US Dollar : Neutral
Though we have yet to see the wave of deleveraging wash over US equities – the stronghold of moral hazard – we have nonetheless seen a significant market adjustment to the September Fed Taper. If the dollar is to extend its climb, Taper concern needs to evolve into a full blown ‘risk aversion’ trend for the global financial markets.
Over the past weeks and months, we have seen early speculation turn to consensus for the FOMC to make the first reduction in the $85 billion-per-month QE3 stimulus program at its September 18-19 policy gathering. We can see the progress of this pricing effort starting back in early May when the US 10-year Treasury yield began its incredible 70 percent rally. Given industrious investors bought US government bonds to ‘front run’ the Fed’s purchases, it makes sense that these would be the first to be sold off on the first sign of an end to the regime.
Data and Fed member speeches have further solidified the September meeting (where there will also be updated forecasts and another press conference to explain difficult changes) leading Bloomberg’s economist forecast placing next month’s meeting as a 65 percent probability for the cut. The latest corroboration comes from the Primary Dealers survey from the NY Fed. The banks charged with dealing in Treasuries not only set September as the first taper, the survey projected an aggressive pace beyond the first move.
Though not official, the Primary Dealers expectations often precede (encourage?) policy changes as it is seen as the market’s acceptance. Yet, if this particular survey - or the data or the FOMC minutes or a number of milestones – has proven the tipping point to speculation on the Taper, why has the USDollar not extended its bull trend 11,000 and EURUSD reversed back below 1.3000? This is likely a sign of saturation. The impact of the first move to moderate stimulus has been incorporated. Further easing steps will certainly carry more weight, but the first moves are accounted for…that is unless there is a meaningful deleveraging of risky positioning.
Euro : Bullish
The euro have been much more resilient that many forecasted at the beginning of the month. The pick-up in Euro Area growth in Q2 is unambiguously welcome news, particularly in view of the positive mix of contributions from Core domestic demand and Peripheral net export. Event risks continues to surprise to the upside and the emergence of the euro recovery theme is more and more pronounced.
What is really interesting is that the rally did not bring out a bullish consensus among pundits and forecasters yet, as was the case this year in the January and June highs. This makes me believe that with not much news releases in the way this week to change current sentiment apart from German IFO the rally is still not completed and will continue.
Moreover Euro continue to be supported by important fundamentals like rates differentials as well as central banks balance sheets differentials.
Yen: Bearish
With Chinese manufacturing data calming fears – even on the private sector gauge which has been much more bearish than the official government reading – it’s possible that Asian-Australasian-borne concerns abate soon; and this could spur some risk taking to weaken the Yen. The same can be said about Europe and North America – with growth pointed higher, the Yen serves little purpose as a safe haven beyond the speculative role against QE3 at the moment.
So then what will be the issue to derail the Yen out of Japan? It could be two-fold – both monetary and fiscal. On the fiscal side, the Japanese debt burden just passed ¥1 quadrillion. As such, Prime Minister Shinzo Abe’s government is readying to announce a sales tax hike of 3%, from 5% to 8% (which rings the memory of the Asian crisis, when Japanese fiscal tightening alongside American monetary tightening exacerbated credit issues). If a sales tax is indeed on the way to help shrink the growing debt burden, we’ll learn more this week as government officials are holding meetings all week on the very issues. Recall that a few weeks ago the possibility that there would be no sales tax boosted the Yen; now the situation is reversed.
Likewise, if there’s a sales tax hike, then the Bank of Japan might have to introduce further easing measures to help fight a downturn in inflation. If consumption is squeezed, demand falls, and price pressures are reduced. With growth already underperforming expectations, it’s possible that inflation begins to follow. We’ll get insight into that picture this Thursday when the July National Consumer Price Index is released (+0.7% expected from +0.2% (y/y)). Growth has indeed lagged, with the 2Q’13 GDP print in at +2.6% versus +3.6% expected, and the prior revised lower from +4.1% to +3.8%. Japanese data on the whole has been disappointing since mid-July, and we thus suspect that a miss on the July CPI reading could occur.
As such, in light of some weaker data expected and the exogenous issues surrounding the Yen abating, I find that Japanese domestic concerns will prevail and pressure the Yen over the coming five trading days.
Pound :
Bullish
The British Pound fell back from a fresh monthly high of 1.5716 even as the preliminary 2Q GDP report showed an upward revision in the U.K. growth rate. But the economic docket is expected to show a further improvement in U.K. consumer confidence along with a pickup in private sector credit
With BoE Governor Mark Carney scheduled to speak next week, the fresh batch of central bank rhetoric may heavily impact the British Pound ahead of the September 5 meeting, and the sterling may face a larger correction should the central bank head show a greater willingness to expand the balance sheet further. Indeed, Mr. Carney may continue to strike a rather dovish tone for monetary policy amid the persistent slack in the real economy, and the sterling may trade within a broad range over the near to medium-term as the policy outlook remains clouded with high uncertainty.
However, as the MPC anticipates a more broad-based recovery in the second-half of the year, prospects for stronger growth may keep inflation above the 2% target for an extended period of time, and the ‘knock out’ for forward guidance may shore up the sterling on a longer-term scale as it raises the scope of seeing the BoE implement its exit strategy ahead of schedule.
Australian Dollar: Bearish
Stabilization in Chinese economic news-flow has helped drive moderation in the RBA interest rate cut outlook.
Traders are now pricing in a mere 6 percent probability of another rate cut at the September policy meeting (according to data from Credit Suisse). More noteworthy still, a dramatic improvement in the 1-year outlook over recent weeks shows investors to no longer expect any further easing over the next 12 months.
My concern is that on the back drop of those good sentiment readings, the australian dollar did not profit. So the question I am asking is when/if data deteriorate what will happen in the case of a dovish shift?
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