Sentiment Improves as Markets Anticipate Policy Response

BBH CurrencyView

• Market sentiment improves ahead of this week’s Jackson Hole speech; Stocks and oil higher.
• Market focus this week on Jackson Hole; Policy announcement likely to disappointment.
• Singapore and South African CPI and central bank meetings in Turkey and Hungary in focus.

The dollar looks set to begin the week on its back foot as market sentiment is improving on the hopes of a policy response from the Fed ahead of this Friday’s speech. As a result, regional European stocks are higher, with the EuroStoxx 600 advancing over 1%, though European financial shares continue to deteriorate ahead of the NY open. Firmer equity markets and talk of ECB support in the bond market has kept the euro firm, up nearly 0.2%. Nonetheless, headwinds for the euro loom amid concerns over the ratification changes to the EFSF, which according to the ECB’s Nowotny is unlikely to be complete by the October deadline. Elsewhere, the according to local press reports the Swiss government expects the SNB to target a EUR/CHF rate of at least 1.2, while Swiss mortgage data is likely to garner more attention than normal as fear of low interest rates and abundant liquidity stoke fears of a possible housing boom.

In the G10 space this week markets will surely be focused on Friday’s Jackson Hole Speech by Chairman Bernanke, with investors hoping for signs of a policy put. Indeed, recent “soft” data flow out of the US has deteriorated substantially over the past couple of weeks, leading in part to a sharp drop in equities and a flight to perceived safe haven assets. In fact, according to the recent CFTC speculative contracts the market has added nearly $10bln in yen and Swiss franc contracts, while substantially cutting its exposure to euros and other growth sensitive currencies. Notwithstanding the recent deterioration in sentiment over the past few weeks, we suspect that markets likely to be disappointed with the speech as we view the prospects of QE3 unlikely at this juncture. Recall, that when QE2 was signaled at last year’s Jackson Hole speech deflation was a much more of a concern and while the pace of growth is clearly showing signs of fatigue the 5-year, 5-year breakeven forward is nearly 60bps higher at this time. At the same time, markets are also likely to keenly focus economic data again this week for signs of economic stagnation in the major developed countries. In the US, the focus is likely to be on the other regional Fed surveys and whether or not these reports corroborate the dismal expectations outlined in the Philly Fed survey. On the other hand, markets are likely to also focus on “hard” data reports (like durable goods) to confirm if recovery on this front remains intact. In Europe, markets will look to the regional PMIs and Ifo data to provide signals of economic stagnation in the euro zone, with consensus estimates expecting a slowing of both. And while sterling is likely to remain in vogue amid increasing market concerns over the EZ sovereign debt crisis, economic data in in the UK is expected to continue to underperform. All told, with the Fed unlikely to announce a dramatic policy shift this week we suspect that market sentiment is likely to remain negative and thus expect safe havens to remain in demand.

Looking forward in EM, a few key events look out for this we include Singapore CPI and central bank meetings in Turkey and Hungary tomorrow – we expect no action in both cases. On Wednesday we have CPI out of South Africa and retail sales in Poland. On Thursday Brazil releases its unemployment rate for July. On Friday we have industrial production out of Singapore and the Mexican central bank meets – no change is expected on rates but Banxico may come out with some more dovish language. Elsewhere, the key drivers in the EM space overnight was the BoK’s released its lending data which showed that Korean household leverage continued to rise in Q2. This is likely to weigh on the central bank’s decision to continue tightening since elevated debt levels in the economy is seen as one of the key risks to financial stability. Yields on 1-year swap rates have declined roughly 100bp since the start of the month, pricing out much of the previously expected hikes by the BoK. We are not yet entirely convinced that the tightening cycle is over, especially after the latest CPI numbers (July) which came in well above expectations. Still, we concede that the environment has changed and any further hikes, if they happen at all, will likely be postponed. USD/KRW will continue to float at the mercy of broader risk appetite and is unlikely to be impacted trajectory of interest rates at this point. We expect the pair to remain roughly in 1060-1100 range with the BoK taking action on either side to smooth out volatility.