Bernanke keeps markets guessing

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Some traders decided yesterday afternoon that Fed Chairman Bernanke would not provide a definitive commitment to QE3 during his Jackson Hole address this afternoon at 14:00 GMT. This provided the dollar with some minor assistance, the euro drifting back to the 1.25 level. It turns out that Bernanke’s speech is a reflection on monetary policy over the past five years, although it would still be surprising if he did not spell out potential options for Fed policy in the future.

The last set of FOMC Minutes suggested that the Fed was poised to implement additional asset purchases unless they saw a sustainable recovery pretty soon. That said, since the last Fed meeting, the economic data has been more encouraging. Pivotal in the Fed’s deliberations ahead of the next FOMC meeting on September 13th will be the outcome of the next non-farm payrolls, due out next Friday. Central bankers gathering at Jackson Hole will no doubt be conscious of the fact that monetary policy in most advanced economies is in uncharted waters.

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For currency markets, the real action will probably come after the Labour Day holiday, with the ECB meeting on the 6th, payrolls on the 7th, the German Constitutional Court on the 12th and the Fed meeting on the 13th.

Commentary

Turning on sterling.  As August draws to a close, we’ve seen a lot of key reversals on many FX pairs, with EUR/GBP included in that observation. Prior to August, the cross had been moving lower in all but one of the preceding five months, from around the 0.8400 area to having briefly dipped below 0.7800 towards the end of July. The correction has been driven from both sides, with the euro reversing the generally negative sentiment towards it that had prevailed, together with the more mixed data emerging from the UK, both in terms of the real economy and also on borrowing.  But it’s also interesting to see how interest rates are becoming less of a factor for this pair. From one respect, as rates get ever nearer to zero, this should not be too surprising, although there is still a near 30bp premium of UK 2Y rates over the euro 2Y (swap) rates. For the third time this year, the correlation between EUR/GBP and the 2Y interest rates spread (done on swaps and 2mth rolling basis) has moved into negative territory.  For now, it appears as if sterling is struggling to find an ideological home. Although it’s not the euro, it’s also a stretch for many to perceive it as a safe-haven, given that the UK remains in recession, runs a modest current account deficit and, as a nation, remains heavily in debt. It also not a funding currency (which investors borrow to invest for higher yields elsewhere). This explains why it has been better aligned to the dollar of late, largely holding to the relatively narrow 1.54 to 1.58 range for most of the past three months. It’s probably better to watch cable in the coming days as a break of the recent high at 1.5912 could easily prompt a re-assessment of the pound as a dollar/euro alternative. In this respect, the 3mth high in speculative longs on the weekly CFTC data was suggesting that some bigger players are willing to bet on this.

The policy minefield for Europe.  ECB President Mario Draghi and his staff are labouring under serious time pressure to finalise a fresh sovereign debt-purchase plan in time for the next meeting of the Governing Council on September 6th. Some speculation has emerged that the ECB might opt for hard caps on sovereign bond yields or spreads. However, we expect that it will announce a less ambitious program, whereby the ECB will buy shorter-term government paper of troubled sovereigns as long as the latter have applied to either of the two rescue funds for financial assistance and also signed up to the associated conditionality. Draghi has been pounding the table since outlining the scheme a month ago, amidst fierce opposition from the Bundesbank which remains deeply uncomfortable with what it regards as monetisation of government debt. His major justification for the plan is that the ECB must act to repair Europe’s dysfunctional financial markets, which are imposing heavy but potentially avoidable costs on Europe’s peripheral economies.  It is possible that the ECB might hold off making an announcement on the bond-buying plan until after the German Constitutional Court has delivered its verdict on the legality of the European Stability Mechanism on the 12th. Although it is difficult to predict the outcome, one hypothesis is that the Court will adjudicate in favour of Germany’s participation in the ESM but at the same time impose significant conditions on any future transfer of sovereignty (to Europe). On the same day, Dutch elections will be held, with two parties, the Socialists and the Freedom Party, both enjoying significant support on platforms that are resistant to any more European integration.

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1 Comment

  1. Im anxious for all this stuff to be done…Lets get past spain and the recession let the healing begin…