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Risk managers buying the rumour and selling the fact
Publication date: 19 September 2012
Author: Michael Derks, FxPro
Tagged with: Michael Derks
The first half of this week has been another fine example of that old trading adage which implores risk managers to ‘buy the rumour and sell the fact’. In this instance, the rumour and fact are the recent steps by both the ECB and the Fed to engage in additional and unconstrained balance sheet-expansion. How much further this corrective price action extends is obviously the burning question. In coming weeks, more monetary firepower will be unleashed by the major central banks, with the BoJ committing to further asset purchases overnight, China is likely to ease further and the BoE potentially implementing more QE this side of Christmas. As such, after a decent few weeks for risk assets and currencies, some consolidation and profit-taking was to be expected. For the single currency, the pull-back has been relatively minor, which could well imply that there is serious buying interest just below. As we have been implying recently, there are a lot of potential forced buyers of euros around at present, which implies that any pullbacks will be shallow. Much the same can be said for equities, where investors are also structurally short – if central banks are making it clear that they will print money until the economy delivers sustainable growth, it is as though they are putting a floor under the market. Quite simply, if the economy is weak and jobs growth stalls, then the central banks will keep the printing presses running. Interestingly, the favourite high-beta currency for many traders, the Aussie, has given back some ground over recent days (see below).
Sterling shines a little. Sterling is holding steady in the wake of the latest inflation numbers which, as expected, fell from 2.6% to 2.5% (for August). This was after a surprise increase in the July inflation reading. August saw inflation easing on the high street, with the annual rate pulled down by clothing & footwear, housing & household services, together with furniture & household goods. The biggest upward force was from petrol prices. For the rest of the year, the key question is whether inflation can fall more towards the 2.0% level into year end. It has been nearly three years since inflation was below the 2.0% target level and the Bank of England still expects it to take a year more before it’s below there again. The main risk is from food prices and less so fuel, with the move higher in GBP/USD recently dulling some of the recent pain of the increase in dollar prices. This could once again frustrate the Bank of England’s expectations of a continued downward drift in the inflation rate. The Bank of England, the Federal Reserve and the ECB have all expanded their actual quantitative easing plans (or potential for) in recent weeks. But the impact of this on inflation has so far been muted, with the more likely impact being that deflation was avoided (together with a more prolonged and deep recession). It is asset markets (stocks, commodities) where the more immediate impact is being felt. For sterling, we’ve seen a modest recovery in the past couple of days vs. the EUR as the single currency has chosen to take a breather above the 1.30 level on EUR/USD. Against the dollar, sterling remains just short of the highs for the year (1.6302 at end of April) and this is likely to prove tough near-term resistance to further sterling gains, at least for the time being..
Swings and roundabouts for the Aussie. Life is nothing if not interesting for those who ply their trade attempting to make money from the Aussie dollar’s gyrations. The bears were chastened in the second week of this month, with the AUD climbing more than four big figures to an eventual peak above 1.06 last Friday. However, the sellers have reasserted their authority since then, encouraged by the buying vacuum which was evident up at these lofty levels. In the first couple of days of this week, the Aussie has retreated relatively quickly and fell back to near 1.04 yesterday. From a fundamental perspective, this tug-of-war is understandable. Those with a negative disposition focus on the recent plunge in the prices of Australia’s two major exports, coal and iron ore, which are weighing on the terms-of-trade. The stuttering performance of the Chinese economy, the currency’s relatively expensive valuation and the potential for more rate cuts from the RBA are additional arguments supporting the bears’ case. Also, the Australian central bank will be more inclined to lower rates in coming months as a counter to the significant tightening of fiscal policy being undertaken by the Federal Government. At the same time, the Aussie remains a favourite of central banks, as Australia remains one of the strongest sovereign credits in the world. According to a recent article by Bloomberg, as many as 23 central banks hold the Australian currency as part of their forex reserves. Also, institutional investors are attracted to the Aussie because the central bank does not engage in regular money-printing. Indeed, the dollar suffered recently because of concern over the increased supply of the greenback once the Fed implements QE3. Finally, the AUD still attracts the carry trade, with the cash rate of 3.5% still the highest amongst the major advanced economies. Although the Aussie is likely to remain volatile given the myriad of forces described above, we continue to like the suggestion that it will essentially trade in a range of parity to 1.06. The latter looks decidedly expensive, while the former will surely trigger some buying interest at a time when the other major central banks are still debasing their own currencies.
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