While hope remains, Citigroup's Steven Englander notes that the much stronger than expected ADP has probably shifted market expectations towards neutral, but like us he believes the market remains more hopeful of an aggressive fed than wary of disappointment. In parentheses below, we indicate what we think will be negative, neutral and positive surprises from an investor viewpoint.
Fed:
- Negative surprise – downgrade of forecast but nothing much else in way of change from last statement; no nod to any near-term move (15% probability)
- Neutral – economy disappointing, extension of zero-rate horizon to mid-2015, will act soon if data continue to come in soft (60% probability)
- Positive – open to balance sheet expansion, other stimulatory policies, strong September signal (25% probability)
The zero-rates till mid-2015 is probably largely priced in even after ADP (but not fully priced in, Figure 1) so there may be small further gains if FOMC crystallizes that expectation in the statement.
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The impact is becoming more of a statement of desire (the Fed’s wishlist) than anything they can implement or commit to, since few of the current voting members are likely to be around then. So it is far stronger if they show an open door to balance sheet expansion in September in addition to putting out an increasingly conditional and non-binding forecast.
ECB:
- EUR Negative surprise – no action; vague comments on what they can do in the future; ‘no monetary solution to fiscal problems (20% probability)
- Neutral – SMP under close consideration; coordinated with EFSF; joint CB and governmental measures will be introduced; can be implemented anytime but not immediately (45% probability)
- Positive surprise – SMP will be restarted immediately or very soon; or other policy measure that explicitly support long end of peripheral bond market (35% probability)
We think that FX investors are jumping between the ‘neutral’ and ‘positive surprise’ fenceposts. As per Dickens, ‘dishonesty will stare honesty out of countenance any day in the week, if there is anything to be got by it’, but there is simply no percentage in central bankers sending a market–moving policy message that will be reversed within a week. If they do so the outcome will likely be worse than had they kept silent in the first place. So while we think ‘neutral’ in the market sense does not require actual SMP buying by the ECB, we would assign more likelihood that there concrete indication of a policy shift, even if the Bundesbank is expressing reservations.
Importantly, we also think that SMP buying would be EUR positive and positive for risk-correlated currencies. The EUR and S&P have moved in the same direction 14 of the last 20 days and 29 of the last 43, so the near-term EUR reaction will probably be driven by whether investors view the ECB policy move as risk positive or not. This is still controversial in the market so there may be some knee–jerk sellers if the ECB announces its own form of QE, but we continue to read the evidence as suggesting that risk-positive is EUR positive.