Sunday, September 20, 2009

FX Briefing : US Economy Shifts into Forward


  • EUR-USD reaches fresh high for the year at 1.4768
  • Markets speculate about differences of opinion within FOMC
  • Pound comes under pressure as BoE contemplates further easing
  • New Japanese finance minister sees no need for intervention

The downward trend of the dollar continued this week. At 1.4768, EUR-USD reached a new annual high while Eastern European and Scandinavian currencies appreciated even more strongly. The losses recorded by the dollar reflect investors' growing willingness to take on risks, which can also be seen in rising equity prices, falling credit spreads and higher commodity prices. The upbeat sentiment on the markets was also bolstered by quite respectable US economic data which are suggesting that the American economy might grow again for the first time in the third quarter. Fed chief Ben Bernanke also made a statement to this effect which the press, however, immediately interpreted as Bernanke calling the end of the recession.

In fact, the latest data do confirm an increase in economic activity in the third quarter. Retail sales rose strongly in August, up 2.7 % on the preceding month, so that overall growth so far for this quarter is just on 2 %. Industrial production increased sharply in both July and August, equating to a rise of 0.7 % for the quarter so far. Furthermore, the surveys conducted by the New York Fed and – with certain reservations – the Philadelphia Fed are showing a consistently friendly trend for the manufacturing sector in September.

However, the Fed has not joined in the euphoria of the markets so far. Although the US central bank can see the first signs of a recovery it also points out that there are ongoing headwinds. Speaking earlier this week, Bernanke explained that the structural adjustments in the banking sector and by private households (deleveraging and debt reduction) were far from over. The credit markets were functioning to a limited extent only and it remained to be seen how the economy would cope when the government scaled back its fiscal and monetary support. The Fed therefore expects the recovery to be much slower than in previous economic cycles and a correspondingly sluggish decline in unemployment.

In view of these remarks, the Fed's open market committee can be expected to largely confirm its assessment of the economic situation and its monetary policy at its meeting next Wednesday. During the last few days, however, we have seen the markets speculate about differences of opinion within the open market committee: while the majority of committee members are in favour of a prudent monetary stance, a minority of hawks are said to be urging an early tightening of the monetary reins – the names Lacker, Lockhart and Evans being dropped in this context. However, we think it is quite unlikely that such tensions in the FOMC will already be reflected in its statement. The minutes of the meeting, when they are released, should be much more revealing.

The weakness of the dollar is linked to the idea that the Fed will at least not start tightening the monetary reins before other central banks. Speculation on diverging opinions in the FOMC shows that this assumption is being questioned. This could contribute to the dollar stabilising in the run-up to the meeting.

BoE: Additional easing conceivable

On its way down, the US currency was even overtaken by sterling, which fell below 1.64 on a dollar basis while EUR-GBP rose by more than 2p to approach the mark of 0.90. This was triggered by statements by BoE governor Mervyn King before the House of Commons Treasury Committee. King's assessment of the economic prospects was rather hesitant: there were signs, he said, that growth had resumed in the third quarter but the strength and sustainability of the recovery were highly uncertain.

The markets were, however, most surprised by the fact that Mr King is considering cutting the rate it pays on bank reserves further and increasing the Asset Purchase Facility, currently amounting to 175 billion pounds. It appears that his aim is to make the quantitative easing measures more efficient. The central bank would merely be paying a lower interest rate on the bank's reserves exceeding a certain amount. The markets, however, are taking this as confirmation that the BoE is still far from exiting its policy of quantitative easing.

"Strong yen" in Japanese

Japan has had a new prime minister since Wednesday, when the chairman of the Democratic Party, Yukio Hatoyama, was elected into his new office as expected. Appointments were also made for the most important posts in the cabinet. Hirohisa Fujii (77), who was first elected into parliament back in 1977, will be the new finance minister. He held this post back in 1993 and worked in the finance ministry for more than twenty years before starting his political career.

The forex markets closely followed Fujii's statements this week when he voiced his reticence towards interventions on the foreign exchange markets and pointed to the long-term benefits of a firm yen. Market participants felt this confirmed their expectations that the new government would be more tolerant as regards an appreciation in the Japanese currency. USD-JPY fell thereafter, nearly reaching 90 at times. Even BoJ governor Masaaki Shirakawa commented on the long-term positive effects of a stronger yen during the press conference held after the monetary committee meeting. He also stated, however, that the BoJ would be closely monitoring the foreign exchange rate trends, a stable development being most desirable.


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