Europe's very slow
recovery
Stabilization rather than recovery
For the first time in 18 months the Eurozone's composite PMI
regained the critical threshold level of 50. It now looks like the recession,
which lasted a record six quarters, is finally over. We would argue, however,
that the old continent's economy is stabilizing rather than recovering. A
sustained recovery is still not in sight given continued depressed demanded in
many member-countries.
Divergence not only between core and periphery
While PMI indicators have improved more or less across the
board, it is worthwhile to note that consumer confidence indicators are
diverging not only between the core and the periphery. Indeed, while the rise
in disposable income has improved consumer sentiment in Germany, in France
consumer confidence is at a record low because of ever more oppressive taxation
and rising unemployment. If one adds France to the periphery countries that are
still in recession, one can come to two conclusions: 1) a strong Eurozone
recovery is not on the cards; 2) divergence amongst the regions remains
alarmingly high.
China's ominous slowdown adds to Europe's concerns
China's Flash PMI indicator contracted again in July. Thus,
while Europe's periphery economies will continue to constitute a drag on
growth, the old continent is also unlikely to benefit from strong external
demand. The China slowdown is particularly bothersome for Germany, which is a
main exporter to China of both luxury goods (especially cars) and capital
goods, such as machinery.
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Recent FX sideways
moves favour the use of oscillators
Oscillators call for patience during summer
Given the recent trendless environment notably in USD/JPY,
AUD/USD or the roller coaster moves in EUR/USD and GBP/USD, it is difficult to
find an attractive directional trade. Oscillators could be helpful in these
market conditions as they can improve the timing of a potential trade.
Uncertainties in Japan exacerbated by extreme JPY short
positioning
USD/JPY is facing significant risks in the Autumn. Mr Abe,
who now controls both chambers in parliament (together with his coalition
partners), is expected to propose a new batch of pro-growth reforms and an
agenda for consumption tax, where a hike was approved in late 2012 to improve
Japan's fiscal imbalance. The bold monetary stimulus from the Bank of Japan
remains a strong driver for further yen depreciation. However, the substantial
aforementioned uncertainties coupled with extreme short JPY positions make
current prices unattractive from a risk/ reward perspective. We would therefore
wait for oversold conditions to initiate a long USD/JPY position. Given the
oscillators current high levels, it is unlikely that we will find attractive
entry points in the next two weeks.
AUD/USD marginal new lows suggest weakening selling
pressures
Although we remain confident about further medium-term
weakness in AUD/USD, given the slowdown in China and the rebalancing of growth
from mining to the rest of the economy in Australia. However, we are skeptical
about further short-term weakness. Since 20 June, the Aussie has only been able
to make marginal new lows, suggesting a short-term exhaustion in the selling
pressure. Furthermore, the extreme AUD short positions and the decent rebounds
occurring in related markets like Gold or NZD/USD increase the likelihood of a short-term
rebound. Once again, it would be wiser to remain on the sidelines until
short-term overbought conditions make a short position more attractive.
EUR/USD and GBP/USD sideways moves favour the use of
oscillators
Since March, the Euro and the British pound have been moving
broadly sideways. In this case, the use of overbought and oversold conditions
are interesting to monitor in order to identify selling and buying
opportunities Currently, we would focus on overbought conditions given the
recent rise in prices. Furthermore, while the Fed is willing to reduce the pace
of liquidity injections, The European Central Bank (ECB) and the Bank of
England (BoE) are still striving to be more accommodative. In that respect, the
7 August announcement of the Bank of England about the use of forward guidance
should put pressure on the British pound.
Summer should alleviate some excesses in FX positions
To sum up, for the time being, we do not see attractive
entry points in major FX crosses coherent with our medium-term outlook. We
would therefore wait for the market to erase some of the directional excesses
in positioning, notably in the Japanese yen and the Australian dollar, while
bringing prices to more attractive levels in respect to our medium-term
outlooks.
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Monetary Policy
US Federal Reserve (Fed) - Next meeting: 31 July
• The monthly $85 billion bond-buying programme is expected
to be tapered later this year (at the earliest in September). The pace of the
reduction is expected to be extremely gradual and highly dependent on the
labour market and the inflation outlook. A termination of the asset programme
in mid-2014 likely represents the most optimistic scenario.
• The Fed funds rate will not be raised as long as the
unemployment remains above 6.5% and the inflation outlook is consistent with
the Fed's 2% target. Therefore, a rate hike seems very unlikely in 2014.
European Central Bank (ECB) - Next meeting: 1 August
• The OMT with its potentially unlimited purchases of debt
creates a strong and credible backstop to protect the eurozone’s weaker members
from high borrowing costs. Still, despite the overall low sovereign interest
rates, SMEs' access to credit is difficult in peripheral countries.
• The ECB has broken an unwritten rule by giving forward
guidance on interest rates. Rates are expected to remain at present levels, or
lower, for an extended period of time (likely more than 12 months). Bank of
Japan (BoJ) - Next meeting: 8 August
• The BoJ has introduced its "quantitative and
qualitative monetary easing", a bold and aggressive monetary programme
aimed at reaching an inflation target of 2% in a 2-year time window. In order
to do so, the monetary base will be doubled (from ¥138 trillion at end-2012 to
¥270 trillion at end-2014), mainly by increasing JGB purchases (of all
maturities). The reduction in JGB volatility favours no change in the BoJ's
programme.
• Thus the BoJ changed its target for money market
operations from the overnight call rate to the monetary base. FX Markets
Monetary Policy Bank of England (BoE) - Next meeting: (1 August) / 7 August
• The BoE has maintained the size of its asset purchase
programme at £375 bn. On 7 August, the Committee will announce potential
implementations of thresholds and forward guidance, as well as its view of the
trade off between growth and inflation.
• Forward guidance has already been introduced when Mr
Carney mentioned that the rise in the expected future path of Bank rates was
not warranted, suggesting that rates are expected to stay at 0.5% longer than
expected. Reserve Bank of Australia (RBA) - Next meeting: 6 August
• The RBA has to manage a growth transition from the
resources sector (whose peak may have already occurred) to the other sectors,
which have been hurt by the strong AUD and the relatively high interest rates.
• The RBA has maintained the cash rate at 2.75%, but has
left the door open for more accommodative measures given the below trend
growth. Bank of Canada (BoC) - Next meeting: 4 September
• The BoC is expecting exports to be the key driver to boost
growth in the private sector. The central committed to leave rates unchanged
notably as long as there is significant slack in the economy and a soft landing
is emerging in the housing market.
• Thus, the overnight rate was left unchanged at 1%. Swiss
National Bank (SNB) - Next meeting: 19 September
• The SNB is expected to continue to defend with the utmost
determination the minimum exchange rate at 1.20 in EUR/CHF.
• Target range for the 3-month Libor unchanged at 0.0-0.25%.
Sustainable JPY
weakness unlikely given short positioning
The International Monetary Market (IMM) non-commercial
positioning is used to visualise the flows of funds from one currency to
another. It is usually viewed as a contrarian indicator when it reaches an
extreme in positioning.
No real change in positioning except perhaps the persistent
augmentation of sellers in Swiss franc. However, the levels are nowhere near
extreme, so little conclusions can be drawn from these readings.
In the Japanese yen, net short positions are the most
extreme (-47.01%) in six years and are coming closer to the historical extreme
made in June 2007 (-53.39%). As more structural reforms are only expected for
September, we do not see many catalysts to weaken the yen much further. On the
other hand, any signs that Mr Abe is watering down his promises for structural
reforms could lead to a strengthening of the yen. Furthermore, a visit to the
Yasukuni Shrine on 15 August would indicate that Mr Abe is following his
nationalistic instincts, along with constitutional changes that could consume
much of the government's energy, at the detriment of his economic agenda.
Overall, we do not see sustainable weakness in the yen until at least September
especially given the elevated net short JPY positions.
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