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Although there was a modest recovery yesterday, the story going into Thursday’s FOMC meeting is one of a US dollar under pressure as expectations of further stimulus measures abound.   For gold bulls, this has also given the metal a much welcomed boost, the 3 month (inverse) correlation between gold and the dollar index at a high for the year (at -0.74).

The other stand out in overnight activity has been the decline in Chinese stocks, against the background of continued concerns over the slowdown being seen in the domestic economy.   The fact that new yuan loans data from the central bank was higher than expected just reflects the complicated policy backdrop at the moment, the authorities keen to ensure this does not lead to further problems in the property market.

Guest post by Forex Broker FxPro

With the German constitutional court decision looming tomorrow (although still talk of a possible delay), we are set for continued nervousness in FX markets, with EUR/USD having struggled yesterday to build on Friday’s post-payrolls gains.


Ben must not risk unlimited purchases. Following on from Super-Mario’s commitment last Thursday to unlimited bond purchases, there is growing speculation that Fed Chairman Bernanke might also opt for unlimited purchases when they meet later in the week. From our perspective, this looks unlikely, although the Fed are clearly considering further monetary stimulus. Unlimited QE at this point is a very big call to make if only because there are genuine concerns that excessive asset purchases risk undermining the deep liquidity of the treasury market which is so fundamental both to the dollar and the global financial system. Signs are already emerging that the market for American fixed income securities is much less liquid, not just because of the Fed’s huge presence but also regulatory changes, the Fed’s ZIRP and the demands imposed by client account segregation. For example, in late 2007 total dealer positions in corporate bonds reached an all-time high of nearly USD 300 bn, according to recent Fed data. However, in the week ended August 29th, these positions had been pared back to less than USD 60bn, barely a fifth of the record high. At the same time, the Fed must recognise that simply extending the commitment to near zero interest rates out to 2015 will not wash as a sufficient response to the current economic situation. Having committed to a response, extra QE of some form or other must be delivered. One suggestion is that the Fed will announce a specific QE target, with the proviso that asset purchases will continue if the economy does not achieve a certain growth threshold. This particular idea partially gets around the reservations regarding the market liquidity impact of more QE, but at the same time pre-commits the Fed to more of the same if certain conditions are not met. More than anything, the fact that the Fed are in this position simply highlights the cul-de-sac that monetary policy now finds itself in. Despite Bernanke’s protestations, the Fed’s policy locker is virtually empty. The only path left for them is non-traditional, untested policy responses, which could have unintended consequences even greater than those of QE, hardly an environment conducive to investing.

The Aussie arm-wrestle. Anticipating the Aussie’s next move is a particularly interesting task right now. The bears should take note of the fact that it took two weeks for the AUD to decline from 1.06 to just under 1.02, but only two days to jump back up to 1.04. For those with a negative disposition towards the Aussie, they are focused on the generally pallid global growth picture (especially coming out of China), the extreme net long positions being held by traders, and the likelihood that Australia’s interest rate carry advantage will disappear over coming quarters. In contrast, the bulls like the AUD because Australia is one of the very few genuinely AAA-rated sovereign credits still around, sovereign wealth funds continue to allocate to the AUD as a result, the US and others continue to resort to QE (whereas the RBA does not) and the growth outlook down under is better than most other advanced economies. In coming weeks, it should be a fascinating tug-of-war. Recently we suggested that the price action for the Aussie was not especially supportive of the bearish case, in that the pace of descent was much too gradual. We may well find that the AUD now trades in a range over the next few months bounded by 1.06 on the topside and parity on the downside.

China also set to stimulate. After Thursday’s commitment from the ECB to unlimited bond purchases and with the Fed set to announce more QE as soon as this Thursday, there is every prospect that Chinese policy-makers will soon join them. Apparent is that the economy is still struggling to regain anything like the momentum it has had over recent years. Growth in industrial production fell to 8.9% YoY last month, a three-year low, and fixed asset investment growth continues to slow. According to the China Daily, the Commerce Ministry has confessed that the August trade figures ‘are not encouraging’.   Early last week, an index of manufacturing contracted for the first time this year, and Chinese shipyards suffered a 51% decline in new orders in the first seven months of 2012. Notwithstanding a rise in consumer prices last month because of higher food prices, the general direction for inflation is still downwards. At the producer level, prices dropped by 3.5% YoY in August. In recent days, Beijing announced an additional USD 125bn of infrastructure projects. More announcements aimed at easing the stance of policy are surely on the way. The PBOC last reduced key lending rates on July 5th, and the bank reserve ratio (which remains extremely high) has not been lowered since May. It is remarkable just how hesitant Chinese policy-makers have been in their response to the obviously abrupt economic slowdown.