April 10th 2011: Weekly Market Preview - Fed divisions in focus
Central banks will remain firmly in the limelight over the next week, but the focus will be more subtle that last week when the ECB meeting was the key set-piece event. The ECB laid played its hand last week and delivered the expected interest rate increase to 1.25%. There are very important reservations whether it was the correct policy decision, but this issue will be determined over the next few weeks and months and the outcome will certainly not be clear in the very short term.
The Euro-zone credit markets will need to be watched very closely during the week. European governments have made a concerted effort to convince markets that Portugal was the last country that will need a bailout. The evidence of real-money flows will be under the microscope to see whether the markets are buying the message that there will be no further contagion risk with Spain Italy, Belgium and even France all under scrutiny. The Spanish Finance Minister has ‘told’ markets that there is no risk to Spain, but there is certainly no guarantee that markets will be listening as the peripheral economies get sucked ever closer to some form of debt re-scheduling.
Attention will also focus on US Federal Reserve speakers during the week, especially as it’s a rather lacklustre period in terms of US releases, particularly during the first half of the week.
The US retail sales, trade balance and Michigan confidence index will be monitored during the week, but they are unlikely to have a decisive impact on the Fed’s thinking or the dollar with movements in oil and commodity markets liable to dominate trading.
In contrast, at least 12 speeches are due to be delivered by voting members of the FOMC and there will also be important contributions from non-voters as well.
The next FOMC meeting will be held on April 26-27th and the Fed at that meeting will have to decide whether the second quantitative easing scheme will be adjusted. Officials are very reluctant to comment in the week running up to the meeting so the next 10 days will be vital both in terms of the internal battles within the Fed and the equally important public relations task of communicating any policy changes to the markets.
The evidence at this stage suggests that the core FOMC members do not see the need for any short-term tightening and will also resist any attempts to curtail the existing quantitative easing programme. Fed comments will, therefore, be watched very closely to see whether the hawks have made any impression. The most likely outcome is that they have not. There should be broad agreement that there is no need to extend quantitative easing beyond June.
Despite the very strong Euro rally, there has been strong evidence that sovereign reserve managers have still been willing Euro buyers against the dollar as efforts to keep their currencies competitive through intervention give them excess dollars to sell. At some point, they will decide that the Euro has become too expensive and they will draw back from further buying which will leave the more speculative buyers in a much more exposed position. This could well be the week when that point is reached as EUR/USD approaches the 1.45 level. Late in the week, G7 members will also have the opportunity to discuss exchange rates when they meet on the fringes of the IMF Spring meetings.