7th of October 2011 - Fundamental Forex Market Overview

DAILY MARKET COMMENTARY
7 October 2011 – 8:00 GMT
Friday

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Market Analysis Desk
Foreign Exchange Research: www.fibosignals.com/5585/resources.html
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FUNDAMENTAL ANALYSIS at 0800 GMT

USD
Risk sentiment improved further in Asia on signs officials are becoming more focused in tackling Europe's debt crisis and after the ECB said it will provide markets with additional liquidity. While keeping rates on hold, the ECB announced its intention to restart the covered bond purchase program and to re-instate 1y tenders to provide Eurozone banks with longer-term access to unlimited euro liquidity over the end of 2011 and of 2012. As the ECB's liquidity measures do not lead to currency debasement and President Trichet did not indicate an impending rate cut, the latest policy moves are supportive of both European stock markets and the euro. Thus yesterday's events also bolster the prospect of renewed net inflows to the Eurozone, to the benefit of the euro. Officials are also becoming increasingly focused on supporting the banking sector. German Chancellor Merkel again stressed yesterday that she takes the advice that banks need more capital very seriously and that one should not hesitate if the time comes to recapitalize them. The Bank of Japan left rates unchanged today, in line with market expectations. US stocks closed higher yesterday, with the S&P 500 up by 1.83%. In Asia the Nikkei added 1.5%. EURUSD traded 1.3404-1.3428 and USDJPY 76.62-76.76. Investor focus will now turn to the release of US non-farm payrolls.

EUR
The ECB kept rates unchanged at 1.5% and again stressed that inflation has been elevated of late while risks to the outlook are broadly balanced. At the same time Trichet again highlighted increased downside risks to growth. Altogether the rhetoric was not much more dovish than the last policy meeting, and Trichet did not indicate a rate cut at the next meeting, which will be chaired by his successor, Bank of Italy Governor Draghi. Indeed, growth momentum is likely to stabilize by the end of the year, not only on the back of seasonal factors, but also due to the high likelihood that demand conditions will improve on more constructive labour markets in large Eurozone member states such as Germany. Medium-term inflation expectations are therefore unlikely to drop considerably in the short term, supporting the notion of stable interest rates for now. Trichet highlighted that non-standard measures will be used to ease market stress.

Given the additional liquidity measures, no un-sterilized action, and stable rate expectations, European risk assets are likely also to become more attractive to foreign investors. Alongside some re-pricing of risk in the banking sector as officials take a more aggressive stance on the debt crisis, this supports the scope for renewed net inflows to the Eurozone, to the benefit of risk and the euro.

European Commission President Barroso said the Commission would propose coordinated action by member states to recapitalize banks. A consensus appears to be developing around a three-step approach whereby banks would first attempt to raise capital privately. If that fails, injections of government money could be considered. Finally recourse could also be made to the EFSF once the ratification of the July 21 agreement (which authorises the EFSF to fund bank recapitalizations) is complete.
GBP
The Bank of England left rates unchanged at 0.5% but they expanded the QE programme by GBP 75bn to GBP 275bn. According to the central bank there are severe strains in the funding market. In addition it was highlighted that the margin of slack has increased in the economy and that the deterioration in the inflation outlook made it more likely that inflation will undershoot in the medium term. The aim is to take four months to complete the planned asset purchases.

In an unusual move, Governor King was interviewed on national television and described the decision to do more QE as "pre-emptive", adding that he could not rule out doing even more QE. We note that when the Bank first embarked on QE in March 2009, a figure of GBP75 bn was also targeted initially, however further incremental increases eventually took the program size up to GBP200 bn. King denied suggestions that the QE decision raises the risk of a currency war, and also refuted the claim that the government had put pressure on the bank.

CHF
Swiss FX Reserves rose to CHF 282.352bn in September from 253.4bn in August. As this is the first release that covered data till end of September it is the first indication of intervention costs. However, data is still distorted as a large volume of FX swaps have yet to mature.

CPI in September rose 0.5% y/y, slightly above market expectations for a 0.3% rise. However the latest data does not impact the SNB's stance with respect to keeping the price floor intact. This is especially true as most recent releases of forward looking indicators such as the Kof leading indicator or PMIs are pointing to further weakening growth momentum and hence muted price risk.

JPY
The BoJ kept monetary policy unchanged and did not announce any new measures to support the economy. The central bank expects the economy to resume moderate growth. It also said that overseas growth is expected to slow, which may pose additional risks to domestic growth conditions.


A. White
Analyst at Fibosignals.com


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