Euro Stalls, What Is The ECB Up To?

Pianalto Supports More Easing Measures
GBP: Lifted by Dollar Weakness
CAD: Big Disappointment in Retail Sales
AUD: Sharp Decline in BHP Earnings
NZD: Trade Balance on Tap
JPY: Expected to Downgrade Economic Assessment

What is the ECB Up to?

The euro held on to its recent gains against the U.S. dollar as the rumors continue to flow out of Europe. First it was talk of a yield cap on peripheral sovereign bonds and now there’s speculation of a potential setback to the European Central Bank’s bond buying program.

Most of these reports have not been substantiated but this morning, ECB member Asmussen admitted that the bond-buying program is still being developed and will be addressed at next month’s monetary policy meeting. While the market is focused on what the Federal Reserve will do come September, the European Central Bank is preparing to take additional steps to fortify the Eurozone economy.

The euro recovered smartly from its July lows thanks to the rally in global equities and decline in Spanish and Italian bond yields. Volatility in the FX markets has declined significantly in recent weeks but with growth in the region slowing and a number of Eurozone countries falling back into recession, the central bank still needs to work hand in hand with European governments to bring an end to the region’s debt crisis.

There is no question that the ECB is up to something big and it will be announced in September or October. When the central bank last met at the beginning of this month, President Draghi spent a lot of time talking about a new “framework” for open market operations. He said the details of the intervention in the bond market will be developed in the coming weeks and will provide “full transparency” on the countries involved and the size of the bond purchases.

Mario Draghi made it a point to say that intervening in the bond market to buy short term bonds “falls squarely in our mandate.” According to a story released by Bloomberg News on Friday, the ECB may not have this plan prepared in time for the September meeting but comments from Asmussen suggests otherwise. Either way, the ECB is coming to the rescue. If the central bank unveils the details for their new program next week, investors will most likely take the EUR/USD higher in approval because buying bonds reduces the risk premia in short term yields and the potential of more funding troubles.

The decline in the German IFO report indicates that businesses in the Eurozone’s largest economy have not been encouraged by the recent stabilization in the financial markets. German business confidence dropped to 102.3 to 103.2. While their assessment of current conditions improved, they became less optimistic about the future economic outlook.

USD: Pianalto Supports More Easing Measures

The U.S. dollar strengthened slightly against the Japanese yen and commodity currencies but held steady against European currencies. With no major U.S. economic data on the calendar yesterday, it was quiet during the North American trading session. The Dallas Fed manufacturing index was the only piece of U.S. data released and according to the report, manufacturing activity improved dramatically in the month of August, with the index coming close to turning positive this month.

Ben Bernanke’s annual speech at the Jackson Hole Summit on Friday is the main focus for U.S. dollar traders this week. We published an extensive piece talking about why the Jackson Hole Summit is important and we encourage everyone to read this piece.

Investors are desperately trying to figure out where the Federal Reserve stands on monetary policy. According to Fed President Pianalto, who is a voting member of the FOMC this year, bond buying could boost GDP if the risks are managed properly. This indicates that certain members of the central bank still support easier monetary policy despite improvements in the economy.

Recent developments have investors thoroughly confused about where the central bank stands on monetary policy. The minutes from the most recent monetary policy meeting revealed that the Federal Reserve was much closer to easing monetary policy than most people had anticipated and as a result, the dollar sold off aggressively. However confusion was created by the latest economic reports that showed stronger job growth and consumer spending.

While it may be clear that the Fed is disappointed by the recovery in the U.S. economy, the central question at hand is whether the FOMC minutes appropriately reflects their current views. If the dovish tone of the minutes turns out to be stale, then the dollar could recover quickly. Consumer confidence, House Prices and the Richmond Fed index are scheduled for release on Tuesday. We expect confidence to be lifted by the recent improvements in U.S. data and rise in equities.

GBP: Housing Market Continues to Struggle Despite Low Rates

The British pound ended the North American trading session unchanged against the U.S. dollar and euro. Yesterday was a bank holiday in the U.K., which means there was no data in the calendar. On Sunday, house price data were released by Hometrack and according to the report house prices are forecasted to decline during the rest of the year as supply outpaces demand. The housing market remains under pressure as the economy struggles to recover from a recession and the effects of the Eurozone crisis straying in onto other nations.

Despite low interest rates, Hometrack’s Director of Research Richard Donnell said the housing market remains in a fragile state. A survey by Rightmove showed that house prices declined by 2.4% the fastest pace ever seen for a month. The Bank of England is assessing the impact of their new plan to boost credit as they ponder whether to expand stimulus through quantitative easing.

Although some disagree on further QE, BoE Chief Economists Spencer Dale defends it saying, “Our economy today would be in a far worse state without QE and a bank rate at 0.5%. The recession would have been even deeper, the rise in unemployment even greater.” He says the purpose of the monetary policy is to stimulate the economy to return to stable growth, low inflation and a “more normal level of interest rates.” No major economic reports are scheduled for release from the U.K. on Tuesday.

AUD: Falls to 1 Month Low

The Australian and New Zealand dollars weakened against the greenback yesterday while the Canadian dollar strengthened. The Aussie slid to its lowest level in a month after China, its largest trade partner reported that industrial profits declined 2.7% in July.

This was the fourth month in a row that profits fell. Chinese Premier Wen Jiabao said difficulties in stabilizing the economy is “relatively large” and called for measures to promote export growth to help meet the country’s annual economic targets. BHP Billiton (BHP.AX) expects “long-term” prices of commodities to decline as the faltering economic expansion in China hinders global demand.

Reserve Bank of Australia Governor Glenn Stevens is optimistic about the mining boom in Australia but said it will peak within the next year or two. Along those lines, he added that the RBA is, “prepared to respond to significant deviations from the central outlook, to the extent that it is prudent and possible to do so, within the framework that aims to foster sustainable growth and inflation at 2-3% over time.”

JPY: Expected to Downgrade Economic Assessment

It was a mixed day for the Japanese Yen, which weakened against the U.S. and Canadian dollars, held steady against European currencies and lost ground against the Australian and New Zealand dollars. There was no data out of Japan. China’s industrial profits dropped in July and Chinese Premier Wen Jiabao said his nation needs to do more to support exports which hit the Yen crosses. If demand from China slows, Japan’s recovery could suffer. Bank of Japan Governor Masaaki Shirakawa said on Friday that “chronic” upward pressure on the yen is placing downward pressures on the economy. The BOJ is keeping rates near zero as it tries to stimulate the world’s third-largest economy. The Japanese government is expected to downgrade its assessment of its economy for the first time in 10 months in a monthly report released by the Cabinet Office tomorrow.