Waiting on Ben

Highlights
The US dollar remains soft, but within yesterday’s trading ranges, as the market awaits Federal Reserve Chairman Bernanke’s speech early in the North American session (8:15 EST/12:15 GMT) on “Monetary Policy Objectives and Tools in Low Inflation Environment”.  The market is hoping to glean more insight into the likely Fed actions.  Headline risk also stems from US economic data today with a string of reports and the possibility that the US Treasury releases its report on the currency market, which is due today, though is often late.     The over-extended nature of the dollar’s decline, extreme sentiment readings, and the crowded nature of the trade in general, makes short-term participants reluctant to chase the market.  However, but the negativity related to perceptions that rather than leading the recovery from the crisis, the US may now be lagging has not dissipated, encouraging selling into modest dollar bounces.

Asian stocks dropped back after the yen rose to a 15-year high, heightening concerns that the strong yen will dampen exporters profits.  The Nikkei slipped nearly 0.8% by mid afternoon in Europe.  After all, nearly 60% of Japanese exports are destined for other Asian countries.  On the other hand Chinese stocks rose a seventh day, extending the longest rally in 11 months, as economic growth spurs fund flows and the potential for higher earnings.  Despite the setback of most Asian stocks, the MSCI Asia Pacific index is up 0.8% for the week and is 21% higher than the year’s low in May.  In Europe, German stocks advanced ahead of reports that may show retail sales in the US increased in September and consumer sentiment rose in the region this month.  The Stoxx 600 was up by 0.08%, while stocks in the UK were flat, falling by 0.1%

Global Islamic bonds, Sukuk, are poised to extend gains after climbing to a record this week, buoyed by Asian economic growth and issuance in the Persian Gulf.  Otherwise, bond markets were mixed. Europe opened lower even as Juergen Stark of the ECB said the central bank would keep buying government bonds. 10-year German bund yields rose 3 bps to 2.328%, while the Greek 10-year yield was up 12 bps to 8.92%. Treasuries were little changed ahead of the Fed’s planned purchase of 4-6 year debt today. The 2-year note fell by 1 bps, while the benchmark 10-year feel by 2 bps.

Currency Markets

Bernanke’s speech is more important than the US economic data being released today.  The prospects of a new round of long-term asset purchases by Federal Reserve has been a major driver not only fueling dollar sales, but also contributed the lifting commodities, emerging markets and equity markets in general.  Speculation in some quarters that Bernanke is about to step away from QEII which has been heard in recent days seems far off the mark.  Given expectations, fueled in part by Bernanke himself, are so strong, with surveys pointing to upwards of 90% anticipating QEII, not to deliver would be potentially more disruptive than the risks associated with long-term asset purchases.  Fed officials have also identified other measures that could be taken, such as a formal inflation target and more emphasized commitment to keep rates low for longer.   Banks are holding around $1 trillion in excess reserves with the Federal Reserve.  They are being paid 25 bp to do so.  Few seem to be asking why.  The banks did nothing to earn those excessive reserves.  The Fed simply granted them.  The 25 bp does not sound like a lot, but it is more than the banks could get by loaning them out in the federal funds market.  It is more than the banks could get by buying 3, 6, and 1-year Treasury bills.  If the Fed wants to moderate the ongoing reduction of bank’s balance sheets, maybe it should stop paying them keep the funds with them.  Buying T-bills would increase money supply aggregates and have some positive albeit modest impact.    In any event, the combining the surveys with the price action, it would seem that the market has priced in QEII into the short-end of the curve as the US 2-year yield and the implied yield of Dec Eurodollar futures, as representative, have not made new lows this week. 

The euro-zone August seasonally adjusted trade deficit widened to EUR 1.4 bln, from a deficit of EUR 0.2 bln in the previous month.  This was below the market consensus, which expected the balance to narrow by 0.8 bln.  Exports rose 1.0% m/m, but this was overshadowed by an even stronger 1.8% m/m increase in nominal imports.  The latter is impacted by the pickup in import prices, and three months accumulated data show an improvement in the deficit to EUR 3.3 bln from EUR 4.8 bln in the three months to July. More to the point, the data highlights that the recovery has to broaden and rely more on domestic demand in order to be sustained.  But the strong rise in exports came despite the quarter to date 3.26% rise in the euro versus the dollar and 7% increase in the BoE’s trade-weighted euro index since June.  Although, the empirical relationship between exchange rates is based on long and variable lags and sometimes tenuous, it is hard to see the euro-zone sustaining strong export numbers as the global economy cools and the euro continues to rise.

Former BoE MPC member Lomax warned of further QE. In a speech yesterday, Lomax stated that further quantitative easing "makes me fairly queasy". "What exactly does it do? It pushes up asset prices, but how effective is it in stimulating domestic demand? We really don’t know." When asked if she would vote for further monetary policy stimulus if still on the MPC, she commented that she would want to see more data on the economy and details of next week’s spending review: "If they go ahead with the worst case scenario on risk retrenchment, I’d be voting for more QE, but with a heavy heart". She also said that the government’s plan seems to be "based on the hope that the central bank will step in by switching on more QE if things go wrong. The bank may or may not oblige. There are at least three opinions rattling around there." Moreover, former MPC member Julius also warned about further QE. In an interview with the Yorkshire Post yesterday, she said "It is time to begin withdrawing the stimulus". "Interest rates are very low and the deficit is very large so it is tricky to come out of a situation of extreme policy stimulus like that."  In fact, the latest Reuters poll now showed that there is an even split between economists on whether they expect further quantitative easing from the BoE.  All in all, sterling has traded higher on speculation that the BoE will not extend further QE, testing an important technical level of 1.6067 but further longs will be contingent on the dollar’s action this morning and the MPC minutes on Tuesday. 

Upcoming Economic Releases

Aside from the Bernanke speech this morning at 8:15 EST / 12:15 GMT (which will capture most of the market’s attention) the US will report a host of important data at 8:30 EST / 12:30.  With nearly 70% of GDP comprised from consumer spending the most important figure will be the retail sales figure.  The consensus is for the figure to remain unchanged from last month; meanwhile the markets expect an uptick in empire manufacturing.