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There have been a few developments that may impact policy expectations. First, in Japan, recent reports suggest a more robust policy response. Prime Minister Noda is preparing to use funds in the FY12 budget that are not earmarked for a stimulus program. The political difficulty is that the opposition LDP is blocking the issuance of new bonds until Noda calls for an election, which he seemed to agree to in order to get the controversial sales tax hike approved.

Although there is rightfully much discussion of the looming fiscal cliff in the U.S.,considerably less attention is paid to the fiscal cliff in Japan, where the government has warned it will run out of money by the end of next month. At the same time, the BOJ is expected to come under more pressure internally and externally to ease policy further at the October 30 meeting. Following the government's three consecutive economic downgrades, the BOJ's new forecasts are likely to recognize that its inflation target is unlikely to be met over the next two years.

The Nikkei rallied 2% to three week highs on the back of the weaker yen. The dollar has been trading at its best level against the yen since late August. The JPY79.40 area corresponds to the 200-day moving average and the late August high comes in near JPY79.60. This area may be difficult to breech and there is talk of selling interest emerging around there.

Second, the BOE minutes released yesterday and the better than expected retail sales report today (0.6% headline vs. 0.3% consensus) have thrown some doubt into the market over whether the gilt purchases scheme will be extended next month when the current program is completed. We are still inclined to expect an extension of the program to lean against the still strong economic headwinds and the government's austerity agenda.

Sterling is consolidating yesterday's gains against the dollar. The $1.6100-$1.6180 range is likely to confined the near-term price action. Sterling has lagged behind the euro and is also trading within yesterday's ranges on the cross. Resistance for the euro is seen near GBP0.8140 and a break of GBP0.8090 is needed to signal profit-taking ahead of the weekend.

Third, Governor Ingves of the Riksbank has dampened expectations for a Swedish rate cut. This has sent the Swedish krona sharply higher, and ironically this currency strength is likely to support the more dovish members of the board, like Svensson and Ekholm. The Riksbank meets on October 25 and because the economy has slowed more than expected (understandable in the face of the recession in the euro area) with headline and core inflation below 1%, expectations have built for a rate cut. This had weighed on the krona (vs. the euro) over the last few weeks, despite the general risk on environment, and now it is playing catch-up.

Fourth, the banking union was supposed to be a key item in the EU heads of state summit that begins today. Prospects for a single bank supervisor in Europe have been dealt a significant setback, although it might not be immediately obvious. The Financial Times claims to have secured a paper from the EU Council's top legal adviser that argues the current proposal to make the ECB the single supervisory goes beyond current treaties.

The European Commission that made the proposals wants to avoid treaty changes due to the protracted period required and possible rejections, as has been experienced over the years on a number of occasions. In addition, it was initially hoped that non-euro area countries would participate, but are reluctant to do so without representation on the ECB, which the legal opinion said is not possible.

Countries like Sweden, Hungary and Poland have threatened to veto the banking union plans unless they can participate in the oversight decisions. The legal opinion also suggests that the ECB might not be able to legally establish a separate decision-making mechanism for the supervisory function. This also means that Germany's hope of having more say over on supervisory matters was setback

The ECB hoped to finish its draft of the supervisory design over the next several weeks. The most important take away from this is that this is yet another indication that the bank supervisory is not going to be established in the coming months. In turn, this means that banks will not be able to borrow directly from the ESM.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.