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Beginning of New Quarter Front-Loaded With Crucial Event Risk

Beginning of New Quarter Front-Loaded With Crucial Event Risk

2011-10-03 04:00:00
Christopher Vecchio, CFA, Sr. Currency Strategist

After an incredibly choppy week – the front end gave way to correction and while the second half of the week continued recent the broader shift to risk-aversion – the week ahead looks to offer little relief to such price action. This is considerable in the sense that there was very little by way of significant data out over the past week. With four rate decisions on tap for the coming week, however, price action will remain high and perhaps one sided, as central bankers reveal their analysis on the economic developments during the inter-meeting period.

USD ISM Manufacturing (SEP): October 3 – 14:00 GMT

The ISM manufacturing gauge declined six out of the past seven months, after peaking in February. In fact, February's reading was its highest level since May 2004, when it reached 61.4. The index is expected to show continue the trend of further weakness, however, a sign that the manufacturing sector is expanding, albeit at a slower rate. A strongerU.S. Dollar across the major currencies has certainly diminished demand for American goods, ultimately weighing on exports. Another weak number could restart dovish rhetoric within the Federal Reserve. On the contrary, if the figure beats expectations, it could lead to a weaker U.S. Dollar, as those retaining the belief that the U.S. economy isn’t headed towards a recession, boosting risk-appetite if only slightly.

Reserve Bank of Australia Rate Decision: October 4 – 03:30 GMT

The Reserve Bank of Australia will hold its October meeting on Tuesday, where it is expected that the rate will be maintained at 4.75 percent. At the previous board meeting in September, the Reserve Bank of Australia decided to hold the rate steady at 4.75 percent, a level that has remained unchanged since November 2010. According to the Credit Suisse Overnight Index Swaps, there is a 29.0 percent chance of a 25-basis point rate hike at the central bank meeting on Tuesday. However, 133-basis points are being priced out over the next 12-months, indicating a cut in the rate is coming down the pipe.

At its meeting on September 6, the Board of the Reserve Bank of Australia voted to leave the cash rate unchanged at 4.75 percent. Governor Glenn Stevens noted that “conditions in global financial markets have been very unsettled over recent weeks….as a result, the outlook for the global economy is less clear than it was earlier in the year.” The Reserve Bank of Australia continued to say that growth was slowing. Governor Stevens’ statement included a note that some “temporary impediments” to growth, such as the supply-chain disruptions from the Japanese earthquake as well as higher commodity prices, were “lessening.” The statement afterwards also suggested that “employment has been moderate this year” while “CPI inflation should start to decline.”

Given these observations, it appears that the Reserve Bank of Australia is becoming increasingly dovish. While concerns over the Australian economy are limited in scope, any pullback in Australian growth is likely to be provoked by broader global macroeconomic trends. This has translated into a weaker Australian Dollar over the third quarter of 2011, as interest rate expectations have deteriorated sharply in recent weeks, a trend that is expected to continue. Join a DailyFX analyst for live coverage of event!

Bank of England Rate Decision: October 6 – 11:00 GMT

The Bank of England’s Monetary Policy Committee is expected to maintain its key benchmark rate at 0.5 percent at its meeting on Thursday, the thirty-second consecutive month at such a rate. The primary underlying reasonto maintain the rate continues to be the Monetary Policy Committee’s focus on economic growth rather than on reducing inflation, which ticked higher recently.The United Kingdom is facing an inflation rate of 4.5 percent as of August, more than double its target of 2 percent. Policymakers agree that the economy is not stable enough to withstand higher rates at the current time, given the eroding condition the housing and labor sectors. Traditionally, an inflation rate of this level would be a signal for the Monetary Policy Committee to increase the bank rate.

With economic recovery expected to be shaky in the short and medium-term, the Monetary Policy Committee will likely hold the bank rate at 0.5 percent through at least the end of 2011. The Overnight Index Swaps point towards the same conclusion, with a 3.0 percent chance of a rate cut at the meeting on Thursday, and 10.4-basis points priced out of the Sterling over the next 12-months. It is also important to watch whether or not the Committee expands the central bank’s asset purchase program, a move that would be an extension of quantitative easing.

European Central Bank Rate Decision: October 6 –11:45 GMT

The European Central Bank is expected to keep its key interest rate unchanged at 1.50 percent at its meeting on October 6. On September 8, the Governing Council of the European Central Bankmaintained the overnight rate at 1.50 percent.European Central Bank President Trichet said that the European Central Bank’s “monetary-policy stance remains accommodative.However, with German growth slowing as well as a necessity for lower rates in the periphery countries, rate cuts are likely in the coming months, in my opinion. This meeting is notable as it is the last meeting at which Jean-Claude Trichet is president, before Mario Draghi takes over.

The Credit Suisse Overnight Index Swaps suggest that a rate cut is in the future as well. Currently, markets are suggesting that rates will be cut by 25-basis points on Thursday, with a 16.7 percent change of a 50.0-basis point rate cut. Similarly, there are 41.6-basis points being priced out of the Euro for the next 12-months, signaling a potential rate cut by year end, if not next week.

In recent weeks, interest rate expectations have plummeted for the Euro, and as recently as Monday markets were pricing in an eighty-eight percent chance of a 50-basis point rate cut. Friday’s inflation data out of the Euro-zone suggests that a rate cut would be ill-advised, but lowering borrowing costs across the Euro-zone is of greater importance at this point of the crisis. Ultimately, no matter what decision the European Central Bank makes is going to weigh on the sentiment.

In one outcome, we could see the ECB hold rates at their current level, a move that would keep borrowing costs high for the periphery countries. Pundits have pointed towards the recently elevated rates as a reason why Greece has had trouble in the bond market, as well as a reason why Italy and Spain may soon see their debt go stale as it is deemed undesirable by investors. On the other hand, a rate cut would be a white flag of sorts: acknowledging the strains on the market and the necessity for lower rates could scare investors. Certainly, loosening conditions could be perceived as bullish for equity markets in the short-term (as they have historically), but the Euro would be viewed as substantially weaker, given its actual lower yield. In either case, risk-aversion will remain the theme, and market participants will continue to err on the side of caution by finding haven in the Dollar and Yen. Join a DailyFX analyst for live coverage of event!

USD Change in Non-farm Payrolls, Unemployment Rate (SEP): October 7 – 12:30 GMT

According to a Bloomberg survey, economists have forecasted that September data will show an increase of 73K in U.S. nonfarm payrolls figure, the American index of the labor market. The August figure came in at a disappointing0K print, falling well-below expectations. A slew of disappointing data releases over the past month coupled with economists largely missing the target on this indicator recently suggests that another miss on the data is possible.

Accordingly, economists expect the rate to remain at 9.1 percent. In July, the unemployment rate dropped to 9.1 percentbeating economists forecast that the rate would hold at 9.0 percent. Confidence remains low as the labor market fails to recover; this data release is the most important event on the economic docket the coming week next to the European Central Bank rate decision.Join a DailyFX analyst for live coverage of event!

Rate Hike Probabilities / Basis Point Expectations (12-months)

Beginning_of_New_Quarter_Front-Loaded_With_Crucial_Event_Risk_body_Picture_1.png, Beginning of New Quarter Front-Loaded With Crucial Event Risk

See the DailyFX Calendar for a full list, timetable, and consensus forecasts for upcoming economic indicators.

Written by Christopher Vecchio, Currency Analyst

To contact the author of this report, please send inquiries to: cvecchio@dailyfx.com

Follow Christopher Vecchio on Twitter: @CVecchioFX

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