Strategic Currency Briefing

Outlook:

Today we get the US ISM manufacturing survey, forecast (WSJ) at 56.8 from 57.1 in July, which was the strongest since April 2011. Analysts point to the excellent Chicago Busi-ness Barometer on Friday as highly correlated with the ISM report. The WSJ notes “Although the ISM is a diffusion index based on a questionnaire that asks if various measures are the same, better or worse, it has shown a surprisingly strong relationship with economic growth. And, while it doesn't do a very good job of predicting what it will be in the future, the ISM is timelier… Assuming the econo-mists' consensus is right, the average reading of about 57 this quarter would signal one of the strongest three-month periods of the recovery so far. The ISM survey's average of 55.2 in the second quarter was considered consistent with about 4% gross-domestic-product growth. A government estimate last week put it at 4.2%. The upshot of two consecutive 4%-plus quarters of growth would be that the Federal Re-serve, on schedule to end its bond-buying program around the time of the first GDP estimate for the third quarter, could feel even more comfortable about its next step: raising short-term rates from zero.”

Another piece of important data today is the OECD report on global inflation—down to 1.9% in July from 2.1% in June among the 34 members. The G20 (which includes developing as well as devel-oped countries) has 2.8% from 2.9%. The WSJ says G20 accounts for 90% of global economic activity. Slower growth and lower energy prices account for the drop. “But only in Europe have falling energy and food prices contributed to very low annual rates of inflation and, in a growing number of countries, to consumer prices that are lower than they were a year earlier. According to the OECD, six of its members experienced a decline in prices over the 12 months to July, all of those being in Europe: Estonia, Greece, Poland, Portugal, the Slovak Republic and Spain.”

In addition to the RBA (no change), BoE, BoJ and BoC meeting this week, we have musings and specu-lation about the ECB. The ruling consensus so far is that the ECB will not announce anything new but just “prepare” the market for QE. First the ECB wants to see the effect of TLTRO and bank tests. If so, the market will be very unhappy and sentiment will continue to worsen. Previous historic lows are being tossed around, like 1.3000 (the low from July 15, 2013) and 1.2755 (the low from July 9, 2013), accord-ing to Market News.

To make matters worse, on Friday Goldman announced a forecast of parity by 2017. This is two things—a ploy to manage the market to favor Goldman’s position, and a grab at “market leadership,” now held by other big bank names like Deutsche Bank, Credit Suisse, BNP Paribas, Nomura and some-times even our alma mater, Citibank. Goldman has grabbed for leadership headlines in gold and oil. To be fair, JPMorgan Chase also cut its forecast to $1.26 from $1.28 by the end of June 2015.

One thing it is not is a sane and reasonable forecast. We haven’t seen parity since Nov 2002. The lowest lows are 1.1682 (2005), 1.1953 (2010) and 1.2143 (2012). We may say that a test of one of these is high-ly likely, but not parity. For one thing, the ECB cares deeply about its reputation. A falling euro is good for inflation and inflation expectations, to be sure, not to mention trade, but it has a limit when it comes to the ECB’s reputation. A “stable currency” is not on the ECB mandate list in a formal way, but you can bet it’s on the ECB’s mind all the same. We fully expect Draghi to finesse the press conference with strong words, such as promising an asset purchase program by a specific date and possibly even promis-ing QE at an unspecified later date depending on data. Draghi’s promises are powerful things. Central bankers hardly ever make promises so when they do, and especially when Draghi does, no one doubts him. If the promises are strong enough, the euro rout could be stopped cold in its tracks.

The problem is attaching a probability to the appearance of promises, aka reading Draghi’s mind. Since we can’t expect to hear from him directly ahead of the event, we will be looking for clues from other bigshots, especially German ones. If the BBK gives anything resembling a nod of approval to ABS and QE, you won’t want to be short euros.

And all this while we await the usual nonfarm payrolls shenanigans. Current thinking is another reading over 200,000, probably 225,000. This is not really on the radar screen just yet—the Beige Book comes first—but get ready.