Market volatility remained the predominant theme last week, and no dramatic turnaround is anticipated this week either, as ongoing upheaval in the financial markets continues to dent investors’ confidence. To make things worse, a lack of political leadership on both sides of the Pond has depleted confidence among consumers and businesses alike. This has resulted in World Bank’s chief, Zoellick, to warn that the market is venturing into the realm of a “new danger zone”. The Eurozone received another “life support” following a reactivation of ECB’s SMP bond-buying programme, which resulted in the 10-year yield on the Italian and French government bonds to drop below the 5% and 3% level, respectively, last week. At the same time, the Italian government succumbed to intense market and political pressure by approving tough austerity measures to cut the fiscal deficit by EUR 45.5bln and balance the budget by 2013, a year ahead of schedule.
However, troubles of the Eurozone are far from over, as it emerged last week that Chancellor Merkel may not be able to implement various changes to the EFSF by the end of September, partly on the back of upcoming elections in two German states. The situation became worse after an influential member of Merkel’s CDU party and the President of the German Parliament, Norbert Lammert, spoke out against the changes during the weekend. Indications are that the German population is becoming pessimistic on the future of the EUR itself. This was emphasised by a survey for the Bild am Sonntag newspaper, published on Sunday, indicating that nearly a third of Germans believe the currency will not be around in 10 years. Even the integrity of the Eurozone has recently come under question as a Maurice De Hond poll, published on Sunday, showed that 54% of Dutch voters want Greece and other peripheral countries thrown out of the euro rather than rescued. The cumulative effect of all these events may weigh on EUR and equities this week, and is likely to support Bunds and safe-haven currencies.
This week markets are likely to keep a close eye on the strength of the CHF and JPY, on the back of safe-haven flows, and on any forthcoming reaction from respective central banks and governments. The SNB has recently lowered its 3-month benchmark LIBOR rate, and has asked small Swiss corporate banks to conduct currency swap operations to curb the CHF’s strength. Moreover, according to an article in the Swiss newspaper SonntagsZeitung, the SNB is poised to set a lower limit for the EUR/CHF exchange rate. Elsewhere, in a coordinated move, we saw forex intervention from Japan, together with further monetary easing by the BoJ recently. However, the USD/JPY still remained near its all time low, which may witness further interventions soon. Market participants may also analyse comments from Japanese finance minister Noda who said that he envisions forming a grand coalition with opposition parties if he were to become the next PM. This may provide positive sentiment to the market in the hope of a more stable coalition government emerging soon.
In terms of economic releases, this is a busy week, with regional Fed manufacturing reports, including the Empire manufacturing and Philadelphia Fed, housing data as well as inflation reports due to be published from the US. Following worse than expected ISM manufacturing data, markets would be looking to see some good news from these reports, which would also boost confidence. The BoE will release minutes from its August MPC meeting on Wednesday, and some analysts have already predicted a 1-7-1 split, with BoE’s Dale switching sides for a no change in rates and leaving Martin Weale as the sole member advocating for a rate hike. If this be the case, GBP will likely come under intense pressure, whereas support may be seen for Gilts and Short Sterling futures. Also, most analysts agree that Adam Posen will stick to his stance for further “QE”. Elsewhere, GDP data from the Eurozone and Germany are also due this week, which may provide further insight into the growth pattern in the region. In fixed income, EUR 30bln worth of supply is due from the Eurozone, with T-Bills from Spain, Greece and Belgium coming on Tuesday, preceding Portuguese T-Bills on Wednesday. It was evident last week that the SMP operations from the ECB helped lowering the yield on the government debt, however markets will keep a close eye on appetite for the Eurozone debt among investors.