FUNDAMENTAL OUTLOOK at 0800 GMT (EDT +0400)
Risk appetite continued to recover overnight as hopes of a rescue package for the Eurozone continued to rise. It is apparent that several plans are in the pipeline, all of which involve some degree of leveraging up of the EFSF. The latest reports, according to CNBC, suggest that the EFSF will be able to capitalise a special purpose vehicle created by the European Investment Bank. How this would actually work remains in question, given the Eurozone itself does not have exclusive ownership of the EIB, though it does limit the impact of the ECB’s objections to expanding its own balance sheet. All these proposals appear to be in embryonic stages and while the sudden flurry of activity appears to have reassured markets, it could also build potential for even greater disappointment. We continue to see the Eurozone crisis weighing on risk materially, and given the lack of impetus for the Fed to move, the US dollar is likely to continue its broad-based rally..
EUR
We aggressively lowered our 1m and 3m EURUSD forecasts to 1.30 (prev. 1.35) and 1.20 (prev. 1.30) respectively. This reflects our belief that the Eurozone sovereign debt crisis is likely to escalate further, while investors continue to price in future rate cuts from the ECB in response to declining growth momentum. And all at a time when the Fed has declined to expand its balance sheet further.
Evidence is mounting that active discussions are taking place to find a way to boost the EFSF’s firepower through the use of some form of leverage. ECB Executive Board member Bini-Smaghi said that further policy initiatives that go beyond the July 21 EFSF agreement will likely be needed, and that discussions on the use of leverage are already underway. Intriguingly, Bini-Smaghi said that EFSF assets could eventually be used as ECB collateral. This contrasts with reports over recent days which suggested that the ECB might prefer to avoid getting directly involved in any new venture. German Finance Minister Schaeuble however said there is no plan to boost the EFSF.
Another report stated the EFSF would be used to capitalise an SPV created by the European Investment Bank. The SPV would then be allowed to issue bonds and use the proceeds to purchases the debt of sovereign states. In turn, the bonds can be used to participate in ECB liquidity tenders, rather than using the ECB’s balance sheet itself to purchase sovereign debt.
There were further signs too that the ECB could be preparing the way for a round of easing – either through rate cuts, liquidity provision, or both. Arguably, Bini-Smaghi arguably signalled the possibility of a rate cut, saying it is useful to have room to manoeuvre on rates – a reference to the fact that the ECB’s policy rate is currently 50 bp above the crisis low. However, ECB Governing Council member Mersch said wild expectations about ECB rate cuts show some people have lost direction.
ECB Governing Council member Nowotny said he sees “good reason” to expand the provision of ECB liquidity. ECB Governing Council member Liikanen reminded his audience that both 6m and 12m liquidity operations are still in the ECB’s toolbox.
Bundesbank President Weidmann said he expects to see robust German growth in Q3. However, he also warned again that the line between fiscal and monetary policy is being completely blurred and that this could erode public support for the euro.
The German IFO business climate measure for September came in at 107.5, better than expectations for 106.5. The current assessment was at 117.9, better than expectations for 118.1, and after 118.1 in August. Our European economist notes that the components will likely continue to slide in the coming months. However the steep drop from last month was probably exaggerated by very negative news from financial markets and is unlikely to continue at this accelerated pace.
Bloomberg reported that German Chancellor Merkel and Greek Prime Minister Papandreou are due to meet at 1800 GMT on Tuesday.
CHF
The SNB’s average sight deposits for the week ending Sept 23 declined slightly to CHF242.3 bn. Market speculation continues that the SNB may raise the exchange rate floor from 1.20. The SNB has in the past noted the current floor remains too low and the SNB quarterly report warned that Swiss economic activity may come to a halt in the second half the year. We raised our 1m and 3m USDCHF forecasts to 0.92 (prev. 0.89) and 1.00 (prev. 0.92) respectively.
JPY
Japanese Finance Minister Jun Azumi said Japan is ready to offer further support to the Eurozone, such as buying EFSF bonds, on condition that Europe makes efforts on its own first. He also stressed that a sharp rise in the yen would damage Japan’s economy though refused to comment on intervention.
Our 1m and 3m EURJPY forecasts fell to 100 and 90 respectively on the back of the EURUSD weakness we now expect to materialise over the coming months. Our USDJPY forecasts remain unchanged.
GBP
BoE MPC member Broadbent struck a dovish tone on Monday. He justified the bank’s previous tolerance of high inflation on the grounds that keeping CPI on target would have hurt the economy. He also claimed that more asset purchases would, even now, help the banking system and boost nominal growth. Although he voted not to launch another round of QE at the Sept. 8 policy meeting, he said that his decision was a reasonably close one..
Clearly mainstream opinion on the MPC is shifting in favour of MPC member Posen’s long-held belief that another round of QE is justified. As such, we maintain our bearish view on sterling, sharply lowering our 1m and 3m Cable forecasts to 1.51 (prev. 1.57) and 1.40 (prev. 1.51) respectively.
CAD
We raised our 1m and 3m USDCAD forecasts to 1.05 (prev. 1.00) and 1.10 (prev. 1.05) respectively.
We remain long a 3m USDCAD call spread with strikes at 1.0317 and 1.0969, for 1.8636% notional with spot at 1.0330.
TECHNICAL OUTLOOK
EURGBP 0.8632 support.
EURUSD BEARISH Fall through 1.3356, a Fibonacci level, would expose 1.3245. Near-term resistance is at 1.3601 ahead of 1.3797.
USDJPY BEARISH Key support is at 75.95; a break below which would open the way towards the psychological level of 75.00. Resistance is at 77.00.
GBPUSD BEARISH Initial support lies at 1.5433, a move below which would expose 1.5328. Resistance is at 1.5632.
USDCHF BULLISH Rise through 0.9183 would open 0.9340 next. Near-term support lies at 0.8928.
AUDUSD BEARISH Break below 0.9622 would open the key support of 0.9537. Resistance is at 0.9928.
USDCAD BULLISH Clearance of 1.0386 would signal extension of gains towards 1.0512. Support lies at 1.0052.
EURCHF BULLISH Focus is on 1.2346/1.2403 area. Break above this would expose 1.2646. Support lies at 1.2051.
EURGBP BEARISH Decline through 0.8632, a Fibonacci level, would expose 0.8596. Resistance is at 0.8772.
EURJPY BEARISH Move below 101.94 would open the way towards the psychological level of 100.00. Resistance is at 104.38.
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