The most succinct post-mortem summary of the FOMC announcement comes from Citi's Stephen Englander.
"Market response - will add to downward pressure on bond yields and may be worth another 10-15bps on the downside. FX terms - hard to see it as anything but USD negative for now. Main buying opportunities probably high current account deficit EM, AUD,and JPY. Discussion of waning Summers odds had been in market last week so we would see impact on JPY in 0.5-1.0 percent range. Whether this puts Yellen in driver's seat is unclear, so this Wednesday tapering and FOMC forward guidance are still the focus. We still think tapering schedule rather than FOMC language will be the main market driver."
"The opposite of currency wars is not necessarily currency peace; it can easily be interest rate wars," is the warning Citi's Steve Englander sends in a note toda, as EM and DM bond yields have relatively exploded in recent weeks. The backing up of yields represents an increase in risk premium, so this will likely have negative effects on asset markets and the wealth effect abroad as well. It is difficult to explain the magnitude of the yield backup in terms of normal substitution effects, and broadly speaking, if you were to compare the backing up of bond yields with the beta of the underlying economy and asset markets there would be a good correspondence. So, Englander adds, it is fear, not optimism that is driving bond markets.
As Citi's Steven Englander suggested earlier, the developments in Cyprus will lead to EUR selling and USD, CHF, GBP, NOK and SEK buying (in that order). He adds, the issue is whether to believe that the Cyprus levy on depositors is one-off, but depositors and investors elsewhere could easily see this as another in a string of ‘one-offs’ and react badly. The risk-return to depositors in countries with weak banking systems may not favor taking the risk that Cypriot banking system was so unique that such a levy would never be considered elsewhere. The levy on deposits ostensibly covered by deposit insurance may also undermine confidence in weak banks. The question is whether this becomes a full-blown crisis or a mini-crisis. For now, as FX markets open, it appears EURJPY is getting hammered (from 124.47 close to 121.6) implying S&P futures will open down around 30 points. We are sure Abe is watching closely...
When a note by a Citi FX strategist begins with the following proclamation endorsing outright fascist despotism, you know it's going to be good: "This is the first European election in which voters didn't do the right thing." Perhaps if Citi would be so kind to overrule the democratic vote, in which 55% or the majority of the people voted against the "right thing", and impose its own unelected Italian dictator, just like Goldman did in November 2011, that long EURUSD call would be happier? Then it only gets better: "Elections are more problematic than market scares or sentiment shifts as they can't be undone by printing monry" (sic). True: some things outright money debasement by central banks can't buy - for everything else there are Siberian Gulags. And the absolute punchline: "Still the outcome does not seem so dire that a bit of growth and ECB flexibility could not turn it around." Why yes, all Europe needs is a "little growth" obviously in lieu of lots of growth, but frankly it will settle for any growth - something it has been unable to do under the wise tutelage of the banker-dominated oligarchy for the past four years, as for that little "ECB flexibility" - wink wink: just where would you like those Euro Stoxx Steve?
From Citi's Steven Englander, who confirms what we said previously: the UK is now officially in the hands of the monetary apparatus, which is controlled by, you guessed it, yet another Vampire Squid tentacle.
Citi's risk-warning signals, based on implied volatility on currencies that are very sensitive to risk appetite, have backed up sharply in the last couple of weeks and especially over the last day or two. The back-up has been so sharp that they have unwound all the easing in risk aversion since September/October. To be clear these indications are still suggesting that risk aversion is very low by 2008 standards, but all of our indicators have backed up markedly, suggesting that despite the abundance of liquidity investors are getting nervous.
With Abe talking his down explicitly, Weidmann talking his up explicitly, Draghi's subtle talk-down, Hollande's outright plea, and the developing world in full 'war' mode, Citi's Steven Englander sets out some brief 'rules of engagement' for the G-20 nations as competitive devaluation escalates.
JPY could fall a lot further because weak JPY has been the most effective tool to create equity market wealth and spur Japanese demand. Moreover, Citi's Steven Englander notes, Japanese policymakers do not have many other options. If JPY is ticket for the Nikkei to regains ground lost versus other equity markets, USDJPY would have to go into three digits. By implication JPY would have to weaken a lot more. The loss of market share in part reflects long-term structural issues but Japanese governments (like others) are more mindful of incurring the anger of domestic political constituencies by making tough structural reforms than of G20 counterparts by weakening the exchange rate. From a political perspective, the Nikkei-JPY relationship is too much a good thing for Japanese policymakers to give up - but divergences are abundant at the short- and long-end of the JGB curve - and too much of a good thing in this case is a disaster.
With EURUSD having lost over 2 handles since Draghi began to speak at the press conference, we thought it worth examining just what he did (and did not) say. As Citi's Steven Englander notes, for the ECB it was a twofer. They can claim they are not engaging in currency wars while giving a big wink and nod on monetary policy ease that says 'sell my currency'. Yesterday when they said they were not too worried about currency, they didn't mention that they would sound very dovish on liquidity and monetary policy and stress the EUR's level as a factor in inflation and economic forecasts. So while they did not do the currency war thing, they did the next best thing.
G4+CHF can fight the currency wars longer and more aggressively than small G10 and EM countries can. However, as Citi's Steven Englander notes, it also takes a lot of depreciation to crowd in a meaningful amount of net exports. His bottom line, GBP, CHF and JPY have a lot further to depreciate. In principle, the USD can easily fall into this category as well, but right now the USD debate is focused on Fed policy – were it to become clear that balance sheet expansion will end well beyond end-2013, the USD would fall into the category of currency war ‘winners’ as well. Critically, though, the reality of currency wars is that policymakers do not use FX as cyclical stimulus because of its effectiveness; they use it because they have hit a wall with respect to the effectiveness of fiscal and monetary policies, and are unwilling to bite the structural policy bullet. The following seven points will be on every policymakers' mind - or should be.
While we will shortly present some practical perspectives on what the debt ceiling fiasco due in just about a month, means practically for the economy (think sequester, and another 1% cut to US GDP, which when added to the payroll tax cut expiration's negative 1.5%-2% impact on 2013 GDP, and one wonders just how the US will avoid recession in 2013), here is a must read perspective from Citigroup on how the markets may and likely will react to what is shaping up to be another "12:30th hour" (the New Normal version of the eleventh hour) debt ceiling resolution, which is now under a month away. To wit: "We think this means that 1) risk will sell off less approaching the debt ceiling deadline; 2) currency investors will hold on to risk in spot but buy tail risk hedges; and 3) there will be a wholesale cutting of positions in FX and other asset classes, if the debt ceiling is breached. So it may looks as if the debt ceiling breach is not worrying asset markets, but it means that investors are banking on the chestnuts being pulled out of the fire. If they are not pulled out, positions go up in smoke."
It is hard to find a policymaker who hasn’t actively tried to talk his currency down. The few who don’t talk, act as if they were intent on driving their currency lower. Citi's Steven Englander argues below that the ‘currency wars’ impact is collective monetary/liquidity easing. Collective easing is not neutral for currencies, the USD and JPY tend to fall when risk appetite grows while other currencies appreciate. Moreover, despite the rhetoric on intervention, we think that direct or indirect intervention is credible only in countries where domestic asset prices are undervalued and CPI/asset price inflation are not issues. In other countries, intervention can boost domestic asset prices and borrowing and create more medium-term economic and asset price risk than conventional currency overvaluation would. So the MoF/BoJ may be credible in their intervention, but countries whose economies and asset markets are performing more favorably have much more to lose from losing control of asset markets. So JPY and, eventually CHF, are likely to fall, but if the RBA or BoC were to engage in active intervention they may find themselves quickly facing unfavorable domestic asset market dynamics.
The median Bloomberg expectation for NFP is 153k, Citi is at 140k; the central tendency of the forecasts is about 125-185k. Now that the Minutes are out and have raised market fears that the fed will pull back from ease earlier than anticipated, investors are worried about a repeat of 1994, when a surprise Fed tightening after a long period of easy money (by standards of those days) devastated fixed income markets. Then 10yr Treasury yields rose 170bps over a two month period. In that light, you have to respect bond market skittishness. However, you have to respect the market response. And if payrolls come anywhere near close to a 200k handle we will very likely see further a further equity and fixed income sell off. So there is the possibility that we will have a much more exciting morning after payrolls than anyone had anticipated.
FOMC Minutes are due in 20 minutes and we find that investors are not paying much attention (yet). Recall, however, that asset markets rallied when the FOMC released the Statement and then sold off on fears that the FOMC was hinting at a quicker than expected pullback of Fed stimulus. The pullback logic was based on how rapidly the US economy is approaching 6.5% or a read of the Statement/Press Conference comments that suggested that we might see some pullback from QE in 2013. The question is whether the Fed really meant to convey that type of hard conditionality or incipient stimulus withdrawal.