After trawling through half the number of overnight news headlines as usual it is obvious that the market has not returned in full from the holiday break and in that respect some of the moves over the last couple of days should be taken with a pinch of salt as low liquidity is still the dominant feature of financial markets, particularly FX.
The start of 2012 has seen European Central Bank intervention in Italian and Portuguese Sovereign Bond markets, the Turkish Central Bank intervene in the Lira and some very sharp movements or corrections in a range of asset classes. However the core uncertainty that dominates both the global macroeconomic backdrop and the key driver of financial markets is still ‘uncertain’. The events of the Eurozone will continue to dominate at least the first quarter of 2012.
In equities at least the New Year got off to a risk positive start, perhaps as a function of an improving US economic backdrop, or a better than expected performance of the manufacturing sector globally (but most significantly in China and the US) in December. However, I would expect the uncertainties on the European continent to become the dominant factor as the month of January progresses.
Lender of last resort
Whilst I will refrain from analysing the financial markets too much at this early and illiquid stage of the year, there are a couple of events that are worth noting. Firstly, the ECB facility as a lender of last resort and as a Bank for banks should strike a precautionary tone to markets. The amount held on deposit at the ECB has risen steadily over recent weeks and this morning reached a record EUR453 billion, a factor that has been noted by ECB president Draghi as damping the transmission of monetary policy and non standard measures of liquidity as banks withdraw funding from the market and ‘save’ it at the ECB. This ‘saving’ by banks has lead many to question the relative health of some of the Eurozone’s banks.
Perhaps even more worrying is the fact that so soon after the 3 year unlimited lending operation by the ECB (with reduced collateral requirements) the amount borrowed at the marginal rate of 1.75 percent from the ECB overnight has remained very high (reaching its highest level since March last year yesterday at EUR17.3 billion) again indicative that the interbank funding mechanism is not working, or perhaps even worse, causing some to suspect that there is good reason that banks are not lending to each other!
Fed communication
The second event of note was last night's FOMC (Federal Open Market Committee) meeting minutes. The minutes suggested that the committee saw the economy “expanding at a moderate rate” and noted that “labor market conditions improved somewhat”. However, on a more precautionary note the committee predicted only a gradual decline in unemployment and said that “global financial strains pose significant risk”.
The key point however was likely the continued progress of the Fed towards a clearer communication policy. A number of members favoured a change to the “mid 2013 rate view before long” and there was an announcement that the Fed plans to release fed funds rate forecasts at this month's meeting. The text that accompanies the forecasts will also include an analysis of the Fed balance sheet and as well as “describe the key factors underlying those assessments” they will provide “qualitative information regarding participants expectations” for the Fed balance sheet – All should enable a clearer market view of fed expectations and a cleaner transition to policy normalisation.
Over the next week I will begin to publish my views for the progression of 2012. For now I would expect the underlying weakness of the situation within the eurozone to dominate and the EUR to suffer from a weakening bias.