Europe’s political leaders in general, and Angela Merkel in particular, must be thankful for the cover provided by the Fed’s latest conversion to QE as they enter yet another fraught set of negotiations with the Greeks. Speculation that the Fed may well opt for QE reasonably soon is part of the explanation for the euro’s advance over the past week – it has appreciated by more than 1.5% against the dollar and is not that far away from the 100d moving average at 1.2620.
Accentuating the positive euro price action has been the fact that many stops on short positions in EUR/USD, EUR/AUD and EUR/CAD have been triggered; this process possibly still has some way to run, potentially providing the single currency with a further fillip. One cross that we have been watching very closely is the EUR/AUD, which reached 1.20 yesterday. In addition, yesterday’s German GDP and European PMI data were actually slightly better than expected.
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The former was especially impressive – into the teeth of a howling global economic headwind, German exports still managed to grow by 2.5% in the second quarter after a 1.2% increase in Q1, a remarkable result and the envy of the rest of Europe. For now, the euro bears (which are still numerous) are running for cover. If the price action continues like this over coming sessions, some of the bears will be forced into hibernation with very sore heads.
Dollar dented by Fed dovishness. The dollar’s recent defensiveness continued yesterday after the surprisingly dovish tone adopted in the latest set of Fed Minutes. Most FOMC members apparently envisage the need for large scale QE ‘fairly soon’ without signs of a ‘substantial and sustainable’ improvement in the economy. With the latter unlikely, notwithstanding some mildly encouraging data recently, and after such unambiguous language, another big injection of monetary medicine looks a fait accompli when the FOMC next meets on September 13th. No doubt Fed Chairman Bernanke will mount the case for such decisive action in his speech at the Jackson Hole conference next Friday.
In view of the softness of the recovery over the middle months of the year, and with mounting calls from various Fed officials for decisive action in recent weeks, the pressure on Bernanke to commit to more QE has clearly been growing. Chicago Fed President and Ã¼ber-dove, Charles Evans, believes the Fed needs to act urgently because uncertainty regarding Europe, the global economy and America’s looming fiscal cliff is crimping business decision-making dangerously. The imminent prospect of more substantial QE knocked the dollar overnight, and there is the potential for further weakness as we approach next week’s Jackson Hole speech by Bernanke. Over the course of this week, the dollar index has fallen by around 1.5%; compared with a month ago, the dollar is down 3%. Technically it continues to look vulnerable, having broken the 100d moving average last night; the 200d moving average at 80.6 may well be tested before too long. How long the dollar’s soft patch lasts remains to be seen. Any suggestion that the economy is actually relatively resilient will curtail estimates of how large QE3 could be, and thereby assist the dollar. As such, for those contemplating a short dollar position, be aware that the risk/reward past the short term is probably not very high.
Problems for the pound. Evident recently is that the pound is taking rather more notice of the relatively steady drumbeat of negative economic news coming out of the UK. Little wonder – apart from the remarkable resilience of the labour market, the British economy looks to be worsening. Retailers continue to howl in protest at the lack of sales – consumers were apparently so distracted by the Olympics that footfall this month fell dramatically. Yesterday’s CBI Distributive Trades survey reaffirmed that sales are flagging badly, despite the fact that retailers are discounting more aggressively than at any time in the past three years. Elsewhere, the manufacturing, construction and service sectors remain very subdued. At the most recent meeting of the MPC, members opined that demand might start to pick up in the future, helped by both lower prices and lower market interest rates. However, it appears that consumers remain very hesitant, and are more inclined to save than spend. Clearly, the uncertain global economic situation, not to mention ongoing concerns regarding the domestic economy, are weighing heavily on spending decisions. Before too long, the MPC surely must consider additional QE, just like the Federal Reserve is doing. The last set of Minutes witnessed members placing rather too much hope on the relieving powers of the new (and unproven) Funding for Lending scheme. They cannot afford to prevaricate much longer.