Uncertainty over economic growth and euro drive wild market moves

Tom Tong15/Αυγ/2011Currency Updates

Risky assets ended the week down again, but the relatively subdued weekly moves contrast with the tremendous volatility experienced on daily trading.  Equities worldwide experienced moves in the order of 5% every day last week except Friday. Once again, headlines from policymakers drove market moves. Central banks in the developed world are increasingly concerned with the outlook, and their decisions last week were almost uniformly dovish and supportive of risk assets. The ECB reversed itself and bought significant amounts of Spanish and Italian bonds; the Federal Reserve struck a pessimistic note on US prospects and ratcheted up its monetary easing by announcing that it intends to hold interest rates at zero at least through 2013. The Swiss National Bank stated that it is considering all measures to stop the relentless appreciation of the franc, including further monetary easing and pegging it to the euro and the Norges Bank kept rates steady against expectations, blaming the increasingly negative global backdrop. Monetary policy is clearly entering the domain of diminishing returns, as these strongly dovish actions and statements were insufficient to prevent another negative weekly close in equities worldwide; they did, however, close well off their worst levels of the week. FX markets were relatively subdued amid all this volatility, with the glaring exception of the Swiss franc, which experienced possibly its most violent swings in history: its five day annualized volatility spiked to over 60% – an unheard of level – driven upwards by the panicky search for a safe haven and downwards over fears of renewed SNB action to stop the appreciation.


Obviously the week in the UK was dominated by the outbreak of riots. While it is hard to gauge their immediate impact on the economy, we expect the GFK consumer confidence data to be released at the end of the month to take a serious tumble. Together with the general weakening in global sentiment and the fall in equity markets, this does not bode well for faltering UK domestic demand in the third quarter. The inflation report and press conference was also dovish, as expected. In addition to revising the medium term forecast for inflation down by half a percentage point, Mervin King sounded a distinctively downbeat tone in the first conference. Interest rate hikes are off the agenda, and the question is now whether and when to expand quantitative easing. Sterling maintained a weak tone all week, closing down 0.6% against both the euro and the dollar.


The euro ended the week essentially where it begun against the dollar, but this belies a tumultuous week of trading. The ECB finally stepped into the breach left by the failure of Euro Governments to ratify the new agreement and increase the firepower of the bailouts facility, the EFSF. Its sizable purchases of Spanish and Italian bonds brought down these sovereigns’ 10 year yields by over 100 basis points. However, equity markets remained unsettled and hugely volatile all week, weighed down by rumours of troubles at French banks, later dispelled. Macroeconomic news out of Euroland continue to surprise to the downside; French GDP growth came in flat vs. expectations of 1.3% QoQ saar, on softer consumer spending. The tendency of consumers to retrench is emerging as a common risk factor across industrialized economies. The key driver for the common currency over the short term will be whether euro officials agree to expand significantly the EFSF, the current firepower of which is insufficient to handle a rescue of Spain or Italy, and whether the ECB is patient enough to continue buying those countries’ bonds until that happens.


While US macroeconomic news has tended to come in somewhat above the dismal expectations, the dollar has failed to capitalize on the generalized flight-to-safety and ended the week more or less unchanged in trade-weighted terms. Investors are dismissing this better than expected news and expect that consumer and business confidence in the coming weeks will be severely dented by the debt ceiling spectacle. The Michigan consumer confidence survey out on Friday provided support for this gloomy view, coming in at its lowest level in decades, providing further evidence of a sustained retrenchment in consumer spending. The Federal Reserve is no less gloomy on US prospects, and indicated that it is ready to continue expanding its portfolio of unconventional monetary tools; it announced that it intends to hold interest rates near zero until at least 2013, something it has never done before. While the decision had three dissenters, it is clear that Chairman Bernanke continues to dominate the discourse at the Fed, and this means exceptional monetary accommodation for the foreseeable future.


Written by Tom Tong

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