Sunday, September 22, 2013
News:German Right Unified as CDU Recieves Record Total on Collapse of FDP
Germany's center right government, composed of the Christian Democratic Union and its sister party the Bavarian Christian Social Union, came close to securing an absolute majority in Bundestag in elections this Sunday. Together, the two parties received 42 percent of the vote, up sharply from the 33 percent the duo garnered in 2009 federal elections. Results for the main opposition party were largely disappointing, but the Social Democratic Party, or SDP, got 25 percent of votes cast, up slightly from the 23 percent the party received in 2009. While Ms. Merkel addressed ecstatic supporters Sunday night declaring "we did great," reality set in later in the night as in became clear that the rise in the CDU's vote total came largely as a result of an implosion of the Free Democrats, Germany's other right wing party which usually gets around ten percent of the vote. Support for the pro-business Free Democrats plunged from 14 percent in 2009 to a meager 4.7 percent in 2013, below the required five percent threshold to win seats in parliament. Other minor parties faired a bit worse than four years ago. Collectively the Greens and the Left, two minor leftist parties, received only 16.9 percent of the vote, compared to the near 23 percent these parties siphoned away from the more mainline parties in 2009. The anti-Euro Alternative for Germany also failed to break above the five percent threshold.
It appears unlikely that the CDU will win an absolute majority in the Bundestag. Therefore, with the Free Democrats out of parliament, Ms. Merkel may be forced to form another "Grand Coalition" with the Social Democrats. Such a partnership governed Germany from 2005 to 2009. The CDU had governed with the Free Democrats since 2009, avoiding a costly alliance with the left which greatly curtailed Merkel's agenda when they were full coalition partners from 2005 to 2009.
On FX, markets were mute to the election results, as participants were widely expecting a CDU victory. On the other hand, if Merkel does indeed fall shy of an absolute majority, she will face tougher choices on coalition partners since all of the minor right wing parties have been voted out of office. Markets have been calmed by the Merkel 'victory' but it is not clear at all that the prospect of a CDU-SDP coalition has been fully digested, especially since most English language news outlets are reporting a CDU landslide. A more accurate characterization would be a coalescence of the German right around a single party, but a failure of the new unified movement to produce a parliamentary majority. The silver lining the SDP is that it will a major player in the formation of the next German government. Markets are calm for now, but prolonged coalition negotiations could inject some short-term volatility.
Wednesday, September 18, 2013
Commentary: What Today's Decision Means
The FOMC voted 11-1 today to maintain its 85 billion dollars in monthly asset purchases. The central bank justified its decision by highlighting its concern that rising market rates for debt ranging from corporate bonds to mortgages may threaten the still fragile recovery. The committee also stated that further fiscal tightening by the Federal government continues to be a major downside risk for the economy. Finally, the lack of robust data to indicate a broad recovery in labor markets also gave the Fed pause. Particularly, the committee remains concerned about the recovery's "staying power," as highlighted by Chairman Bernanke's use of this term during the post-release press conference.
On FX, the dollar was broadly weaker. Falling substantially against all major currencies. The dollar also sank against EM currencies. The Mexican Peso soared nearly 3000 pips against the greenback, or 2.3 percent. As of 11:26 GMT, one USD fetched 12.66 MXN, compared to 12.97 when morning trading started in New York. This represented the biggest one day move in nearly two years. TRY also had an incredible day, moving an amazing five big figures. The lira, which has been under tremendous pressure due to taper fears moved to 1.95 against the USD, as compared to 2.00 yesterday.
In general several key points can be taken Fed's statement and the market reaction. First, the Fed still believes that quantitative easing can help fuel a stronger recovery. Many voices, from outside the Fed and few on the inside such as Dallas Fed President Richard Fisher, had made clear their belief that QE had already done all it could to help jumpstart the economy and that further easing would have little to no effect. The Fed's willingness to continue its asset purchases at the same 85 billion per month clip means that the FOMC rejects the pessimistic "monetary policy has done all it can" view of some economists. Crucially, we note that the Fed remains committed to weighing the downside risks of its easy money policies. It therefore appears unlikely that the central bank would continue with its asset purchases if it did not believe they would have a tangible effect.
Secondly, board's outlook on inflation remains subdued, and the Fed in general remains confident that it can exit without causing markets to panic or the real economy to suffer.
The Fed remains acutely aware that bond traders are terrified by the potential dumping of trillions of dollars worth of securities onto the capital markets if the Fed unwinds too quickly. The Fed therefore is likely to use other tools to tighten monetary policy, rather than selling securities. When I spoke with one senior official at a regional Fed who was involved with preparing briefings for this month's meeting, they stressed the Fed's new authority to pay interest of reserves. They also mentioned that while the central bank is confident that the capital markets are deep enough to absorb very large asset sales by the Fed, the central bank has no desire to be "a bull in a china shop." Therefore, asset sales, if they occur will be slow and measured. In general, my numerous discussions with Fed officials over the past year have centered around alternatives tools the Fed has at its disposable. A mass dumping of Treasuries and MBS on the markets therefore seems unlikely unless inflation reached double digit levels.
Finally, we note that communication and forward guidance remain the most important factors in the outlook for rates and FX markets. The Fed has already tightened policy in that last three months by signalling the possibility of a reduction in asset purchases this fall. It is particularly troubling that the "tightening financial conditions" cited by the FOMC as threat to the recovery were essential created by the committee's own actions. It is unclear whether or not the Fed intended for market rates to rise, but if it indeed believes that rising mortgage rates and bond yields have dampened the recovery, we've just gone through three months of volatility for nothing.
In general, today's news is probably a green light to sell the greenback against EM currencies with strong fundamentals. Then again, the waiting game continues now for when the Fed will actually taper, so expect volatility to remain very high.
On FX, the dollar was broadly weaker. Falling substantially against all major currencies. The dollar also sank against EM currencies. The Mexican Peso soared nearly 3000 pips against the greenback, or 2.3 percent. As of 11:26 GMT, one USD fetched 12.66 MXN, compared to 12.97 when morning trading started in New York. This represented the biggest one day move in nearly two years. TRY also had an incredible day, moving an amazing five big figures. The lira, which has been under tremendous pressure due to taper fears moved to 1.95 against the USD, as compared to 2.00 yesterday.
In general several key points can be taken Fed's statement and the market reaction. First, the Fed still believes that quantitative easing can help fuel a stronger recovery. Many voices, from outside the Fed and few on the inside such as Dallas Fed President Richard Fisher, had made clear their belief that QE had already done all it could to help jumpstart the economy and that further easing would have little to no effect. The Fed's willingness to continue its asset purchases at the same 85 billion per month clip means that the FOMC rejects the pessimistic "monetary policy has done all it can" view of some economists. Crucially, we note that the Fed remains committed to weighing the downside risks of its easy money policies. It therefore appears unlikely that the central bank would continue with its asset purchases if it did not believe they would have a tangible effect.
Secondly, board's outlook on inflation remains subdued, and the Fed in general remains confident that it can exit without causing markets to panic or the real economy to suffer.
The Fed remains acutely aware that bond traders are terrified by the potential dumping of trillions of dollars worth of securities onto the capital markets if the Fed unwinds too quickly. The Fed therefore is likely to use other tools to tighten monetary policy, rather than selling securities. When I spoke with one senior official at a regional Fed who was involved with preparing briefings for this month's meeting, they stressed the Fed's new authority to pay interest of reserves. They also mentioned that while the central bank is confident that the capital markets are deep enough to absorb very large asset sales by the Fed, the central bank has no desire to be "a bull in a china shop." Therefore, asset sales, if they occur will be slow and measured. In general, my numerous discussions with Fed officials over the past year have centered around alternatives tools the Fed has at its disposable. A mass dumping of Treasuries and MBS on the markets therefore seems unlikely unless inflation reached double digit levels.
Finally, we note that communication and forward guidance remain the most important factors in the outlook for rates and FX markets. The Fed has already tightened policy in that last three months by signalling the possibility of a reduction in asset purchases this fall. It is particularly troubling that the "tightening financial conditions" cited by the FOMC as threat to the recovery were essential created by the committee's own actions. It is unclear whether or not the Fed intended for market rates to rise, but if it indeed believes that rising mortgage rates and bond yields have dampened the recovery, we've just gone through three months of volatility for nothing.
In general, today's news is probably a green light to sell the greenback against EM currencies with strong fundamentals. Then again, the waiting game continues now for when the Fed will actually taper, so expect volatility to remain very high.
Friday, September 6, 2013
News: Mexico Cuts, Markets Yawn
Mexico's central bank cut the overnight rate to by 25 basis points this morning to a record low of 3.75 percent. The bank's statement cited subdued growth in both the EM countries and the US and Europe, as well as an environment of rising global rates in face of an expected shift in the stance of US monetary policy. Given the weaker than expected growth this year, the bank seems especially concerned about the rise in medium and longterm rates, even in the Peso denominated money market, driven entirely by an "anticipation in of a reduction of asset purchases by the Federal Reserve," in the banks own words translated from the Spanish. Mexico is not ready to raise rates, and therefore felt compelled to do something on their end by easing conditions on the local money market with a rate cut. The bank also tried to calm the FX market, directly mentioning the volatility in EM currencies. The bank cited that inflation expectations remain unaffected by swings in the exchange rate, but remains committed to monitoring the situation. The bank also applauded strengthening public finances, and the low risk premiums Mexico pays to borrow money compared to other emerging markets. In general, the bank expects inflation to remain subdued and growth to strengthen in 2014. However, it remains concerned that external factors, such as rising global rates may derail the local recovery. Therefore, the bank ended its statement with a commitment to monitor "inflation, the evolution of economic activity, and its own policy stance vis a vis other central banks with the ultimate objective of continuing to achieve its inflation target of three percent." Although the bank covered all the bases, including growth, inflation, and exchange rate volatility, the bank, inflation and price stability remained clearly in focus despite the fact that today's statement came with an easing of policy. This mixing of a somewhat hawkish statement with an easing of policy left the MXN unchanged after the announcement of the cut. Specifically, the USD/MXN spiked briefly up to 13.35 from around 13.24 in the minutes after the announcement, only to fall back down to around 13.1855 by 4:45 PM GMT. For the day, the Peso is up despite the rate cut.
As far as outlook for the MXN, the market seems directionless. Weaker than expected NFP numbers sent the dollar down this morning against everything, as expectations of the Fed tapering this month weakened. Again, the fundamentals of the Mexican economy, despite weakening substantially this year along with US, remain strong. Both north and south of the border, growth has slowed as governments have tightened their belts, but consumer confidence remains at five year highs. Major reforms to the energy sector are being debated this month in the Mexican Congress, and is widely expected to pass. In light of recent developments, I am raising my year end target for USD/MXN to 12.70. I expect the peso to regain its footing after tapering by the Fed becomes fully priced in. The FOMC meeting later this month is the next big event and should set expectations for the rest of the year. On the upside, 13.46, this year's high, remains as an area of critical resistance for USD/MXN. The pair failed to breach this level a few days ago and today's rate cut ironically has it moving in the opposite direction. In short, investor appetite remains strong for the peso, as evidenced by today's activity and the fact that this summer's second round of EM volatility was much kinder to Mexico than to other EM currencies such as INR, TRY, ZAR, BRL, and even smaller regional stars like the Thai Baht (THB) and Peru's Nuevo Sol (PEN).I continue to remain cautiously optimistic, for now.
As far as outlook for the MXN, the market seems directionless. Weaker than expected NFP numbers sent the dollar down this morning against everything, as expectations of the Fed tapering this month weakened. Again, the fundamentals of the Mexican economy, despite weakening substantially this year along with US, remain strong. Both north and south of the border, growth has slowed as governments have tightened their belts, but consumer confidence remains at five year highs. Major reforms to the energy sector are being debated this month in the Mexican Congress, and is widely expected to pass. In light of recent developments, I am raising my year end target for USD/MXN to 12.70. I expect the peso to regain its footing after tapering by the Fed becomes fully priced in. The FOMC meeting later this month is the next big event and should set expectations for the rest of the year. On the upside, 13.46, this year's high, remains as an area of critical resistance for USD/MXN. The pair failed to breach this level a few days ago and today's rate cut ironically has it moving in the opposite direction. In short, investor appetite remains strong for the peso, as evidenced by today's activity and the fact that this summer's second round of EM volatility was much kinder to Mexico than to other EM currencies such as INR, TRY, ZAR, BRL, and even smaller regional stars like the Thai Baht (THB) and Peru's Nuevo Sol (PEN).I continue to remain cautiously optimistic, for now.
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