Brave New World

Foreign exchange outlook for Event-Risk Thursday 01/04/2009

Currency markets have been relatively quiet of late, perhaps in anticipation of tomorrow and Friday’s important market moving announcements and data. Market has jumped around quite a bit in the last few days, often quite independent of economic figures released. Risk appetite has generally been higher than expected given the diminishing likelihood of anything tangible coming out of the G20 meeting, awful European economic data and the wait for a belated interest rate cut from a reactive and overcautious central bank. One of the main reasons for this, of course, has been the month and quarter end flows moving heavily towards risk; boosting equities and keeping a lid on any advance in the US dollar. However, tomorrow should provide a very different trading environment, as a sudden flight away from risk is likely if either the G20 or the ECB fail to provide detailed proposals to tackle the current crisis. And the likelihood of that is very high.

The US dollar remains the world’s safe haven currency at the moment and could gain strongly against the EUR and GBP if the G20 meeting is seen as a failure. Given the number of substantial issues the meeting is expected to cover- increased funds for the IMF, coordinated fiscal stimulus, supporting world trade and changing regulatory oversight of finance, the outcome is bound to disappoint. This has largely been priced into the market but with increasingly antagonistic noises coming participants, including and increasingly vocal row between the Germans and Japanese over the need for fiscal stimulus, the risk is that the outcome may be something more dramatic than a generic and non-commital communique. Any large scale bust up would lead to a significant retreat from risk and precipitate a sell-off in equities, commodities, Sterling, the Australian dollar, the Euro and a flight to US treasuries and the US dollar. It is difficult to imagine the market not reacting to tomorrow’s announcement and it is almost inconceivable that the result of the meeting will be anything other than disappointing.

The ECB decision tomorrow on interest rates will hopefully provide a clear understanding of the bank’s strategy to provide monetary stimulus and signify how far power has shifted away from the inflation hawks to the doves. The market is expecting a 50bps cut to 1.00%, a new low, although from a record that goes back to 1999 as opposed to 1694. Economic activity has weakened considerably in the region in the last month. Today’s figures show German retail sales falling -0.2% in February (vs the market expectation of +0.3%), the Eurozone Purchasing Managers Index lower and unemployment back up to the levels witnessed three years ago. A rate cut itself will not lead to a move in the market- although in the unlikely event of a 100bp cut, a big jump in the EUR would be expected. Trichet’s press conference, after the announcement, is likely to provide much more scope for currency movements. If the ECB chairman outlines a framework for the introduction of quantitative easing the market is likely to take a sanguine attitude and EURUSD could rise. A statement that strikes a cautious tone or one that lacks clarity will lead to nervousness in the market and a lack of faith that the Eurozone will be able to get itself out of a frighteningly deteriorating situation.