Don’t fight the Fed, urges J.P. Morgan Private Bank in currency forecast
J.P. Morgan Private bank has given its latest weekly thoughts on currency markets, including a warning to currency investors not to fight the Federal Reserve when making bets.
With the US election looming it seems natural for the FOMC to leave its interest rate policy statement broadly unchanged. The US fiscal cliff debate will be back on the agenda by November 7th at the latest. We now look to the minutes for further colour on how the Fed will handle the expiry of Operation Twist in December. Nothing really has changed. The statement made by the Fed was clear; policy is locked in a mode of continuous monetization of government debt, buying $40bn per month of Mortgage Backed Securities, and still pledging to do more if they deem it necessary. That is the path that the Fed will follow for a long time (extremely low interest rates until mid-2015). Because of the Fed’s pledge to maintain this policy for a “considerable time after the economic recovery strengthens, there is good reason to expect that the monthly economic releases will have a diminished ability to affect market pricing of Fed policy. One question that remains unanswered is the longevity of this policy particularly if Bernanke is not reappointed after his term expires in January 2014.
Japan: USDJPY finds bid again
Repeated threats of currency intervention by the Japanese finance ministry have pretty much kept speculators at bay and stopped Yen appreciation in its tracks. In fact, over the last month the Yen has depreciated by some 3% vs. the USD. This recent weakness has been attributable to two factors that will shape the path of markets in the near future. The first of which is improving US data and the possibility of a Republican victory in the upcoming US Presidential elections. 10yr interest rate differentials have widened by 100 basis points in favour of the US. The second factor is a potentially increased risk of additional monetary expansion by the Bank of Japan after another weak manufacturing Tankan survey. The next BOJ meeting is on the 30th of October; where 10 trillion Yen of expansion is expected. The net effect has been a contraction of implied volatility, currently at its lowest levels since December 2007. It’s as if the European financial crisis never happened. Looking forward, there are still potential events risks on the horizon including the US elections and the US fiscal cliff, growing tensions between Japan and China and a weakening eurozone economy. Despite the pace of outward M&A activity picking up recently, we see a continuation of range-bound trading in USD/JPY.
UK & Europe: Sterling shines but…
The longest double dip recession in the UK since the Second World War has come to an end following last week’s positive GDP data. The economy grew by 1 per cent between July and September after shrinking for the previous nine months this year. Government borrowing, unemployment, jobs and inflation all seemed to be heading in the right direction, at least for now. However the UK Chancellor, George Osborne, warned that Britain still faced “risks” from the eurozone crisis and instability elsewhere. Moreover, in contrast to the US Federal Reserve’s re-affirmation of its commitment to QE, it is now less likely that the Bank of England will continue to print money (currently £375bn). Sterling has found a welcome boost from the news and is very much supported at current levels. Notably this emergence of green shoots in the UK has come at a time when the eurozone economy is struggling. Moreover, Germany’s central bank, the Bundesbank, warned that the German economy could shrink in Q4. In France, manufacturer confidence is at a two year low. The Spanish economy contracted for a fifth quarter in a row at 0.4% and unemployment hit a record 25%. Mario Draghi however defended the ECB’s bond buying programme, saying the Outright Monetary Transactions (OMT) provide a fully credible backstop.