Sunday, December 13, 2009

FX Briefing : More Credit Rating Problems

  • Bernanke sees “formidable headwinds” for economy, dampening exit expectations
  • Rating agencies warn about rising public debt in Greece, Portugal and Spain
  • Eurozone industrial production likely to have contracted in October
  • Bundesbank president Weber signals rise in money market rates

EUR-USD seems for now to have given up all attempts of reaching new highs before the end of the year: after the release of the US labour market figures at the end of last week, it dropped below 1.49 initially; during the course of this week, it slipped below 1.48, and even below 1.47 temporarily.

Although both movements were in favour of the dollar, each was motivated by quite different factors. The US labour market figures had been better than expected, fuelling speculation that the Fed could embark on an exit from its quantitative easing policy earlier. Interest rates and yields had gone up accordingly.

Then Fed chairman Ben Bernanke hastened to dampen exaggerated euphoria about an impending policy shift. In a speech on Monday, he emphasized that, despite increased signs of recovery, the US economy was facing “formidable headwinds”. At least with a view to the upcoming open market committee meeting on 16 December, he did not reveal any intention of changing the policy stance.

Mr Bernanke’s warning about “headwinds” coincided with markets focusing increasingly on credit risks. They had not yet fully digested the debt problems in Dubai, when rating agencies triggered fresh fears: Moody’s led the way by making a subtle distinction between the AAA ratings on Canada, Germany or France, termed “resistant”, and the ratings on the UK and the US, which were only “resilient”. On Tuesday, it was reported that Fitch had downgraded its rating on Greece for the second time in the space of less than two months, from A- to BBB+. S&P put Greece, Portugal and also Spain on negative credit watch.

Credit spreads widened markedly on the rating reports. The interest rate spread between Bunds and 10-year Greek government bonds, for example, rose by around 80 basis points to almost 250 basis points. Mounting crisis fears weighed on the euro at the same time, whereas the dollar and the yen, both typical funding currencies for carry trades and other more risky investments, particularly commodities, strengthened.
Data on industrial new orders and production in the eurozone turned out to be weaker than expected, which was also a drag on the euro. In Germany, industrial production contracted by 1.8% in October, in France and the Netherlands by 0.8% respectively; Italy was the only country to post a slight increase. Thus growth in Q4 is set to be much weaker than in the previous quarter.

Remarks made by Bundesbank president Axel Weber on the development of interest rates in the short maturity segment of the money market, though striking, have not as yet sparked a significant market reaction. At the press conference, ECB president Jean-Claude Trichet had said that the measures announced were not intended to lead to a rise in the overnight rate. According to Mr Weber, as liquidity management normalises, the Eonia rate could go up gradually. At least he expects the Eonia rate to remain below the central bank rate in the first quarter.

In line with this notion, the Bundesbank’s latest Financial Stability Report had pointed out that banks’ bidding behaviour would contribute to reducing excess liquidity in the money market, even if full allotment at refinancing operations is maintained. In this case, the overnight rate ought to converge with the refi rate.

This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK Group") solely for the information of its clients.

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