fx360

Overnight equity markets finished the day fairly flat considering the anticipation built around the German court ruling which confirmed that the ESM was legal under German law and they would be able to contribute to the rescue fund. The outcome was more of a relief for markets and although broad risk markets kept the underlying bid tone, moves higher were fairly placid as ‘selling on fact’ capped moves as we shift to the FOMC roll of the dice later tonight.
EU Watch
The decline in Spain and Italy’s bond yields reflect the markets confidence that this Outright Monetary Transactions plan (OMT) may actually see the light of day. Last night’s German Constitutional court ruling went a long way to reduce the downside risks for struggling economies that in the past has seen financial markets quickly shut them out if there was a hint of catching the periphery debt flu.
The most comforting part for markets was that the conditions that were expected to be attached to its approval where simple, effective and only one. They ruled that Germanys 190 bio Euro contribution cannot be increased without parliamentary approval. This important insert should keep the majority of the German public onside.
US Watch
There is no doubt that the recent USD weakness and rallies on risk assets, indicate that the large majority are looking for an asset purchasing plan to be announced. For the moment, let’s leave aside the guessing game of whether they will or won’t announce QE3 and concentrate on the positions and expectations that the market has embellished in and play those. The market is well short USD and long anything risk associated (Eq, Comm, high yielding ccys) - banking on QE3 being announced.
If QE3 is announced then speedy evaluations will be needed on the dollar amount to be used and time range of the plan. The greater these two numbers the stronger the rally on broad risk assets which will be relative also to the power behind a USD sell off. (This printing of money devalues the worth of its currency as there is more in the system).
If no QE3 is announced then with a market needing to adjust to getting it wrong, we will see USDs fortunes turn quickly, and those caught long and wrong on risk asset positions will need to dump fairly quickly. The pace of this adjustment will be in Bernanke’s ability to sell future easing (dangling the carrot), something he has been doing well of late with such a large slice of the market believing QE3 is about to be announced.
As I have reported recently the fitting of an expensive venture such as QE3 to the current story doesn’t sit well with the only realistic aims to be either politically motivated or to weaken the USD to bring competitive forces into play. This attempted selling that QE3 is about addressing the labour force issues would have to be one of the worst red herrings I have seen in ages and unfortunately brings Bernanke’s credibility into focus.
Outlook
Initially I was looking for the trade that the market has overdone it on easing expectations which is understandable given the Federal Reserve’s guidance. I still think that the avenue of disappointment will be the play, however, we may start to see more players lower expectations as the one sided position for QE3 starts to even out a bit. This will see risk assets capped with a slight preference for the downside (if anything)