Brave New World

Markets respond well to TARP plan 23/03/2009

Following last week’s dramatic collapse in the USD and uneasiness about poor policy coordination and dismal economic news, the dollar and equities have got off to a strong start this week. Given than there have been plenty of reasons to criticise Treasury Secretary Tim Geithner the market was holding its breath ahead of today’s announcement on the dealing with toxic assets. As part of the plan, the government will match private sector money with treasury funds to buy up to $1 trillion of toxic assets from the balance sheets of failing institutions. So far there has been positive reaction to the plan.

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.

FX Mid Morning Update 17/03/2009

The foreign exchange market has had a relatively quiet session in Asian and early European trading as doubts have emerged about the sustainability of the recent rally in equities. Although markets have yet to reverse the gains made in the last week, there appear to be signs that the recent rise is increasingly resembling a bear market rally, rather than a true reversal in sentiment. Overnight,  the Nikkei closed up 3.18% but the Hang Seng closed lower at -0.33%. European equity markets are also down slightly. The movement in the FX  market has been very closely correlated. The performance of the Dollar was almost perfectly inverse to the the Dow Jones, falling to lows against the EUR and GBP before rising at around the NY close. In the last 12 hours, the main currency pairs have been trading in a very narrow range. EURUSD, having twice above the key psychological level of 1.30 in the last 24 hours, has settled to a very narrow range of around 1.2980. Cable looks heavier although has displayed little price action, setting around the 1.4950 level. USDJPY, which many market participants had been predicting would breach the 100 level following last week’s SNB intervention has also remained tightly ranged bound, trading between 98.05 and 98.78 in the last 12 hours. Fundamentally, the evidence in favour of a sustained equity market rally- feeding risk appetite and so a sell off in the USD- is too flimsy. Unexpected news from the banking sectors has been the main driver- macroeconomic data remains dismal and government policy unclear.

Expect EURUSD and GBPUSD to remain biased to the downside. Any sustained break in EURUSD above 1.30 should see the pair target 1.3300. That is unlikely to happen without a strong rally in the S&P/Dow.                            

NEWS  

JPY: Finance minister Kaoru Yosano comments that both Japan and the world economy are on the verge of a deflationary spiral. The Tertiary activity index rose 0.4% in January – the first increase in three months and thwarting the consensus forecast for a 0.5% fall after a 1.6% drop in December.  

EUR: ECB Executive Board member Juergen Stark is quoted in Handelsblatt: “We have a little more wiggle room on reducing rates. To fix a threshold at which we will stop does not make sense in the current situation … For me personally though, the threshold is not far from where we are now”. Asked about pushing interest rates toward zero, Stark said such a step would not necessarily reactivate the interbank lending market and that there would be a danger that unprofitable investments were made and the foundation for new excesses established.

CNY: Former PBOC advisor, Yu Yongding commented that China should not lend a lot of money to the IMF because the cash would be used to bail out countries that are richer than China and are biased against Beijing. He said: “If we do so, it will seem like the poor is rescuing the rich, wouldn’t it?”

Key Event 10am: The German ZEW investor index came in at -3.5 (exp -7.7), better than expected. Eurozone ZEW index was -6.5 (exp -11.7). EURUSD jumped over 20 pips to 1.301 before settling back to around the 1.3000 level . The figures needed to be fairly significant to change the holding pattern in the market ahead of the US equity market opening. The ZEW surveys investor confidence, and so is less highly valued as an economic confidence indicator than other data surveying corporate sentiment.

Sterling and Inflation 13/03/2009

If sterling’s really fall is telling us that there’s a risk of inflation, then it should have been accompanied by a rise in the breakeven inflation rate (the gap between conventional and index-linked gilt yields). But my chart shows that the opposite has happened. As the pound has fallen, investors have become less worried by inflation, not more.