Brave New World

Foreign Exchange Update 18/03/2009

USD– Given the weak state of the US economy and with interest rates are effectively at their lowest possible rate per cent today’s FOMC announcement is squarely based around whether or not it will join the Bank of England and start monetising government debt  or quantitative easing” (QE). The USD has weakened over the course of the day, breaking clearly through the 1.30 level to trade at 1.3150 at 2.30pm GMT, signifying that the market believes that threat of deflation has receded. Consequently, the market believes that the Fed will delay outright quantitative easing and the purchase of US Treasuries. This follows a positive and slightly better than expected US CPI today, a 22.2% m/m boost in US housing starts (rising for the first time in eight months and the sharpest rise since January 1990) yesterday’s better than expected sentiment data from Germany. The bear market rally that is giving rise to this optimism will fizzle out soon, and with it generate a better analysis of the three pieces of economic news just mentioned. First, the rise in CPI is most likely a result of deep discounting at the end of the holiday season. Price cuts are likely to resume if consumer spending deteriorates further; very likely with a skyrocketing unemployment rate. Second, housing starts remain in dire state, 47.3% down on the year. January’s figure was the lowest since records began in 1959 (when the US population was 177 million!). It is too soon to call a bottom to this market but many commentators will so long as this temporary rally lasts.  

EUR– The single currency appears to be the main beneficiary from the the more upbeat mood. Increasingly, the public spat between European and US policy maker over the need for a coordinated fiscal stimulus should dominate the exchange rate. Roughly put, when economic conditions point to a deep recession rather than depression European policy makers look vindicated in their caution towards the  aggressive stimulus measures favoured by the UK and US. Moreover, any sign of a bottoming out of the economic picture removes the need for a safe haven currency, attracts yield seekers, and provides surplus countries with another region to place their FX reserves. However, what a further strengthening Euro will do to already emaciated German exports, let alone Eastern European debt repayments one shudders to think.  The upbeat assessment is also, in my opinion, way overdone. Nevertheless, EURUSD is still above 1.30, and against sterling the single currency has hit the dizzy heights of 0.94.

Sterling experienced a sharp sell-off today, with the FT reporting that the IMF is making a sharp downward revision to its forecast for 2009 and 2010 and a record rise in unemployment refocusing the FX spotlight on the weakness of the British economy. Tomorrows IMF report forecasts that the UK will remain in recession throughout 2010, falling 0.2% after a drop of 3.8% in output this year. Only Japan is expected to experience a sharper fall in output. Data released this morning shows that  jobless claims rose by 138.4k, considerably higher than the market expectation of 84k and the highest rate since records began in 1971. Minutes from the Bank of England  showed unanimous decisions both to cut rates and to initiate QE. Despite a sharp initial sell-off GBPUSD is back above the 1.39 handle. EURGBP has moved a penny higher from 0.928 to 0.938.