By Dean Popplewell
The market is trying hard to stay out of trouble and not accumulate any unnecessary new positions ahead of this weeks Central bank meetings. Already we have seen this week that despite poor European data being released, the market “continues to drink the Kool-aid” being offered up by Mr. Draghi and company who promise action. As many have indicated with sarcasm, “Really … trust me … this time for sure.” Another way of interpreting the situation is it “looks so right but feels so wrong.” With the FED acting a day before the ECB, the market is looking for some sort of signal that will tell us there is more coordinated Cbank action being taken, especially since Geithner has been in town.
The growing chorus of euro defending comments could be stoking expectations that the ECB will make a major push to support the EUR and peripheral bonds at tomorrows meeting. The strong signal of forthcoming policy action from the ECB this week has allowed some of the pressure to be taken off helicopter Ben to deliver “his own policy innovation” at the conclusion of the Fed meeting this afternoon. The market has been dictated to that policy easing by further AP is required and is likely if U.S. economic data does not improve. However, no time fame has been applied and this week seems to be too soon according to general thinking.
What are we to expect? The overall market feeling is that today’s statement is to include language signaling a September move is more likely, unless of course domestic data begins to improve notably. A decision in line with consensus may not be too damaging for risk sentiment and current long EUR positions initiated over the past few sessions. However, if the statement does not leave room for pricing a September move, investors should expect risk-sensitive currency prices too come under pressure again, perhaps a similar market reaction to China’s not so stellar manufacturing PMI release last night (50.1), and a dollar to strengthen broadly. The big dollars appreciation would likely be limited as investors again would want to be cautious about over extending themselves ahead of the ECB meet. On the flip side, a surprise decision to introduce new AP, extend policy guidance, or lower the interest on the reserves rate would be strongly supportive for risk assets and would likely weigh on the dollar, just as we have seen for most of this week. The upside move for the EUR will be also be somewhat limited, but only until the market gets to see the ECB’s decision tomorrow.
Along with the FOMC rate decision the market happens to get a plethora of manufacturing PMI’s. Last night, China was one of the first to report and the results were a tad weaker than expected, allowing some dollar buyers to briefly dominate. The official manufacturing PMI fell to 50.1 in July from 50.2 in June, disappointing consensus expectations for a pickup to 50.5, and at odds with the rise in the HSBC manufacturing PMI. There was nothing unusual in the report, the fall was broad-based across the sub-indices. However, with benign inflation pressures this will allow the PBoC to take more action and potentially cut lending rates a further two times before the year is out. The UK’s recession hit economy was dealt another blow as contraction in the country manufacturing sector has deepened sharply last month. The PMI for the sector slumped to 45.4 from June’s 48.6, confirming that the sector is continuing to sink as weakening demand from Asia is been added to the growing list of UK headwinds. The fall to the 38-month low should raise the risk of looser monetary policy being adopted in Q4.
The market currency of choice of late has been the AUD. It has been the darling of the risk rally, appreciating some +400 points approximately in the past week. Central banks, dealers and investors alike have taken a renewed interest in this currency that has approximately a +7% market share of the estimated +$4t a day FX market. It seems that the limited liquidity of Aussie assets is exasperating the impact of rising demand. When Cbank’s, like Russia and Switzerland, not forgetting the investor who seeks a yield, competing for the Australia’s assets should keep the currency well bid on pullbacks. However, be aware when the market turns to get out, it will be like catching a falling knife!
With prices remaining in a tight trading rage its difficult to get ones hope up for an extended move. The market EUR bias remains currently on the upside for a retest of 1.2395, and above this, the single currency should have momentum to extend further. With the daily momentum remaining positive, the market will have to play the percentages and buy on dips despite the dips become higher and the tops lower. Something has to break the monotony, will it be Ben later today? Few will probably take that bet.