FRS and rates: we don't need a war if we have exercises

Will not be any rate increase in December without clear acceleration of the US economy
Last week was oversaturated with fundamental data, and therefore, active speculators has enough opportunities for making money. In general, the market stays suspended, there are still no clear signals. And again, we will dream about the goals of FRS/ECB, digging in the official reports from the both sides of the Atlantic. As it was expected, FRS rates remained on the previous levels. In general, the statement contained two main dimensions:

  • The wording with regard to global risks was removed;
  • The tone regarding 2% inflation was changed - a required condition for rate increase - it became the condition for assessing the situation.

Currency market produced the identical response to dollar growth, and stock market has long fluctuated; however, it went up in the result. Futures grew up on FRS rate increase in December; however, they are still below those desired by FRS members - 50%. December 16 will be the last chance; however, an opinion is rising among analysts that we will not see a miracle this year. The fears of the consequences of the wrong decision may be stronger than possible loss of face and breach of promise. In any case, the market is getting ready for the pre-New Year's rally, whose direction must be shown by FRS. That is why any American statistics is recommended to be examined under a microscope, especially the information regarding labor market, inflation, industrial production, as well as adjustments of previous data towards wanted goals favored in the USA.

It will be useful to study the FRS Protocol that will be published on November 18; however, it is becoming clear even now that there will not be any rate increase in December without clear acceleration of the US economy. Weakening of dollar may produce a temporary effect for improvement of indicators; until November 18, dollar, in most cases, will be prone to growth; that's why we should expect reassessment of FRS "forward guidance" and possible fixation of profit. All the published European statistics has already been taken into consideration in the current prices. Draghi's speeches in non-market time are becoming a bad habit. The market becomes nervous while analyzing the interview even if comments, in general, are in the same tone of what was said previously. The regulator realizes that before the beginning of 2016, inflation in the euro zone will not exceed zero level and that it is still too far to the key 2% CPI. Although, it is possible to remind ourselves that in case of conflict of reality with plans developed, ECB will launch new stimulus measures for EUR sales.

It is an interesting moment - Constancio and Noyer from ECB Board spoke the other day. They expressed the opinion that sovereign bonds as a part of assets of European banks are capable of "wiping" trillions of euros off their common capital. The share of the national debt as a part of papers held by any bank is, maximum, 25%, and European banks have a large number of such assets, i.e. now, large amounts are tied up and produce practically no profit (in case of negative real rates). In case of inflation that is close to negative, sovereign bonds are a burden. Banks will be forced either to dump papers in the amount of, as least, 1.6 trn euros or they will need new additional capitalization in the amount of 6 trn euros. That proves once again that European QE was designed for financial purging of assets. Banks always consider bonds as safe assets that are more comfortable to keep than money; however, if banks are forced to get rid of bonds now, only real "trash" will go. However, there is another side to that: CB has the right to purchase papers only with yield not below -0.2% but only around 4% of the total number of kept Eurozone's bonds (with the term of 30 years) are traded with lower yield. That means that ECB will not be able to buy anything soon. In the result: we should not expect the decrease of deposit rate, and expansion of QE in the area of state treasury bills purchases is doubted, possible expansion will be maximum by 5-10 bln euros partially at the expense of state treasury bills and partially at the expense of corporate bonds. The market has already been anticipating more; therefore, we should expect reaching bottom in EUR/USD in November before growth.

Let's note some more useful points:
  1. Greece may cost Europe much cheaper: by the results of the new session of stress tests made for Greek banks, the third package of aid for recapitalization may be reduced to 14 bln euros. In general, the nearest future is seen as dim. Employment situation is catastrophic: general - 28%, youth (under 25) - 50%. Due to long-term problems, such total unemployment has produced some type of self-support - people got out of habit to work. A new stage of unpopular measures is coming, which the new government is trying to pull through the Parliament. It has been unfruitful so far.
  2. A new wave of rating threats: Standard & Poor's places the ratings of holding companies with regard to eight American systemic important banks into the Credit Watch list with a negative forecast. That, in particular, relates to JP Morgan Chase, Bank of America, Citigroup, Morgan Stanley. It is believed that in case of problems, the probability of supporting these giants by the US government is very low. Besides, Britain may lose its AAA rating in S&P, if it leaves the European Union.
  3. Pound satisfied with a strong positive report: its growth has been registered practically in all indicators, including employment and export orders. Presently, purchases of GBP/USD have reduced; however the growing momentum is still in force.
  4. Large carry trade clients of Asian banks continue to buy the currencies of developing countries (China, India, Mexico) for euro expecting the expansion of monetary stimulation by ECB.

Euro: American GDP data have not satisfied dollar, and that is why EUR/USD has gone into active adjustment, but the upcoming week may bring this pair to a decrease. The price is trying to consolidate over the psychological barrier 1.100, the reliable way out upward is possible only in case of penetration 1.1134-1.1171, intraday support has been at 1.1007-1.0971. The fall down levels are protected with options at 1.0883-1.0727.

Yen: Strong resistance in the area 120.44 remains relevant, and a little above it - a strong mid-term barrier 121.01-121.30. Strong intraday support 119.42. Potential target below - 118.67. We can expect continuation of growth and another following testing of resistance 121.75.

Author: Navsher Bartash,
ForexChief Currency strategist