Bundestag Approves, Agenda Shifts

BBH CurrencyView

• Dollar is paring back its overnight gains as Germany ratifies changes to EFSF; European banks higher
• Ratification of the EFSF sets the tone for a shift in the political agenda; Q2 US GDP expected higher
• Brazil’s August wholesale IGP-M expected to ease, South Africa credit; Taiwan’s CB remains on hold

The dollar largely reversed most of its overnight gains witnessed late in the North American session and into Asia in anticipation of EFSF ratification vote by Germany, which was passed by 438 votes. The boost to market sentiment lifted European stocks, with the Euro Stoxx 600 advancing by 0.3% led by a 2% move higher in banking shares. Asia shares closed mostly positive after paring back early session losses. What’s more the Euro Stoxx 600 Bank Index has rallied by nearly 2% or more in four of the last five trading session. The European economic calendar today was mixed. German labor jobless numbers came in better than expected, while the August European Commission Economic Confidence dropped more than feared — at the lowest level since 2009. Elsewhere, UK mortgage approvals rose by the most in roughly two year, while net mortgage lending fell and UK Nationwide house prices remained soft, justifying comments from the BoE’s Dale, who hinted at possible QE2.

The political wrangles of the euro zone continue, with the aftermath of the German EFSF ratification vote expected to set the tone for the North American session. The clear backing is likely to give reassurance to Merkel and with the vote out of the way the government may be more open to discuss further changes to the EFSF. Politics aside, once the EFSF has been ratified by all the euro zone governments (which is an important step in the right direction but a key vote from Slovakia still remains) we doubt that is likely to be a silver-bullet for the EZ’s problems. Indeed, according to the proposals discussed following the IMF/G20/World Bank meeting the market is focusing on the plan to use leverage to “top up” the size of the EFSF. In fact, many observers expect the EFSF to increase its firepower by allowing it to use bonds purchased with initial funds as collateral to borrow more from the private sector and buy yet more bonds. But this is not a panacea either given that the use of leverage is not risk free and most likely would drive up the EFSF’s financing costs. In turn higher funding rates would imply higher borrowing costs for indebted governments than if the EFSF’s guarantees were increased outright, which of course may limits the facilities effectiveness. Looking ahead, we see three factors that are likely to limit any EUR/USD bounce over the coming weeks, which include: the potential for more accommodative policy from the ECB, uncertainty over the EFSF and political discord over the Greek 2.0 bailout package, given there is talk that as many as 7 countries want a large haircuts and more private sector participation. Elsewhere, in the US we have initial jobless claims (which continue to show a gradual improvement in the employment picture, at odds with most other employment figures) and we are also expected to see Q2 GDP revised higher.

In LATAM today Brazil wholesale IGP-M for August is due out and expected to ease to 7.45 y/y from 8.0% y/y in July. However, m/m rate seen rising to 0.62% from 0.44%. The central bank will also release its Q3 inflation report. Brazil is reportedly mulling more fuel tax cuts to help fight inflation. We note that large Japan bank is looking for a 100 bp cut at oct COPOM and 50 bp at nov COPOM. That would take the SELIC down to 10.5%. Brazil policy-making has moved from credible, predictable, and transparent to untrustworthy, erratic, and opaque. Can’t rule anything out, but we just would say that they shouldn’t cut so aggressively given the strength of the domestic economy. They just cut gas taxes and appear ready to use administrative measures to fight inflation while at the same time making huge pro-growth policy changes. We continue to expect the BRL will remain 1.80-1.90 range for now. Indeed, it is hard to get bullish BRL (or anywhere else in EM for that matter) beyond current levels when euro zone still unsettled and Brazil policy-making is becoming more uncertain by the day. Elsewhere, South Africa M3 and credit growth for August due out. Market expects ongoing sluggishness in both series, with M3 seen steady at 5.6% y/y and private sector credit at 5.45% y/y vs. 5.65% y/y in July. August PPI is also out and seen accelerating to 9.1% y/y from 8.9% y/y in July. SARB next meets November 10. Rate cut is slim possibility then, but we think a cut won’t be seen until 2012 as the bank must balance rising price pressures with a slowing economy. In Asia, the CBC joined other regional central banks by keeping its policy rate on hold amid the market turmoil. As expected, policy makers highlighted growth concerns driven by a declaration of export growth and a moderation in domestic demand. Altogether, with inflation expected to remain under control and growth risks biased to the downside we look for the CBC to remain on hold for the rest of the year.