After the EU summit what is the likely to be the next focus for markets?

BBH CurrencyView

• FX markets are consolidating recent gains with most majors and EM weaker ahead of the open
• After the EU Summit what is next for FX markets; today markets likely to focus on US income/spending report
• Swiss KOF leading index fell to 0.8 from 1.21, signaling further economic weakness; EM price action in focus

The FX market saw some light profit taking, which kept the dollar on a supportive footing, but it remained relatively close to yesterday’s lows following the broad move back into risky positions amid the euro zone rescue plan. Regional stock markets were mostly higher, but gains were limited after yesterday’s outsized moves. The market nonetheless remains optimistic that China will invest in the EFSF, though it will come with conditions and reportedly depend on other country participation. As a result, European peripheral yields are relatively unchanged, while CDS are tighter, though Italian yields are higher following this morning’s auction. Meanwhile, the UK GfK consumer confidence survey, released overnight, was below expectations, printing at its lowest level since February 2009.

After the EU summit what is the likely to be the next focus for markets? For sure over the longer-term many will continue to wonder how much this summit actually resolved the euro zone’s core issues which include the sustainability of Greek debt, Italy’s ability to boost growth through structural changes and larger global governance issues, such as integration. Over the next few months we in fact continue to believe implementation risks and economic growth are the likely catalyst that prompts a renewed weakness in the euro as the 2-year interest rate spread moves in favor of the USD as the ECB embraces more accommodative monetary policy. What’s more despite the outcome of yesterday’s summit Italian bonds sold today for 2014 maturity saw their average yield increase from 4.68% to 4.93%. Nevertheless, with risk appetite likely to gain more ground ahead of next week’s key policy (FOMC and ECB meeting) and economic events (along with the G20 Summit) we suspect that the dollar is likely to remain under broad selling pressure. But with the euro zone summit behind us it is likely that the attention shifts back to the US. First and foremost, US data have substantially surprised to the upside. Indeed, relative to all the other countries in the G10 US economic data has outperformed better than most, while yesterday’s encouraging Q3 GDP numbers suggests that US data is not as bad as once thought, even though growth is too slow to absorb excessive economic capacity. To us, the improvement in the US data coupled with potential for more policy support from China indicates that from here those growth sensitive/dollar bloc currencies are likely to extend their recent rallies.

Today markets are likely to focus on US personal income and spending data which are both expected to improve from last month. Indeed, yesterday activity figures suggested that Q3 was driven primarily by consumption which is likely to bode well for the start of Q4. The decent gain in September retail sales suggests in some part that spending show remain strong. The rises in employment, average earnings and hours worked last month suggest that personal income is likely to have increased from the previous month. Overall, though, incomes probably continued to grow at a slower pace than spending, suggested consumption growth is primary driven by a drop in saving. Elsewhere, the Swiss October KOF leading indicator fell to just 0.80 from 1.21 in the previous month. Indeed, with Switzerland’s currency one of the most overvalued in the G10, barring its sizeable current account surplus and net international investment position, it economic fundamentals are among the worst in the G10. Its open economy has left it exposed to a slowdown in trade, leading to deterioration in it terms of trade as external growth has slowed. As such, its economic data continues to underperform expectations, highlighting the current weakness in the Swiss economy.

In EM price action the first out of the gate are the high beta and high holding countries. These include KRW, ZAR, TRY, BRL, MXN and RUB. But aside from the EU news, there are some other factors which will still support these currencies in the short term. Commodity prices have also rebounded strongly for one. But more importantly, the outlook for the US economy has improved and along with it, there have been some notable changes to expectations for monetary policy in these counties. For example, markets have trimmed expectations for cuts Mexico and Korea and official communication from the Brazilian central banks seem a bit less dovish than some had expected. But more notably, Turkey made a U-turn towards tightening policy. Even though the bank has been very confusing, rates have more unambiguously higher. Further down the line, we expect countries with more solid fundamentals, such as Indonesia, to catch up and gradually begin to outperform.