October: calm before winter storm

Within 12 months, global sales of US bonds have reached 123 billion dollars
The first non-speculative week has been gradually setting goals for the period until the end of the year. In general, the market has come to the conclusion that FRS has added one more problem to its regular two - global risks. Considering distrust to inflation and confirmation of exports decline in September, speculators have happily sold US dollar, since, at least, until FRS December meeting, we shouldn't expect any rate increase. Quite grey FOMC protocols were inefficient for both mass media and quotes movement. Let's recall that quantitative easing was organized for budget replenishment, and while the budget lacks funds, QE (at least in small volumes) must continue. No attempts of redemption of "long" securities instead of "short" ones, zero loans for "too large" ones, and regular redemption of securities with newly printed money have not been able to free the Treasury from its strict ration. Money can be returned to the system only via banks (redemption of state and private securities both as a pledge and for following cancellation); however, presently, easing has been officially stopped and the course towards rate increase has remained.

For the last year, 5 largest buyers of American treasury papers - China, Russia, Norway, Brazil, Taiwan - have been getting rid of them with record-breaking speed (especially China), within 12 months, global sales of US bonds have reached 123 billion dollars. However, every commodity has a buyer - companies, funds, individuals, third world countries, for instance, for the same period of time India has purchased 36.6 billion worth of treasuries. Now, if treasury bonds eventually get out of control due to their sales, FRS will have to buy everything that China and Europe want to sell in order to retain yield on low level. In such circumstances, rates can be increased only in case of complete normalization of the following conditions:

  • Investors must keep on buying American debt;
  • China will stop its manipulations with the currency rate and sale of gold and foreign currency reserves;
  • The global market, especially developing, will begin to stabilize.

We would like to note two more events that passed quite unnoticed, but will certainly influence the global market in the nearest future:

  1. Problems in Deutsche Bank that resemble the situation before the Lehman Brothers collapsed. As early as at the beginning of ramble with VW, it was clear that Deutsche Bank will be one of the most affected. On October 7, the bank announced about many billions worth of losses and a number of other negative factors. The bank is experiencing serious problems with liquidity. It will have some legal expenditures worth of about 1.2 bln euros, and a fine for manipulation of Libor rate in the amount of 2.1 bln euros. It is planned to reduce (or completely stop) payment of dividends; shares showed 6% decline; in June 2015, S&P lowered the bank's rating to BBB+. The volume of Deutsche Bank's open positions in PFI is USD 75 trn, which is 20 times more than the German GDP volume. That negative was thoroughly veiled, but the consequences for the German economy can become a local catastrophe.
  2. The largest trade agreement Trans-Pacific Partnership, TPP, has been established, which includes the USA and 11 Pacific Ocean states. This trade agreement has already been signed, but has to be ratified by the legislative bodies of the respective countries. The Partnership will take more than 40% of the global trade under its control and plans to abolish more than 18 thousand of various taxes in member countries. The redivision of the largest players' Asian interests is at hand.

In the midst of investors' doubts regarding rate increase this year, hedge funds, for one week until October 6, reduced the number of net long positions in dollars in all assets to the minimum level of the previous year. Euro had a good growth in the midst of anti-risk sentiments; however, in the nearest future, the situation must change against the background of weak economic growth and pressure on the members of the ECB Governing Council. The numbers of European statistics reduce the probability of stimulation measures on the part of ECB; however, no one puts off Central Bank's verbal interventions.

Here is the technical forecast regarding euro: the probability of abrupt surges is unlikely this week, since when leaving the range of 1.1477/1.1460/1.1400 - 1.1350/1.1315/1.1261 there will be too little positive for active growth, and not enough interest for sales - for decline. Let's study the statistics carefully, listen to the fundamentals; however, in general, a decline looks more preferable by the end of this week.

Author: Lachlan Patel,
ForexChief Currency strategist