A Week of Policy Shifts Ahead?

BBH CurrencyView

• Dollar and yen maintain supportive tone amid global growth concerns; ECOFIN meet to discuss EFSF
• Important week ahead with focus on data and policy; potential shifts from the ECB and BoE possible
• US NFP excluding Verizon expected to remain unchanged; central banks meetings in Poland & Peru

The dollar and yen maintained a supportive tone amid the combination of global growth concerns and euro zone debt concerns. Europe’s Stoxx 600 equity index is showing a 1.7% net loss ahead of the North American open, extending Friday’s correction of the big gains seen in the early part of last week. The MSCI Asia Pacific index fell by 2.7% and U.S. equity index futures are point to a negative open on Wall Street. Although China’s PMI held up better than expected, today’s European data mostly painted a more worrisome picture, increasing demand for safe havens. Today’s ECOFIN meeting will give further opportunity for discussion about a possible extension or leveraging of the EFSF and measures to shield bank against the possibility for larger Greek haircuts. Oil below $80bbl and 3-month copper on the LME down as much as 5.5% to $6,635 a tonne, which was the lowest since July 21, 2010 and down nearly 30% this year.

This week in the US, euro zone and UK policy and data will on again be in focus, along with key developments in technical indicators. In Europe many are likely to be focused on the policy front with the potential for policy shifts from the ECB and BoE. We continue to expect the ECB will shift its policy stance from neutral to dovish and also expect that the ECB is likely to deliver some form of accommodative policy. And while we would downplay the expectations of the potential for a 50bps rate cut, given the stubbornly high level of inflation witnessed last week, we would not rule of a 25bps cut. Rather, we expect the ECB to extend the provision of the unlimited fixed rate funding by one year into 2012, providing a further six-month LTRO. All told, although it is possible that the ECB disappoints the market with expectations of a more accommodative policy we nevertheless suspect that the risks to the EUR/USD are to the downside whether or not the ECB softens its policy stance. The lack of policy response from today’s ECOFIN meeting, where finance ministers will discuss leveraging the EFSF could also provide headwinds. In fact, short-term technical and positioning data continue to remain negative for both the EUR and GBP with the potential for the downside break of the 50 and 200dma expected in the coming days likely to add further strain. In the UK, it is quite possible that the BoE restarts a fresh round of QE at this week’s meeting. However, we do see some downsides risks to this potential outcome off the back of the MPC’s preference to make policy shifts in the months in which it publishes its new inflation report, which would see them hold off until November. Nonetheless, we view the announcement of further QE as negative for sterling and would recommend shorting versus the USD, rather than the EUR due to continued EZ banking stress.

Elsewhere, many will focus on US data with ISM and NFP expected to be the closely watched this week. And while the ISM may provide a boost to sentiment based on the readings from the Chicago PMI print, payroll growth may be negligible when you strip out 45k Verizon workers who returned to work at the end of August. That means, adjusting for the Verizon strike payroll growth is likely to have been unchanged or might have even fallen. In EM markets this week, the markets are likely to focus on central bank meetings in Poland and Peru, which are slated to meet on 10/5 & 10/6. Neither are expected to change rates, but they could start preparing the markets for eventual easing by laying out a more dovish forecast framework Indeed, recent comments from several MPC members suggest the committee has shifted to a "wait and see" mode amid the intensification of the euro zone debt crisis. At the same time, the central bank is concerned that current zloty weakness will feed inflation, which in our view is expected to keep it from cutting just yet. Nevertheless, looking ahead we expect EM central banks are likely to provide dovish surprise outcomes, as shown by Israel’s recent decision to cut rates 25 bps. EM reserve managers will start to release August data this week as well which is likely to be on most radar screen. For one, Polish central bank intervened in the FX market again on Friday. In fact the Fed reported a huge drop in custody holdings this past week, -$32 bln. That’s more than the -$23 bln the previous four weeks combined. And this is just the dollar side. In Brazil, data is expected to be mixed, with activity down but inflation likely to remain on the upside. In fact, many are likely to focus today on October PMI and September trade, with a keen eye on Tuesday’s August industrial production release. PMI was 46 last month, and IP for August will be released Tuesday. Watch for possible signs of weakness, which we think would likely accelerate the pace of easing in Q4. Next meeting is October 10/19 and while we disagree with the expected outcome the market continues to price further easing. USD/BRL expected between 1.82-1.9.