Financial Sector Under Pressure
01/11/09 21:58
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Last week was rather ugly for risk appetite and this week threatens to add insult to injury with three of the world's most important central banks due to meet, and the G20 summit will be held where FX seems to be on the agenda for many of the participants. The financial sector is once again under pressure as a US lender finally filed for bankruptcy late Sunday afternoon US time. In addition, November commences and year-end position liquidation could also prove disruptive to capital markets as investors crystallise this year's gains. In short, how this week evolves could have major implications for FX markets and the global economy, as investors and policymakers alike seek to establish their strategies for next year. As I teach in workshops and in the "Inside the Banks" online course... Look for rate spreads to become a primary driving force for FX moves in the months ahead.
Central banks normally should not be influenced by one week's worth of market volatility (though developments throughout the crisis suggest otherwise) and if the Fed, ECB and BoE all choose to ignore the volatility of last week and instead focus on data improvements throughout the past two quarters, subtle or even outright shifts in their tone and stance on monetary policy are possible. The bond markets are rallying, which is not good for stocks.
Last week was rather ugly for risk appetite and this week threatens to add insult to injury with three of the world's most important central banks due to meet, and the G20 summit will be held where FX seems to be on the agenda for many of the participants. The financial sector is once again under pressure as a US lender finally filed for bankruptcy late Sunday afternoon US time. In addition, November commences and year-end position liquidation could also prove disruptive to capital markets as investors crystallise this year's gains. In short, how this week evolves could have major implications for FX markets and the global economy, as investors and policymakers alike seek to establish their strategies for next year. As I teach in workshops and in the "Inside the Banks" online course... Look for rate spreads to become a primary driving force for FX moves in the months ahead.
Central banks normally should not be influenced by one week's worth of market volatility (though developments throughout the crisis suggest otherwise) and if the Fed, ECB and BoE all choose to ignore the volatility of last week and instead focus on data improvements throughout the past two quarters, subtle or even outright shifts in their tone and stance on monetary policy are possible. The bond markets are rallying, which is not good for stocks.
Although no changes to policy rates are expected,
there is an outside chance that the ECB will signal a
subtle shift in stance. Long-term inflation
expectations still drives policy decisions of the
Governing Council and as the chart below shows, even
though they are stable for now, the move above the
ECB's 2% target will have the hawks pressing for
action. The first signal the ECB could send, is to
contemplate placing a premium on the final 12-month
refinancing operation scheduled for December 17th.
This would obviously come as a surprise to markets,
potentially drive EURUSD higher but hurt European
stock markets (especially banking shares which are
under renewed pressure).
It is more likely however that the liquidity taps will stay on. The ECB is already uncomfortable with the dollar's decline and the upward pressure it places on the EUR and if the Fed's decision is dovish on Wednesday, the ECB will be compelled to follow on Thursday as it cannot afford to widen the policy differential with the Fed excessively at this stage. The Bank of England is in a more comfortable position, especially on the currency front as a further hit to the pound would suit the BoE's mission to rebalance the UK economy. An FOMC commitment to low rates/cheap credit as needed would be a perfect tonic for markets battered by last week's moves.
Risk Aversion them may continue. Risk appetite suffered a broad-based decline during the US session on Friday, causing the dollar and the yen to advance as the S&P500 shed 2.5%. The VIX reached 30.69, its highest level since July. 10yr UST yields fell 11 bps to 3.38%. During the US session, EURUSD traded from a high of 1.4858 to a low of 1.4703.
Risk assets sold-off despite the Chicago PMI reading for October comfortably exceeding expectations and climbing to 54.2 (cons. 49.0, prev. 46.1), a level not seen since Sept 2008. The University of Michigan consumer confidence survey also surprised to the upside coming in at 70.6 (cons. 70.0, prev. 73.5). But a weaker than expected Canadian GDP seemed to set the tone.
The risk rally has shown increasing signs of exhaustion as economic data continues to be mixed. Attention has now shifted to the upcoming FOMC meeting, and speculation continues that a minor change of wording in Wednesday's FOMC statement will be used to signal a slightly more hawkish tone. Ordinarily, this would be an important catalyst for further risk-seeking. However, with the rally in risk assets dependent on an abundant supply of cheap liquidity, and with the USD now being used as a funding currency, any hawkish undertones from Fed could have the opposite effect on risk assets, but would very likely be dollar-supportive. We maintain our 1m EURUSD forecast at 1.45.
An important week for US economic data kicks off today, with ISM manufacturing, construction spending and pending home sales all due. The highlights of the week will be the FOMC rate decision and accompanying statement on Wednesday. Non-farm payrolls and the unemployment rate for October will follow on Friday. The market is expecting further moderation in the rate of decline of payrolls numbers (cons. -175K, prev. -263K) while the jobless rate is expected to tick higher to 9.9% from 9.8% in September.
BoJ votes to end CP and corporate bond buying
The BoJ unanimously voted to keep the policy rate unchanged at 0.1%, and also announced that its facility for buying CP and corporate bonds will expire as planned in December. Although the decision was expected, it has come a little sooner than expected. A third program for providing low-interest rate loans will be extended until March, but no further. Although he supported holding the policy rate steady, Policy Board Member Mizuno voted against the decision to end the three programs.
The CP and corporate bond buying programs in particular saw active use earlier in the year, but activity levels have since fallen off considerably, and now demand has dried up almost completely. However the new government was known to be in favour of keeping the facilities operational and, as such, this decision will be seen as important victory for BoJ independence under the new administration.
Given that both the BoE and the Fed, operate similar schemes, Japan's experience when December comes will be studied carefully in an effort to assess the likely consequences for corporate credit markets when such measures are eventually withdrawn in the UK and the US.
On the data front, the unemployment rate unexpectedly fell to 5.3% (cons. 5.6, prev. 5.5%) while CPI inflation was steady at -2.2% y/y, in line with the consensus. Finance minister Fujii acknowledged that jobs data had shown improvement, while Strategy minister Kan said that he was somewhat worried about the deflation trend.
The BoJ minutes will be released on Wednesday.
ECB's Stark said that there are increasing signs of economic recovery for 2010 and there were also some better developments on the prices front. Eurozone CPI came in at -0.1%y/y, still in negative territory but better than the prior -0.3% release. Eurozone unemployment however ticked higher to 9.6%.
German retail sales disappointed to the downside however, as monthly consumption fell by 0.5% as opposed to expectations of a 1.0% gain. The annualized figure also deteriorated to -3.9%.
Thursday's ECB meeting will likely concentrate on two topics: the value of the EUR and the ECB's interest rate bias up ahead. On the former, there is very little the ECB can do at this stage apart from continuing to appeal to the US to maintain its strong dollar policy with credibility, while asking for Asia, especially China, to appreciate up ahead. On the latter, markets will be interested in whether a premium will be applied at the December long-term refinancing tender, though a decision need not be taken at this stage.
In light of the deeply disappointing Q3 GDP report, another expansion in the Bank of England's asset purchase facility is all but guaranteed. In the past few days, the consensus has shifted towards another GBP 50 bn extension to the BoE's QE program. This makes the recent bout of GBP strength all the more peculiar, suggesting that economists' views are not adequately reflected in the price. Consequently, we expect to see considerable sterling-downside as Thursday's meeting approaches, and an extension to the QE program is likely to be greeted with renewed sterling weakness.
UK consumer confidence came in higher than expected at -13 (cons. -14, prev. -16), and is now back to levels last seen in Jan 2008.
CAD: GDP disappoints
GDP growth turned negative again last Friday coming in worse than expected at -0.1% m/m (cons. 0.1%, prev. 0.0%). for August.
On Friday this week, Labour data is due in Canada and we look for unemployment rate to creep higher to 8.5% from 8.4% previously.
Source: UBS, Bloomberg, Chris Lori
Forex Trading, Education, Funds Management, Foreign Exchange Trading
It is more likely however that the liquidity taps will stay on. The ECB is already uncomfortable with the dollar's decline and the upward pressure it places on the EUR and if the Fed's decision is dovish on Wednesday, the ECB will be compelled to follow on Thursday as it cannot afford to widen the policy differential with the Fed excessively at this stage. The Bank of England is in a more comfortable position, especially on the currency front as a further hit to the pound would suit the BoE's mission to rebalance the UK economy. An FOMC commitment to low rates/cheap credit as needed would be a perfect tonic for markets battered by last week's moves.
Risk Aversion them may continue. Risk appetite suffered a broad-based decline during the US session on Friday, causing the dollar and the yen to advance as the S&P500 shed 2.5%. The VIX reached 30.69, its highest level since July. 10yr UST yields fell 11 bps to 3.38%. During the US session, EURUSD traded from a high of 1.4858 to a low of 1.4703.
Risk assets sold-off despite the Chicago PMI reading for October comfortably exceeding expectations and climbing to 54.2 (cons. 49.0, prev. 46.1), a level not seen since Sept 2008. The University of Michigan consumer confidence survey also surprised to the upside coming in at 70.6 (cons. 70.0, prev. 73.5). But a weaker than expected Canadian GDP seemed to set the tone.
The risk rally has shown increasing signs of exhaustion as economic data continues to be mixed. Attention has now shifted to the upcoming FOMC meeting, and speculation continues that a minor change of wording in Wednesday's FOMC statement will be used to signal a slightly more hawkish tone. Ordinarily, this would be an important catalyst for further risk-seeking. However, with the rally in risk assets dependent on an abundant supply of cheap liquidity, and with the USD now being used as a funding currency, any hawkish undertones from Fed could have the opposite effect on risk assets, but would very likely be dollar-supportive. We maintain our 1m EURUSD forecast at 1.45.
An important week for US economic data kicks off today, with ISM manufacturing, construction spending and pending home sales all due. The highlights of the week will be the FOMC rate decision and accompanying statement on Wednesday. Non-farm payrolls and the unemployment rate for October will follow on Friday. The market is expecting further moderation in the rate of decline of payrolls numbers (cons. -175K, prev. -263K) while the jobless rate is expected to tick higher to 9.9% from 9.8% in September.
BoJ votes to end CP and corporate bond buying
The BoJ unanimously voted to keep the policy rate unchanged at 0.1%, and also announced that its facility for buying CP and corporate bonds will expire as planned in December. Although the decision was expected, it has come a little sooner than expected. A third program for providing low-interest rate loans will be extended until March, but no further. Although he supported holding the policy rate steady, Policy Board Member Mizuno voted against the decision to end the three programs.
The CP and corporate bond buying programs in particular saw active use earlier in the year, but activity levels have since fallen off considerably, and now demand has dried up almost completely. However the new government was known to be in favour of keeping the facilities operational and, as such, this decision will be seen as important victory for BoJ independence under the new administration.
Given that both the BoE and the Fed, operate similar schemes, Japan's experience when December comes will be studied carefully in an effort to assess the likely consequences for corporate credit markets when such measures are eventually withdrawn in the UK and the US.
On the data front, the unemployment rate unexpectedly fell to 5.3% (cons. 5.6, prev. 5.5%) while CPI inflation was steady at -2.2% y/y, in line with the consensus. Finance minister Fujii acknowledged that jobs data had shown improvement, while Strategy minister Kan said that he was somewhat worried about the deflation trend.
The BoJ minutes will be released on Wednesday.
ECB's Stark said that there are increasing signs of economic recovery for 2010 and there were also some better developments on the prices front. Eurozone CPI came in at -0.1%y/y, still in negative territory but better than the prior -0.3% release. Eurozone unemployment however ticked higher to 9.6%.
German retail sales disappointed to the downside however, as monthly consumption fell by 0.5% as opposed to expectations of a 1.0% gain. The annualized figure also deteriorated to -3.9%.
Thursday's ECB meeting will likely concentrate on two topics: the value of the EUR and the ECB's interest rate bias up ahead. On the former, there is very little the ECB can do at this stage apart from continuing to appeal to the US to maintain its strong dollar policy with credibility, while asking for Asia, especially China, to appreciate up ahead. On the latter, markets will be interested in whether a premium will be applied at the December long-term refinancing tender, though a decision need not be taken at this stage.
In light of the deeply disappointing Q3 GDP report, another expansion in the Bank of England's asset purchase facility is all but guaranteed. In the past few days, the consensus has shifted towards another GBP 50 bn extension to the BoE's QE program. This makes the recent bout of GBP strength all the more peculiar, suggesting that economists' views are not adequately reflected in the price. Consequently, we expect to see considerable sterling-downside as Thursday's meeting approaches, and an extension to the QE program is likely to be greeted with renewed sterling weakness.
UK consumer confidence came in higher than expected at -13 (cons. -14, prev. -16), and is now back to levels last seen in Jan 2008.
CAD: GDP disappoints
GDP growth turned negative again last Friday coming in worse than expected at -0.1% m/m (cons. 0.1%, prev. 0.0%). for August.
On Friday this week, Labour data is due in Canada and we look for unemployment rate to creep higher to 8.5% from 8.4% previously.
Source: UBS, Bloomberg, Chris Lori
Forex Trading, Education, Funds Management, Foreign Exchange Trading