Agencies do warn again

While a reaction to the summit was skeptical at the end of the last week, it turned to clearly negative yesterday. Not without a help from rating agencies – all three major rating agencies warned that the summit didn’t deliver what it takes to cope with the situation. Moody’s said it will have a closer look at euro zone countries, echoing a warning issued last week by the S&P. Fitch said that the summit didn’t reduce a pressure on bond markets in Europe. However, a statement from the S&P was probably the strongest. The chief economist of the agency said yesterday that it might take one more shock to the euro zone for some countries to become aware how serious the situation is. He said that this kind of shock might take a form of difficulties of a German bank. We hard that already: Kenneth Rogoff issued a similar warning about the US banks in the summer of 2008.

While we think the summit was a step in the right direction we underlined in our comments that the markets and the agencies might not have enough patience to wait until the detail of a fiscal compact are worked out. And because that will take time, a pressure on bond prices (and thus euro, equities and emerging currencies) will return.

Today, the EURUSD faces a test of 1,3145 – a low from October that is at the same time the lowest point since January of this year. Unless bulls manage to defend that level, a sell-off might be quite steep as the pair is not extremely oversold yet. The next support is as far as 1,2870.

Forget about a QE3

There was not too much talk about the Fed on the markets as of late and for some good reasons. Obviously, everyone knows that developments in Europe are critical and may affect the US and global economy so that dominates the market sentiment. However, developments in the US should not be omitted here. The US economy reacted surprisingly well to the summer shock the data coming out of it suggest that it is actually accelerating, even as Europe is plunging and Asia might be slowing down (but the extent is not yet clear here). Even the labor market – while still far from buoyant – is in the best shape since the early spring. Consequently short term interest rates inched up, suggesting that market doesn’t see the Fed relaxing the policy again in the foreseeable future. Unless 
Asia slows down significantly and/or we have a serious banking crisis in Europe, you should forget about the QE3.

Two things should be noticed here. First of all, we see some consequences for the forex. The Fed’s policy no longer weighs on the dollar and FRA spreads shift in favor of the US currency not only because some other banks are to ease (ECB, RBA) but also because US FRAs have moved up. Looking at those spreads we see some upward potential for the USD against currencies like EUR, JPY and AUD (other factors being constant). Furthermore, vanishing chances for the QE3 might a blow to gold bulls, especially as the ECB resisted calls to print money.

Przemysław Kwiecień PhD, Chief Economist

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