Afternoon analysis 29.10.2014:
New highs hit by the Polish government bonds. Investors in the currency market await the FOMC statement. Ukraine struggles with severe problems. The zloty is down against its major pairs.
The major event of the week is a decision about the interest rates from the Federal Open Market Committee. Today the Federal Reserve will eventually end its third round of asset purchases renowned as quantitative easing according to majority of analysts. The Fed shifts from an unorthodox monetary policy to a rates-driven, traditional approach.
The US monetary authorities are set to show the nuanced statement as they weigh every single word in order to avoid spurring an increased volatility in the markets. So the statement is going to be fit to market's consensus – the phrase “considerable time” and remarks on “under-utilization” of the labor market both will be preserved. Nevertheless, the Fed ultimately ends QE today (a wider view in our morning commentary).
The EUR/USD hoveres near its previous close as the other major pairs. There was a wait and see regime in the markets.
If the Fed moves to more hawkish rhetoric, it may push the dollar higher. Although the central bank said a strong dollar weights negatively on the economy, there are some good arguments for rates increase – the overall shape of the economy is quite good, especially is we look at the labor market. So it is a ground for a surprise, but the probability that scenario is not very high.
Bonds hit highs
The Polish 10-year government bond yield fell to 2.591 percent – the lowest level in history. Demand for Warsaw's debt remained strong despite imminent closing of the QE. So it reflected expectations that the Fed will show rather dovish statement. Otherwise, the market would have moved in the opposite direction due to fact, that investors drop emerging market assets to dollar denominated assets when the Fed is getting more hawkish. And that didn't occur.
Moreover, this signal is even stronger due to shift in expectations for interest rates in Poland. In recent days the Monetary Policy Council members sketched out a view for interest rates that leaves place for additional cut by 25 basis points. Therefore, a more hawkish stance of the central bank should rather move bonds in the opposite direction.
Ukraine with more problems
Although the winter is near, Ukraine and Russia didn't agree on restarting gas supplies. Today in Brussels bilateral negotiation with the European Union envoy will be relaunched. Although a positive view on the expected result was expressed the Russian and Ukrainian parties, it was similar as previously, and the latest negotiations didn't yield any solution.
Ukraine doesn't have any leverage and it is going to seek a support from the European Union. It has only 3.1 billion dollar – less than 5.3 billion dollar of debt ousting to Russia and Kiev believe it can borrow the rest from the EU.
Moreover, after a positive result of the Ukrainian elections the political landscape is getting more gloomy. The President Petro Poroshenko's party is willing to be a leader of coalition, what is questioned by Arseniy Yatsenyuk, who is the leader of the People's Front that won the elections. Yatsenyuk said that although the Poroshenko is his major partner, he may seek other option if there is no agreement.
Disagreement among the Ukrainian politicians is not what the distressed country currently needs. For the zloty, mounting of the economic and political problems in Ukraine may spur a risk aversion and lead to heightened volatility in the Polish markets.
The Fed today ends the QE. Although it is a tightening of monetary policy, it won't strengthen the dollar if the central bank's statement meets expectations. So the EUR/USD will probably extend its streak of gains. For the zloty, this scenario meas that the currency will remain stable at current low levels.
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