What to expect from Ben and the FOMC?

Despite the ECB having made good on its promise to tackle the Euro-zone debt crisis by widening its bond-buying program to include paper from Spain and Italy, the move so far is not enough to allay investors deep concerns, as seen by another night of uncertainty. From a neutral stance, ECB’s actions are seen as a temporary relief measure for banks which are saddled with sovereign debt. Investors seek proactive solutions, and not reactionary measures.

Stateside, investors have so far tried unsuccessfully to deal with last weekend’s hangover. Now its up to the authorities. Today we get the FOMC decision. The market expects Ben to announce creative steps towards further monetary accommodation. Will he? The very least, market anticipates maturity extensions of the Fed’s current treasury holdings, creating no changes to the Fed’s balance sheet, but should translate into increased downward pressure on the long end of the yield curve. Investors expect the Fed to modify its ‘extended period’ language, to signal that monetary conditions will remain accommodative even longer. Last Friday’s NFP release probably reduced the immediate expectations of implementing QE3. However, investors are hesitant to buy the dollar this morning given the risk of more QE.

Markets will be expecting a moderate relief rally if the above predictions come true. Sustained improvement is unlikely without European authorities keeping their foot on the gas. The problem, the ECB, as the last line of defense, cannot ‘walk alone’ while being undermined by internal political strife. Their direct actions are breaching a key treaty in the Euro’s founding treaty and undermines its credibility. Where is this coordinated effort?

The US$ is weaker in the O/N trading session. Currently, it is lower against 13 of the 16 most actively traded currencies in a ‘violent’ session.

Only one day into this week and the market is shattered with investors looking for all and any exit strategy despite some released positives, albeit, thin and infrequent. The equity markets selloff continued in the Asian session, mostly playing catch up, following yesterday’s -6.7% drop in the S&P and with VIX spiking to +48.0%, its highest levels since the credit crisis. Asian equities sold off another -0.5%-4.0% ‘across the board’ on Chinese concern. Their CPI inflation accelerated to +6.5%, y/y in July, another cycle high and above the consensus forecast of 6.4%. The upside surprise came mainly from food inflation. Ex-food inflation moderated slightly to +2.9%,y/y, from +3.0%. In this one bright spot of growth, the uptick in inflation will increase market concerns that further monetary tightening in China would weigh on ‘their’ growth and ‘world’ growth.


The dollar is lower against the EUR +0.75%, GBP +0.55%, CHF +1.56% and JPY +0.90%. The commodity currencies are weaker this morning, CAD -0.33% and AUD -0.11%.

The Loonie and the AUD are carbon copies, both dipping below parity, earlier than expected, both are commodity and interest rate sensitive, and both are second tier reserve requirements for many portfolios. However, with the US and China their largest trading partners respectively, the brunt of the pain is born as one. With global equities and commodity prices in constant free fall, both currencies are expected to experience aggressive negative repositioning and this despite healthier fundamentals. The loonie has traded on the back foot on concern slowing global economic growth will weigh on demand for raw materials and increase risk aversion trading strategies.

Last week’s historic S&P’s downgrade is creating a new financial and trading environment. For the time being, the loonie will remain at the mercy of risk aversion trading strategies and commodity prices. In the O/N market, investors remained better buyers of dollars on dips (0.9950).

The wild ride for commodity currencies continues, with the AUD being the prime example. A matter of weeks ago, the market was happily singing its praises, as we witnessed the currency breach the 1.10 barrier, some weaker global data and a credit downgrade later and this growth and interest rate sensitive currency is bouncing back from the USD trading premium outright last night. Helping its cause in the O/N session was Asian Central Bank intervention (Taiwan and South Korea), acting to stem equity declines, and amid speculation that the Fed will announce measures to support markets this afternoon.

Big picture, the currency continues its slump, taking its run of daily declines against the greenback to the longest in a decade, as concern that the global economy is slowing sapped demand for higher-yielding assets. The US credit downgrade is pressurizing commodities, which in turn is negative for all growth sensitive currencies. In one session, the currency breached all major key support levels that resulted in parity again being printed, first time in five month. The next range now depends on what Ben has to say this afternoon. In current climate conditions, investors remain better sellers on upticks (1.0168).

Crude is lower in the O/N session ($78.42 down -$2.89c). Crude prices have plunged again, extending last week’s biggest weekly decline in eight-months, after S&P’s lowered the US credit rating to AA+, the first-ever reduction for the world’s biggest crude consuming nation. Disappointing US data shows that the consumer continues to spend less in response to a sluggish job market and higher fuel costs. The US global economic recovery is stalling and sapping demand from the world’s biggest consumer. Pressure is going to remain on prices until we see some sign that things are improving.

Last week’s inventory build has helped prices to slide. US gas stockpiles rose sharply and demand over the past four-weeks fell-3.6% compared with a year-ago, adding to concerns about tepid consumption in the midst of the peak summer demand period. Inventories increased by +1m barrels to +355m, and remain above the upper limit of the average range for this time of year. Not to be outdone, gas inventories moved up by +1.70m barrels last week, and are in the upper limit of the average range. Analysts had expected crude stocks to gain by +1.5m barrels and gas inventories to rise by +250k. The commodity sector will remain volatile on the back of weaker fundamentals. Currently, crude is straddling strong support levels and is in danger of penetrating the psychological $75 barrier medium term.

For seven months it’s been a safe bet. Gold surged to another new record high this morning, breaking through key psychological barriers and on its way to $1,800, after a US downgrade and on escalating concerns that the global economy is losing momentum. The yellow metal continues to be a recipient of safe-haven flows. However, with the equity market being continuously pummeled, liquidation of the metal to cover margin calls in other asset classes could pare some of these sharp gains. Investors have bought more gold in the last month than in the prior six months according to CFTC data last week.

Year-to-date, the yellow metal has advanced +24.3%, heading for its eleventh consecutive annual gain. This ‘one directional trade’ is far from over, with speculators continuing to look to buy the metal on pullbacks until proven wrong. There remains a demand for the commodity for insurance purposes as alternative asset classes underperform with many investors receiving margin calls. Analysts are continuously changing their medium term target price. In this environment $2,000 is very much in the realms of possibility over the next six months ($1,773 +$56).

The Nikkei closed at 8,944 down-153. The DAX index in Europe was at 5,612 down-311; the FTSE (UK) currently is 4,880 down-189. The early call for the open of key US indices is lower. The US 10-year eased 18bp yesterday (2.37%) and is little changed in the O/N session.

Treasuries have surged in the last few trading sessions, as plummeting global bourses boosted the demand for the safety of US government debt, reversing an initial decline sustained in response to the nation’s credit downgrade at the weekend. The front end of the curve found support from Japan’s Minister of Finance who indicated that US debt remains attractive.

Today, we get the FOMC rate announcement where no rate change is expected. Some analysts anticipate policy makers to increase the ‘extended period of time’ outlook because of the recent rating’s chop. If anything, the downgrade adds more uncertainty to the US’s growth picture, which means Treasuries are what to buy. Does Ben think so?

Refunding requirements has the US government selling +$32b of three-year notes later today, +$24b of 10’s tomorrow and +$16b of 30-year bonds on Thursday. With what’s occurring in the US and the Euro-zone, investors are slowly coming to the realization that global growth expectations for the second half of this year will have to come down drastically. So far, the S&P notch has had little negative affect on US bond prices because sentiment had already been weak and because no one needs to change their risk weighting because of the Euro-zone sovereign debt issues.

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