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Valuations in many developed equities are far from compelling, but nowhere near extremes; while we continue to see signs that the global recovery is underway, there are reasons to be a little cautious.
Developed market central bank policy is still very accommodative, with the ECB highlighting it could look to revisit balance sheet expansion through a new LTRO (long-term refinance operations). We question whether this is largely designed to keep EUR/USD from pushing back above 1.35, or whether Mario Draghi is genuinely concerned about the falling levels of excess capital held by European banks and the impact a further contraction could have on lending rates. We feel there is probably an argument either way, but the other side of the coin is whether the European banks would genuinely want the LTRO funds. Back in 2011 and 2012 Italian banks bought Italian debt, with yields as high as 7.48% (the average through 2011 to 2012 was 5.41%), while Spanish banks bought huge amounts of Spanish debt with yields as high as 7.75%. Today with yields on both ten-year bonds at 4.27% and 4.26% respectively, is there going to be the same demand for the funds from the banks?
On the news of a future LTRO, EUR/USD fell to a low 1.3480, but has since found modest upside, while EUR/CHF has closed below the 200-day moving average for the first time since November. The pair has found buyers at this average on a number of occasions, so this break may be telling and one to keep an eye on as it could signal a deeper correction is coming.
Debt ceiling in focus
The market may be weighing up balance sheet expansion from the ECB, but traders are still pretty confused over the Fed’s own balance sheet, given Bill Dudley’s predicably dovish comments. Dennis Lockhart followed suit defending the FOMC decision not to taper its bond purchases, and this pushed bond yields in the US lower, with the ten year treasury now at 2.69% (down four basis points on the day). The US is effectively $25 million from the $16.699 trillion debt ceiling and we highlight that the market still expects that we avoid a major negative event, especially as public opinion in the US is against defunding Obamacare at the expense of a potential government shutdown. Once again it’s the Republicans that have the most to lose from this, and the market knows it. Still, the prospect that the Fed will continue to buy $85 billion a month of mortgage-backed securities and US treasuries through this time is high, and consensus remains for a December tapering exercise, just in time for Christmas.
Given one of the reasons why EUR/USD has held up so well is the differing paths of the ECB and Fed’s balance sheets. A change in 2014 (i.e. we see the ECB’s balance sheet expanding, while the Fed’s grows at a slower pace) could see the pair start to head down to its longer-term fair value closer to 1.20 (UBS calculation), despite the Fed saying time and time again that tapering is not tightening.
Today's Asian trade
Asian equities have been offered today, with the ASX 200 down 0.5%, the [indiesJP225|Nikkei] reopening and trading down 0.8% and China CSI 300 lower by 1.5%. There hasn’t been any major news today and the weaker leads from Europe and Wall Street have simply been replicated in Asian markets. The ASX 200 traded through yesterday’s low of 5227.4, found support at 5217.4 and has since rallied back just above this low which could be taken positively. A daily close below 5227.4 could suggest a test of the lower region of the bullish channel at 5185. While a subsequent break of this level could target the 38.2% retracement of the 14.4% rally seen in June to September at 5045, with momentum still strong (as seen in the daily MACD) pullbacks still represent good buying opportunities from a technical perspective.
China as well looks interesting and after a strong run from June to September, we’ve started to see cracks appear in the price action of the A50, CSI 300 and Shanghai Composite. Given the strong correlation these markets have had with AUD/USD, ASX 200 and risk associated assets, this market is definitely worth keeping an eye on.
Ahead of the European open
European equities look to resume where they left off, with US futures finding modest downside and testament to the poor tape seen in Japan and China. It’s going to be a day of central bank action with five ECB speakers on the wires. Ewald Nowotny speaks on the future of monetary policy, so that will be worth listening too, while we also hear from Yves Mersch, Jorg Asmussen, Vitor Constancio and Benoit Coeure. In the US we hear from Sandra Pianalto and Ester George, although it doesn’t seem apparent that they will talk about monetary policy. On the data front we get US Richmond Fed, US consumer confidence and the house-price index, while in Germany we get the latest read on the IFO business survey.