Pressure on the central banks

Last week ended in a slump on equity markets and the current one doesn’t look any better. On the forex euro was losing, while CHF was on a (rapid) rise again. The whole picture creates serious pressure on the central banks:

Fed – Ben Bernanke is about to speak on the US economic outlook on Thursday – the first opportunity to address the weak labor market data (employment did not increase in August); Bernanke is aware that another selling wave on equities could undermine remaining islands of confidence but even if he would support a QE3, he might find it hard to convince dissidents at the Fed

ECB – the Bank has already bent to demands of buying more government bonds and now the market is calling for interest rate cuts (especially as the economic outlook is deteriorating rapidly). We have a curious situation when the FRA market sees one cut this year and possibly another one next year, while bank economists do not see any move until the end of next year. That creates a downside risk for the EURUSD and any remark indicating such a possibility on Thursday could cause a decline on the pair, possibly ending multi-month consolidation

SNB – the Bank was probably happy to see the EURCHF close to 1,20 last Monday (at least under current circumstances) and refrained from talking the CHF down on Wednesday (three previous Wednesdays brought the statements). As the second part of the week demonstrated that was a costly mistake. There are rumors on the market that the SNB may enter the market below 1,10 and indeed we do observe some bottoming out above that level following a massive decline. Another factor to watch is the CPI index for August to be released tomorrow.

More problems in Europe

That Europe is in a serious hole is not new to most investors at this point. Fiscal problems on the peripheries have been compounded by economic slowdown which is dangerous as it will hit export-dependent North that is expected to foot the bill of the fiscal restructuring in the euro zone. But the worst part for investors is that there are no sign of a determination to bring this house into order. The latest worries include:

-       Italian austerity package – the package announced at the height of the turmoil in August to gain a support from the ECB (which subsequently started purchasing Italian bonds) has already been trimmed – there will be no solidarity tax for the richest and some funds for local governments will not be cut. It is hard to avoid impression that Italian government is trying to console voters after the worst is (or so they might think) over and the support has been gained; meanwhile the market would love to see more reforms – especially structural ones – in Europe

-       Local election results in Germany with the SDP and the Left getting seats at the expense of the CDU – the sign that Germans are not happy with the way Angela Merkel is handling a crisis in Europe; markets fear that in a response a German government will be even more reluctant to support a dwindling zone and that perhaps even a parliamentary vote on the enlargement of the EFSF might be under threat.

Przemysław Kwiecień PhD, Chief Economist

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