Gradual improvement
fosters deadlock in the eurozone
How come the euro is so resilient?
In the next pages we explain how the euro could further
strengthen against the US dollar in the coming weeks, even months. The
arguments for such further strengthening are both technical and fundamental, in
particular the continuing divergence in monetary policy with the ECB's balance
sheet shrinking, whereas the Federal Reserve sticks to QE.
Solving the euro conundrum
LTRO repayments by the banks imply a reduction of
outstanding liquidity. What is more important, such reduction has not prevented
a gradual improvement of business confidence and the old continent is therefore
soon expected to move into, albeit very modest, positive growth territory. This
improvement is not spectacular and "normal" after the reduction of
fiscal pressure in the two larger periphery economies, Italy and Spain.
Bad news means action, no news means deadlock
Yet, this modest economic stabilisation is enough to ensure
that no major action from the ECB is to be expected over the next months.
Indeed, both the LTRO and the OMT were announced under pressure and in
agreement with the German government. Pro-active, instead of reactive,
unconventional monetary policy is not yet part of the ECB's operational
handbook. As a result, the ECB's balance sheet could continue to shrink and, as
long as the Fed does not embark on effective and significant QE tapering,
upside pressure on the euro could persist. If, however, the global economic
situation would unexpectedly deteriorate, for example because of the US
congress not agreeing on fiscal policy, spreads could re-widen, political
instability in the Spain and Italy could again become relevant, and the euro
would again come under pressure, even before the Federal Reserve finally
embarks upon its tapering intentions.
The FOMC meeting
confirms an ultra accommodative Fed
A longer dovish Fed is hurting the bullish case for the US
dollar
Mr Bernanke surprised the market on 18 September by
postponing the tapering process. Notwithstanding the US dollar decline
following the announcement, the dovish commitment by the Fed is expected to
have further medium-term effect on the greenback. The continuation of the full
monthly $85 bn liquidity injection by the Fed and the concerns about the
tightening of financial conditions highlighted by the FOMC suggest a
significant slower tapering process than previously hinted by Mr Bernanke in
June. Indeed, the tapering seems now unlikely to start in October as the Fed
will only have one month more of data to assess if the recovery is strong
enough to sustain a reduction in liquidity injection. Moreover, the
uncertainties linked to the US debt ceiling are also suggesting that the Fed
could wait until December before tapering. Furthermore, the likely nomination
of Mrs Yellen as the new Fed chairperson strengthens the stance of an ultra
accommodative Fed. One could also speculate that the more dovish stance
reflects the prospect of a forthcoming Yellen nomination. On the other hand,
the European Central Bank (ECB) is still passively removing liquidity through
the LTRO repayments. This increasing gap, which could persist for longer than
expected in the light of the September FOMC meeting, is supportive for EUR/USD.
In the UK, this supportive effect should be less significant as the liquidity
remains unchanged through the decision of the Bank of England. Overall, even
though the US dollar could receive some short-term support from a potential
escalation in the debate surrounding the debt-ceiling, the persistent
divergence in liquidity across the Atlantic should remain a supportive factor
for EUR/USD in the next few months. In the longer term, we remain convinced
that the US is more advanced in the tightening cycle, which should eventually
favour a sustainable rise in the USD. However, the recent developments suggests
that this time is farther than previously thought.
A technical update on
forex after the FOMC decision
EUR/USD is breaking its summer peaks...
The surprise move by the FOMC has had a significant impact
on the Forex market. Cyclical currencies like the EUR and the AUD have
significantly appreciated against the USD following the news. EUR/USD has
broken its summer peaks at 1.3417 (19/06/2013 high) and 1.3452 (20/08/2013
high), opening the way for a test of the annual high at 1.3711 (01/02/2013
high) and potentially its long-term declining trendline around 1.40. Even if we
do not expected this move to be made in a straight line, the mediumterm
prospects are now tilted to the upside. AUD/USD is also benefiting and broke
its strong resistance at 0.9345. The technical configuration favours a further
short-term rise towards 0.9666 (14/06/2013 high), possibly 0.9843 (21/05/2013
high). However, a bigger upside is unlikely given the long-term distributive
phase that has taking place since mid 2011.
...while the yen is weakening
Even though the initial move from USD/JPY was on the
downside, the annual highs posted by EUR/JPY and GBP/JPY are positive and
confirm a global bearish stance on the yen. It is true that major resistances
in these pairs are looming (EUR/JPY: 139.22, GBP/JPY: 163.09), which calls for
caution, especially as the yen is extremely shorted among investors (see page
7). However, USD/JPY, with its potential symmetrical triangle and its major
resistances around 105.50 (61.8% retracement from the decline from June 2007)
and 110.66 (15/08/2008 high), suggests that the yen could weaken further in the
medium-term.
Mr Summers' exit
reduces uncertainty of future Fed's policy
Democrats support Mrs Yellen to be new Fed chair(wo)man
The lack of support for Mr Summers among democrats,
especially in the Senate Banking Committee, has forced him to withdraw his
candidacy for Fed chairman. Indeed, with four democratic senators openly
against Mr Summers and given the thin democratic majority in the Committee
(12-10), Mr Obama would have had to rely on Republicans to back Mr Summers'
nomination. A too difficult prospect given the looming confrontations with
Republicans around the budget and the debt ceiling.
New chairman expected to follow Bernanke's monetary stance
Even though a new candidate could still be chosen by Mr
Obama, the future Fed chairman is likely to be either Mrs Yellen (highly
likely) or Mr Kohn. Both have served as vice-chairman for Mr Bernanke and share
his view on the monetary policy, so the continuity in the Fed's commitment to
keep interest rates low is increased, strengthening the credibility of the
Fed's forward guidance. A nomination of Mrs Yellen would likely lead to further
transparency and clarity in the Fed's communication, reducing uncertainties in
the Fed's monetary policy. Furthermore, her nomination would strengthen the
Fed's determination to fight high cyclical unemployment even if that would lead
to potential temporary overshoots in inflation.
Implications for the Forex market
The withdrawal of Mr Summers was negative for the US dollar
as he seemed less inclined to leave rates as low as Yellen's "lower for
longer". Now that the market has mostly discounted a Yellen nomination, we
would see any other choice than Mrs Yellen herself or Mr Kohn (at the limit a
return of Mr Bernanke) as rather bullish for the US dollar, as it could
potentially weaken the forward guidance put in place over the last year.
Short JPY positions
are edging towards historical extremes
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 changes, again, in the week ending on Tuesday 10
September.
The Japanese yen short positions have reached a 5 year
record at -48.23% and are edging towards the historical extreme made on June
2007 at -53.39%. Given this large pool of sellers and the strong resistance in
many yen crosses (110 in USD/JPY, 139 in EUR/JPY and 163 in GBP/JPY), it is
difficult to call for an aggressive medium-term bearish view on the yen.
The Australian dollar remains also heavily shorted,
representing potential fuel for a further short-term rise. Therefore despite
the recent sharp rise, we remain a short-term positive bias on AUD/USD as a
risk of a further spike higher remains significant. However, we continue to see
this rise in AUD/USD as a counter-trend move within the underlying medium- to
long-term downtrend.
The British pound remains attractive due to its relatively
high short positioning. However, the GBP appreciation has by now priced in most
of the surprises caused by the strong economic data from UK and the
lessthan-expected dovish stance from the Bank of England. Furthermore, on a 12
month horizon, the BoE is expected to be the second most dovish major central
bank, only behind the Bank of Japan.
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