Article / 16 September 2014 at 12:26 GMT

No Status Quo for FX this week

Head of Trading / The ECU Group plc
United Kingdom

  • Downside to Scottish Yes vote has UK leaders scrambling
  • Eurozone looking to replicate Japanese "three arrows" success
  • USD vulnerable to policy changes, but solid compared to its fellow majors

By Neil Staines

"What you’re proposing…" — Status Quo

If you are reading the UK press, you would be forgiven for believing that there is only one event this week: the Scottish Referendum. A Yes vote in Scotland will induce enormous political, historical and economic ramifications. The uncertainty over debt, energy, monetary policy, and business investment will significantly dent sentiment towards the UK, will impact confidence (business and consumer) and will likely lead to significant weakness in GBP and UK equity markets. It is perhaps little wonder, therefore, that the three main political parties in the UK are falling over themselves to offer Scotland...

"Whatever you want (to stay in the union)..." — Status Quo

These panic measures being promised will no doubt have a considerable political and constitutional impact on the UK, even in the event of a No vote. Whatever the outcome, the political wrangling ahead seems likely to be protracted and heated. 

Status Quo

Aside from Francis Rossi and company, there is no longer
a status quo to be kept. Photo: Status Quo

With the Federal Open Market Committee meeting (which arrives at a current critical juncture for US monetary policy), the Swiss National Bank meeting (where further measures to defend the CHF cap are increasingly anticipated, including negative interest rates) and the first of the European Central Bank’s new targeted long-term refinancing operations (not to mention the G20 summit), this week offers perhaps the greatest "event risk" of the year so far.

This morning’s UK inflation data was broadly in line with expectations, as the annual rate softened a touch to 1.5%. Some persistent stickiness in the core was the only marginal positive for GBP and interest rate expectations but with Thursday’s vote taking centre stage, it is likely that the Consumer Price Index data and any inference from tomorrow’s employment report and Bank of England minutes will be widely disregarded until the outcome of the Scottish vote.

"Down, down… deeper and down" — Status Quo

The developments in the Eurozone are becoming a little more complicated. It is increasingly apparent that September’s monetary easing from the ECB comes with caveats for fiscal progress and structural reforms. Indeed, comments from the Eurogroup that "fiscal policy [and] investment must accompany ECB moves” are consistent with the view that the ECB is effectively aiming to replicate the "three arrows" of the Japanese record economic stimulus (massive monetary and fiscal stimulus, accompanied by structural reform).

"Accident prone"? — Status Quo

In the near term (and again similar to the intention of the Bank of Japan), ECB policy is likely also to encourage a weaker EUR. Draghi’s continued references to the “significant differences in policy cycles globally” is testimony to this.

This week’s major event risk for the Eurozone and the euro (outside of EURGBP, as a function of the Scottish vote) is the first of the long awaited TLTROs. The maximum possible drawdown of the region's banks over the two offerings (September and December) is 400 billion euros. On this basis, it is reasonable to suggest that somewhere in the region of 200 billion euros would be deemed successful, with anything closer to 100 billion more of a disappointment.

This morning’s Centre For European Economic Research (ZEW) report highlighted the continued deterioration in the current situation index within the Eurozone. Against this backdrop, it is hard to see where the boost in demand for lending is going to come from. If anything, the 20 basis point charge for funds held as excess reserves in the system may make banks more cautious about over-borrowing, making Thursday’s TLTRO announcements significant.


New data from Germany point to cooling investor confidence. Photo: Mapics / iStock

One key area of analysis will be whether the French and German banks take up their allowance and also how the Italian and Spanish banks will replace their LTRO borrowings that are significantly above the proposed new lower maximum under the TLTRO arrangements.

Next month in the Eurozone, we will get (at least) further information and possibly the first purchases under the ECB’s asset-backed securities programme. ABS is designed in some respects to remove the Eurozone economy's dependence on bank lending by improving access to capital through capital markets (the dominant form of financing in the US).

"Beginning of the end"  — Status Quo

In the US, the main focus is on the FOMC, as the last of its asset purchases comes within reach. The emphasis of expectation is skewed towards the words (and not the actions) of the committee's statement. Will the statement omit the “extended period” and “for some time” language? Will the forward guidance take a new form (or be removed altogether)?


US dollar investors are looking to the Fed to see if the greenback
will continue to dominate forex markets. Photo: USO / iStock

The latest (weaker than expected) employment report from the US may offer Federal Reserve chair Janet Yellen a window of opportunity to move towards data-dependent (rather than time-dependent) monetary policy without inducing an immediate tightening of expectations. This could occur by playing down the second-quarter gross domestic product "rebound" and playing up the still below target inflation. From our perspective, however, this maintains the positive bias towards the USD against a group of major currencies that all have seemingly worse concerns ahead.

"In my chair..." — Status Quo

With the Scottish vote (GBP), "three arrows" (JPY and EUR), the possibility of negative rates (CHF), and the spectre of overvaluation (AUD, NZD and CAD) all weighing on major currencies, it might take a lot to knock the USD off its perch in FX.

-- Edited by Michael McKenna

Neil Staines is head of trading at The ECU Group


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