Markets Entering Into A Crucial Month

After much anticipation, Fed Chairman Bernanke finally delivered his speech in the Jackson Hole Symposium. Did he disappoint? Judging from the reactions in the markets, he didn't. The biggest reactions were firstly found in Treasurys where the 10-year yield dived to close at the week's low at 1.562%, down from prior week's 1.678% and compared with August's high of 1.863%. 30 year yield also tumbled to close at 2.684%, also at the week's low. That compared to prior week's close of 2.792% and August's high of 2.984%. Secondly, gold rebounded strongly to close at 1687.6, comparing to intraweek low of 1647.1. Both are clear reflection of intensified expectation of additional quantitative easing from Fed.

Stocks did rebound too but both Dow and S&P 500 were limited well below August's high, suggesting that investors might not be too convinced about the effect of another round of QE, and are hesitating ahead of an important month. In the currency markets, the weakness in USD/JPY was most apparent after Bernanke but kiwi and aussie were the weakest currency in the week as a whole.

Technically, the Dollar Index's development last week affirmed the case of medium-term reversal and raised the chance of falling back to 80 and below in the near-term. In other words, EUR/USD's rally will likely continue following broad based weakness in the greenback. But we'd tend to avoid European majors again based on the uncertainties ahead.

Meanwhile, further intensification of QE3, as triggered by economic data like ISM indices and NFP this week, should benefit the yen most. And based on recent weakness, should disappointing economic data pressures stocks, aussie and kiwi will be hit hard again. Indeed, the aussie is vulnerable to a gap down opening as China PMI manufacturing released on Saturday showed deeper than expected contraction at 49.2 in August. So overall, we'd continue last week's strategy in preferring to short AUD/JPY in the near-term.

September will be an important month to the markets considering the key events scheduled. Starting with US first. Bernanke didn't hint on when will Fed implement new stimulus program, and what to do in his speech Monetary Policy since the onset of the crisis in the Jackson Hole symposium. But he did somewhat set the stage.

He noted that there is "no net improvement in the unemployment rate since January." And, "unless the economy begins to grow more quickly than it has recently, the unemployment rate is likely to remain far above levels consistent with maximum employment for some time." And more importantly, Bernanke said that the "stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years."

"Grave concern" was cited by some analysts as the strongest word Bernanke has ever used regarding the dire situation in employment. Remember that in the minutes for August FOMC meeting, "many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery."

The overall situation makes this Friday's August payroll report even more important. Markets are expecting the US job market to grow 127k. And it's speculated that a sub-100k number will tremendously add the odds of Fed easing in the FOMC meeting on September 13. Also, Fed will release revised projections at Bernanke's post-meeting press conference.

There are also a number of key events in Europe in September. At this point, we're still facings the many questions. Will ECB restart the bond buying program? Will ECB target to cap yield, or in what form the bond buying would be? Will Spain apply for a sovereign bailout eventually. And, could Greece secure the next tranche of bailout fund and successfully seek extension to its fiscal adjustment program? Hopefully, we'll get clear answers this month.

The first key events in Europe will be this Thursday's ECB meeting. Expectations are high on Draghi to deliver the details of the prospective bond-buying program as he cancelled his trip to Jackson Hole Symposium for "heavy work load". In an article titled "The future of the euro: stability through change," Draghi pointed out that fulfilling the central bank's mandate "sometimes requires us to go beyond standard monetary policy tools." Current financial markets are "fragmented or influenced by irrational fears." And, that affect the transmission of ECB's monetary policy. He also said that such "blockages" need to be fixed to "ensure a single monetary policy and therefore price stability for all euro area citizens."

However, we'd like to point out again there have been talk that ECB could announce the program only after Germany Constitutional Court's ruling on legality of ESM on September 12. Meanwhile, ECB could cut the key interest rate by another 25bps to a new historical low of 0.50% this week. Then, after German court ruling, Eurogroup and finance ministers will meet on September 14/15.

Using EFSF/ESM to purchase bonds should be discussed there. There would also be discussion on Spain as well as on Greece. Talking about Greece, the Troika will deliver the final report on Greece's reform efforts. The report would be crucial in determining whether Greece could at least get some easing on program requirements ahead.