QE tapering still on
the agenda
Labor data confirms Federal Reserve tapering QE
In August the US economy created only 169'000 new jobs and
July figures were revised down to 104'00 from 162'000. Worryingly, while the
unemployment rate fell to 7.3%, the labor force participation rate continued to
slide gradually south, reaching 63.2%, a level not seen in decades. We have,
however, stressed that the labour market will recover only gradually and,
considering also the recent strong improvement in the ISM index, we still see a
large likelihood of a reduction of the monthly 85 bln USD asset purchases
already this month. It would be important to stress that tapering would be
implemented in a very cautious manner. First of all, only additional liquidity
injections will abate, total outstanding liquidity remaining unaltered.
Furthermore, so as to mitigate negative implications for the housing market,
the Fed is likely to first focus on reducing Treasuries acquisitions, rather
than mortgage-backed securities. Most importantly, the Fed will stress that it
would resume acquisitions in case the improvement of the outlook would appear
to be at risk
Modest tapering already in the prices
In spite of all the moderate language by the central banks,
borrowing costs have now significantly risen not only in the United States, but
also in the Europe, with markets pricing in a Fed rate hike towards the end of
2014, and a ECB rate hike in the summer of 2015. There is a clear risk that
some of the enthusiasm regarding the recovery in advanced economies, especially
in Europe, is overdone. Thus, while further upward pressure on US yields is in
the cards, it is far less likely that Europe would be able to manage a similar
development. Over a one year horizon, a very anemic recovery in Europe is more
likely to determine a further decoupling of cross-atlantic yields and, with it,
further downward pressure on the euro.
Who will lead the Fed
next year?
Discussions have started to replace Mr Bernanke in February
2014
All eyes are on the Fed, as the 17 September FOMC meeting
could start the tapering liquidity injections. However, the nomination in fall
by Mr Obama of Mr Bernanke's successor is also of critical importance as the
new chairman could deviate from the current monetary policy led by the Fed. Mr
Obama has acknowledged that he is in the process of interviewing three
candidates: Larry Summers, Janet Yellen and Donald Kohn. The former is
perceived as the front-runner, while the latter, a Fed vice chairman, is the
less likely to be chosen.
Summers is Obama's favourite, while Yellen represents
continuity
Mrs Yellen, as the current vice chairwoman of the Fed, would
be the choice of continuity at a time when the Fed will have to manage an exit
of its unorthodox monetary policy. She would likely lead the Fed in the same
way as Mr Bernanke, as she has been deeply involved in the bond-buying
programmes and introduction of forward guidance. Furthermore, her leadership
would not differ too much than Mr Bernanke's: strong focus on data and a
consensus-building approach, aimed at minimizing surprises and market
volatility. Mr Summers, on the other hand, has never served at the central
bank, but his years of experience at the US Treasury (two as Secretary) and at
the National Economic Council give him a good understanding of financial
markets, and plausibly better experience in crisis-management (because, a.o.,
of his involvement in the 2009 auto bailout when he gained Mr Obama's trust).
However, his provocative nature and his involvement in financial deregulation
during Clinton's presidency have also left him with many detractors, especially
among democrats. It has to be noted that both are seen as "doves",
putting more focus on supporting the US recovery than worrying about potential
inflation threat. However, Mr Summer, by questioning the benefits of the Fed's
asset purchase in 2012, seems less dovish.
Implications for the US monetary policy
A Yellen nomination would mean an unchanged monetary policy,
as she has been one of the key architects behind Mr Bernanke's policy. She
would continue to put a strong focus on the clarity and the transparency of the
Fed's policy. A Summers nomination could lead to less predictability and
transparency in the US monetary policy, resulting in more market volatility.
Furthermore, increasing odds of a Summers' nomination should support a stronger
US dollar, as he seems more worried about the risks of the unorthodox measures
taken by the Fed to lift economic growth. However we remain sceptical that,
over time, Mr. Summers would dramatically change the thrust of US monetary
policy. Therefore any short-term spike in the US dollar preceding a Summer
nomination would be best sold.
A Summers nomination could lead to undesired effects
To become the new chairman, the candidate must be chosen by
the President and then confirmed by the Senate. Even though the Senate has a
democrats majority, the public endorsement of a group of democrat senators for
Mrs Yellen suggests that the favourite candidate of Mr Obama could face a long
and painful confirmation. Moreover, Mrs Yellen could decide to leave the Fed at
the end of her vice chairwoman term in October 2014 if she is not elected.
Coupled with other already announced or potential departures (four in the next
year), a confirmation of Larry Summers could lead to a significant reshuffle
inside the Fed's Board of Governors, thereby raising uncertainty, especially
with regard to the Fed's long-term commitment to keep rates low. This would
additionally add to US dollar strengthening and increasing market volatility.
Australian dollar
supported by short-term positive news
Slightly hawkish statement from the RBA
As expected, the Reserve Bank of Australia (RBA) kept rates
unchanged at 2.5% during its 3 September policy meeting. However, the statement
following the decision did not mention the usual "scope to ease policy
further", suggesting a less dovish stance than in August. Coupled with
better-than-expected domestic growth figures and recent improvements in China
(a key trading partner), the odds of a rate cut before year-end have greatly
decreased. Furthermore, although the RBA is independent, broad-based political
support for further rate cuts seems to be shrinking.
Rally could be fueled by extreme short AUD positions
Looking at the technical configuration of AUD/USD, we note
that shortterm improvements have occurred: the previous low at 0.8848
(05/08/2013 low) has been successfully tested in late August and a significant
declining trendline has been broken. Coupled with diminishing odds to see a
rate cut in the next few months, the current rally could be further supported
by a short-squeeze among investors, the majority of which is heavily short AUD
(see page 7). Therefore, in the short-term, AUD/USD is likely to edge higher
towards its strong resistance at 0.9345 (26/06/2013 high). However, in the
medium-term, we remain skeptical on China and on the ability of Australia to
manage a smooth growth transition from its mining sector to the rest of its
economy.
British pound still
favoured by a persistent 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.
The data ending on 27 August show that long positions in
Euro have continued to increase. As mentioned last week, EUR long positions,
though not extreme, favour a bearish stance as the current levels are near the
ones reached during EUR/USD February peak. On the other hand, the British pound
remains highly shorted. Overall, the dichotomy between EUR and GBP positioning
favours a bearish stance on EUR/GBP.
The Australian dollar and the Japanese yen continue to
exhibit extreme short positions. Although it calls for some short-term caution,
we continue to view these extreme as a confirmation of a structural shift in
the underlying trend of the currencies (from structural appreciation to
structural depreciation).
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