Markets Await Cues From the Fed

BBH CurrencyView

  • Market sentiment modestly improves after most Asian stocks fall ; EFSF to delay €3bln bond sale
  • Greek cabinet endorsed referendum plan overnight; aims to win Friday’s confidence vote
  • FOMC unlikely to announce further asset purchases, forecast updates; soft PMIs in EMEA

Market sentiment continues to improve ahead of the North American open after recent developments in Greece weighed on risk appetite in the overnight session. As a result, the dollar eased and US futures point to a modest open as the market awaits the Fed policy announcement and more importantly the subsequent press conference. Nevertheless, an early-session rebound in European stocks fizzed out following news that the EFSF delayed a €3 bln bond sale due to market turbulence. Periphery yields are mostly higher, while weak EZ data increased demand for bunds.

The Greek cabinet endorsed the referendum plan last night, and said it aims to win Friday’s confidence, scheduled to clear the way for the referendum. The political strategy with a higher chance of succeeding and most likely to be adopted should the referendum go through is to frame the vote on euro zone membership, as it would be the only way to unite the country behind the austerity drive. In any event, it appears that Papandreou has started to lose grip and may not survive the confidence vote Friday evening. Should Papandreou fail Friday’s vote, an election will follow, and polls suggest that the opposition (the New Democrats) is likely to take over. From there, uncertainty is likely to increase further, given the New Democrats have openly sought to reopen the bailout agreements concluded thus far. Above all, the latest developments have indeed wiped out any progress to improve sentiment ahead of the G20 Summit and more importantly increased the tail risks of a disorderly default, raising the potential of Greece leaving the euro zone. The decision to move forward with the referendum also puts the sixth tranche of new EU funding in doubt. The impact of Greece’s decisions on financial markets continues to be felt, especially through the sharp increase in periphery bond yields (with both the French and Italian bond yields spread to Germany recently reaching new highs) and widening of European libor-OIS spreads, indicating financial stress.

Apart from the events in Europe, the FOMC meets today amid talk of more MBS purchases and further cuts to growth forecasts by the Fed’s staff. We do not think any form of QE3 is imminent at this time but we recognize the risk that Bernanke would drop some hints about it in the post-meeting press conference, as well as the scope for as much as three dissents (Plosser, Fisher and Kocherlakota), although Kocherlakota has recently suggested he is not a serial dissenter so it is possible he may refrain from dissenting this time around. Clearly increasing the balance sheet remains an option that the Fed refuses to reject. We expect the option not to be exercised unless there is a material risk of a renewed US economic contraction or that the risks of deflation increase markedly. Instead, the near-term direction may have been foreshadowed by Fed President Evans, who recently argued in favor of shifting the time frame of mid-2013 with more explicit, numerical thresholds for inflation and employment. At the same time, it is also likely that the Fed’s forecasts are fine-tuned to reflect the information that has become available since the last forecasts in June, by cutting its growth outlook and rising it inflation outlook. What’s more, we also expect Bernanke to be careful in communicating language in clarifying the implications for future policy actions of the FOMC’s revised economic outlook, which includes the first glimpse of its 2014 outlook.

PMIs in Poland and Hungary out today are consistent with the recent rise in PLN/HUF and our long held view that Hungary is heading towards some rough times. Polish October PMI rose to 51.7 (vs. expectations for 49.8) from 50.20 in September. Recent data in Poland has come in consistently higher than expected, including industrial output, PPI and retail sales. In contrast, PMI in Hungary dropped to 48.2 in October from 50.7 in the previous month, the lowest since late 2009. Still, EURHUF dropped over 1% as markets focused mostly on the much higher than expected PPI, rising 4.1% YoY (vs. expectations for 3.3%), the fastest on 5 months and likely to impact the next CPI readings. Inflation does not seem to be subsiding despite the slowdown in the Hungarian economy. This is in part due to the weaker forint and higher import prices. Local swap yields have risen sharply since September as markets price out the chance of cuts and price in the risk that bank may hike rates to contain HUF weakness. We hold on to the view that the bank will keep unchanged for the moment as the risks to growth and FX weakness balance themselves out. We see any protracted HUF rally as an opportunity to get short against other currencies in the region, especially if EUR/HUF falls below 300.

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