Greece Secures a Government, Attention Shifts Back to the Fed

BBH CurrencyView

• Dollar firmer across the board after profit taking capped losses; growth concerns still abound
• Greece secures confidence vote, next hurdle is austerity vote; market focus shifts to FOMC meeting
• Brazil likely to keep inflation target of 4.5% for 2013; China expected to tighten policy further

In the wake of the Greek confidence vote markets appear to be suffering from a bout of profit, with the dollar edging higher against most of the majors. The euro struggled to maintain gains above $1.440, while the rest of the G10 has largely traded sideways following yesterday’s rally. The one exception to this overnight trend is sterling, which underperformed against the dollar and the euro (down 0.7% and 0.5%, respectively) following the BoE’s minutes. Of note, new member Ben Broadbent, who replaced hawk Sentence on June 1, sided with the doves. Global stocks were mixed with Asian stocks extending early gains yet follow through was limited into Europe as European stocks retreated after the Euro Stoxx 600 had its biggest gain in two months, up 1.4%. That means, although the worst case scenario for Greece is likely to have been averted by the successful confidence vote, markets are still cautious about the outlook for global growth. As a result, crude marked time under $94bbl, while copper futures are down 0.7% ahead of the open. Elsewhere, Norges bank expected to keep rates unchanged at 2.25%.

Following the Greek government vote of confidence the next big event risk driving the markets today is the FOMC policy announcement and press conference. Weaker than expected US growth, moderation in the labor market and the spillover from Euro zone stresses have increasingly united the market around the view that Chairman Bernanke will probably delay the Fed’s exit from its record stimulus without resorting to additional asset purchases. We believe that the Fed will maintain the middle ground by delaying quantitative tightening without approving further asset purchases for longer than the market expects. Although the slowdown seen in the first half of the year is in part driven by transitory factors related to the MENA and Japan crises, it is clear that the economy‘s expansion will remain consistent with a subpar absorption of spare capacity, which bodes badly for the outlook for domestic demand and unemployment. At the same time we expect little in the FOMC language or press conference today to alter our view that that the size of the Fed’s balance sheet will remain large enough to prevent a shift away from the policy commitment “for an extended period” for the rest of the year and into 2012 (although we do expect the FOMC to downgrade its outlook for the economy). As such, we expect the proceeds from maturing MBS and Treasury securities will be reinvested for the foreseeable future, which despite the winding down of QE2 is unlikely to have much of an impact on the short-end rates curve. In terms FX, FOMC days in the recent past have for the most part been negative for the dollar. The dollar has indeed fallen roughly 83% of the time since September 2010, with US weakness broad-based versus some of the more risk-sensitive currencies, such as EUR and AUD. Altogether, while some profit taking is hampering further euro gains following the Greek confidence vote, we expect the euro to advance in the coming days on momentum ahead of the budget vote next week, with additional supply likely to enter the market around $1.455 – 1.47.

In the EM space, Brazilian local news sources suggest that, after a lot of debate and criticism, the inflation target will be kept at 4.5% for 2013, which was largely expected. A reduction of the target would have sent an important signal about Bacen’s commitment towards inflation in a time where the relatively new governor Tombini’s credibility is still being tested. At this stage, it looks like Bacen and the market have met in the middle of the way with respect to tightening expectations: the market got more short-term hikes than previously expected (in line with our call) but at the same time it pared back expectations for tightening later in the year, reducing the expected peak rate for the cycle. The bank is likely to hike once more by 25bps then pause to assess the trends in local credit markets and the state of the global economy. Should risk continue to stabilize, USD/BRL has more room to decline in the short term, in our view, especially as the carry from implied forewords has nearly normalized. Turning to China, Shibor rates spiked overnight reflecting a combination of rate hike expectations and tightness in the interbank market after 600bps of reserve requirement increases. Also of note, the PBoC has been recently increasing the rate of its bond auctions, usually interpreted as a signal of forthcoming tightening. The 3-month rate, for example, rose 22bps to 6.059%, after rising for 12 consecutive months. As previously noted, we still think that there is a considerable amount of tightening still in the pipeline, despite some signs that credit growth is slowing and increasing tightness in the local bank markets.