IG Markets Macro Thoughts - Central Banks This Week

IG Markets Macro Thoughts - What To Expect From Central Banks This Week.

Over the next few days we will get to hear the views of two of the most influential central banks - the ECB (European Central Bank) and the Federal Reserve - and whether they will adjust policy. Expectations vary with each central bank and the price action of risk assets like EUR/USD, AUD/USD, equities and commodities will largely be affected by their potential actions. Tomorrow morning (04:15 AEST), the Federal Reserve will speak. While there are a range of outcomes, this event is perhaps a lead-in both for the September Fed meeting and ECB rate decision (tomorrow night), followed by Mario Draghi’s press conference.

For those ultimately hoping for quantitative easing (QE) i.e. printing money, expanding the money supply and buying mortgage-backed securities and longer-dated US treasuries, they may be disappointed. We believe that when we receive the next quarterly Summary of Economic Projections and press conference in September then it will be a more fitting forum for this to take place, potentially using the Jackson Hole symposium (August 31) as a soundboard to prepare the market. We also like the idea that instead of asset purchasing, which is generally seen as consensus by the traders now, perhaps the Fed could look at ways banks can increase lending into the real economy. One way is using its discount window facility, whereby the Fed could provide an extremely low rate (even zero) of funds to banks which are meeting a certain lending criteria. With consumer credit in May running at $17.11 billion (a historically high number), we know there is demand for borrowing, despite high unemployment.

We feel Ben Bernanke will need to remain dovish, and we will be very surprised if he isn’t, given there certainly isn’t too much reason for him to change his tune of late. Perhaps we will see a change of interest rate guidance from the current stance of keeping the Fed funds rate ‘exceptionally low until late-2014’, perhaps pushing this out to mid-2015. It is unlikely we will see the Fed using other tools, such as lowering the rate it pays on overnight deposits, as some have argued. If we do see a change in interest rate guidance, then moves in the bond market will largely dictate the USD and equities’ price action, and a move lower in treasuries on fund buying could potentially cause the USD to weaken.

The policy decisions likely to be announced by the ECB could be the difference between AUD/USD trading to 1.03 or 1.06, or EUR/USD moving back down to 1.21 or grinding up to 1.25. It could mean the difference between the ASX 200 trading back to the July 25 low of 4084, or pushing to the May highs of 4440, with the S&P advancing convincingly above 1400.

Mario Draghi has effectively built a rod for his own back, arguing he will do whatever it takes to save the euro, while Mr Juncker confirmed yesterday that a decision on unspecified ‘measures’ would happen in the coming days. The market would ideally like to see bond buying both by a reactivation of the Securities Market Programme (SMP) and using the EFSF bailout facility to buy bonds at future auctions, with the idea to lower borrowing costs for Spain and Italy from current unsustainable levels. There has also been talk the ECB could buy private-sector securities which is allowed under euro area legislation; in theory this should help cleanse European bank balance sheets and make it easier for it to lend to small and medium-size business. The issue here lies with Germany and its willingness to embrace these measures. Mr Draghi needs to get them on board to really install confidence in these programmes and keep the ‘risk on’ rally going.

Perhaps the biggest influence on the euro will come from widening the repo-deposit rate by cutting the deposit rate to a negative number. This would cause fund managers who have money parked with the ECB to seek alternative safe havens, with much of this money moving outside the euro system, thus causing euro outflows and weakness in the currency. Negative deposit rates would solidify the euro’s mantra as the number one funding currency for the carry trade, and they would bring out further sellers of EUR/AUD.

The recent rally we have seen in so many risk assets over the last four days has been premised on the ECB delivering; a failure to meet expectations will cause much of this goodwill to be unwound. There will be some fantastic trading opportunities to be had on the back of potential actions, but remember that whatever your view, you should protect yourself in case it is incorrect. Stop Losses are a must in this type of environment (if not always).

Kind regards,
Chris Weston
Institutional Dealing
IG Markets
www.igmarkets.com.au

ENDS

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