In theory, following the ECB risk-appetite boost, set-piece events this week should provide a further boost to optimism and undermine the dollar. Even if negative event risk is excluded, however, and this would be very dangerous in itself, underlying political and economic trends paint a much darker picture and do not support the case for dollar selling. Risk-relief rallies and dollar selling are likely to fade quickly and the Australian dollar remains particularly vulnerable.
The global economic outlook will be a very important focus. The Euro-zone is in recession while fears surrounding the Chinese outlook are likely to intensify. With US momentum fading, fears over the impotence of central bank and government policy actions are liable to increase. An overlooked statistic from last week was that world-trade growth has stopped. Container volumes remain weak and international freight rates have fallen again in September with the Baltic dry freight index approaching multi-year lows. In this context, the latest Chinese and US trade data will be watched closely on Monday and Tuesday respectively and falling volumes would undermine underlying confidence, especially with high oil prices and protectionism already acting as major growth threats.
A crucial underlying theme is likely to be one of dissent taking root and intensifying within key electorates as negative political and economic feedback loops combine. Corralling Euro-zone governments into further unpopular austerity measures will not provide a durable Euro-zone solution. Ultimately, this discontent is likely to be the force that triggers a fundamental realignment of the Euro-zone. According to the latest opinion polls, for example, a majority of the German population wants the ESM to be blocked and the German media reaction to the ECB bond-buying plans has been extremely negative. The rise of the far-right in Greek opinion polls should also be flashing a huge warning light. As the popular tide turns increasingly hostile, official policy action will also be increasingly ineffective.
The German Constitutional Court is due to rule on Wednesday whether the European Stability Mechanism (ESM) is compliant with German law and whether it can go ahead as planned by the government. The importance of the outcome should not be under-estimated as an outright rejection of the ESM by the Court would be a terminal blow for the Euro. It would be extremely difficult to set-up a new mechanism to provide support for peripheral economies, especially as there would be an extremely negative market reaction.
An outright ESM rejection looks unlikely, but the Court could impose tough conditions and demand greater parliamentary oversight which would undermine the workings of the ESM and further increase underlying stresses. There is also the possibility that they will demand further time to assess the implications.
Spain and Prime Minister Rajoy will also be an extremely important focus. Markets will continue to assess the implications of the ECB's bond-buying plan as there will be no action to buy bonds until a request is made. The Spanish government remains extremely reluctant to make an immediate application for aid given the expected domestic political backlash, especially with regional elections in October. If the Spanish government refuses to co-operate, the ECB plan will be stillborn.
The Federal Reserve FOMC will announce its latest interest rate decision on Thursday. At the previous meeting the Fed stated that it will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labour-market conditions. Chairman Bernanke also placed a big emphasis on the labour market in his Jackson Hole speech. The weaker than expected US payroll data will, therefore, put extreme pressure on the Fed to provide an additional stimulus. According to the latest data, the average payroll increase over the past three months has been below 100,000. By constantly referring to employment, the Fed has painted itself into a corner and will have to take some action.
A much more difficult element in the Fed's decision making will be what they can actually do to boost the economy. There could be a pledge to keep interest rates at ultra-low levels for even longer beyond 2014, but the impact would be marginal at best and some form of open-ended quantitative easing may be the preferred route.
The primary US data releases are for retail sales and the latest University of Michigan consumer confidence index on Friday. These releases will, however, be overshadowed by the US Federal Reserve interest rate the previous day and the impact is likely to be generally limited.
The Swiss National Bank interest rate decision will be watched very closely on Thursday with both important domestic and international implications. The central bank has maintained the 1.20 minimum Euro level for 12 months and there has been renewed speculation that it will consider an increase.
The latest reserves data showed a sharp slowdown in the rate of accumulation in the latest month. This will fuel expectations that pressure on the Euro has eased. There would also be reduced Euro supply from the central bank as it diversifies its reserves and this would ease fundamental pressure on the Euro.