Merkel 8217 s Pro Growth Coalition amp Taperless USD

Last week’s blow to “Taper Mania” by the Fed decision to go taperless despite explicit hints at scaling down purchases in September by Chairman Bernanke and notable declines in jobless claims and the unemployment rate, will highlight the Fed’s division during this week’s upcoming public appearances by Fed presidents and board governors.

Five of this week’s nine speakers are voters at this year’s FOMC—Dudley (dove), Stein (hawk), George (hawk), Evans (dove) and Rosengren (dove)–while the four non-voting speakers are Lockhart, Fisher, Pianalto and Kocherlakota.

A decision to taper in October would be seen as preposterous

St Louis Fed president Dennis Bullard, who voted at last week’s FOMC decision said 2 days after the Fed announcement that decision not to taper was a “borderline decision” and that a scaling down of purchases was possible at the October meeting. If the Fed does change its mind and decides to taper as early as the October meeting –six weeks after spectacularly surprising markets – then the 100-year old institution may be likened to a high-frequency trader, raising questions over the way it interprets macroeconomic data.  Why would the Fed suddenly decide to scale down a 10-month old policy at a meeting with no press conference, when it could have waited 2 weeks later (December FOMC on 18) to communicate such a decision with greater detail and more probability?  Even if the September jobs report (due in Oct 4^th) shows a reading of greater than 200K and the unemployment rate drops to 7.2%, then what would have become of those fiscal concerns raised by the Fed last week? Surely, those are unlikely to disappear. And by this reasoning, the long-awaited Fed-driven support to the US dollar will have to wait.

Another factor likely to help the recent sell-off in the greenback is the increasing probability that Fed vice Chair Janet Yellen will become the next Fed Chairman. Yellen’s postponement of a speech to the NY Economic Club scheduled for Oct 1^st suggests that she will have received the nomination by then, which would oblige her to delay any public appearances until confirmation hearings are finalized in Congress.

Merkel’s Pro-Growth Coalition

Since Chancellor Merkel’s CDU/CSU coalition with the FDP will most likely shift to that with the centre left SPD, policy-making may tilt closer to the agenda of the SPD i.e. more supportive of growth-oriented policies and less focused on austerity. Considering that a Grand coalition would be more receptive to broader Eurozone integration and an activist ECB, such point might be capitalized upon by eurofiles and sceptics alike to make their argument heard for and against more integration. Finally, a Grand coalition is also perceived to imply less political uncertainty than the weaker majority under the present coalition of CDU/CSU & FDP. Coalition hearings may take up to 6 weeks, during which the euro will likely take its cues from ECB policy makers.

The euro’s weak footing on Monday can be attributed to the fact that Merkel’s CSU/CDU will have to form a new partnership with the centre left SPD after its pro-business coalition partner FDP dropped out of parliament whose increasingly belligerent leader Peer Steinbruck, will likely raise the price for a new alliance lead to contentious negotiations over taxes, regulation and bailout policies.  Overall, the single currency is unlikely to break away from its recent uptrend as the more dynamic forces of a continued Eurozone data improvement and “taperless” Fed are seen as the more dominant factors in FX. A return to $1.37 appears inevitable at this point.