Fed ups the ante, as Europe agrees bank deal

Last night’s decision by the Fed to open the monetary taps a little bit wider and turn a trickle into a steady flow suggests that the decision to expand QE in September with the indefinite monthly purchase of $40bn worth of mortgage backed securities has ultimately proved to be completely inadequate.

The FOMC has undertaken to not only add another $45bn worth of treasury purchases but has also scrapped its calendar date linked low rate guidance in favour of tying the low rate guidance to the unemployment rate while it remains above 6.5%, though inflation also has to remain below 2.5%.

This last measure appears to have caught the market slightly off guard; however the market relief rally in response to these more aggressive measures proved to all too brief as US markets closed mixed on the day, though the US dollar has weakened somewhat, particularly against the euro.

This market reaction appears to suggest that the medicine of unlimited QE, like some forms of medicinal antibiotics, is starting to lose its effectiveness on the patient, as the law of diminishing returns starts to kick in.

Mr Bernanke also stated that the Fed would be unable to mitigate the effects of any failure to reach agreement on the fiscal cliff, thus neatly tossing the ball back to the Republicans and Democrats to agree a deal, on which they so far, remain miles apart from agreement on.

As far as the US economy is concerned the latest weekly jobless claims are set to come in unchanged at 370k while November retail sales are expected to get a pep of 0.5% from the Thanksgiving holiday break, after the disappointing October decline of 0.3%.

In Europe talks about a single supervisory mechanism for European banks from all 27 countries appear to have reached some form of agreement to give the ECB wide ranging powers to supervise the euro zone’s largest banks with assets over €30bn, and intervene in the case of smaller banks if they feel it necessary.

The new mechanism is hoped to be in place by the end of 2014, but it first needs to be ratified by EU leaders at today’s EU summit after Germany softened its stance after winning some concessions on the extent of the oversight, with regards to its smaller banks. The agreement appeears to be exclude the small German banks, a key sticking point while the delay in implementation leaves plenty off room and time for unpicking the deal.

Approval for the next aid tranche for Greece is also likely to be approved after this week’s debt buyback, even though it fell slightly short of expectations.

After the uncertainty at the beginning of the week which saw bond yields spike sharply in the wake of Italian PM Mario Monti’s resignation there is the matter of a new 3 year Italian BTP auction for up to €3.5bn this morning. Given that yesterday we saw a successful €6.5bn 12 month t-bill auction with yields at 9 month lows, the odds are that we could well see a similarly successful auction here as the frayed nerves from Monday continue to ebb away.

We also have a small Spanish auction at around the same time for about €2bn.

EURUSD – the move through 1.3020 keeps the euro on course for the highs this month at 1.3125, and the larger resistance at 1.3175. A move back below 1.3020 retargets the key support at the 1.2880/90 level which is the 50% retracement of the up move from 1.2660 to last week’s high at 1.3125.
A move below the 1.2880 level opens up a move back towards the trend line support from the 1.2050 low, which now sits at 1.2825, and the 200 day MA at 1.2790.

GBPUSD – once again the 1.6180 level and November highs has capped the cable advance. The 1.6120/30 level should now act as support on any move back down towards the key support at 1.5980. Only a break through here targets major trend line support at 1.5865 from the 1.5270 lows, the 200 day MA at 1.5870 as well as 1.5660.

EURGBP – yesterday’s break above the 0.8080 level retargets the 0.8130 level and then 0.8165, the November highs. The 0.8080 level needs to hold for this move to unfold otherwise we’re probably heading back towards 0.8030 and trend line support from the July lows at 0.7755 which remains the key level for the uptrend to continue.
A break below the 0.8010 level targets the November lows at 0.7960.

USDJPY – the break above 82.70/80 now brings the potential for a move towards 84.00 initially and the highs this year at 84.16.
The previous resistance at 82.70/80 should now act as support, but if we do drop below this then there remains solid support at 81.70. If we break below 81.60 then the potential is there for a move towards 80.50, and even 79.90.