Time for a bold approach

Ahead of his address to Congress on America’s jobs’ crisis later today, equity markets were buoyed by a suggestion that the size of the package the US President will present could be more than USD 300bln. It is expected to include substantial middle class tax cuts, a boost to infrastructure spending, and targeted state and regional expenditure. Fed Chairman Bernanke is also due to speak later on the US economic outlook. In recent days, a number of Fed officials have been intimating that the US central bank needs to ease monetary policy further, possibly quite significantly. For his part, Bernanke may not yet be ready to make explicit what the Fed’s next steps will be, but he is likely to discuss the various policy options and commit to using them should the Fed decide it is warranted. The FOMC next meets in less than two weeks.

Prior to Bernanke’s speech, the policy committees of the BOE and ECB meet – QE will certainly be up for discussion at the MPC meeting, while some ECB officials must surely press for a rate cut. The expectation that policy officials in the major economies are considering further action over coming days to support their ailing economies has encouraged some short-covering in risk assets, with the FTSE 100 up more than 3% yesterday and the battered DAX up over 4%. The gold price took a sharp tumble yesterday, briefly plunging through $1,800, this after reaching a record high the previous day of USD 1,921. Of interest for the FX market over the last couple of days has been the softness of the pound. With the Chancellor still firmly committed to fiscal consolidation, the Bank considering additional asset purchases and the economy still in dire shape, it is little wonder that the currency is under pressure.

Guest post by FxPro


BoE will discuss more QE today. The smattering of UK data released yesterday is not going to tip the balance for the Bank of England when it meets this morning, but does add to recent data suggesting the economy has slowed still further. The initial thinking from the ONS was that some of the softness in GDP evident last quarter (up just 0.2% QoQ) would dissipate allowing for a fairly robust third quarter. In recent weeks, there has been little support for this thesis – in the month of August for instance, production dropped 0.2% after being unchanged in the previous month. Furthermore, the BRC shop price index showed the headline YoY rate falling for the second consecutive month, this time from 2.8% to 2.7%. It would be surprising to see any specific announcements from the BoE today. That said, notable last month was the shift in tone of the minutes, both in terms of the voting pattern (no more votes for rate increases) and also the more widespread discussion of quantitative easing (rather than this position being confined to the lone voice of Posen). The Bank is probably not yet ready for QE2, but this meeting will likely see it shifting further more towards it and discussion of the relative merits of further gilt purchases (which remains its only viable option).

More on the SNB’s shock and awe. Response to Tuesday’s exceptional announcement from the SNB has been generally favourable. Naturally, Swiss exporters are absolutely ecstatic, welcoming not only the weaker exchange rate but also the commitment of the SNB to protect the 1.20 level. For Swiss companies still reeling from previous currency strength and at the same time adjusting to a harsher global economic climate, a more stable exchange rate (if that is what now eventuates) can only be helpful. For its part, the SNB must be pleased that its inspired ‘shock and awe’ strategy has had the desired effect. EUR/CHF remains poised just above their new desired level of 1.20, with traders not yet prepared to test the resolve of the SNB quite so quickly. In addition, many of them will be licking their wounds after taking a hammering on long Swissie positions. At the time, many investors right around the world will be re-assessing whether the Swiss franc is now as attractive as a safe haven. A central bank that has essentially committed to allowing the printing press to run all night and all through the weekend runs the risk of generating high inflation over the medium term, diluting the value of the currency. The SNB has already flooded the local money market with liquidity, resulting in negative short-term interest rates. If interest rates remain negative and there is little prospect of currency appreciation, then investors will need to have a very pessimistic view of other major currencies in order to justify holding the Swiss franc. Suddenly, the Swiss franc has ceased to be a one-way bet.

Sigh of relief from German constitutional court. There was only modest relief after the German constitutional court decision upheld the legality of Germany’s involvement in European financial rescue packages. In truth, few expected that the court would rule that Germany’s participation was unconstitutional. However, the court did state that approval from the parliamentary budget committee must be obtained for further bailout packages that involve the German budget. The caveats to the decision reflect the fact Germany is uncomfortable with the position in which it currently finds itself, not least because it is not one that the no-bailout clause of the Maastricht Treaty was designed to cover. This clause stipulated that no member state is liable for or can assume the commitments of any other member state. Strictly, there has been no breach of the clause, but the fact that Germany is lending to the likes of Greece at rates which are way below the credit risk involved is stretching it beyond a level which many Germans are comfortable with. This direction from the court appears designed to assuage such concerns. But in the wider picture, they are only a sticking plaster. The choice remains for Germany whether to accept some sort of fiscal union which would require treaty renegotiations, or watch the eurozone disintegrate around it. As such, there is little to celebrate regarding the decision and the muted euro reaction reflects this.

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