- Fed stays on hold but strengthens the easing bias.
- Market reacted slightly disappointed after Fed’s announcement and US stock markets closed with losses.
- Focus today on ECB meeting. It remains relatively unclear what the ECB intends to do but unless today’s policy response is substantial, there is a risk of disappointment. See ECB Preview: Show us the “full Monti”, 1 August.
Marke ts Overnight
The Fed kept its monetary policy unchanged but signalled a clearer easing bias saying that “The Committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed”. The statement was in line with our expectations and supports our view that the Fed will add
more stimulus at the 13 September meeting in terms of QE3 and extending the “exceptionally low rates” language into mid-2015. See Flash Comment: US - Fed preparing to ease in September, 1 August, for further details.
The Greek government reached an agreement on EUR11.5bn of budget cuts last nightafter Pasok leader, Evangelos Veniselos, revoked his request for an two-year extension for implementation. Negotiations with the Troika start today and the Troika will conduct its final review in September ahead of disbursement of the next EUR31.2bn loan tranche.
Markets reacted slightly disappointed after Fed’s policy announcement as some investors clearly had expected more. US equity markets declined, reversing earlier gains and both S&P 500 and Dow Jones Industrial Average closed 0.3% lower. However, sentiment has been more mixed in the Asian trading session ahead of today’s ECB meeting with Nikkei and Topix showing small gains, while Hang Seng is down by 0.7%.
US bond yields are unchanged from yesterday when the 2-year and 10-year yield rose 3bp to 0.235% and 1.52%. The 10-year Italian yield fell another 10bp yesterday to 5.9% on expectations of ECB action today, while the 10-year Spanish yield was broadly unchanged ahead of today’s government bond auction.
In FX markets EUR/USD dropped to this week’s lowest level at 1.2217 after Fed’s announcement, while USD/JPY rose 0.5% to 78.50 after IMF once again said that the yen is moderately overvalued.
Today there are no important data release before the ECB press conference and markets are likely to trade mostly sideways as we wait and see what the ECB will do.
Global Daily
Focus today: All eyes will be on the ECB today. Judging from the “Believe me, it will be enough” comment last week by ECB president Mario Draghi, we should see a crisis response and it should be substantial, see ECB Preview: Show us the “full Monti”, 1 August. ECB might not be able to deliver anything specific already today, as it needs more time to coordinate with the EFSF, Spain and Italy. In addition, there are indications
that Draghi did not secure backing among the other board members for last week’s comments. Reactivation of the SMP bond purchase programme, another long LTRO or even another rate cut are all possibilities but there is a risk that markets will be disappointed.
Bank of England (BoE) will also meet today. In line with consensus we expect BoE to keep both base rate and the target for its asset purchases. At the current juncture BoE needs more time to evaluate the impact from its funding for lending programme announced at its previous meeting before it decides on any additional easing.
Ahead of today’s ECB meeting there will be focus on Spain’s auction of government bonds with 2014, 2016 and 2022 maturities. In addition, Italian prime minister Mario Monti is scheduled to meet his Spanish counterpart Mariano Rajoy this afternoon in his attempt to create a consensus for a more forceful policy response to secure backing for a more forceful policy response in the Eurozone.
Fixed income markets: With the numerous possible outcomes of the ECB meeting, it is relatively hard to forecast the market reaction. Our general take is that expectations are probably not as exuberated as generally anticipated but that the ECB still has to make a relatively bold move to keep the market in check. We do not believe that a 25bp standalone combined refi and deposit rate cut would be enough, although it would certainly be a surprise. The EONIA curve is only discounting around 10% probability of a cut in the deposit rate to -0.25%. Hence, this would push the EONIA curve lower.
As focus is on the sovereign funding cost in Spain and Italy, we believe that the ECB has to deliver either credible signals of direct intervention in the sovereign bond market or a combination of several other indirect measures (e.g. combined 3Y+LTRO, rate cut and easing collateral requirements) to satisfy the market. Otherwise we fear of a disappointment, which will could spark another round of pressure on Italy/Spain and renewed flow into safe fixed income markets.
FX markets: EUR/USD dropped to this week’s lowest level at 1.2217 after Fed announced that it decided to stay on hold. With all eyes on the ECB today, FX markets are likely to trade mostly sideways until the ECB press conference. However, if ECB disappoints we could see EUR/USD back testing 1.20, while the effect on EUR/USD in case of a strong ECB response depends on which tool will be used. Government bond
purchases by the European bailout fund and the ECB should be euro positive via reduced sovereign credit risks, while the effect would be less clear-cut euro positive when coupled with a rate cut.
USD/JPY rose 0.5% to 78.50 as intervention fears re-emerged after IMF once again said that the yen is moderately overvalued.
Scandi Daily
If the ECB, contrary to our expectations, cuts the refinancing rate by 25bp, the Danish central bank is likely to deliver a 20bp rate cut in the lending rate, currently at 0.20%. This implies that Danmarks Nationalbank in the future would be willing to lend at the same rate at which banks currently can place money at. The Danish deposit rate is already negative at -0.20% and will probably only be reduced further if currency inflow picks up, if EUR/DKK goes lower or if the ECB cuts its deposit rate below zero. None of this is currently on the cards.
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