The dollar ended the week slightly weaker against the European majors as a small decline in US front-end yields, coupled with a general desire to book some profits after a strong run, helped to push the dollar lower against sterling, swiss, and the euro.
The week’s major events were centred over the Scottish independence vote, the ECB potential to expand their balance sheet, Bank of Japan vowing to expand its stimulus and the continued good news stream from the US economy.
On the foreign exchange side, the dollar continues to make new highs against the yen and has hit a level not seen for over six years. One of the key drivers for the surge in USDJPY is the rise in US treasury yields, with the two-year yields getting closer to the three year high seen this summer.
As mentioned earlier, the euro regained some of its losses back this week as euro funded trades continued to be covered. Even with a couple of stabilising days, the euro remains under broad pressure in the weeks ahead as the effects of ECB action continue to weigh on the currency.
The pound started the week dropping to level we haven’t seen in long time. As the Scottish independence vote continue to create volatility in the short end, with a possibility of a UK break-up next week; the sterling hit a 10-month low against the dollar on Wednesday but has since then erased some of its losses.
In conclusion, we expect the USD to continue to hold firm against the other low yielding ahead of next week’s Fed meeting.
In the commodities markets, the dollar strength managed to send oil prices down to their lowest, while gold continued to be sold on expectations that the US interest rates might not remain low indefinitely.
Investors may be growing a little too comfortable with the prospect that Federal Reserve officials will leave interest rates near rock-bottom lows for the foreseeable future, according to a research note from the San Francisco Fed published this week.
Many economists and investors believe the central bank will begin raising short-term interest rates from near zero next summer, a view some top officials have encouraged. However, Fed Chairwoman Janet Yellen and others have also warned they could move earlier if the labour market improves faster than they expect.
Fed officials are attempting to keep market expectations on interest rates aligned with their own to avoid surprises that could trigger market turmoil like in 2013.
Europe
ECB to expand balance sheet: ECB President Mario Draghi was quoted this week stating that the ECB balance sheet should expand to the early 2012 levels. If he is quoted correctly, the ECB wishes to expand the balance sheet at somewhere between ¤700bn to a very maximum of ¤1 trillion. The Asset back Securities they discussed last week during the ECB meeting is unlikely to be enough to achieve this level, so it is difficult to think what can be done other than the simple Quantitative Easing and start buying European sovereign debt.
In an interview with a German newspaper, ECB Vice-President Vitor Constancio mentioned “there was no proposal for doing QE at the latest ECB meeting. “QE was discussed, but it was not on the table for a decision.”
He also added: “We are convinced that we are allowed to buy government bonds in the secondary market, if it is justified by monetary policy considerations. But we also know what it means and this is certainly something we would prefer not to be forced to do.
“Buying government bonds certainly is something we cannot exclude. With the recent interest rate cut, we are now at the zero lower bound. So if we believe that we need an even more expansionary monetary policy, we have to find different channels. An increase in the balance sheet is one option”
France, Italy need to reform: European Central Bank Governing Council member Christian Noyer stated this week that France and Italy needed to pursue reforms in order to lift growth. According to Noyer:
German inflation woes: According to data released this week, German annual inflation rose 0.8 percent in August, following 0.8 percent growth registered the previous month. The data was in line with analysts’ forecasts. On a monthly basis, German CPI remained flat, after climbing 0.3 percent, as expected.
Scotland In or Out?: Scottish referendum and the pound took a breather following the Survation poll released on Thursday (‘yes’ at 42 percent, ‘no’ at 48 percent and ‘don’t know’ at 10 percent). That being said, with plenty of polls still to come, it’s clearly not all over yet. The stakes remain extremely high for Scotland.
Asia & Commodities
The move upward in the Dollar Yen is being driven by a combination of factors: Mainly, expectations of a more hawkish Fed, rising Japanese appetite for offshore assets thanks to lower Japanese government bonds yields, better risk appetite, an imminent government pension investment portfolio shift, and finally, a rebuilding of positions by hedge-funds from very low levels over the summer.
China CPI disappoints:
Chinese August consumer inflation fell to a four-month low and some economists warned of the potential for deflationary pressure if pricing weakens further.
Weak Gold: Gold fell to a seven-month low as investors reassessed the outlook on US interest rates. Prices have dropped reaching a low of $1,232 following the release of a Federal Reserve Bank of San Francisco report that said that the market may be too comfortable with the prospect that Fed rates could remain low for the foreseeable future. Gold recent price action may be an indication that investors’ sentiments are starting to shift towards the view that the Fed may be less accommodative than had been expected.
The Peninsula
