Has the bazooka been fired? Perhaps: the European Central Bank’s bailout scheme, dubbed Outright Monetary Transactions (OMTs), offers the most recent attempt by the Euro-zone’s leadership to put a floor under confidence. But a major part of this scheme is the necessary participation in the European Stability Mechanism (ESM) by a struggling state (Italy and/or Spain); we don’t find this likely given the fact it would mean the European Troika seizing control of these governments’ finances. But a major hurdle is on the horizon this week that must be discussed first.
The key events kick off the week on Wednesday, when the German Constitutional Court will rule on the legality of the ESM; without the ratification, the ECB’s plan is dead in the water and President Mario Draghi stands to lose a great deal of credibility, obviously a major concern at this inflection point of the crisis. Meanwhile, the EURCHF generated some attention for the first time in weeks as it was rumored that the Swiss National Bank would raise the floor from 1.2000 to stem flows as a result of the debt monetization on the horizon. With the SNB meeting on Thursday, the timing couldn’t be more perfect for a floor shift.
Outside of Europe, both the Federal Reserve and the Reserve Bank of New Zealand are due to meet on Thursday and Wednesday, respectively (see below). There’s also some interesting US consumer and labor market data due this week; though coming after the Fed’s meeting, the only way there is a material impact is if the Fed does not implement QE3 and instead delays the decision until the October policy meeting.
09/12 Wednesday // 08:00 GMT: EUR German Constitutional Court Announces ESM Ruling
Is the European bailout fund legal? After hearing arguments in mid-July, the German Constitutional Court is set to announce its ruling on the €500 billion European Stability Mechanism (ESM) on Wednesday. Following the June 29 ratification by two-thirds majority in both houses of parliament, concerned lawmakers filed an injunction claiming that the bailout measures transfer power away from Germany and into the supranational European body.
When all is said and done, the ESM will likely be ratified, not struck down. But the details within the ruling – how close the judges think the ESM gets to breaching Basic Law – will be what’s key. If the judges outline a case that German involvement in the Euro-zone is at its limits, this would present a serious roadblock to future solutions as Germany would be forced into a firmer austerity position; without core European involvement to backstop bailout funds, the region will be in dire straits if finances fall apart in Italy and Spain. Needless to say, a complete rejection is the worst case scenario and would be immensely negative for the Euro. The key pairs to watch are EURCHF, EURJPY, and EURUSD.
09/12 Wednesday // 21:00 GMT: NZD Reserve Bank of New Zealand Rate Decision
The Reserve Bank of New Zealand will meet on Wednesday to keep its key rate on hold at 2.50%, according to a Bloomberg News survey. Economic conditions have been moving sideways to better in New Zealand, but with the country so heavily exposed to both the Asian and European situations, the New Zealand economy often finds itself influenced by exogenous forces beyond its control: in Asia, slowed Chinese growth is hurting New Zealand trade with China and Australia (whose growth is tied to China as well); and in Europe, the combined effect of declining growth and a damaged financial sector are holding back the New Zealand economy.
But with these concerns subsiding in the near-term, there is only a small chance of any change in the key rate. According to the Credit Suisse Overnight Index Swaps, there is a 15.0% chance of a 25.0-basis point rate, and only 4.0-bps are being priced out over the next 12-months. As such, we think that the New Zealand Dollar is fairly stable around this release, though any increased concerns over China could lead to downside price action in the near-term. The key pairs to watch are NZDJPY and NZDUSD.
09/13Thursday // 07:30 GMT: CHF Swiss National Bank Rate Decision
The Swiss National Bank will keep its key interest rate on hold at 0.00% this week, though our focus does not lay there. Instead, we are intrigued by the possibility of a shift in the EURCHF exchange rate floor, as it has been at 1.2000 for the past year – this does mark the one-year anniversary of the floor implementation (which coincided with a top in Gold, ironically). Rumors were afoot last week that the SNB was planning a move to 1.2200, sparking a sharp upside move in both EURCHF and USDCHF. If the SNB is going to make a move, the time is now: the ECB is in the process of unrolling a major bond-buying program that can be chalked up to debt monetization, which will weigh on the EURCHF floor. If there’s no floor raise, the Swiss Franc should strength. The key pairs to watch are EURCHF and USDCHF.
09/13Thursday // 12:30 GMT: USD Federal Open Market Committee Rate Decision
The Federal Reserve’s Minutes from the July 31 to August 1 meeting suggested that new QE was on the way, and that if the US’ economic recovery continued to move at stall speed, the Federal Reserve would pull the trigger on more accommodative measures. Chairman Ben Bernanke’s remarks at the Jackson Hole Economic Policy Symposium defended nontraditional policy measures (beyond setting rates), but there was a clear lack of conviction for more of the same: diminishing returns were noted. More recently, the discouraging August labor market reading likely pushed the Fed towards more action. But in what form?
In light of recent developments, we still don’t believe that the “New QE” referenced in the Fed Minutes necessarily means “QE3,” or a bond-buying program aimed at lower yields. Similarly, we don’t believe that the “New QE” necessarily means a large-scale asset purchase program (LSAP) aimed at asset-backed securities (ABS) or mortgage-backed securities (MBS), like QE1.
Instead, we think it is possible that the New QE means a program aimed to help consumers in a more tangible sense to help the recovery further; it is clear that despite all-time low mortgage rates, the housing market still can’t catch a break. Any form of housing assistance would make sense for a number of reasons. This would satisfy the innovative stimulus idea that many have searched for, and would restore credibility to the Federal Reserve, as it would show that there are a number of policies that could be deployed to help the US economy, not just LSAP or debt monetization.
The idea is simple: free up income for consumers to dispose of, and growth will strengthen (consumption represents nearly 75% of the headline growth figure in the US now). If the Federal Reserve doesn’t resort to QE3 a la QE1 or QE2, then it saves that bullet for a more crucial time, when yields start to spike, for example. This fits in very neatly with the approaching “fiscal cliff,” which could very-well push yields up. In that sense, then, if yields do climb in the beginning of the year, QE3 could be implemented to help cushion the economy.
If QE3 is announced, we should expect the US Dollar to take a severe beating, especially against the Euro and the Japanese Yen. However, if any form of New QE is announced which doesn’t suppress the yield curve, the US Dollar could actually gain. The key pairs to watch are EURUSD and USDJPY.
09/14 Friday // 12:30 GMT: USD Advance Retail Sales (AUG)
The US economy has been churning out weak data in recent weeks, and the Advance Retail Sales report for August doesn’t look like it will break recent trends. According to a Bloomberg News survey, sales are forecasted to gain by +0.8% last month after growing by the same rate in July. Sales growth peaked at 1.0% in February and contracted every month between February and July. Considering the pent up expectations from more stimulus from the Federal Reserve, it is likely that a disappointing print spurs some risk-appetite, with the US Dollar selling off thereafter. If the print beats, expect the US Dollar to steady or enhance its gains. Regardless, the impact of this release is probably limited this month with the Fed meeting the day before. The key pair to watch is USDJPY.
Rate Hike Probabilities / Basis-Points Expectations
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--- Written by Christopher Vecchio, Currency Analyst
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