Despite comments by the German Finance Ministry that it sees no need to give the ESM bail out fund a banking license, market hopes of European Central Bank (ECB) action tomorrow remain in place, helping to give some support to markets and the EUR. However, the Fed is unlikely to deliver fresh stimulus measures following the conclusion of its two day meeting today.
Sentiment slipped slightly overnight although any weakness was limited by stronger than expected data releases in the US in the form of July consumer confidence and Chicago PMI. US and European equities ended lower but overall its appears to be a case of treading water until the policy decisions over coming days as well as Friday’s US jobs report.
There is perhaps less expectation of Fed action than the ECB but nonetheless, recent press reports suggest that the Fed is shifting closer to pulling the trigger for more balance sheet expansion. This in turn has put some restraint on the USD.
Although it is more likely that the Fed will want to wait to assess more economic data (the Fed will not be privy to the July jobs report before its release on Friday) there is a chance that the Fed could extend its guidance tonight. This will be less important from a USD perspective but if the Fed opens the door even wider to a third round of quantitative easing the USD will find little solace from a lack of QE today as the Fed will merely be seen to delay such a move until September.
Combined with the impact of firmer risk appetite over recent days and consequently reduced safe haven demand the USD will struggle to make any headway in the near term, with the USD index to find it difficult to break above 83.000.
AUD has been the best performing major currency in July. Yield attraction has increased and the AUD has been a key beneficiary. While my forecasts remain among the most bullish this year (1.08 by year end) I am cognisant of the risks of a pull back in the interim.
AUD has benefited to some extent from expectations of further policy stimulus in China as well as a generally more favourable tone to risk appetite. Reports that China is interested in buying Australian regional government bonds will also help buoy AUD.
While external conditions hold various risks to the AUD the domestic picture does not look too adverse and various domestic economic indicators have beaten expectations. Consequently I believe that market expectations for a bigger 75bp of Reserve Bank of Australia (RBA) policy easing are overdone and an eventual correction in the markets’ overly dovish stance will help to support the AUD.
Meanwhile, speculative AUD positioning is well below the all time high reached in April 2011, suggesting scope for more gains. AUD/USD looks well supported around 1.0374.