Sunday, January 31, 2010

FX Briefing : Uncertainty boosts the dollar

  • Greek bond prices plummet due to desolate state of public finances
  • Commitment to ultra-loose US monetary policy is crumbling
  • ECB governing council meeting unlikely to provide much impetus

This week the euro slipped below 1.40 against the dollar again for the first time in six months. The Greek debt crisis is continuing to weigh on the single currency. But market participants were also unsettled by the outlook on Japan's sovereign debt being revised to negative and the US central bank gradually moving away from the ultra-loose monetary policy. The dollar was therefore the most sought after currency this week, not only against the euro but against the yen as well.

Rumours that China might rescue Greece by purchasing €25bn worth of government bonds were seen as proof of the desolate state of Greece's public finances. The fact that Athens apparently prefers to seek help in Asia rather than in Europe hardly boosts confidence in solidarity in the eurozone either. Consequently, Greek bonds plummeted, which probably particularly annoyed investors who had subscribed to a new €8bn 5- year bond at the beginning of the week: in the first few days of trading alone, the bond's value dropped by €3. This disappointment is likely to have a negative impact on the 10-year bond due to be issued mid-February.
The other shaky candidates in the eurozone were also hit by falling bond prices. Portuguese bonds were particularly affected, as rating agencies had warned that Portugal would have to intensify its budget consolidation efforts.

Markets were also rattled by the news that S&P had cut its outlook on Japan's sovereign debt to negative because of the country's debt problems. The rating agency is of the opinion that the new government under prime minister Yukio Hatoyama is not making enough effort to bring the country's debt problem under control and ward off the danger of deflation. Government debt currently stands at 200% of GDP and is set to rise to 250% in the next five years. This put an end to the yen's recent rally

This week, markets will also be trying to guess how long the FOMC's 'extended period' actually is. Apparently the FOMC is becoming more and more convinced that the upswing in the US, though weak, is self-supporting. Given substantial resource slack, the majority of the committee members are still of the opinion that low interest rates are warranted for an extended period. But this view seems to be gradually changing.

Thomas Hoenig of the Kansas City Fed, for instance, voted against the committee's decision to retain the phrase. In his view, given the significant improvement in economic and financial conditions, maintaining monetary policy for a longer period no longer seems justified. Thus a shift in US monetary policy is becoming more likely, particularly as the central bank has confirmed that its special liquidity facilities are to expire shortly. In our view, there could be a first interest rate step as early as the end of the second quarter. A lot will depend on next week's US labour market data. Job losses are widely expected to have slowed down - a crucial precondition for a monetary policy exit.

The upbeat economic data from Europe released this week failed to have much impact. The ifo business climate improved for the eighth time in a row, and the economic climate in Europe has continued to brighten up and is now only slightly below the long-term average. In our opinion, the chances for an, albeit weak, but sustained upswing in Europe have improved significantly.

Next week, apart from events in Greece, markets are likely to focus on the ECB governing council meeting. After the last meeting, however, Jean- Claude Trichet had already announced that the important decisions on further exit steps would probably be taken in March. We are therefore not expecting the forthcoming meeting to provide much impetus. The ECB governing council is not likely to change its stance on helping Greece either

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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