Markets curb their enthusiasm

After taking a knock early on risk appetite returned in the European session, although stocks have had a more cautious open in the US after a stunning rally yesterday. There was another encouraging signal from the Us economy today as durable goods orders rose by 4 per cent in July, smashing the 2 per cent forecast and the fastest pace of growth since January. The markets are extremely sensitive to growth signals right now and traders, politicians and central bankers are all looking at the economic data to try and determine if we are going through a slow patch or if this is something more serious.

Some of the detail of the durable goods report was also positive. Shipments were up for a third straight month suggesting that exports may pick up the slack if there is a slowdown in domestic demand. However, the bulk of the increase was driven by transportation orders for vehicles and commercial aircraft. However, demand for business equipment was lower, which suggests that businesses are not spending or investing in the current economic and political environment.

Focus is also on Federal Reserve chairman Ben Bernanke’s speech on Friday. If part of this risk rally is driven by the expectation of more QE then the markets may well be disappointed. The chairman is unlikely to add more stimuli at this stage when the growth outlook is still unclear. Added to that the core inflation rate is much closer to its target than it was last year when the Fed embarked on QE2. Thus, there may be volatility as we get close to the weekend.

Elsewhere, Moody’s downgraded Japan to bring its rating in line with other agencies. Although the Nikkei closed down more than 1 per cent, European indices have shrugged this off. The yen also continued to strengthen versus the dollar. The downgrade caused a flight to safety and the yen remains close to record lows. Although this screams intervention risk there are growing signs that the Japanese authorities are begrudgingly accepting a strong currency and today the government announced a stimulus plan to help exporters cope with the strong yen and make overseas deals.

In Europe, Angela Merkel reiterated that she was against the idea of Eurobonds and Spanish bond yields have edged above 5 per cent. There are some rumours that Germany will demand gold from bailed out nations in return for continued financial support akin to Finland who asked for collateral in return for a second round of bailout loans. The EU authorities are currently working on a plan to figure out collateral arrangements, which may delay the next tranche of bailout funds for Athens next month. If this happens it would be a major risk event for the markets to look out for.

The economic data out of Europe wasn’t as good as it was in the US. German business sentiment fell to its lowest level in two years as growth starts to slow and fears remain about the Eurozone debt crisis. This is adding to the body of evidence that growth will be extremely sluggish in the third quarter.

Other member states with precarious finances are also trying to work a bit harder at reducing fiscal deficits. France is working on a plan to slash its deficit at an even faster rate as it tries to hold onto its top credit rating. The government is also planning on closing tax loopholes, and today some of France’s highest paid business men sent a joint letter to announce they would pay a one-off special tax to help raise revenue for the country and bring down the deficit. This has hurt the euro versus the safe havens, but EUR/USD is holding onto recent gains and is currently trading around 1.4450.

European troubles are keeping the pressure on the Swiss franc, which is higher versus the dollar and the euro, and stocks are starting to give back some gains as we start the US session. This happened yesterday before a strong rally, so expect volatility as we lead up to Jackson Hole.

Kathleen Brooks is research director at Forex.com

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