Global financial markets are digesting two major developments at the start of the week. The developments: the start of the European Central Bank’s Outright Market Transactions programme (OMT) and the prospect of another round of quantitative easing by the Federal Reserve following Friday’s uninspiring jobs report from the United States. Risk assets surged at the end of last week as investors welcomed the latest move by the ECB and anticipated the Fed will soon follow suit in order to lift an ailing US labor market.
Yields on Spanish 10-year government bonds fell below six per cent for the first time since May- Emman Xuereb
ECB President Mario Draghi looked to be on the path of delivering on his promise to do “whatever it takes” to save the euro, when he announced last week the ECB’s new bond-buying programme. Draghi, at the news conference following the governing council’s decision to keep rates at a record low 0.75 per cent, announced the modalities of the bank’s programme called Outright Market Transactions. Although the success of this programme is yet to be seen, it showed the ECB’s resilience and commitment to show that the fate of the single currency is “irreversible” and followed Draghi’s off the cuff remarks in London on July 26, when he made an extraordinary pledge to preserve the euro.
In a nutshell the OMT programme will be unlimited in regards to a time frame and amount, and the liquidity created by it will be fully sterilised. Bonds with maturities of between one and three years will be purchased and is subject to strict conditionality of the EFSF/ESM programme. Draghi stressed that the governing council could suspend the programme for a member state in case of non-compliance. He also noted that the ECB will be accepting the same treatment of any other private creditor, a pari passu.
The other major development was another lackluster employment report out of the United States. The weak payrolls number raised hopes for an announcement of more QE by as early as from today’s FOMC meeting. Change in non-farm payrolls were short of the 100,000 mark, at 96,000 in August, from 141,000. Change in private payrolls also disappointed, and were printed at 103,000 against a forecast for 142,000. On a positive note, the unemployment rate fell to 8.1 per cent from 8.3 per cent, but was hardly the “sustainable and substantial improvement” which minutes from the last FOMC meeting of July 31 - August 1 were referring to, and the lower rate was mainly due to a lower participation rate.
Analysts and economists are now forecasting more easing from the Fed, which could come in the form of a new round of QE or even a longer-term commitment to keep interest rates at their current level near zero. Risk appetite rallied following the release of the US jobs report. Equity markets rose sharply and US stocks ended the week at their highest levels since December 2007, at pre-crisis levels. Riskier currencies rallied, and sovereign bond yields of indebted nations eased substantially from near unsustainable levels.
Yields on Spanish 10-year government bonds fell below six per cent for the first time since May, while Italian yields also dropped, lifting the euro across the board. Commodity-linked currencies like the Aussie rose from two-month lows against the euro and the dollar. AUD/USD rose to above 1.0400, for the first time since late August, after hitting a two-month trough by 1.0164 on Thursday of last week.
EUR/USD broke above a significant resistance level, represented by the upper limit of a falling channel that stretches back to August 2011. The pair extended its rally to hit a fresh four-month high by 1.2837 on Tuesday of this week, and now tests resistance levels off the highs of February, March and April of this year, by the 1.2800 area and the 200-day moving average by 1.2838. On Tuesday, the euro rallied after Germany’s top constitutional court said it will proceed with a ruling on the country’s role in the currency bloc’s permanent bailout fund (ESM), which was expected to be taken yesterday.
A positive outcome came from the German court ruling to back the eurozone bailout fund and if the Fed does go ahead with more QE in today’s FOMC decision, we should see further gains in this risk rally and may well see EUR/USD surge higher towards the 1.3000 handle.
Disappointment by the Fed and a rejection by the German court of the ESM could give scope for some dampening in risk sentiment and see EUR/USD retreat to support levels by 1.2710 first and 1.2620 on the short term. However, a rally in risk appetite is still favoured over the medium term in light of the fact that global central banks are expected to take more action to spur global growth.
Upcoming FX key events:
Today: US PPI & US FED FOMC decision.
Tomorrow: EZ CPI & US CPI.
Technical key points:
EUR/USD is bullish, target 1.3250, key reversal point 1.2400.
EUR/GBP is bearish, target 0.76, key reversal point 0.80.
USD/JPY is neutral.
GBP/USD is bullish, target 1.63, key reversal point 1.5450.
USD/CHF is bullish, target 1.00, key reversal point 0.9425.
AUD/USD is bullish 1.08, key reversal point 1.02.
NZD/USD is bullish, target 0.83, key reversal point 0.7850.
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Mr Xuereb is a trader at RTFX Ltd.