2011-10-17 08:00 (UTC)
Christopher Vecchio
As G-20 finance ministers readied for their weekend summit in Paris, market participation rates were exceptionally low, allowing higher yielding currencies and risk-correlated assets to post massive gains the past week.
This past week was notable as one trend continued and another was finally broken. The trend that continued was the one established last week, as noted in last week?s article, that price action was largely determined by fear. The ?headline? trading, as it has been dubbed, continued to exist, but with one slight difference: there were no overly negative headlines. While banks across Europe and Spain were downgraded, these developments hardly shocked market participants, as it has become mainstream knowledge that the financial sector has too much risk on its balance sheets and Spain?s finances look shaky at best. Accordingly, instead of large drops on these news items, because they were expected and even priced into prior price action, any shift to risk-aversion was quickly retraced.
In terms of the trend that was broken, the volatile price action that characterized market activity for the past few weeks disappeared without warning. Higher yielding and risk-correlated assets floated higher throughout the week, with the Australian Dollar posting its biggest week since February 2009, the Euro having its best week against the U.S. Dollar since January, and the S&P 500 posting its best week since July 2009. Much of this was due to the exceptionally low participation rates; the S&P 500 had its lowest volume day on Friday since July.
Even though the rally has continued with no signs of stopping, I remain bearish on higher yielding and risk-correlated assets and bullish on the safe havens, such as the U.S. Dollar and Treasuries. A tenet of technical analysis is that a move by an asset (commodities, currencies, equities, etc) is considered to be ?technically strong? if there is strong volume supporting the move. Such has not been the case. After today?s price action, the 20-day correlation between the S&P 500 and volume is now at a significant -0.830. This is a warning sign that as participation rates pick back up, equity markets and highly correlated assets, such as the Aussie and the Canadian Dollar, will fall hand-in-hand.
With that said, there are some significant events on the docket that could bring participants back to the market. In fact, starting on Friday, G-20 finance ministers were meeting in Paris to find ways to prevent a complete market collapse as the world?s most advanced economies slow. The meeting precedes the G-20 summit next week, where a concrete plan to ?save Europe? is expected to be established. Considering market participants have bid higher yielding assets higher on hopes that a plan with emerge, should this weekend?s meeting yield little results, expect volatility to increase on concerns Greece will default with no plan on how to control potential contagion in financial markets.
Meeting of the Euro-zone Finance Ministers: October 14 to 16--:-- GMT
European finance ministers are meeting in Paris this weekend in order to discuss how to recapitalize Europe?s banks. With the most recent act of the Greek drama unfolding, seemingly in favor of further support for the periphery nation, as news emerged today that French President Nicolas Sarkozy and German Chancellor Angela Merkel were able to move past their impasse, on whether or not the private sector would be held largely responsible for shouldering the next tranche for Greece, Sunday?s meeting is tantamount for the future of the Euro-zone ? if this meeting does not result in support for the periphery countries bordering on insolvency, the Euro will be facing significant downward pressure for quite some time.
AUD Reserve Bank's Board August Minutes: October 17 ? 00:30 GMT
At its meeting on October 3, the Board of the Reserve Bank of Australia voted to leave the cash rate unchanged at 4.75 percent. Governor Glenn Stevens noted that ?conditions in global financial markets have continued to be very unsettled, with uncertainty increasing about both the prospects for resolution of the sovereign debt and banking problems in Europe, and the outlook for global economic growth.? The Reserve Bank of Australia changed its tone and said that ?indications are that economic activity is continuing to expand in China and most of Asia,? a departure from last month?s meeting when it noted that growth was slowing. The statement afterwards also suggested that ?Recently revised data show a pick-up to date in the underlying pace of price rises that was less sharp than initially indicated.?
Given these observations, it appears that the Reserve Bank of Australia is becoming moderating its dovish outlook. While concerns over the Australian economy are limited in scope, any pullback in Australian growth is likely to be provoked by broader global macroeconomic trends, as the bank indicated. This has translated into a weaker Australian Dollar over the second half of 2011, as interest rate expectations have fallen and the Australian Dollar remains below its 2011 high set in July just above 1.1000 against the U.S. Dollar.
United Kingdom Consumer Price Index (YoY) (SEP): October 18 ? 08:30 GMT
It?s clear that the continued period of low interest rates employed by the Bank of England has certainly allowed inflationary pressures to move in on the British economy, with the consumer price index forecasted to show price pressures at 4.9 percent in September.This comes after the inflation rate subsided to 4.2 percent then 4.4 percent in June and July, then rebounded back to 4.5 percent in September, the highest such clip since October 2008. The Bank of England is ready to sacrifice purchasing power for economic growth, as evidenced by the Monetary Policy Committee?s decision to leave the key interest rate on hold at 0.50 percent at their most recent meeting, so the 4.9 percent rate for September is reasonable.The Sterling is unlikely to find bids on the higher rate of inflation as rate expectations are completely suppressed. Join a DailyFX analyst for live coverage of event!
United Kingdom Bank of England Minutes: October 19 ? 08:30 GMT
On October 6, the Bank of England voted to maintain the key interest rate at 0.5 percent. The Monetary Policy Committee boosted the target of its bond program to ?275 billion from ?200 billion. The country?s inflation rate increased back to 4.5 percentin September, though the central bank looks unlikely to raise rates despite price pressures persisting at more than double its target of 2 percent.Despite the high rate, policymakers at the Bank of England agree that the economic outlook is not stable enough to withstand higher interest rates.
Looking ahead, it is evident that the Bank of England?s Monetary Policy Committee is focused on economic growth rather than reducing inflation. This has been a trend that is emerging across the globe, with the Bank of Canada, European Central Bank, Federal Reserve and Reserve Bank of Australia all reaching similar conclusions. With economic recovery expected to be shaky in the short- and medium-term, the Monetary Policy Committee will likely hold the bank rate at 0.5 percent through the end of 2011. The minutes of the meeting will be published on October 19 and will include highlights of the board meeting as well as forecasts of future growth for the country. The key information will be the Bank of England?s decision in regards to expanding its asset purchase program.
United States Consumer Price Index (YoY) (SEP): October 19 ? 12:30 GMT
According to a Bloomberg News survey, economists forecast U.S. consumer price index tocontinue to show signs of pressure, with the median estimate calling for a 0.3 percent gain in September, on a monthly basis. Year-over-year, the index is expected to show that price pressures held at 3.8 percent in October, the same level in August. Prior to next week?s release, the consumer price index has steadily risen from 1.6 percent to 3.8 percent in 2011. The consumer price index is the headline figure for inflation, reflecting a decline in the purchasing power of the dollar. However, inflation can also be a sign of a healthy economy.
The objective of the Federal Reserve?s quantitative easing stimulus program was to achieve a target inflation rate of about 2 percent. If price pressures continue to increase, this could provide evidence for hawkish Federal Reserve officials to resist calls for further easing and instead continue solely with ?Operation Twist.? Join a DailyFX analyst for live coverage of event!
Rate Hike Probabilities / Basis Point Expectations (12-months)
See the DailyFX Calendar for a full list, timetable, and consensus forecasts for upcoming economic indicators.
--- Written by Christopher Vecchio, Currency Analyst
To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com.
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