Sunday, February 15, 2009

FX Briefing : Finance Ministers in the Spotlight


  • US bank rescue plan disappoints markets
  • Aggressive central banks weigh on pound sterling and Swedish krona
  • Eurozone recession deepens, GDP contracts by 1.5% in Q4
  • G7 finmins to discuss crisis measures, financial market regulation, protectionism
This week, the markets have been focused on the two major political events in the US. First, the US Senate has approved the economic stimulus package, thus clearing the way for the joint compromise plan to be approved by both houses of Congress. The stimulus bill is to be signed into law by President Obama within the next few days. Second, the new US Treasury Secretary Timothy Geithner has unveiled his bank rescue plan.

Market participants' hopes were pinned primarily on the bank rescue plan. They had been expecting it to provide fresh impetus. And they were visibly disappointed when it became clear that Mr Geithner had no clear-cut solutions to offer. The new plan is based on much the same lines as before: recapitalisation of financial institutions with the potential to survive, removing toxic assets from banks' balance sheets with combined funds from the public and private sector (this is new), reviving lending to consumers and SMEs by significantly expanding funds to buy securitised loans (up to a volume of $1,000bn), and easing restructuring of existing mortgage loans by offering government aid.

The plan leaves a lot of important questions unanswered, however, particularly in connection with removing toxic assets from banks' balance sheets. Mr Geithner only touches briefly on the main problem - how to obtain a fair valuation of the assets, and how to avoid favouring banks or private investors to the detriment of taxpayers.

Against this backdrop, gains on equity markets crumbled again, and credit spreads widened. In the forex market, EUR-USD, which had been around 1.30 at the beginning of the week, retreated below 1.29. Weak economic data from Japan and the eurozone strengthened this tendency. Both the German and the Japanese trade balance figures show that foreign trade collapsed in December; very bad euro area production data complete the picture. The GDP figures released on Thursday and Friday show an unprecedented collapse in economic activity in Q4: in the eurozone, real GDP fell by 1.5% quarter-on-quarter, and even more dramatically in Germany by 2.1%. The negative impact came mainly from the foreign trade side and fixed investment.

The pound sterling and the Swedish krona weakened significantly. In the previous fortnight, the pound had recovered quite well: at the beginning of the week, GBP-USD had improved from its low of around 1.35 to 1.50; at the same time, EUR-GBP had lost about 8 pence to around 0.87. In his statement on the release of the Inflation Report, BoE governor Mervyn King clearly signalled that the economic situation and the tight financial market situation might make further monetary policy easing necessary. He also confirmed that the BoE was considering quantitative easing. A combination of crumbling equity markets, dismal macroeconomic prospects and BoE interest rate cut hints weighed on the pound: the euro rose to over 0.89, cable fell back to 1.45.

The Swedish krona suffered a similar fate when on Wednesday the Riksbank unexpectedly cut interest rates by 100 basis points to a mere 1.0%. It referred to the rapid deterioration in the economic situation: according to the Swedish central Bank's revised estimates, real GDP will shrink by 1.6% in 2009, while the unemployment rate could more than double to 8.0%.

At the weekend, the G7 finance ministers and central bank governors are meeting in Rome, to discuss measures to combat the financial and economic crisis. In our view, they are not likely to come up with a magic solution. We see a slight danger here of the markets' hopes of a quick solution being dashed - which would support the dollar. In addition, currency matters will probably be discussed in the normal manner. The new US government has already signalled that it also considers the yuan undervalued. The G7 statement is therefore likely to contain a reference to China again. In the markets, there had been some speculation as to whether Japan could bring up the subject of the appreciation of the yen. But finance minister Shoichi Nakagawa has since denied this.


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