An eventful week looms ahead
The first week of November will likely prove a volatile and pivotal week, potentially setting market direction for the remainder of the year, with no less than 5 central bank meetings (all eyes on the US Fed), US Congressional elections, and US October employment on the schedule. Below we provide brief outlooks for the major events, followed by our thoughts on likely US dollar and overall market direction.
- US Congressional Mid-term Elections on Tuesday -- We expect a split Congress to result, with Republicans winning control of the House by a few seats, and Democrats retaining a small majority in the Senate. The result will likely lead to political stalemate, eliminating prospects for additional economic stimulus. While we think risk assets (stocks and commodities) may see some gains on the initial results, we think markets will take a dimmer view of the economic outlook as the reality of more austere conditions ahead sets in and that risk assets are likely to decline subsequently. We would note that key US stock indexes and many commodities (e.g. gold and oil) are hovering just below recent highs, setting the stage for a potential failure and rejection lower.
- FOMC Decision on QE2 on Wednesday -- Markets are fully expecting some announcement of additional Fed asset purchases, but we think there remains a risk that no FOMC consensus has been reached and that markets may yet be disappointed. Looking at the consensus view, however, expectations are for $500 bio. of Treasury purchases over a six month period, less than markets had earlier expected. While it seems QE2 can't be mentioned without the USD selling off, we think there are decent prospects for a USD-recovery after an initial bout of post-announcement selling. The USD may recover on a 'sell the rumor/buy the fact' reaction or due to the smaller size of Fed asset purchases. EUR-related risks have also risen in the last week (see below) and options pricing suggest EUR-downside risks are growing. We would note recent EUR/USD highs in the 1.4050/4100 area as critical resistance, above which we would have to reckon with another round of USD weakness, but we will be especially alert for a rejection and failure from those levels.
- Bank Of Japan (BOJ) meeting on Thursday in Tokyo --The BOJ moved up its meeting to follow the Fed's decision, raising expectations the BOJ could increase the size of its own asset purchase plan from the previously announced JPY 5 trillion, potentially triggering JPY-weakness. The BOJ may also reduce or eliminate the amount of interest it pays on excess reserves held at the BOJ, potentially setting off an exodus of foreign banks' money from Japanese short-term bills and deposits, which could lead to a surge higher in USD/JPY.
- US October Employment Report on Friday -- Consensus forecasts look for a +80K private payroll increase and a steady 9.6% unemployment rate. Coming on the heels of the Fed decision, the Oct. NFP report is likely to be another reminder of the very difficult US economic environment heading into 2011, potentially triggering further erosion in risk sentiment and sending risk assets lower, especially if they have already turned weaker following the elections/FOMC decision. Sharp declines in risky markets could also increase demand for the USD against all but the JPY.
In general, we expect volatile trading conditions next week across all major markets. Overall, we think there can be some further USD weakness/risky asset gains in the first half of the week through the FOMC decision aftermath. Thereafter, however, we think the USD is most likely to stabilize and may begin to recover lost ground. We will monitor EUR/USD 1.3650/3700 and gold $1320/25/oz as critical support levels, and 2.72/75% in US 10 Year Treasury yields as critical resistance levels, through which the USD would likely extend gains.
MPC unlikely to pull the monetary trigger quite yet
Sterling had a week to remember after third quarter GDP beat analyst estimates, and rose by a stellar 0.8 per cent. Growth was fairly broad-based; the construction sector contributed the most to overall GDP expanding by 11 per cent over the quarter with manufacturing up 5.3 per cent and the services sector up by 2.1 per cent. On an annualized rate, UK growth is growing at 2.8 per cent, above the long-run average rate for the UK economy.
There were further positive economic signals on Wednesday after a survey showed that retail sales volumes increased at a healthy clip in October. This has raised hopes that domestic demand is picking up and growth could be sustained into the fourth quarter.
While there are certainly headwinds for the UK economy: the housing sector is under pressure, money growth remains weak and economic growth may be patchy going forward as austerity cuts start to bite, for now, the market is concentrating on the positives. A growing economy and inflation running above the Bank of England’s 2 per cent target at 3.1 per cent, suggests the economy is not in need of another dose of QE medicine. While the Bank Of England is still going to keep its hand on the printing press as the economy deals with public sector spending cuts in the coming quarters, it is unlikely to pull the monetary trigger at its meeting on 4 November.
As the market recalibrated its expectations for further QE from the BOE this caused an unwinding of short sterling positions, and the pound has rallied more than 1.8 per cent on a trade weighted basis this week. But it was the unwinding of long EUR/GBP positions that was the most extreme. A weekly close below 0.8700, could herald further losses for the single currency to 0.8650 then 0.8570 – the 200-day simple moving average.
Event risk gathers for Europe’s peripheral economies
After a quiet couple of weeks, the market’s focus panned back to Europe and the debt problems facing the peripheral economies. Greek, Portuguese and Irish bond yields all rose this week, and it became more expensive to insure these bonds against default. Nerves started to fray after Ireland announced it was doubling spending cuts next year. Investors are worried that Ireland’s weak economy won’t be able to cope and spending cuts could exacerbate the deficit in the long-term.
Concerns then shifted to Portugal where tense talks are taking place as the minority government tries to persuade the opposition to support its austerity budget prior to it being put to a parliamentary vote on 3 November. Failure to meet next week’s deadline could see even more upward pressure on peripheral bond yields.
Greece stole the limelight on Wednesday when the Prime Minister revised up the 2009 deficit for a third time to 15 per cent of GDP and also said that tax take for this year is below expectations. Like Portugal, the socialist government of Greece faces some tough tests to try and pass deficit reduction packages that would ease market fears and reduce pressure on their bond yields.
The 7 November is the first round of Greek local elections, a second round, if necessary, will take place on 14 November. The Prime Minister has said that if his party fails to get a clear mandate at the local elections, he will call a general election to put his austerity plan to the public for a vote. If this were to happen it would put in doubt the government’s scheduled presentation of next year’s budget to parliament on 18 November, which has to be voted on by 21 December.
Against this backdrop are EU Treaty discussions. The German government wants holders of peripheral debt to share any losses in the event of a default, instead of Eurozone taxpayers being on the hook to pay in full for any bailout. This has caused some jitters among investors and may weigh on the euro going forward. EUR/USD hasn’t been able to break convincingly above 1.40 in recent weeks, which looks like the high for now, while the downside could be 1.3730 in the near-term. Any escalation of peripheral concerns as we head into year-end, when fears about nations’ solvency into 2011 may gather pace, could see the euro grind even lower.
Reserve Bank of Australia likely to hold steady on rates
On Tuesday November 2, the Reserve Bank of Australia (RBA) meets to decide on interest rates. We agree with the market consensus that the bank will keep interest rates steady at 4.50% as recent economic data out of Australia and uncertainty regarding the global outlook support maintaining the current policy.
Inflation figures released earlier in the week came in lower than expectations with the QoQ headline reading at +0.7%, short of the expected +0.8% (prev. +0.6%). The core reading also missed the QoQ forecast of +0.7% with a print of +0.6% (prior +0.5%). This suggests that although inflation is still rising, the pace of price increases have eased.
The risk is that the RBA raises rates as mentioned by an IMF staff report released on Thursday. The report stated “the RBA agreed that if the downside risks to the outlook diminished and further inflation pressures emerged, the policy rate would need to be raised.” Many downside risks to outlook remain amid heightened levels of uncertainty in the markets.
In our view, the RBA is likely to pause for now as the outcome of significant central bank meetings next week may be weighed to determine outlook and future policy decisions. Moreover, investors view the Aussie as overvalued at current levels and a rate hike would likely result in a stronger AUD which may not be welcomed by the RBA at this time. In keeping with the spirit of the Melbourne Cup (known as “the race that stops a nation”) which is also on Tuesday, we expect the RBA to stay on hold for now.
Key data and events to watch next week
U.S. data starts off on Monday with the September personal income and spending, September PCE figures, October ISM numbers and September construction spending. Tuesday sees the Mid-term Congressional Elections. Wednesday brings the October ADP employment change, October ISM non-manufacturing, September factory orders and the November FOMC rate decision. Thursday follows with the October initial and continuing jobless claims as well as October ICSC chain store sales. Fridays rounds out the busy week with the October employment report, September pending home sales and the Fed’s Plosser, Hoenig, Fisher, Bullard and Bernanke all have speeches scheduled.
The Eurozone kicks off the week on Monday with October French final PMI manufacturing. October EZ and German final PMI manufacturing will be released on Tuesday. Thursday sees October EZ PMI composite, October EZ & German final PMI services, September EZ PPI and the November ECB interest rate announcement. Friday finishes off the week with September EZ retail sales and September German factory orders.
The U.K. economic data begins with Monday’s October PMI manufacturing. Tuesday sees the October PMI construction and BRC October shop price index, while on Wednesday the October PMI services is on tap. On Thursday there is the November BOE interest rate announcement and BOE asset purchase target. Friday closes out the week with October PPI numbers.
Japan’s economic data begins on Monday with the September labor cash earnings. Tuesday sees October vehicle sales and the BOJ’s October Meeting Minutes. Set for release on Wednesday is the October monetary base, while Friday rounds out the week with the November BOJ target rate announcement.
Canada’s calendar starts off on Thursday with the October Ivey purchasing managers index. Friday wraps up the week with the November employment report and September building permits.
The calendar down under starts on Monday with the Australian October AiG performance of manufacturing index, Australia’s 3Q house price index, New Zealand’s October inflation expectations and the October RBA & ANZ commodity prices. The RBA will announce their cash target on Tuesday and New Zealand’s 3Q average hourly earnings.
Australian October AiG performance of service index and Australian September building approvals are scheduled on Wednesday. Thursday sees Australian September trade balance and retail sales. Friday wraps up the week with the RBA’s release of their quarterly monetary policy statement, Australian October AIG performance of construction index and New Zealand’s 3Q employment report.
Also be on the lookout for China’s October PMI on Monday, as well as their October non-manufacturing PMI and HSBC services PMI which are scheduled for release on Wednesday.
Disclosure: Author holds no positions