With the US debt ceiling debate exposing a disturbing cleavage in American politics –both parties putting political point scoring above averting financial catastrophe – and EU governments unable to build a cohesive narrative, markets are increasingly looking to central banks to stimulate a measure of risk appetite. Yet despite ECB finally extending its bond purchase program to include Italian and Spanish debt, and the Fed promising record low rates till at least mid-way ’13, markets continue to be hounded by further downgrade and double-dip fears with signs of sustainable relief clearly missing.
The week began with the S&P downgrade hangover predictably strengthening the risk-off environment, sending stocks and commodity prices tumbling as treasury yields fell to all time lows. SNB threat of a possible franc-euro peg finally prompted outflows after last weeks’ surprise interest rate cut failed to check safe-haven inflows and inability to follow up more aggressively would’ve stripped the bank of credibility. After touching a weekly low of 0.7061, USDCHF closed at 0.7780. Goldman Sachs termed the franc the most overvalued currency, by as much as 71 per cent at one point last week. And while the peg threat rubbed market sentiment just the way the SNB would have wanted, a more realistic discourse would be a managed float to trade EURCHF within narrow ranges.
Japanese intervention of the week before had exactly the opposite effect, pushing the USDJPY cross above 80 before the greenback tumbled again, flirting with the all time low and finally settling at 76.28 for the week. With Japanese exporters hemorrhaging millions because of debt and deficit mismanagement on both sides of the Atlantic, another more forceful intervention is suspected. Yet market sentiment favours yen inflows even as opportunists eye post-intervention shorts.
The way continued risk aversion has altered safe haven dynamics over the last two weeks is indicative of the magnitude of erosion of confidence in policy makers. With post QE2 slowdown in the US, and European peripheral debt problems spreading to the mainland, the market seems unable to shrug off concerns that factors responsible for the ’08 crash continue to flow through the system. The money-printing induced uptick in stock prices stands exposed as circumstantial and instead of productivity gains, the financial sector emerged as a much larger portion of the overall economy.
The decision to ban short-selling in France, Spain, Italy and Belgium, too, has come across more as an act of desperation than governments exercising authority. Even as European leasers attempt to curb negative speculation about their banks’ exposure to bad debt, the market has already begun pricing in the dreaded doomsday scenario for France. These means the ECB will almost definitely have to overcome its inflation paranoia and hold interest rates steady till year-end, if not actually consider a reduction.
When market place volatility coincides with decision making paralysis, deepening risk aversion is inevitable. Already, principal decision makers have experimented with too many starts and stops, as reflected in the rush to the franc, yen and gold. The more they look for short term solutions to an integrated large scale problem, the longer they will risk feeding into sustained risk aversion.
Trading Perspective
Please bring your seats to an upright position as it could be turbulent ride next week in the currency markets. GBPUSD is expected to resume its downward slide over predominant fears of weakening British economy. BoE’s quarterly report has already hinted at stagflation, and any collaborating evidence suggesting the same in BoE meeting minutes on Wednesday and retail sales number could push GBP down further. As to EURUSD, with debt-crisis still very much in picture outlook remains weak, although USD is itself on weak footing but Eurozone is witnessing its major economies falling flat (France). German GDP figures coming out on Tuesday are expected to really set the tone for the week, and in case numbers mimic France – it would be wise to run for the trees. USDCHF has slightly lost its safe haven status over SNB’s talks to peg Swiss franc to the euro, although it is expected that SNB might not directly intervene as it would achieve little and only damage their balance sheet. However, despite its strength CHF is expected to slide against the dollar if there is some assertive efforts to curb Franc’s advance which is hurting Swiss exports. USDJPY is back to its pre-intervention levels – markets are expected to test the waters until BoJ intervenesagain, but until then the demand for JPY is expected to remain strong.
