ECONOMETER

A lacklustre day for equity markets yesterday saw many indices close lower and risk aversion edge higher, with the VIX ‘fear gauge’ being a prime mover, Some encouraging signs for global activity continue to emerge from the rise in the Baltic Dry Index but market growth fears remain high. Attention remains firmly focussed on events in Europe, with the Ecofin meeting today likely to see further discussions on a wide range of issues. As yet there is no breakthrough regarding a Spanish bailout or next tranche of Greek loan disbursement, with the latter only likely to be confirmed in November. A visit by German Chancellor Merkel to Athens today is unlikely to result in any breakthroughs. US corporate earnings will also garner greater attention as the week goes on, with Alcoa set to begin the earnings season tomorrow.

The USD is being buffeted by conflicting factors at present. QE3 is likely to cap any gains in the currency but the expansion of balance sheets by other central banks suggests that a weaker USD outlook is by no means a foregone conclusion. Moreover, from a growth perspective the USD comes out on top. Even though US recovery is a weak one by historical standards the economic outlook still looks better than in Europe, notwithstanding the looming US fiscal cliff. Further evidence of recovery will be gauged from the release of the September small business optimism survey today. A likely third straight gain will provide encouraging news although the survey still remains lower than levels it was at earlier in the year. Over coming days I expect the USD to edge higher as it capitalizes on the various strands of uncertainty in the Eurozone.

As Japan returns from an extended weekend USD/JPY has reversed its recent break higher and is verging on another test of 78.00. There seems little in terms of directional influences to give any major impetus to the currency pair especially as many JPY correlations have broken down lately. JPY speculative long positions remain relatively high suggesting scope for some reduction and JPY selling but I suspect that USD/JPY will remain stuck in its current 77.77 – 79.00 range for some time to come. Nonetheless, JPY bears may be encouraged by recent signs of strong bond outflows adding to data showing equity outflows over recent weeks. Indeed, in the week to 28 September 2012 Japan registered its biggest net equity and bond outflows since early May.

AUD has been a major underperformer this month, with pressure intensifying following last week’s surprise RBA rate cut. Although a further sharp drop appears unlikely hefty long speculative positioning suggests that upside traction will be limited. Nonetheless, my quantitative models show that the AUD is looking increasingly oversold against the USD. The market is already pricing in another RBA rate cut by the end of the year suggesting that the reaction to upcoming data will be asymmetric. In other words the AUD will rally more in the wake of positive data than it will weaken in the wake of soft data. Business and consumer confidence indicators will provide further direction over coming days, but the main driver will come from the September jobs report on Thursday where a further drop in employment is expected. I continue to look for strong support for AUD/USD around the 1.0100 level, with 1.0285 a barrier to any upside break.