fail, leaving the economic outlook continuing to twist in the wind.

For the outlook for next week, we would expect further consolidation in major stock indexes and for the USD to trade in recent well-worn ranges. Month-end volatility could see a break of recent ranges and at the moment it looks to be to the USD's downside. But we think it may only be a false break given global market uncertainties, and we would revert to selling risk assets on rallies. Next Friday will see the US August employment report, with a sample coming on Wednesday from ADP, but current forecasts do not signal any material improvement in job creation is at hand.

Eurozone financial stresses continue to appear

Overnight USD lending rates continue to creep higher, suggesting that funding stresses remain within the Eurozone banking sector. The overnight rates are nowhere near crisis levels, but this bears watching as we have repeatedly seen credit confidence plunge on short notice. We would note that credit spreads between the core and periphery have started widening again, and sovereign credit default swaps have resumed edging higher, all indicating heightened credit tensions.

September will see Eurozone parliaments working to pass the laws necessary to implement the changes in the EFSF (European Financial Stabilization Facility) agreed to at the July 21 Summit, and most are expected to do so by the third week. After the EFSF is up and running, we will be watching closely to see if the ECB continues to buy Spanish and Italian government debt. If they do, we would expect financial market conditions to improve, as the ECB has virtually unlimited balance sheet resources. If the ECB steps back, we would expect markets to shudder, potentially seriously, as the EFSF has limited firepower, especially when it comes to Spain and Italy.

Key data & events to watch in the week ahead

United States: Saturday - ECB's Trichet speaks at Jackson Hole Monday - JUL Personal Income & Spending, JUL PCE Core, JUL Pending Home Sales, AUG Dallas Fed Tuesday - JUN S&P/CaseShiller Home Price Index, AUG Consumer Confidence, FOMC Meeting Minutes Wednesday - MBA Mortgage Applications (Aug 26), AUG ADP Employment Change, AUG Chicago PMI, JUL Factory Orders, Fed's Lockhart speaks on economy Thursday - Weekly Jobless Claims, JUL Construction Spending, AUG ISM Manufacturing Friday - AUG NFP, AUG Unemployment Rate

Eurozone: Monday - Trichet, Juncker, Rehn at EU Parliament on debt crisis, Merkel & Juppe meet in Berlin, Germany AUG P CPI Tuesday - EZ AUG F Consumer Confidence Wednesday - EZ AUG CPI Estimate, EZ JUL Unemployment Rate, Germany JUL Retail Sales, Germany AUG Unemployment Change Thursday - EZ AUG F PMI Manufacturing, Germany 2QF GDP Friday - EZ JUL PPI

United Kingdom: Tuesday - JUL Net Consumer Credit, JUL Mortgage Approvals Thursday - AUG Nationwide House prices, AUG PMI Manufacturing Friday - AUG PMI Construction SEP 1-8 - Halifax House Prices

Japan: Monday - JUL Job-To-Applicant Ratio, JUL Overall Household Spending, JUL Jobless Rate, JUL Retail Trade Tuesday - JUL P Industrial Production Wednesday - JUL Vehicle Production, JUL Construction Orders, JUL Housing Starts Thursday - AUG Vehicle Sales, AUG Monetary Base, 2Q Capital Spending

Canada: Tuesday - 2Q Current Account, JUL Industrial Production, JUL Raw Materials Prices Wednesday - JUN GDP, 2Q GDP

Australia & New Zealand: Sunday - AU JUL HIA New Home Sales Monday - AU JUL Building Approvals, NZ JUL Building Permits Tuesday - AU JUL Private Sector Credit, NZ AUG NBNZ Business Confidence, NZ JUL M3 Money Supply Wednesday - AU JUL Retail Sales, NZ 2Q Terms of Trade Index, NZ AUG ANZ Commodity Price

China: AUG 27-30 - JUL Leading Index Wednesday - AUG PMI Manufacturing, AUG HSBC Manufacturing PMI

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