Nothing to fear but the euro itself
- Swedish rate cuts could signify regional weakness
- USD, GBP likely to outperform in near term
- Euro outlook grim on poor fundamentals
By Neil Staines
“Post-crisis uncertainty is more profound” — Stephen Poloz, Bank of Canada Governor
With November nearly upon us, a number of macro themes that seemed destined to last into year-end two months ago now have lost momentum and been replaced by uncertainty. Events, such as yesterday’s release of the European bank stress-test results, that were meant to bring confidence and remove uncertainty, appear to have done nothing of the sort.
As far as uncertainty is concerned, October still has a long way to go.
In reality, crystal balls actually distort things quite significantly. Photo: J. Lopez Pena \ iStock
With very little in the way of Eurozone economic releases over the next two days (following yesterday’s weaker-than-expected German Ifo survey), the market focus will likely fast-forward to tomorrow’s key events.
The first event, of course, is the October Federal Open Market Committee meeting. This conference is expected to herald the end of both tapering and quantitative easing purchases (as monthly purchases under the QE programme are tapered away to zero).
Even given this expectation however, it is important to note that accommodation will necessarily be reduced, as it is the stock of assets held which provides the stimulus, not the pace or quantity of purchases.
The second key event is the European Union's deadline for acceptance of the Eurozone budget plans. France, Italy, Austria, and others have been served letters from the EU asking them to clarify and/or explain their deficit-reduction programmes.
In assessing the implications and connotations of these two events, perhaps we should first look at the broader macroeconomic environment at this current juncture.
“There is nothing insignificant in this world. It all depends on the point of view” — Goethe
During this year's third quarter, the world seemed like a very different place. While there were perhaps concerns relating to the economic, political and inflation-related outlooks within the Eurozone, there was strong growth momentum in the US and UK.
Furthermore, the Reserve Bank of New Zealand had already embarked on the first stages of its monetary normalisation process. The theme of economic and monetary differentiation was evolving and, in many corners, confidence in the strength and breadth of the recovery was increasing.
Those were the days. Photo: Cynoclub \ iStock
From that point forward, the global economy (or "confidence" in the global economy) has taken a sharp turn for the worse. Eurozone growth prospects (at least in the near term) were all but eliminated by Germany's deterioration, which could possibly be deemed a technical recession following the Q3 gross domestic product release (which many European institutes have said could indicate stagnation).
A sharp decline in equities sent US policymakers running for the protection of further QE, and interest rate expectations across the globe were reined in by declining in oil prices and the growing plague of disinflation.
This morning’s action by the Swedish Riksbank is a case in point: the Riskbank cut interest rates more aggressively than expected, to zero, with a downward revision to the repo path and inflation forecasts. This move, of course, may well be indicative of weakness in the region.
Furthermore, the ECB announced yesterday that its latest stimulus sub-programme, covered bond purchases, drew just 1.7 billion euros worth of bonds last week. At this pace, it would take more than a decade to restore the ECB’s balance sheet back to 2012 levels (around one trillion euros higher than today).
“Nothing to fear but fear itself” — Franklin D. Roosevelt
In terms of our FX outlook, we maintain our viewpoint: USD and GBP should continue to outperform over coming months as economic gains rekindle the interest rate differentiation theme (at least returning to prior levels, following the recent "uncertainty" reversal).
In the US, the second step of monetary normalisation will likely be completed this week as the Federal Reserve halts its asset purchase programme.
While this may not have an immediate implication for US yields, the absence of a significant Treasuries buyer should allow the market to find its natural equilibrium more efficiently (in our view, two-year US yields below 40 basis points are too low given current US economic output).
The GDP data set for release later this week (following the announcement from the Fed) may well bring some confidence back to the US, and thus the USD.
Renewed confidence could prepare the dollar for liftoff. Photo: Saddako \ iStock
In the UK, we feel that there is a similar theme. Global uncertainty and lack of confidence (again weighed by the disinflationary impact of lower oil prices, which we see as a clear long-term economic positive) has led to a mixed performance by GBP.
However, GBP has outperformed the euro of late and we expect this theme to continue.
In the Eurozone, while the debate over national budget plans will likely be contained, it highlights the significant troubles that continue to face the region and, thus, the ongoing differentiation theme.
Uncertainty and caution are clearly warranted in some parts of the globe. However, we also believe that confidence and optimism are warranted in others. The next few days will seeFOMC, Bank of Japan and ECB policy meetings as well as US Q3 GDP and October payroll data.
This information may help separate the wheat from the chaff.
-- Edited by Michael McKenna
Neil Staines is head of trading at The ECU Group.