Beware the Ides of March... and Be Careful Around the FOMC Meeting

Tuesday, 15 March 2011

hus was the warning given to Julius Caesar prior to his being killed on that very day. Today is the Ides of March, and a death has occurred. Only it is the financial markets that have taken the place of Caesar, as there is a massive sell-off taking place. And while I don’t fancy myself the soothsayer, I have been warning about the risk in the markets for some time. Today news out of Japan is that there are radiation leaks from the nuclear reactors that were affected by the earthquake and tsunami, which could have an even greater negative impact of the economy. As a result, the Nikkei was down 10% overnight, inducing some major risk aversion. This also has dragged European stock markets lower, ranging anywhere from 2.5% to 4.5% lower so far today. U.S. stocks are also set to open significantly lower, and both oil and gold have pulled back.
So this is definitely the type of day where the risk themes have out-weighed the fundamental data, not that the data is that great to begin with. In the Euro zone, CPI data has come in slightly lower than expected and German confidence figures are also lower than expected. This may give the ECB a reason to keep interest rates steady at its next policy meeting.
But all is not lost today, as "Bubble Ben" and the FOMC could save the day. With QE2 coming to an end shortly, I was wondering if today would be the day where he starts to prepare the market for when the punch bowl of free cash is taken away. However with today’s action already pushing markets extremely lower and strengthening the dollar, it is extremely doubtful that he will invoke that tone.
In the forex market:
Aussie (AUD): The Aussie is lower across the board as risk aversion and its positive correlation to the MSCI Pac Rim index has dragged it lower.
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Kiwi (NZD): The Kiwi is trading similarly to the Aussie, though it does make as extreme a high or low as its antipodean neighbor.
Loonie (CAD): The Loonie is also lower, as oil prices have pulled back to 97.50 as a result of the uncertainty of the Japanese nuclear situation. The ripple effects are now enveloping the global economy which could mean a lack of demand going forward.
Euro (EUR): The euro is mixed, trading higher vs. the commodity currencies but lower against the safe havens. German ZEW confidence figures came in lower than expected, but today is about the fallout from Japan.
Pound (GBP): The Pound is also lower as home price figures came in worse than expected, which means it is extremely doubtful that the BOE will raise rates at the next meeting given what is going on in the global economy.
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Dollar (USD): The Dollar is higher today as the flight to safety trade is in full effect. While there are some ancillary data points due out tomorrow, the big news is the FOMC meeting at 2:15 EST. As a result of today’s sell-off, Bernanke will do all in his power to convince the markets that monetary policy will remain accommodative, perhaps even longer than QE2 is set to expire. Unfortunately that is the problem with blowing bubbles—they have to pop sooner or later.
Yen (JPY): The Yen is strengthening across the board despite the Bank of Japan efforts to pump money into the system. As overseas assets are re-patriated to Japan, demand for Yen goes up. In addition, as selling in the Nikkei picks up (down 16% in the last 2 days—the largest 2-day drop in nearly 25 years), the Yen also strengthens.
The problem with creating bubbles through weak monetary policy is that when disaster strikes, there is nowhere left to go. It is hard to be even more accommodative then "Bubble Ben" has already been, so any tightening of policy at this point would be disastrous.
The ripple effects and the fallout from this catastrophe are unknown at this point, so the "sell now, ask questions later" mentality is the prevailing theme. Yen strength appears to be a short-term phenomenon that could reverse if the BOJ gets serious about injecting liquidity into the economy Bernanke-style.
So be careful around the FOMC meeting, as volatility is sure to ensue and let’s hope that Bernanke’s comments have the effect that’s intended.


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