Five Key Events for the New Week

There are five key events for investors this week. The first is the size of the ECB bond purchases. The market does not learn about these directly, but only indirectly through the size of the ECB’s sterilization operation. Until the resumption of its bond purchases, the ECB was sterilizing about 74 bln euros. The consensus is that the ECB’s announcement at around 13:30 GMT (9:30 EST) will indicate they spent around 10-15 bln euros, though the range of estimates extends to as high as 50 bln euros, according to one survey.

Many seem to be trying to back into an estimate by looking at the price action. Recall that in the ECB’s first week of buying bonds a year ago, it bought about 16 bln euros and Greek 10-year yields initially fell to around 7.2% from 12.5%. Ironically, the less the ECB bought, the more the market may like the report, as it would lessen the operational risks of the sterilization efforts. Relatively small purchases would also help minimize concerns about the EFSF, which will have fewer resources than the ECB.

Second, the Franco-German summit tomorrow attracts attention. There has been some speculation in the press that Germany was warming to the idea of a European bond. However, German Finance Minister Schaeuble threw cold water on the idea, reiterating Germany’s view that such a bond would weaken fiscal discipline.

Word from France also suggested that a European bond was not on tomorrow’s agenda. The euro came off was the news hit, with new bids found in front of $1.4250. The market hopes for a new initiative form the summit, but the short-term market does not seem well positioned as the IMM Commitment of Traders show the net speculative position has switched to a small short position for the first time since mid-January.

Third, the market continues to pare long Swiss franc positions with the local press suggesting the SNB and government may take new measures. Talk of a peg or new band still does not seem like the most practical or efficient strategy. It would imply intervention, which has been a massively losing proposition and/or capital controls. The euro approached the level that initial speculation suggested could be a peg (CHF1.15), but has backed off considerable. The liquidation of long Swiss franc positions has been a favor in helping lift other currencies, as cross positions are unwound.

Fourth, the minutes from the BOE’s MPC meeting form earlier this month will be released on Wednesday. The combination of weak economic data and the decline in commodity prices may see the hawks on the MPC capitulate to the majority. However, comments by MPC member Miles suggests that new asset purchases or a cut in the bank rate are not likely near-term either.

Fifth, of this week’s slew of US economic data, the CPI may be the most important. Last week, the FOMC kept the door open to QEIII, which some observers think is all but inevitable. One of the reasons that the Fed is not in a hurry to purchase more assets is that, as Bernanke has explained, the trade offs are less favorable. By that we believe he was referring to inflation pressures. In order for a new round of asset purchases, Fed officials may need to see price pressure ease.

The CPI report on Thursday is not likely to show this. In fact, the 0.2% decline in the headline rate in June is likely to be reversed in July and the core rate is likely to tick up to 1.7%, which would be the highest since December 09. The firmer the inflation, the less likely that new asset purchases are imminent, and this may spur a larger market reaction than is normally the case with US CPI. Attention will shift to Bernanke’s Jackson Hole speech later this month.

After last week tumultuous activity, market participants welcomes today’s more stable tone. Global equity markets are building on the pre-weekend gain by the US markets. The MSCI Asia-Pacific Index rose 1.9% as it tries to snap its 3-week 11% slide. South Korean and Indian markets were closed for national holidays, but all other regional bourses advanced. The Shanghai Composite advanced 1.3% extending its rally into its fourth consecutive session, which is its longest winning streak since late June. Japan’s Nikkei gained almost 1.4%, helped by a Q2 GDP report that was not as weak as expected (-1.3% at an annualized rate vs. expectations of a 2.5% contraction).

European markets are mostly higher, but the early upside momentum is flagging near midday. Financials in the Dow Jones Stoxx 600 are holding on to slight gains, but under-performing the market. Sovereign benchmark bonds are little changed, with Spanish and Italian 10- year bond yields holding below then 5% threshold. Five year CDS prices are mostly softer.