Currencies | Dec 15 2010
Financial markets continue to operate with an underlying tendency toward risk aversion, a central theme established in early November when the Federal Reserve made the official its $600 billion reboot of quantitative easing (known as “QE2”). Ben Bernanke and company delivered an expansion of asset purchases in line with what investors had priced in since the idea of renewed stimulus was initially floated, robbing the trends that had been established over subsequent months of the impetus to continue and opening the door for profit-taking on QE2-linked positions. Needless to say, this has amounted to downward pressure on stock prices as well as a rebound in US Treasury yields, both of which have proved potent drivers of an upward reversal in the US Dollar over recent weeks.
Broadly speaking, more of the same is likely ahead, albeit not without some potential bumps in the road. Specifically, China’s decision to opt for another reserve ratio increase rather than raising rates in earnest despite the highest inflation reading in two and half years is likely to stoke risk appetite in the near term. Further out, Wednesday’s FOMC meeting could herald some near-term Dollar weakness as policymakers remain acutely dovish, though this ought to prove short-lived considering traders are unlikely to see anything that is not well-known already. Meanwhile, renewed sovereign stress in the Euro Zone should help keep the greenback supported after periphery credit-default swap (CDS) spreads soared to erase their month-to-date reversal last week amid fading optimism from the Irish bailout and budget vote.
EURUSD: Downward Pressure Intact as Debt Issues Persist
A firm correlation with global share prices hints the Euro is likely to remain under pressure, with the re-emergence of acute sovereign stress (as noted above) bolstering downward momentum. Indeed, the first signs of contagion beyond the initial PIGS (Portugal, Ireland, Greece and Spain) may be emerging as Belgian CDS spreads soar to record highs. On the data front, preliminary Purchasing Manger Index figures for December are expected to show manufacturing- and service-sector growth slowed a bit region-wide but accelerated in Germany, underscoring the emergence of a two-speed Europe that only compounds the currency bloc’s problems considering the ECB must fashion a monetary policy to fit increasingly divergent economies. Meanwhile, Germany’s ZEW and IFO surveys of investor and business confidence are expected to diverge, with the former improving for the second month while the latter pulls back a bit.
GBPUSD: Risk Trends Remain Top Driver of Price Action
The British Pound remains anchored to risk sentiment in the absence of anything meaningfully new on the monetary policy landscape until next week’s release of minutes from the last Bank of England policy meeting. Indeed, the economic calendar actually encourages this dynamic: Consumer Price Index figures are expected to show the annual pace of inflation held above 3 percent for the eleventh consecutive month while Jobless Claims are forecast to show the third straight improvement;on balance, these outcomes point to a central bank that is firmly stuck in neutral until either the price level retreats or the recovery is acutely threatened by the government’s austerity plan. As such, the post-QE2 correction is likely to dominate, pressuring Sterling lower along with the spectrum of risky assets.
USDJPY: Yen Selling to Continue as US Yields Advance
The Yen continues to follow the 2-year yield spread, hinting continued weakness against the US Dollar as the post-QE2 correction continues to play out in the bond markets, boosting returns on US Treasuries that had been so battered ahead of the Fed’s November policy announcement. The economic calendar is fairly tame, with the Tankan survey of large manufacturers amounting to the only bit of notable event risk. The outcome may not cause much of a stir however after last week’s analogous (and disappointing) BSI report.
CAD, AUD, NZD: Sentiment Points to Further Weakness
Broad sentiment trends remain firmly in control of the commodity bloc, pointing to continued selling pressure after last week’s losses as the post-QE2 correction continues to weigh on the spectrum of risk-correlated assets. The economic calendar is largely uneventful, with Canadian Leading Indicators, Australian Consumer Confidence and Vehicle Sales, as well as New Zealand Retail Sales and Business Confidence figures being standouts on among a docket of second-tier releases.
The views expressed are not FNArena's (see our disclaimer).
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