Fed minutes shine a light in the dark tunnel

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The minutes of the August meeting of the US Fed showed “a few” members of the committee “felt that recent economic developments justified a more substantial move” going beyond the change in language that was offered previously (committing to low rates until mid-2013). This complemented the three members dissenting against the easing of language. In other words, the committee is the most divided it’s been for at least nearly twenty years. The minutes come at the end of what has been a very fraught month for financial markets. Amongst the major currencies, the best performers have, surprisingly, been the single currency and the dollar.

Against the backdrop of a deepening sovereign debt crisis, the euro has actually managed a small gain against the greenback this month. Also illuminating has been the dollar’s ability to largely ignore the debt ceiling debacle, the S&P sovereign debt rating-downgrade and signs that the economy is possibly lurching back towards recession. The worst-performing major currency has been the Swiss franc, after a long period of being at the top of the currency performance league. No doubt this will please the SNB, which has been extremely aggravated by the strength of the currency. The Swissie climbed back above 0.82 on Monday, after reaching a record below 0.71 just three weeks ago. High-beta currencies such as the Aussie and the South African rand are near the bottom of the rankings amongst the major currencies. It has not been all bad news for the safe-havens; the gold price is still up 10% for August, despite the huge wobble at the end of last week.

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Commentary

A further slump in US consumer confidence. Just like most other advanced economies, consumer confidence plummeted in the US in the current month, with the Conference Board measure plunging to just 44.5, the lowest reading since April 2009. Interestingly, the major driver of the fall was the expectations component, which declined to just 51.9, also the lowest reading since early 2009. Households regarded employment as even harder to get, business conditions are expected to worsen by nearly a quarter of consumers over the next six months and income expectations have weakened.

Gold back in the good books. It was brief, it was ugly and it was painful, but the USD 200+ plunge in  the gold price last week is definitely in the past, judging by the perky price action over the last few days. With risk aversion returning somewhat on Tuesday, that most precious of metals soared another USD 50 to a high of USD 1,832, a far cry from the low of just above USD 1,700 recorded just last Thursday. Gold was helped yesterday by some comments from Chicago Fed President Evans, who opined that he is in favour of further quantitative easing.

Berlusconi backtracks on austerity. After a long seven-hour meeting with members of the Northern League (a coalition partner), Silvio Berlusconi has agreed to water-down his previous EUR 45bln austerity plan. Gone are his pledges to raise tax rates on the rich, there is no compensating VAT increase to compensate for the lost revenue and spending cuts will now be limited only to regional governments (and even these will be reduced). The ECB, which demanded the original austerity package essentially as a precondition for purchasing Italian bonds in the secondary market as part of its SMP (Securities Markets Program), will undoubtedly be seriously concerned by this development. In response, Italian 10yr yields are out by more than 10bp vis-a-vis German Bunds this morning.   

Euro drifts lower into month-end. The euro bravely attempted to hold above the 1.45 level on Monday but ran into fresh selling yesterday which pushed the single currency down below 1.44 at one stage. The mood has not been helped by a warning from a senior official from the Bank of Italy that the economy faced weaker growth which would weigh on the budget deficit. An EU official warned of a possible double dip recession and confidence in the economic outlook in the eurozone dipped sharply this month, according to the latest survey conducted by the European Commission. There is also a growing concern that Angela Merkel faces mounting difficulties convincing her party colleagues and coalition partners to accept expanded powers for the EFSF, especially allowing it to recapitalise troubled European banks. The issue has been thrown back into the spotlight after IMF head Christine Lagarde warned late last week that European banks needed recapitalisation urgently. For the euro, the 1.45 level has encountered very strong resistance over the past four months. That said, notwithstanding the deepening sovereign debt crisis, the 1.40 level has offered equally strong support. We can expect that this very tight trading range will break within the next few weeks once liquidity returns after the summer hiatus.

UK deleveraging extends to the corporate sector. At a time of unprecedented deleveraging in both the household and public sectors comes the news that the corporate sector has also been engaged in a similar exercise. According to some research undertaken by Capital IQ, the aggregate net debt of non-financial companies in the FTSE 350 index fell by a staggering 16%  to GBP 290bln in the two years between late 2008 and late 2010 (a decline of GBP 55bln). This reduction in debt has essentially come about through a significant fall in demand for loans, rather than paying down existing debt. Mid to large-sized businesses report that there is no shortage in terms of the supply of loans.

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