IG Markets - Afternoon thoughts Jan 23

Across Asia, equity markets are relatively flat in a quiet session in which most markets in the region are closed for the Chinese New Year. Australia and Japan are the only two notable markets open in the region today. With the Institute of International Finance (IIF) standing firm and saying that it has put in its best case offer, it has made for a pretty tense Asian trading session. However, despite some disappointment that no deal has materialised, there has been no real panic selling either. The Aussie market is down 0.3% while the Nikkei is 0.2% higher.

Australia's 4Q producer price index rose 0.3% on quarter, coming in below expectations for a 0.4% rise. The data helps to confirm that the inflation environment continues to remain reasonably cool. The data sets the scene for 3Q CPI, due Wednesday, which is expected to show inflation pressures are subdued enough to keep the door open for a further rate cut. The market is currently pricing in an 81% chance of a 25% RBA rate cut in February. AUD/USD has been resilient today and has extended gains after breaking through a key downtrend resistance line.

We are likely to continue seeing relatively thin trading through the week as some of the key markets in the South-East Asia region will remain closed. We were already expecting a relatively soft start to the week amid disappointment after Greece’s creditors struggled to reach an agreement on a debt-swap deal. Given the mixed leads in the Asian session, US and European markets are pointing towards a relatively flat open with a slightly negative bias.

Going forward, a key event risk/catalyst for risk assets is a conclusion to the Greece talks. It was interesting and a touch disconcerting to see the Friday night meeting break down due to long-standing personal commitments. Considering that the IIF represents around EUR200 billion of private sector funds, doesn’t this just optimise the lack of urgency shown by Europeans throughout the crisis? The details of the Greek bond swap have yet to be finalized, despite hopes of a conclusion being reached on Friday. The Financial Times reported that terms had in fact been provisionally established between Greece and the IIF, but that the EU/IMF objected to the plan on the grounds that the proposed coupon was too generous and would prevent a return to a sustainable debt position. Private owners of Greek debt are said to have made their ’maximum’ offer for the losses they are willing to accept. This has raised concerns that any further demands may kill off a ‘voluntary agreement’. Reports are suggesting a deal will be struck in time for today's meeting of eurozone finance ministers. A lack of an agreement by now is further unsettling investors and risk assets could come undone should more delays materialise.

Momentum has certainly been towards the upside in equities of late, assisted in part by an improving US economy and liquidity measures put in place by the ECB, so one may expect to see dips being used by traders to accumulate, however we have a big week of event risk and most sell-side strategists are still hoping to justify their 1.20 EUR/USD call. We look forward to the FOMC meeting on Friday, in which the Fed will announce details on its new communications strategy. This will partly deal with the year in which Fed FOMC members expect a rise in the Fed funds rate, and will determine where individual members think policy will be at year-end in 2012, 2013 and 2014. Supply will be kept to short-dated paper, and so we don’t think the debt markets will have as much of a focus as they have had in recent weeks, however it will be interesting to see how sovereign yields perform if we see a complete breakdown in communication on debt talks; one hopes that doesn’t happen. European PMI and M3 money supply will be closely watched through the week, given these are metrics that feed into the recession argument.

The Fed previously indicated that rates will remain on hold until mid-2013, but UBS analysts expect the Fed to indicate that rates will be on hold until 2014. It seems the US rates market has already priced in a 2014 start to normalization, so the dollar impact is likely to be muted. However, should economic data remain in the recovery mode that we are currently seeing; this will have to be revised at some stage.

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