Next Up – BoE and ECB

Highlights
The dollar weakness after the FOMC gave way to a pretty steady and small trading range through the Asian session.  But the dollar experienced a sharp selloff in the European session as investors further increased their risk appetite. On the margin the dollar weakened the most vs the “risky” currencies – i.e., NZD, SEK and NOK. Meanwhile, the NZD gained after unemployment numbers came in better than expected (see below), with NZD/USD hitting its highest level since June 2008 at NZ$0.7886. Australia had some weak retail sales and export numbers, although the AUD engaged in the risk rally. The Bank of England and European Central Bank meet later this morning and are expected to leave rates unchanged.  And, of course, the risk rally stoked stronger bids in EM.

Asian stocks followed their US counterparts higher after the Fed’s expansion of the QE policies. The MSCI Asia Pacific rose 1.7% and was heading for its highest close since July 28, 2008. Japan’s Nikkei was the leading gainer, up 2.2%, driven by a 4.4% gain in consumer services.  Meanwhile China’s Shanghai Index was up 1.8 led by a 4.3% increase in tech stocks. There were also gains in Hong Kong, Shanghai, Taiwan, Korea, New Zealand and India, while the week to date equity flows into Taiwan increased to $1.6 million (nearly 25% of the yearly flows).  European markets rose to a six-month as the Stoxx Europe 600 Index increased 1.2%.  The gains in the Stoxx 600 were led by a nearly 3% gain in basic materials.

Budget concerns are weighing on Ireland as the yield on the 10-year increased 18bp followed by a 16 bp increase in Portugal’s borrowing costs.  The rise in yield drove the 5-year CDS price up to 548, raising the probability of default to nearly 40%.  Spanish yields were up modestly by 5 bp but now a Spanish pension bill, aimed at increasing the retirement age, will go to parliament for approval next year, later than expected, as the government asserted it is open to modifying its proposal.  At the same time German 10-year yields were up 9bp, while the 2- and 10-year US Treasury yields were up 1bp. And finally, the Bank of Indonesia left interest rates at 6.5%.

Currency Markets

The Fed’s QEII, well telegraphed, has been broadly criticized by luminary economists like Mundell and Stiglitz, as well as policy makers in emerging markets in Asia and Latam.  There was a choppy initial response to the Fed’s announcement in North America and Asia did not do much either, but in Europe the dollar has been sold off hard.   The euro’s high this year was set in mid-Jan near $1.4580 and increasingly this is what momentum players are talking about.   The Fed’s signaling channel worked well and while the amount $600 bln is 20% more than consensus, the period is stretched out a bit longer and the average monthly purchase is, if anything on the low end of expectations.  Nevertheless two aspects of the QEII announcement have captured the attention of participants.    First, there is the open-ended nature of the FOMC commitment.  The Fed seemed to emphasize the binding nature of its commitment to its dual mandate for price stability and full employment.  It is not a question of policy preferences, but a legal mandate.   Without specifying how much progress toward reaching those objectives, it is not clear what terminates the policy.  Second, the amount of Treasury purchases between the QEII and the recycling of mortgage bond holding maturities, the Federal Reserve is committed to essentially buying the complete new net issuance in the coming months.   Although the Fed’s signaling and market expectations would have led to this conclusion, many seem surprised.   What is less commented on, but what seems remarkable is that most high income countries would welcome the Fed’s base line GDP and inflation forecasts for their own economies, but for the Fed it is not good enough. 

Now the Fed announcement has been made the focus for today turns to the BoE and ECB, both of which are expected to provide no surprises.  In the UK, for one, following the string of strong economic data, including the 0.8% GDP reports, and higher-than-wanted inflation pressures, the BoE is likely keep it attention focused on price pressures.  Indeed, any change in focus may be towards bringing inflation levels down (although, we cannot completely rule the possibility of more QE next year as the impacts of the coalition austerity package are unknown).  Sterling should remain bid as dollar selling continues into the North American session.  Sterling traded above 1.6200 as the equity markets continued intraday highs but appeared to peak and is consolidating from its intraday high.

At the same time, the ECB is expected to keep its refi rate unchanged, while continuing to kick the can down the road about the possibility of reversing some of its unconventional policy measures.  It appears the ECB will retain the right to buy bonds as long as the markets remain volatile.  However, new exit steps are likely to be discussed in December when the central bank has to discuss the conditions for the refi tenders in the first quarter of next year.  Overall, both meetings will be overshadowed as the dust settles from the Fed’s move yesterday.  Despite the weakness in the EU periphery the euro continued to gain on dollar shorts.  The euro is testing new highs around the 1.42 range, after breaking the 10/15 high of 1.4159.  If the euro can break the 1.4264 range look for a short-term breakout in the North American session. 

New Zealand unemployment declined more than expected, sending the NZD to its highest level in more than two years. In fact, the NZD is best performer in the G10 today.  The unemployment rate dropped to 6.4% in the third quarter, down from a revised (higher) 6.9% in Q2, but less than the 6.7% rate expected. Recent months have seen data remain on the sluggish side, damping expectations about rate hikes from the Reserve Bank this year.  But RBNZ is playing catch-up with the RBA which may now being start to feel the impacts of the recent tightening cycle. In September, Australian retail sales grew less than expected, while the trade surplus declined as exports shrank. Retail sales rose 0.3% from August, below the expected gain of 0.5%. For the quarter sales were up 0.7%, down from Q2’s 1% and below the 1.1% forecast.

Upcoming Economic Releases

At 8:00/12:00 GMT the BoE announces its repo rate which is expected to remain on steady.  Afterwards, the US reports Q3 productivity data along with initial jobless claims.  The former is expected to increase by 0.5 of a percent and the latter is expected to drop by 5k.  The ECB announces its rate following the BoE meeting and investors will be focused on the guidance at the 8:45 / 12:45 GMT press conference.  Canada’s IVEY is then reported with the consensus looking for a small uptick.  And later on in the afternoon the US reports M2 money supply.  Events: SNB’s Danthine speaks at 12:15 followed by a US Treasury 10-year TIPS auction at 1:00pm/17:00 GMT.