Calmer Markets, but Precariously So

A number of factors have helped stabilize the capital markets today. A partial recovery of US equities helped, though it took a nearly full recovery of the Shanghai Composite from an initial 5.5%+ decline to help lift the European markets. The recovery of US Treasuries yesterday and follow through today have help global bond markets recouped some of their recent losses. The US dollar for its part is steady to softer against the major currencies, while most of the free traded emerging market currencies are broadly higher.

The main impetus for the calmer markets is two-fold. First is simply technical. The sharp downside momentum in bonds and stocks seen from the second half of last week had appeared to exhaust itself. This forced short-term participants, especially momentum players, to pullback and even take some profits. Second, comments by officials, first in the US and then in China, also helped ease investor anxiety.

In the US, comments by Fed's Fisher and Kocherlakota (both non-voting members of the FOMC) reiterated that US monetary policy will remain easy even if there are long-term asset purchases. The useful reminder was not lost on the investors: the Fed is not close to tightening. What will be under consideration in a couple of months is whether the Fed should reduce the pace of easing.

Again, we are struck by the divergence of Fed and market views on the issue of the transmission mechanism of QE. Many in the market continue to see the purchases themselves as the key to the easing of monetary conditions. The Fed takes in Treasuries and MBS and credits dealers with reserves. Yet these reserves sit largely idle. The Fed has consistently argued that the real transmission lies with holding the "risk-free" assets off the market.  

There are at least nine Fed officials who are speaking between now and the end of the week.  Although the speeches do not seem particularly coordinated, we expect the underlying message to be largely the same:  the Fed may slow its easing efforts, as the downside risks have eased, but there is no intention to tighten policy any time soon.  

US economic data slated for release today will likely provide more points for the Fed's assessment that downside risks have eased..  Durable goods orders are likely to post back-to-back monthly increases for the first time since last Sept-Oct.   CaseShiller house price index is expected to have risen 1.2% in April, which is slightly above 3, 6, and 12 month pace.  Rising house prices have lifted some 1.7 mln households (according to CoreLogic) out of the negative equity position, they were in a year ago.  New home sales also are expected to have ticked up.    Meanwhile, keep in mind that core PCE deflator, due out tomorrow, is expected to show this important (for the Fed) measure of price pressures remain near record lows. 

In China, the cash crunch appeared to ease.  The overnight repo rate slipped almost 50 bp to 6% today (at the fix), which is half the rate seen at last week's peak, but it is still twice the average for the year.    The Deputy Director of the PBOC's Shanghai branch had some reassuring words for the market, suggesting that the central bank has the resources and will to keep money market rates at "reasonable" levels and suggested that the seasonal forces (apparently a reference to the quarter end settlement of various wealth management products that have been used to enhance returns available on deposits that involve in some ways a carry trade of sorts).  

In the foreign exchange market, the  euro briefly traded through yesterday's highs in late Asia, but European dealers initially sold into the up ticks that extended to $1.3150.   Short-term technical factors suggest the North American session will try it again.  Sterling has been in less than half a cent range today around yesterday's highs scored late in the day.  Support is seen near $1.5400-20 and provided it holds, a new marginal high seems likely..  Perhaps it the Scandis that best illustrate the corrective forces at work today.   They were among the hardest hit yesterday and are leading the recovery today with the Swedish krona up 1% and the Norwegian krone up 0.7% (near midday in London). 

Yesterday, we noted how the dollar was stopped against the yen at the 50% retracement of the losses it had suffered from May 22 through June 13.  The pullback began yesterday carried it to JPY97 in the European session before finding a bid.   Near-term consolidation that could extent back toward JPY97.70 today seems likely.