Dead cat bounce? Not if Bernanke has anything to do with it…

It was the ECB yesterday, now it’s the time of the BOE and the Federal Reserve. The BOE announces its policy decision at 1200BST today. The market expects rates to be left on hold at 0.5% and for asset purchases to remain at GBP325bn. However, the outcome of this BOE meeting is more uncertain than usual because of some conflicting economic data. On the one hand PMI Manufacturing data fell to its lowest level last month for three years – back in the depths of the last recession. However, on the other hand the services sector PMI held up better than expected. The May survey result was 53.3, versus 52.4 expected. Since the service sector makes up nearly three quarters of the UK economy, you could argue that as long as this sector is expanding the UK economy is on the right track. However, such a sharp drop in manufacturing combined with the Eurozone debt crisis is likely to leave the BOE on high alert.

Will the BOE pull the trigger?

But the key thing for traders to know is whether or not the BOE will deem the risks from Europe high enough to warrant further QE today, or if it believes that the resilience of the service sector is enough for them to hold off and see how things in Europe progress especially with the Greek election coming up on the 17th June and the EU summit at the end of the month. On balance we think the BOE will remain on hold, but it will be a close decision. If it thinks the situation is bad enough to warrant action today then we could see a reversal in the recent recovery in the pound. We would expect a knee jerk reaction lower towards 1.5405 then potentially 1.5350. However, if the Bank holds off from pulling the trigger we could see some volatility and GBPUSD go back to test the 1.5550 area. EURGBP is also worth watching. If the BOE does more QE then this pair could bounce off 0.8100 support to re-test the 0.8150 then 0.8200 zone. If the Bank holds off then we could see a further decline towards the 0.8050 recent lows, which is also the 21-day sma.

The pain in Spain sometimes goes away

The Spanish debt auction earlier attracted healthy demand; hence it’s been deemed a success. Madrid managed to sell EU 2.1bn, above the EU 2bn target. Although yields for the 2014, 2016 and 2022 debt were higher than at an auction in April, the 10-year bond sold at a 6.044% yield at the auction, which is lower than the current market rate of approx. 6.15%. This has helped to ease pressure on Spanish government bonds; the 10-year yield has fallen 25 basis points in the last 3 days. This is a GOOD result, hence we saw EURUSD recover some earlier losses. Above 1.2570 we could see a re-test of 1.26, although this is likely to be an extremely sticky zone and we have heard there is plenty of resting euro offers at this level. Although the debt auction was positively received by the market, it highlights how bad things have got in Spain. It is now almost wholly reliant on its banks, and thus the ECB who fund Spanish banks, to buy its debt. International investors are staying away from Spanish debt, so the “success” of this auction does not mean that the sovereign problems are any less severe. This is important to remember as the sovereign strains could still erupt at any time and rattle the recent stabilisation we have seen in the markets.

Will Bernanke fill the punch bowl?

The ECB wiped its hands of more stimulus yesterday, the BOE may try to buy some time rather than pull the trigger later today, China has said it won’t enact another mega-round of stimulus to prop up its economy, thus it is left up to the Federal Reserve and Chairman Ben Bernanke to keep the markets’ spirited rally alive. He testifies to Congress today on the economic outlook at 1000ET/ 1500BST. This won’t be an easy speech for Bernanke to make: he has to tell politicians in an election year that the US’s economy is showing signs of moving backwards and jobs growth last month was a paltry 69k. He can expect a grilling, but what should traders and investors expect? They need to look out for two things: 1, whether Bernanke and co. think that the downturn in the labour market is going to get worse and 2, whether or not the Fed will act now by pumping more QE into the economy. If he points to more QE then expect an immediate dip in the dollar and the risk rally to notch up a gear in the medium term. Markets love liquidity and this is likely to depress the dollar. We could see EURUSD march back towards 1.2750 if it can get past the offers at 1.2600/10. The SPX 500 surged back above its 200-day sma earlier this week and is currently above 1,300. If we get Helicopter Ben today in front of Congress then we could see a surge to 1,360 – a cluster of daily moving averages and a key resistance level.

But, although we got some hints that more policy support is on the table from the Fed, and out of all the central banks it is likely to be the most accommodative in this environment, yields on long-term Treasuries are already at record lows. Thus, the Fed may hint that it may do something slightly different this time round, potentially buying up mortgage-related securities to target the problem areas of the economy. This could limit the reaction in the markets as it reduces the chance that QE-created money could seep out of the US economy and boost other asset classes. If Bernanke disappoints then there could be blood on the streets – expect sharp falls across asset markets and the dollar to rise. This could especially hurt gold, which has jumped $70 since Friday on QE expectations post the dreadful payrolls report. Support lies at $1,595 then $1,550 in the yellow metal.

It’s hard to forecast where we will be in the next 24 hours until we hear from Bernanke, so expect volatility later this afternoon.

Source: Forex.com

07.06.2012