Euro Prepares for ECB Rate Decision – The Options and Outcomes

• Euro Prepares for ECB Rate Decision – The Options and Outcomes
• Dollar Rallies after Fed Holds, Still Falling Short of a Clear Trend
• British Pound Exposed to both the BoE and ECB Rate Decisions
• Swiss Franc: SNB’s EURCHF Fight Could Find More Pressure Thursday
• Japanese Yen: Finance Minister Azumi Says Only He Can Intervene
• Australian Dollar Slides as Stimulus Hopes Fade
• Gold Drops after Fed Confirms QE3 Not on Tap

Euro Prepares for ECB Rate Decision – The Options and Outcomes

The Euro took a tumble Wednesday after the Fed disappointed and increased the pressure on the ECB. If expectations for an expansion on US stimulus efforts (on dubious evidence) left the markets empty handed, will its European counterpart follow a similar path? And, if the ECB doesn’t offer its support; what do we have to reassure on financial stability and risk appetite? Looking back to the commentary and conjecture that lead to the Euro and risk appetite surge at the end of last week, we should note that ECB President Draghi’s vows to do whatever necessary to protect the currency isn’t any more remarkable than what any other official has said. Furthermore, the proposals that the market has attributed to the policy maker (reactive the SMP, LTRO 3, rate cut and support a bank license) aren’t structural fixes so much as short-term band aids.

In terms of the probable policy moves for the central bank to make, a rate cut would be easiest for the group to fulfill. However, this would not materially support financial health nor growth (we have seen this to be the case with countless others), and they just cut the benchmark last week. If this is all that is pursued, it would have lower the euro’s yield, fall short of market support and remind the market of limited options for the policy authority. Even the more speculative-friendly programs that expand the balance sheet could face trouble if the market holds its skeptical tone. If the masses realize that nearly all of the viable options for the central bank don’t answer the underlying problem, the ‘buy time’ bounce may be simply forgone. All of this taken into account, we should be cautious about expecting a big euro drop. This past session, Greece voted on €11.5 billion in budget cuts and Spain has delayed its stress test announcements. Perhaps the fear drive itself can be delayed.

Dollar Rallies after Fed Holds, Still Falling Short of a Clear Trend

The dollar posted its biggest rally in nearly six weeks Wednesday after the Federal Reserve announced that it wouldn’t offer additional support to the US economy and financial markets via fresh stimulus. Easing fears that the central bank would further devalue its currency by inflating the money supply wasn’t the most influential aspect of this event however. The negative impact on pumped up investor confidence in more support carried the greatest weight. Looking at the dollar’s performance, the Dow Jones FXCM Dollar Index (ticker =USDollar) posted a 0.57 percent advance as the currency rose individually against all of its major counterparts (including the yen, which has tended to outperform in regular risk aversion moves). For risk trends, the impact was less than remarkable. While the S&P 500 technically retreated for a third consecutive day, it was the most reserved three-day decline (10.83 points) since January 10, 2011. Something is keeping sentiment propped up: ECB hopes.

Heading into the FOMC rate decision this past session, both the risk gains and dollar losses through the end of last week were still holding fast. For market participants there was a clear possibility that the world’s largest central bank could add to its ongoing effort to stabilize financial markets and further bolster economic activity. That said, there was some disarming of the high level speculation for a massive QE3-like program before the actual release as calmer heads started processing more realistic outcomes. As such, when the Fed made it clear that they were not introducing another massive rescue program (they didn’t even extend their guidance for holding rates at their exceptionally low levels beyond the ‘late-2014’ projection), the subsequent disappointment wasn’t as severe as it could have been. Looking at the fundamentals behind the market, a hold was arguably the most reasonable outcome: growth cooled in data last week, but it wasn’t showing recession; financial markets and volatility are stable; and they have voiced concern about diminishing returns from successive rescue efforts. The market may have been better prepared for this outcome, but it is still a disappointment to risk. There is an opportunity for backtracking in late August at the Jackson Hole Economic Symposium or early September rate decision (with forecasts), but that is a ways off. Near term, if the ECB doesn’t deliver…

British Pound Exposed to both the BoE and ECB Rate Decisions

According to BoE Governor King, Chancellor of the Exchequer Osborne and Prime Minister Cameron, the greatest threat to the UK is the Eurozone crisis. No reason to doubt their fears. That makes the ECB rate decision an important event for the sterling. The BoE decision, however, will also carry weight. The MPC reportedly heard some arguments for rate cuts last go around. Will the catch traction now?

Swiss Franc: SNB’s EURCHF Fight Could Find More Pressure Thursday

We learned just a day ago that the SNB’s effort to keep its currency from appreciating beyond the 1.2000 line (in the EURCHF pair) has led the central bank to increase its reserves to 62 percent of GDP with Euro holdings accounting for an astounding 60 percent of that pool. In other words, their fight is getting expensive and they are struggling to diversify. That said, the SNB no doubt is concerned about the ECB’s next move.

Japanese Yen: Finance Minister Azumi Says Only He Can Intervene

Japanese Finance Minister Azumi made it clear that he believed (contradictory to one of the new BoJ members) that the BoJ should not and cannot buy foreign government bonds in testimony to Parliament. He noted that efforts to act on the yen exchange rate rested with the Finance Ministry alone. That may be the case, but Azumi has clearly struggled to win reprieve on the currency. This just further reduces the options.

Australian Dollar Slides as Stimulus Hopes Fade

Stimulus is important when yields are low and fading. In the elemental balance between risk and reward, the latter is fading for the Australian dollar. If we can ensure that risk can remain extremely low, though, carry traders may be willing to overlook this concern and keep with the high-yield currency. Yet, with the Fed’s refusal to offer more support, confidence is chipping away. Will the ECB offer more?

Gold Drops after Fed Confirms QE3 Not on Tap

Why is gold falling at the same time that traditional risk measures are sliding? Isn’t the precious metal a safe haven? It is indeed a source of safety, but not in the traditional sense. Gold is more appropriately a source of safety when looking to avoid the devaluation of assets via financial manipulation by policymakers. That said, no QE3 from the Fed, means no need to diversify into an expensive commodity.

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--- Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com

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