A Week is a Long Time

BBH CurrencyView

• European stocks higher in part from ECB and potential policy action; dollar softer against majors
• G10 market focus this week again EZ with EFSF votes, bonds auctions, Greece aid; US macro data
• EMs are likely to be dominated by DM developments but focus on economic data expected as well

The European morning was dominated by the technical adjustments and fund repositioning following this weekend’s G20/IMF/World Bank meeting in Washington. Despite the drop in Asian stocks overnight (MSCI Asia index down over 2%), stocks in Europe rebounded in part from the combination of hopes that policymakers will find a solution to the ongoing sovereign debt crisis and news that the ECB is said to consider restarting its covered bond purchase program. The Stoxx 600 is off its highs presently but is still showing a net 2.6% gain. S&P 500 futures are showing a 1.2% gain, which as it stands would see the cash index open on Wall Street above its Friday highs. Bunds are underperforming, after ECB officials seemed to downplay speculation of a 50 bp rate cut in October. Commodities prices followed European stocks higher, with oil up 0.8%.

In the G10 this week we expect markets to remain focused on the two key drivers that have been moving markets for the past couple of months: uncertainty over the euro zone sovereign situation and US economic data. And while there appears to be considerable external pressure on European policy makers to finds ways to mitigate the crisis following this weekend’s meeting in Washington, we continue to believe that the chance of policymakers erecting a grand solution is limited. Thus, we suspect that for the time being euro zone headline risk is likely to remain to the downside, which may limit a sustained rally in risk appetite. For one thing, despite the call for action by policymakers this weekend, the likelihood for “fast” action remains slow. In fact, this week brings the key votes in the ratification process of the July 21 summit agreement (Germany, Finland and Slovenia) and in turn policy makers are unlikely to take decisive action to “top-up” the EFSF until all euro zone governments have ratified the changes agreed on at the July meeting. Some observers suggest that the potential for an all-encompassing solution is likely to be announced at the October 3 ECOFIN meeting but based on the recent press reports nothing new has put on the table. To us, further structural measures to increase Italy’s competitiveness, clarity over the potential for private bank recapitalizations and funding measures to limits Greece’s public funding gap would be welcome developments but without a “top-up” of the EFSF we suspect that any measure drop in the euro zone fiscal premium is unlikely to be sustained. What’s more, Italy goes back to the bond market this week, issuing nearly €14bln worth of paper, while the Troika returns to Athens and may decide on the further aid disbursement. Key macro data this week are surveys, in particular Germany’s Ifo (better than expected) , US consumer sentiment, regional Fed surveys and Chicago PMI. Hard data includes US durable goods, German and Japanese CPI, with the Japanese figures suggesting the potential for renewed deflation.

In the EMs this week price action is likely to be dominated again by developments in developed markets, with CEE the most sensitive to ongoing uncertainty regarding Greek and the euro zone sovereign situation. In particular, Poland central bank confirmed that it intervened Friday in the FX market to support the zloty. Just as it was in the 2008-2009 EM sell-off, the zloty is once again one of the worst performers in EM during this current sell-off. Central bank Governor Belka said that it was not protecting any targeted level, but rather acted to prevent sudden moves up or down in the currency. He added that bank may intervene again. We continue to maintain a neutral view on the PLN. And while PLN is likely to outperform some of its regional peers, Poland’s large financing requirements are likely to keep the PLN sensitive to changes in risk appetite. Russia political outlook became clearer over the weekend after current President Medvedev stepped aside to allow Prime Minister (and former President) Putin to stand again for his third term in March 2012 elections. Medvedev had presented himself as a reformer, but really has little to show for it during his term in office. Instead, the return of Putin means that economic reform momentum is very unlikely to pick up again in his third term. Instead, we expect further concentration and consolidation of power within the presidency. Russia remains first and foremost a commodity play, and given our negative outlook for global growth and commodities, we would continue to play the ruble from the short side, regardless of the political maneuvering. In today’s session, markets will look for guidance from Mexico’s trade data. All told, MXN recovery on Friday remains vulnerable, and any signs of slowdown in exports due to the US slowdown will likely impact the peso negatively. Israel’s CB meets as well, with rates expected to be kept steady at 3.25%. Again, we believe a cut is premature just yet.