In our ECB Preview, titled How Far will the ECB Go ,
we outlined the various scenarios for tomorrow’s monetary policy
announcement. For the first time in a while, economists are divided on
what to expect from the ECB which makes volatility a near certainty. The
forecasts range from the central bank doing nothing to lowering
interest rates by 50bp which would be the largest rate change by the
central bank since March 2009. In order to understand how the market
could react, it is important to know how traders are positioned. First
and foremost, the euro has ended the day unchanged against the U.S.
dollar which suggests that investors aren’t sure about what to expect
from the central bank tomorrow. With that in mind however, the sharp
sell-off in the EUR/USD 
in September and the overall weakness of the currency indicates that
investors are positioned for easier and not tighter monetary policy. The
most recent CFTC data for the week ending on September 27 th showed short EUR/USD positions at their highest level since June 2010. Considering that the EUR/USD
was trading around 1.35 at the time, the latest sell-off in the
currency pair could have further boosted short positions. In other
words, speculators are aggressively short euros ahead of the ECB
meeting. According to interest rate futures, bond traders also expect
the ECB to lower rates. The market is currently pricing in approximately
20bp of tightening for tomorrow’s meeting and 30bp of tightening for
the November meeting. This implies that a great deal of bond traders
expect the ECB to ease tomorrow and if they do not, then the general
thought is that a November rate cut is a done deal. Eighty percent of
economists on the other hand expect the central bank to hold rates
steady but this does not preclude the possibility of the ECB taking
other measures to boost liquidity. This includes
extending the terms of their refinancing operations, restarting their
covered bond purchase program and widening their interest rate corridor
by cutting the deposit rate. Each of these scenarios is discussed in
detail in our ECB Preview.
Given the ongoing
uncertainty created with Greece, the volatility in the financial market
and deterioration in the Eurozone economy, the ECB cannot necessarily
afford to wait another month to ease the strains in the banking sector
and the financial markets. As a result, there is a 70 percent
chance that the ECB will announce new liquidity measures but stop short
of lowering their main refinancing rate. By reintroducing a 12 month
facility, the ECB would get cash into the hands of banks for a longer
period of time. Restarting the covered bond purchase program would
offload some of the chunkier elements on bank balance sheets and free up
capital for them to lend while cutting the deposit rate would boost
lending among banks and deter them from parking their excess funds with
the ECB. Although helpful and to a large degree expected by the markets,
these measures are not as bold as a rate cut and would therefore mildly
positive for the euro.
The U.S. labor market is the focus this week but based upon the leading
indicators for non-farm payrolls and how the economy has fared in
general, investors do not have a good feel of what to expect for
Friday’s report which may be part of the reason why NFPs have been
overshadowed by developments in Europe. The U.S. dollar weakened against
commodity currencies but held steady against the euro, British pound
and Japanese Yen. According to Challenger Grey & Christmas, layoffs
rose 212 percent in the month of September, which was the largest
increase since January 2009. This sharp rise reflects more than 50k
public sector job cuts (most of which are in the military) as well as
30k job cuts by Bank of America, the country's largest lender. Based
upon the Challenger report alone, it is hard to imagine that there will
be much of a recovery in the U.S. labor market. However losses in the
dollar were mitigated by a rise in private sector payrolls. According to
ADP Employer Services, U.S. companies added 91k jobs last month, up
from 89k in August. Unfortunately given ADP's drastic overestimation of
private sector payroll growth in August, investors have become skeptical
of their rosy assessment of the U.S. labor market. The most reliable
guide for NFPs tends to be the non-manufacturing ISM report which
accurately forecasted the deterioration in job growth in August. The
latest report showed service sector activity growing at a slower pace in
September and companies shedding jobs for the first time in more than
year. The ISM non-manufacturing index fell to 53 from 53.3 with the
employment component dropping to 48.7, the lowest level since April
2010. The decline in service sector employment raises major red flags
for Friday's non-farm payrolls report. Although economists expect a
rebound in job growth, we are not as optimistic and caution traders
against a downward surprise. No U.S. economic reports will be released
tomorrow which means that for the next 12-24 hours, the price action of
currencies will be dictated by the ECB and BoE’s degree of dovishness.
The British pound weakened against both the U.S. dollar and euro as
final GDP showed the economy grew less than expected. U.K. economic
growth slowed more than estimated in the second quarter as consumer
spending fell the most in more than two years, adding pressure on Bank
of England policy makers to provide more stimulus. GDP rose 0.1 percent
from the first quarter, instead of the 0.2 percent previously
published. The data comes as BoE officials meet to decide whether
they’ll revive their bond-purchase program as the government’s fiscal
squeeze and Europe’s debt crisis hamper growth prospects. The Bank of
England could very well expand their asset purchase program by 50
billion pounds, as policy maker Posen has called for. Given the
deterioration in growth of the U.K. economy, more stimulus seems
necessary but there have also been some bright spots and for this
reason, the central bank may not be ready to pull the trigger. Mixed
economic data came out today with September services PMI printing
stronger than expected, but with a poor outlook. The purchasing
managers’ index rose to 52.9 in September from 51.1 in August, bouncing
back from its biggest one-month fall in a decade and moving away from
the 50 line that separates growth from contraction. However, firms’
expectations for the next 12 months are bleak. U.K. shop price inflation
was unchanged as stores cut prices to lure consumers. Retail prices
rose 2.7 from a year earlier in September, the same as in August, as
supermarkets absorbed costs to attract shoppers squeezed by rising fuel
and utility prices. The Bank of England has predicted that inflation
will accelerate to 5 percent before slowing next year as the impact of
higher commodity prices, a declining pound, and an increase in sales tax
earlier their year fade. Business investment picked up from last
quarter, increasing 11.6 percent in the second quarter. Businesses are
building their infrastructure as they try to attract consumers in the
depressed economic climate. As for the BoE rate decision, we believe
there is a 70 percent chance that the central bank will delay increasing
their asset purchase program to November. If the BoE leaves policy
unchanged, the British pound will probably enjoy a minor relief rally
because a small group of investors are looking for the BoE to boost
asset purchases. If they follow through with more stimulus, it would be a
big surprise to the market and will most likely send the British pound
sharply lower.
The Canadian, Australian, and New Zealand dollars all strengthened
against the greenback today as risk appetite returned to the market. Oil
rose from its lowest level in a year after a surprise drop in crude
stockpiles. Commodities as a whole rebounded from their lowest level in
10 months after Federal Reserve Chairman Ben Bernanke said the central
bank may take further steps to sustain an economic recovery. No new
economic data was released from Canada as their equities fell for a
third day on signals that Greece may revert to a bailout. Australia’s
dollar received a boost from its retail sales report. Official retail
sales jumped by 0.6 percent in August, showing shoppers continued
appetite for spending despite growing global economic worries. The
August increase followed a 0.5 percent increase in July. Prior to August
consumers were expecting rate hikes, but with the increased global
volatility investors now expect a rate cut which may have encouraged
consumers to spending. Australian lawmakers called on the government to
investigate claims senior central bank officials suppressed evidence of
corruption at the bank’s note-printing units that sought contracts in
Nepal and Malaysia. The allegations may increase the scrutiny of the
Reserve Bank of Australia after Treasurer Swan said last month it will
lose its sole power to set compensation for its board and executives for
the first time. Australian government debt turnover grew last financial
year at more than three times the pace of the previous period as
federal and state authorities sold more bonds and overseas central banks
became more active. Australian bond yields tumbled to the lowest level
in 20 months relative to U.S. Treasuries after central bank Governor
Glenn Stevens indicated he’s willing to cut the key interest
rate. Stevens, who held rates earlier this week, signaled slowing
inflation may give him scope to lower borrowing costs. Service sector
activity also slowed which may be a cause for concern.
rose from its lowest level in a year after a surprise drop in crude
stockpiles. Commodities as a whole rebounded from their lowest level in
10 months after Federal Reserve Chairman Ben Bernanke said the central
bank may take further steps to sustain an economic recovery. No new
economic data was released from Canada as their equities fell for a
third day on signals that Greece may revert to a bailout. Australia’s
dollar received a boost from its retail sales report. Official retail
sales jumped by 0.6 percent in August, showing shoppers continued
appetite for spending despite growing global economic worries. The
August increase followed a 0.5 percent increase in July. Prior to August
consumers were expecting rate hikes, but with the increased global
volatility investors now expect a rate cut which may have encouraged
consumers to spending. Australian lawmakers called on the government to
investigate claims senior central bank officials suppressed evidence of
corruption at the bank’s note-printing units that sought contracts in
Nepal and Malaysia. The allegations may increase the scrutiny of the
Reserve Bank of Australia after Treasurer Swan said last month it will
lose its sole power to set compensation for its board and executives for
the first time. Australian government debt turnover grew last financial
year at more than three times the pace of the previous period as
federal and state authorities sold more bonds and overseas central banks
became more active. Australian bond yields tumbled to the lowest level
in 20 months relative to U.S. Treasuries after central bank Governor
Glenn Stevens indicated he’s willing to cut the key interest
rate. Stevens, who held rates earlier this week, signaled slowing
inflation may give him scope to lower borrowing costs. Service sector
activity also slowed which may be a cause for concern.
The Japanese yen weakened against all the major currencies with the
exception of the U.S. Dollar, British pound and Swiss franc on optimism
that European leaders may reach an agreement. No new economic data was
released today and the Bank of Japan is set to keep monetary policy
unchanged at the end of a two-day meeting on Friday. However, the
central bank has said it stands ready to act if slowing global growth
and adverse market conditions threaten to derail Japan’s fragile
recovery from March’s earthquake and tsunami. European officials would
be unlikely to welcome any Japanese currency-market intervention to
bolster the euro, even if the aim is to fund the Eurozone’s efforts to
end its debt crisis. The U.S. and Europe want weaker currencies to fight
their economic woes. Market participants view the yen’s upward trend
against the euro and the dollar as reflecting economic fundamentals and
it can’t be reversed by the kinds of sporadic solo interventions
conducted by Tokyo over the past year. The strong yen is helping some
Japanese companies go on shopping sprees as they seek global
growth. Rakuten, an online shopping mall operator has bought several
overseas businesses in the last year and is not the only Japanese
company on an acquisition spree. Businesses from pharmaceutical
companies to toy makers have been empowered by the increased purchasing
power that the strong yen gives them. Japan’s three largest banks also
received a combined $43 billion credit line from the government to help
finance domestic companies’ overseas takeovers. Prime Minister Yoshihiko
Noda is under pressure to help Japanese companies weather the yen’s 11
percent rise against the dollar in the past six months, which has
dampened the economic recovery. The deal is aimed at helping banks to
acquire dollars and offer loans to companies planning acquisitions
abroad. Leading indicators for Japan will be released on Friday. The
index should help the market gauge the strength of Japan’s recovery.
EUR/USD: Currency in Play for Next 24 Hours
Currency in Play for Next 24 Hours
Our currency pair in play for the next 24 hours is the EUR/USD. The
European Central Bank is scheduled to release its rate decision at 7:45
AM ET / 11:45 GMT followed by Trichet’s press conference at 8:30 AM ET /
12:30 GMT. From the United States, we expect jobless claims at 8:30 AM
ET / 12:30 GMT. Also from the U.S. we expect ICSC chain store sales for
the month of September at 10:30 AM ET / 14:30 GMT.
EUR/USD
has been paring some of its losses in the past few days, but still
remains in a down trend which we determine using Bollinger bands. First
support is at 1.3145, the 9-month low reached on October 4 th
. If the pair continues to slide, more significant support will be
found at 1.3040, the 61.8% Fib level. We drew our Fibonacci retracement
from the low on June 7 th , 2010 to the high on May 4 th
, 2011. If the currency starts to rise, the first level resistance will
be at 1.3400, the 50% Fib and lower first standard deviation Bollinger
band. If the pair breaks out from that level, nire resistance will be
encountered at 1.3580, the 20-day SMA and a previous price of
contention.
has been paring some of its losses in the past few days, but still
remains in a down trend which we determine using Bollinger bands. First
support is at 1.3145, the 9-month low reached on October 4 th
. If the pair continues to slide, more significant support will be
found at 1.3040, the 61.8% Fib level. We drew our Fibonacci retracement
from the low on June 7 th , 2010 to the high on May 4 th
, 2011. If the currency starts to rise, the first level resistance will
be at 1.3400, the 50% Fib and lower first standard deviation Bollinger
band. If the pair breaks out from that level, nire resistance will be
encountered at 1.3580, the 20-day SMA and a previous price of
contention.
From: Cathy Lien - Director of Currency Research, GFT
