Policy Divergence Weighs on Sentiment

BBH CurrencyView

  • European session marked by choppy macro price action; France and Germany split over EFSF leverage
  • North American session likely dominated by Greek vote, US reports and headlines surrounding EFSF
  • UK retail sales beat expectations but consumer spending expect to remain soft; EM stocks fall by most in weeks

Waning risk appetite from the US session carried over into Asia and the European session as equity markets remained on the back foot amid doubts about expectations underpinning this weekend’s summit. Indeed, reports that French and German disagreement about how best to leverage the EFSF is holding up negotiations, while Spain’s disappointing auction also weighed on sentiment. Nevertheless, currencies are paring back some of their overnight losses ahead of the North American open in part on guidelines posted in regard to the EFSF. Overall, the document outlined the basic principles agreed at the July 21, including the guidelines for future bond purchases by the EFSF, which is has also part helped boost EM currencies as well. European calendar had German September PPI steady at 5.5%, while U.K. September retail sales beat expectations. S&P futures point to a modest open, up 0.6%, with Philly Fed and jobless the key morning reports. Overnight, Brazil as expected cut its policy rate by 50bps, while the Philippines kept its rate on hold at 4.5%. Turkey left its policy rate unchanged at 5.75%.

Market sentiment continues to be dominated by events and random headlines from Europe, making price action more volatile and prone to sudden whiplash. The final vote on the austerity bill in Greece will be the main focus today, with Parliament having passed a preliminary vote last night, despite the violent protests that continue in Athens. We expect the vote will pass but suspect that the market reaction is likely to remain limited ahead of this weekend’s ECOFIN Summit, where disagreements over leveraging the EFSF are likely to lead to an outcome that might fall short of market expectations. Indeed, the impasse between the France and Germany hinge on France’s insistence that the EFSF should function as a bank, allowing it to access the ECB refinancing operations which currently is in not permitted by euro zone treaty laws. Nevertheless, even if France relents on the bank proposal it remains to be seen whether a leveraged EFSF would be able to prevent further contagion, given the total size of bailouts, loan guarantees and potential banking system recaps needed to support the EZ banking system. From here, resistance expected near 1.39 with recent trend support expected near 1.372.

In the UK, retail sales exceeded expectations, but some of the strength in the headline was diminished by backend revisions. The 0.6% monthly rise in retail sales volumes was driven by increases in household goods (up 3.2% m/m) and department store sales (up 1.4%). However, August data were revised down, to -0.4% m/m from the originally reported -0.2% m/m, which put the y/y comparison down to -0.8%. Most of the monthly rise in sales in September therefore reflected a bounce back from August’s weak sales, which were probably depressed a bit by the riots at the start of the month. What’s more, with real earnings falling by over 3%, households are either sharply scaling back their spending on consumer services or are saving a far smaller proportion of their income. That means, looking ahead soft consumer spending and weak confidence is likely to hamper growth for some time to come. From here, a combination of short positioning and negative sentiment is likely to be supportive of sterling on goods news but with a recent failure to break levels near 1.5848 we see risks for GBP to test levels near 1.563.

Emerging market stocks are falling today by the most in several weeks. News that China’s Shanghai Composite fell to cyclical lows and is now at its lowest level in 31 months has seen some talk beginning to surface of a relaxation of efforts tighten lending. Energy, financials, and consumer shares led the declines. While emerging markets as a whole have outperformed the developed countries in terms of growth and credit ratings, their relative equity performance has lagged. The MSCI emerging market index is a bit more than 20% this year. The MSCI index of developed countries is off by a little more than 9%. Similarly while the financial system in the Europe and the US have come under intense scrutiny, the financial shares of the MSCI emerging market index accounts for 27% of its decline. At the same time, it is noteworthy that after foreign investors sold Asian equity markets heavily in September, they have returned to the buy side, especially in South Korea, Taiwan and Thailand (combined $1.2 bln inflow in the first half of Oct). India and the Philippines still appear to be experiencing equity outflows.

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