Last week certainly had its unique moments, with the different asset classes doing their best to fall in line with directional help from both policy makers and fundamental data. Global bourses were mixed on the back of some disappointing Chinese and European data and actions by the central banks of Australia, U.K. and the eurozone. Providing the latest piece of strong economic data out of the U.S. and raising market expectations that the Fed would soon begin to roll back its stimulus program was Friday’s U.S. labor data.
The stronger than anticipated headline print (+195k) supports the improving fundamentals in the world’s largest economy. Higher domestic yields have favored the dollar mostly since. The FOMC minutes are scheduled for release this Wednesday and are expected to acquire much market attention, as investors remain sensitive and vulnerable to central bank rhetoric. It was only a mere two-weeks ago that comments from "helicopter" Ben managed to send the markets off on one of its unnatural “tail spins.” Friday’s NFP release affirmed that an initial reduction in bond purchases (tapering) would probably come at one of the next two FOMC meetings, with the mid-September meet the most likely timing. Until then, U.S. Treasuries should favor higher yields until proven wrong. Currently, the market expects the USD to outperform, supported by dovish ECB/BoE releases, against both G10 and emerging market currencies.
“Lower for longer” in both euro and GBP rates have been a recurring theme. The new Governor at the BoE, Mark Carney, launched his term issuing a statement along with its decision, slightly uncommon when there is no policy change, but somewhat regular while at the BoC. This was followed by the ECB’s announcement. Draghi and Carney both provided rate “guidance” for the first time last week. In short, they reassured markets that they will continue to provide stimulus for some time going forward. This is in stark contrast to Ben’s comments concerning the possibility that the Fed would consider tapering its monthly bond purchases. Of the remaining G4 members, that leaves the BoJ in unknown territory. The central bank is expected to be "front and center" this week, with investors looking for clues from its post meeting announcement of policy going forward.
The market now seems to be moving from theory to real possibility pricing, expressed by a surge in the dollar and a move in interest rates. Investors are beginning to expect the EUR to remain in the "underperformance category" as the U.S. yield advantage is set to trump the persistently low ECB rate environment. Continued weakness in the commodity market will dampen investor appetite for commodity sensitive currencies like the loonie and the AUD. In the EM stratosphere, the market will now be expecting a further uptick in money flows out of their region and into the greenback.
The problem for the Fed is that its message about tapering and eventually ending QE in mid of next-year continues to see the market price in a “higher path for the Fed Funds rate.” Despite a plethora of Fed speakers telling the market that they have got their FF predictions wrong, the market seems to be holding on to the idea that the Fed is still focused on ending QE until we have +7% unemployment and they will hike rates at +6.5%. Currently, the Fed is not interested in adding further stimulus despite it missing on its “twin mandates.”
The market inherently knows that the Fed cannot keep its “foot on the gas when it recognizes it has to apply the brakes some ways away.” It’s a fine balancing act – the Fed has to be forward looking and they know they need to convince the market to think same way. Expect "helicopter" Ben again to be rather vocal when he delivers his testimony mid-month.
Everything bar the price action suggests that the EUR should be heading south. Today’s Euro-group meeting is expected to discuss the payment and timing of the next tranche of the Greek aid package. As per usual of late, there is some market rumblings that the troika is unsatisfied with the progress of some of the reforms, and further negotiations are expected to take place. This Monday morning the 17-member single currency has seen minimal market interest and volume. In the euro session there has been whispers of some reluctant paring of short EUR positions, which has managed to push the currency to the top-end of its range as the market heads across the pond for the first of this week’s sessions. Option expiries reported at 1.2850, 1.2830 and 1.28 look highly influential in such lackluster conditions. Order books are seen heavily weighted to offers with bids below, scattered amongst the stop-losses sub-1.28. Last Friday’s outright high of 1.2916 should represent strong resistance.