This is a big week for asset markets as we wait for the Federal Reserve’s statement after their meeting on Wednesday. As it stands we anticipate the central bank will taper their asset purchases to zero, signalling the end of QE3. There have been some calls, given the recent market turmoil, for an extension of the buying programme, but personally I find this hard to believe. The purpose of the programme was to enable conditions for a recovery in the labour market, and as it stands events over the period during which QE3 took place have resulted in precisely the improvements that were sought after. So how can we expect an equity market correction which wasn’t, in the end, up to 10%, to be a justification for extending a successful programme? It simply doesn’t make sense to me. Federal Reserve members surely have to have more about them than watching equity indices! I would imagine there would need to be a new narrative… inflation for example, which could in future inform another round of easing, but there is simply no justification for it right now.


So what are the implications for asset markets in general and currency markets in particular? We have seen a substantial equity market rally over the last 2 weeks and easily more than half the losses have been recovered. In my view any sustained move in either direction will always see periods of consolidation or correction… I think we’re due this. I would not be at all surprised to see a quiet end to QE3, and the markets weakening as a consequence. However, the macro fundamentals in the U.S and also the U.K remain robust, and this should mean that any losses are temporary. Over the last few days we have observed a paradigm where higher equity prices have occurred along with a stronger dollar. While I still maintain that the dollar correction which we saw during the market turmoil has met the minimum requirements for a period of consolidation, there is still the possibility that we could see more. Short term dollar weakness is not our base case, but we are open to the possibility, we do however still maintain a strong conviction that the euro should weaken substantially versus both the dollar and pound sterling. It is probably prudent to remain on the side-lines until we see the exact nature of the statement from the Federal Reserve on Wednesday evening.


The ECB stress test concluded over the weekend showed that most of the larger European banks were sufficiently capitalised, with not much reason for concern in Germany, France and Spain. However Italy looks like the sick man of Europe as nine lenders fell short of the requirements. This news was largely positive and this is reflected in the slightly stronger euro overnight. These Italian banks will however need to raise capital to plug the gaps in their balance sheet. In politics we saw Dilma Rousseff winning the second round of the presidential vote in Brazil, I’m not sure the market will be enthused about that news, and the Brazilian real has already weakened significantly since the first round of voting.


On the data front we see M3 money supply data coming out this morning in the Eurozone, as well as IFO data in Germany. Both are expected to continue the trend of slowing growth, deflationary type data releases we’ve seen in recent weeks. As I mentioned above, all eyes will focus on the FOMC this week. Everything else is secondary…


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