Scattered markets can't find focus
- Sentiment shifts to risk-on mode on news of Opec deal
- Banking sector under scrutiny in Europe
- Oil price direction key for risky asset performance
By Neil Staines
“It is in change that things find rest” — Heraclitus
Earlier this week we wrote of the nascent global transition towards fiscal policy and away from increasingly ineffective (and increasingly questioned) monetary expansions. With a limited array of data this week, there has been much time for the market to ponder this evolution. In the meantime, risk appetite has played the dominant role in market positioning and direction.
In the first half of the week, market sentiment was heavily weighted towards risk aversion. Concern over the capital adequacy of the European banks and banking system (Germany and Italy in particular) drove equities and risk assets lower, credit spreads wider, and bond yields lower and flatter – a move that was marginally offset by better service sector activity and a strong bounce in consumer confidence in the US
In Europe, where national governments have singularly failed to recapitalise their banking systems in the way the UK and the US did relatively early into the financial crisis, tremors have arguably always been been lurking around the corner. As we go into new uncharted waters, with banks being forced to raise new TLAC and MREL (total loss absorbing capacity and minimum required eligible liabilities), the opacity of bank balance sheets and valuations adds further uncertainty.
While the data calendar has been thin, the US data that we have seen this week have beaten expectations. However, it was not until last night’s announcement of a production freeze from Opec that risk assets, yields and commodity currencies took some respite.
Ultimately we are still of the view that global economic stimulus will increasingly become dominated (in some cases by default and not design as the efficacy of further monetary accommodation diminishes) by fiscal stimulus and structural reform. Furthermore, as this evolves we would expect the nascent recovery in growth and inflation to accelerate, and thus still believe that we are in the process of bottoming out of global yields (likely led by the US), both in terms of absolute levels and curve steepening.
This should be supportive of the USD (particularly against the JPY we feel) and also for GBP, ceteris paribus.
“You must do the thing you think you cannot do” — Eleanor Roosevelt
Federal Reserve chair Janet Yellen’s testimony to the House Financial Committee yesterday offered a couple of interesting reiterations. She maintained the view that wage growth has “increased a little bit”, that the jobless rate is “close to full employment” and expected to fall further and ultimately that the Fed would “gradually remove accommodation on the economy’s current course”.
Yellen, while maintaining the mantra that the Fed is apolitical, was also clear in stating that an easier fiscal backdrop would heighten prospects of rate hikes
For European Central Bank president Mario Draghi, who has urged Eurozone governments to enact "growth-friendly" structural reforms pretty much since his infamous “whatever it takes” proclamation (and more recently urging surplus nations to pursue easier fiscal backdrops) there must be relief and frustration in equal measure, that the debate is finally becoming more audible.
Though it was interesting to note the comments of former chancellor of the exchequer George Osborne on this matter, who said that it was not the political will that was the major hurdle in large infrastructure projects (such as HS2 and airport expansion projects), but rather planning, regulation, and NIMBYism.
“I focus on one thing and one thing only” — Kobe Bryant
For the rest of the week there will be a number of key focal points. Most imminently, there is the progression of the oil price (and more broadly global risk appetite) following on from the Opec decision. Details of the production freeze will not be determined (or released) until November so any participant comments will be closely watched for signs of commitment.
This afternoon’s revision to the Q2 GDP data will be less relevant (note Q3 is due for release October 28), however markets will be attentive to the PCE release on Friday as a gauge of progress in the Fed’s preferred measure of inflation.
The resultant impact of both risk sentiment and PCE data will see US bond markets dominate broader financial markets and FX in particular. Should US yields and risk sentiment hold up as we would anticipate (and noting the sharp net selling of JPY assets in last weeks portfolio flow data), the overnight bounce in USDJPY could well be the start of a more pronounced move higher.
— Edited by Michael McKenna
Neil Staines is head of trading at The ECU Group