Europe gradually stabilising
Italy's political developments confirm political stabilisation
For the first time in 20 years Mr. Berlusconi has been outmaneuvered by the political movement he himself created. Italy has now, for the first time over the same period, a government that not only has an ample majority in the parliament. It is above all a homogeneous government composed of the most moderate faction from both the right side and the left side of the political spectrum. The chances, therefore, that this government might be able to finally pursue some badly needed reforms is high. Being both mainstream parties in the government, special interest groups and unions will have a harder time to push for the safeguarding of their particular privileges.
Slow adjustment in the periphery
Except for Italy, all other periphery countries have already achieved a significant adjustment of their competitiveness versus core countries, mainly through a reduction in labor costs. This does not mean that the growth pick-up, which will continue to materialize over the next coming months, will be very strong. It will be weak, and it will be weak for years to come. The main point is, however, that - barring a major global crisis - there will no massive austerity measures that would further create severe growth slowdowns.
Stabilisation explains temporary strength of the euro
As will be better explained on the next page, it is the the current stability that is preventing the ECB from taking more aggressive liquidity actions, in spite of being the only central bank whose outstanding liquidity is shrinking. We doubt that this will be for ever sustainable. The start of the Fed taper, in particular, might force the ECB to counteract with more liquidity. That could be the trigger for euro weakness.
The ECB is on hold ... for now
The ECB does not seem in a hurry to loosen its monetary policy
The European Central Bank (ECB) announced on 2 October that their monetary policy will remain accommodative for as long as necessary. However, comments from Mr Draghi did not suggest a forthcoming cut rates or that new unorthodox measures like the LTRO were ready to be launched. The perception that the ECB could remain longer on the sidelines, associated with the resolution of the recent Italian political gridlock, have lifted EUR/USD to new highs. However, the persistent low level of inflation, the fragile recovery, the decreasing level of liquidity in the Eurozone and the strong Euro are likely to trigger a new monetary stimulus from ECB in the next months.
Relative monetary policies less supportive for EUR/USD in 2014
The still questionable access to credit for small and medium enterprises (SME) in periphery countries and the increasing negative pressure coming from the strong Euro on exports could derail the current fragile recovery. Furthermore, the upcoming ECB's asset quality review of European banks is unlikely to lead to an increase in lending in the next few months. Also, the eventual US tapering is likely to push for higher borrowing costs globally, increasing the risk of derailing the Eurozone recovery. It seems therefore very likely that the ECB will eventually have to step in and loosen further the monetary conditions, potentially when the ECB will have a clearer view of banks' balance sheets.
Medium-term upside likely limited in EUR/USD
From a technical point of view, the key resistances are at 1.3711 (February peak) and 1.4000 (psychological level and long-term declining trendline). Given the respective monetary policies expectations and the increasing number of long Euro investors, we would not chase EUR/USD above 1.3711.
US government shutdown and the FX market
USD/CHF and USD/JPY are potential buying opportunities
We consider that an US default is very unlikely, therefore a deal is expected to be found before the unofficial deadline on 17 October. In such an event, a relief rally is expected that should lead to outflows out of safe haven currencies, leading to a decrease in value of the Japanese Yen and the Swiss franc. That decrease should be sustained by the persistent monetary policies conducted by the Bank of Japan and the Swiss National Bank. On the other hand, the US dollar is poised to rebound should a US default being averted. Therefore, USD/CHF and USD/JPY are prime candidates for a long position when the uncertainties will be lifted. The timing will likely be heavily linked to the resolution of the US political crisis. From a chart perspective and given that prices tend to anticipate events, a long strategy on USD/CHF and USD/JPY could also be favoured should they be able to move above a previous high. Currently, the resistances to monitor are 0.9078 (02/10/2013 high) in USD/CHF and 98.73 (01/10/2013 low) in USD/JPY.
RBA's wording more complacent on the Aussie
The RBA is waiting to see more effects of previous rates cuts
On 1 October, the Reserve Bank of Australia (RBA) decided, as widely expected, to leave rates unchanged at 2.5%. However, the wording concerning the valuation of the Australian dollar (not anymore described as "at a high level") and the persistent non-mention to any "scope for further monetary easing" suggest that the RBA could remain longer on the sidelines. Indeed, the rise in housing prices, one of the main beneficiary of the RBA's loose policy, tends to boost consumer confidence through the "wealth effect".
The rebalancing of Australian economy favours further RBA actions
In the longer term, we continue to believe that the end of the mining investment boom will lead to further below trend growth for Australia. Subsequently, the RBA will need to keep a loose monetary policy to help growth pick-up in the non-mining sectors.
High short GBP positioning has been erased
The International Monetary Market (IMM) non-commercial positioning is used to visualise the flows of funds from one currency to another. It is usually viewed as a contrarian indicator when it reaches an extreme in positioning.
With the US shutdown now in place, mounting uncertainties surrounding the debt-ceiling have pushed safe haven currencies, like the Swiss francs or the Japanese yen, higher. However, while the Swiss franc appreciation has been associated with investors adding long positions, the Japanese yen short positioning continues to move towards its historical extreme. We think that an eventual resolution of the debt ceiling issue should therefore act as a significant driver for a new phase of weakness in these currencies, especially the Swiss francs given investors long positions.
As expected, the Euro and the British pound have been bought after the FOMC meeting. The Euro long positions have exceeded their February peak and are now in territory where major tops have previously been made in EUR/USD. Therefore, even though we continue to favour a move towards 1.3711, a sustainable move higher is not warranted by Euro long positions.
The Australian dollar has seen some increase in its short positioning. However, the less dovish comments from the Reserve Bank of Australia on 1 October could lead to a closure of some of these short positions and fuelled short-term strength in AUD/USD.