BBH CurrencyView
- Euro zone summit ends with no line drawn in the sand; European PMI surprises to the downside
- Markets look for euro zone to present comprehensive three-pong approach to finalize crisis this week
- US Q3 GDP expected at 2.5%’; Private sector Chinese Flash PMI reassures our soft-landing view
European markets turned defensive this morning after a rally in Asia amid signs of ongoing divisions in Europe. Euro zone policy makers have made some progress on the way to a comprehensive crisis plan for Europe but there are still a lot of open questions ahead of Wednesday’s second summit, where officials have pledged to present a final solution. As a result, European stocks have given up most of their early session gains and the dollar made up ground after the EUR, GBP and dollar bloc currencies failed to break through multi-week highs. EZ manufacturing PMI remained soft, highlighting growth risks ahead. In Asia, the market took encouragement from a rebound in China flash manufacturing PMI, while Japanese exports also improved as Japan move back into surplus.
In the week ahead, markets are keen to focus on two of the key market forces currently driving FX markets, including stabilizing macro data and the euro zone policy response to the sovereign debt crisis. Indeed, this week’s EU Summit is expected to deliver the final decisions on the strategy that marks the end of the sovereign debt crisis. After the latest meeting this weekend it has become clear that policy makers are expected to move on a three-prong approach that involves 1) bank recaps 2) greater private sector involvement in the Greek bailout 3) leverage scheme for the EFSF, which is likely to German insurance model. While there is more clarity on details that are likely to emerge this week, some observers would suggest the scope for disappointment of the actual announcement remains high. The key issue will remain whether leveraging the EFSF by providing first-loss guarantee would be seen as credible liquidity backstop for the likes of Italy and Spain. On this front we continue to expect that over the medium the potential policy response this week is unlikely to achieve this without significant ECB support, along with a strategy focused on economic growth. Nevertheless, in the short-term we still see scope for marginal support for the euro off the back of the extreme short positions in both risk and the euro against the dollar. Recent CFTC speculative positioning continues to the show market remains long dollar against nearly all reported currencies. We see near-term euro support near 1.380 and also expect the euro to trade within its recent range of 1.365 -1.395.
On the data front, we get German consumer confidence and CPI data, along with Q3 GDP from the US. Italy, which will be important to watch due to the recent run up in bond yields, publishes consumer confidence as well and retail sales. In addition, Italy will try to issue €5-6bn in bonds on Thursday and Friday, possibly the first real test of market confidence after this week’s Summit. Outside the euro zone, we remain of the view that Q3 GDP is likely to support the view that the US economy rebounded sharply from H1. In fact, the market consensus for Q3 GDP is 2.5% with a handful of forecasters expecting growth above 3%. Firmer Q3 growth, coupled with a convincing near-term solution for the euro zone crisis could thus lead to a rebound in risky assets, given the potential for a substantial dollar selloff against EM, the dollar bloc and other growth sensitive currencies. Beyond this there are a host of central bank meetings this week in Sweden, New Zealand and Canada, although all of these banks are expected to remain on hold. The BoC in particular is likely to be supportive of CAD, given our expectations the bank will reaffirm its Q3 growth outlook.
HSBC’s flash PMI on China reassured our soft-landing view on two fronts. The move above the 50 mark (to 51.1 from 49.9) in the overall PMI indicated a return to expansion, dampening fears that the economy might be slowing sharply. Moreover, the input prices sub-index showed a drop (to 54.3 in October from 59.5 a month earlier), suggesting easing price pressures. Indeed, indications of headline inflation continue to ease, including pork and vegetable prices which were partially the culprits for the recent inflation spike. Looking ahead to the rest of the week, we have a rate decision in India tomorrow, when we expect the bank to hike rates by 25bps and more hawkish language. The Hungarian central bank also meets tomorrow but is unlikely to raise rates. On Wednesday we get private sector lending numbers in Brazil and Turkey releases its quarterly inflation report. On Thursday Korea releases Q3 GDP numbers, India releases more inflation numbers, Turkish releases trade data and South African has PPI numbers. On Friday the Colombian and Russian central banks make their announcements, both are expected to leave rates unchanged. We also get current account from Korea and the South African budget.