A Forex View From Afar

Global Demand Required: All Applicants Accepted

2009-07-30T02:46:00.000-04:00

A larger number of market participants are saying that the business cycle is likely to recover in early 2010, and that it will be driven by strong demand, now that the global economy appears to have diminished the pace of contraction.

A fundamental question rises from that thought process; from where is that demand likely to come? We have two main groups to pull from here; consumers, and from industry, and both seem increasingly unlikely to assist in the expansion phase.

Consumer demand is usually driven by credit. However, credit card and loan/mortgage defaults are surging to a record high on both sides of the Atlantic, while, the velocity of money – which speaking from a theoretical point of view, measures the level of economic activity – has reached very low values for the vast majority of developed economies.

The U.S. saving rate increased exponentially, in-line with the drop of available credit, to 7% in the last few months, the highest rate seen since 1993, after being at negative rates just a little more than a year ago. This situation points to a consumer that has started saving for their financial safety, rather than building a pile of unsustainable debt as in previous decades that aided economic expansion, but ultimately proved toxic for Wall Street and Main Street.

As admirable as it is that savings have been forced on consumers, and the heady days of Main Street excess look to be fully restrained, the administration will be pushing for an increase in consumer debt to fund the expansion that pays back the stimulus packages. Strike one; the U.S. consumer will not be consuming the economy into growth anytime soon.

The glimmer of hope, is that global savings rates eclipse the rate at which Americans save, and as such the overseas savers may be able to spark a consumption rally. That however, remains nothing other than a glimmer, rather than a ray of consumption sunshine.

Industrial demand is in a comparable situation to the consumer driven demand. During the economic downturn a high percentage of factories have been temporarily closed, or have reduced output dramatically, while employees are fired. This means that when the economy picks up and factories see a stronger backlog of orders, they will simply re-open the idled machineries, instead of buying or building new.

This economic phenomenon is known as economic slack, and can be measured using the capacity utilization report and detail. Since the U.S. economic slowdown started, the capacity utilization rate has dropped at a very strong pace, and has been far stronger than in previous economic slowdowns.

Due to the economic slack, industrial demand is likely to stay at low rates, until the economy reaches once again the 2007 production levels. That is something that is not likely to happen until the consumer in the U.S. starts to consume. Strike two: the industrial sector will not be manufacturing its way to economic growth anytime soon.

All this put together shows that the recovery period will be slow, and long, and when translated into market momentum will likely transpose itself into a side-ways trend in the currency market over the medium to longer term.

Investors and analysts will try to value regional business cycles and local economic growth, and while that is unfolding divergence will be seen in regional valuations and expectancy. The same divergence was seen recently when the forex market was unable to push the dollar lower in spite of one of the longest, and strongest, equity rallies of the last few years.

The forex market might come back to life on its own, going forward, breaking some of the high correlations it had with S&P futures over the last year, as the regional debt-to-growth ratios are absorbed and valued.

The easiest way to generate growth, historically, is to cut interest rates, lower taxation, and force credit onto banks. However, as we have witnessed from 2003 to 2007, there is a harsh price to pay for the famine to feast business cycle that the U.S. is travelling, as it goes from contraction to peak, and back down again, in record time.

The troughs get deeper, whilst the cycles get shallower, and that creates a unique U.S. based conundrum that may, over time, impact negatively the Usd perception that the consumer will save the day. Just how will the consumer be able to do that? Strike three: the administration may be issuing a new, bigger, better, stimulus package, that covers the interest on the previous package, that looks to be like a drop in the ocean of what is really required.

Inefficient Pricing Models Defy Gravity

2009-07-27T12:24:00.000-04:00

The recent equity market rally had a strong driver behind it; investors’ optimism, which has helped the financial market sustain one of the longest trends of the last few years.

In trade on Monday, equity markets are heading higher for the eleventh consecutive day, the longest streak of the last few years, and a similar pattern to the period when the housing and credit bubbles were being inflated. In particular, the Nikkei closed in the green for the 9th consecutive day, making the current rally the longest in a little more than 20 years.

However, the present rally seems to defy the macroeconomic picture, some are saying. The global economy is still in a contraction phase, even though the pace of decline had a noticeable slowdown, the unemployment rate is projected to surge to around 11%, although just a few months back the estimates were pointing out to a 9% rate. Add to that the fact that the consumer spending sector appears to be deep in contraction, as credit card defaults head towards record highs in U.S. and European markets. Moreover, the major central banks together with the IMF forecast a slow recovery period, which would have a strong weight on both consumer and business revenue streams and expenditure.

Despite these issues, investors have been lured by the number of companies that had better than expected reports in the Q2 earnings releases. Out of the nearly 200 major companies that reported so far, a huge majority beat analysts’ estimation, probably making Q2 appear as one of the best earnings quarters in history. Things are not so rosy after all, it would seem, since the reported earnings so far are lower by 30% than the numbers seen in the second quarter of 2008.

This confirms, via a reduction in income, that consumers have indeed cut their spending, and that is not something that is expected to pick up anytime soon. There is a huge slack in the global economy right now, something that will further delay the recovery period. The current situation has the feel of the April 2009 rally that was initiated by the Federal Reserve, but then fueled by earnings reports.

To some extent, this shows again that the stock market does not reflect the state of the economy, but rather the outlook of the public companies as weighed by investors. As long as the remaining companies continue to beat expectations, chances are that the current rally will continue. Suddenly, 1000 points on the S&P does not look so far away.

Moreover, the current rally shows once again that the free markets are rather inefficient, even though the pricing models that most investors rely upon are built on the market efficiency hypothesis. If the equity rally continues the traded market will see inflated equity values, higher commodity prices, and a lower Usd, all backed by an inefficient valuation model. The issue with that is the ease in which those values can realign themselves, especially when not backed by robust employment, access to credit, and diminishing income flows.

The divergence is also being seen in oil prices, a market where speculative interest has increased in-line with equity valuations going higher. The perfect example of automated trade that has been allowed to grow, with nothing programmed to cover the lack of foundation in the corresponding market. Global oil consumption is forecast to move lower in 2009, but to keep aligned with inflated equity valuations, the pricing models are sending out buy orders, like equities, that do not match the forward valuations. Something will soon give, in the form of price reduction, or economic expansion that gets things aligned. Right now, the economic expansion thought process looks as flawed as the inefficient pricing models that run the automated order process.

The final line in the equity play may be the question of where the XLF is trading. The financial sector historically has lead or backed each sustainable move the equity markets make, and throughout the recent rally, the XLF has been stuck trading around the $12, and held there for the last two months. The markets are not rallying financials, and as such a red flag is running up the pole

The Free Markets Are Dead, Long Live The New Free Markets

2009-07-23T00:23:00.000-04:00

CIT’s success to find someone to lend it $3bn and (temporarily) avoid the bankruptcy filing was seen as a staggering victory of the free market, a market that does not need any more help from the Fed or anyone else.

However, just a day after the new free market was crowned, the details of the transaction came to light, showing a rather painful picture: the price of survival. After being rejected by the F.D.I.C. (which until now was the financial system’s last resort) CIT managed to strike a deal with 6 of its bondholders to provide a $3bn loan.

The cost of the loan is huge, since the 6 creditors require the loan to be paid back at a 13% interest rate (14 times more than the interest rate the government pays for a similar loan), a 5% commitment fee and assets as collateral worth more than three times the size of the loan. Let’s just put this into perspective for a moment; if a person from main street goes to a bank, requests a loan, and then tomorrow he defaults, he would get better terms….

However, even these funds are not enough for the company to survive, TheLFB-Forex.com Trade Team said. In addition to the $3bn, the company will need bondholders to accept a 17.5% reduction of the $1bn debt that will expire next month. Moreover, the company’s total debt is around $60 billion right now, from which $10 billion is expected to mature over the coming months, TheLFB-Forex.com Trade Team said.

Taking a closer look, this does not look like a good deal, but rather as a desperate attempt to survive and therefore avoiding entering the bankruptcies’ hall of fame. The new free markets might be here, but they look like rough ground, on which many corporations are expected to trip over. Interestingly though, the economy is recovering, China grows by 8%, so we are told by the People’s Republic, and the banks keep failing.

Debt Monetization: The Real Affect On An Open Market

2009-07-21T16:31:00.001-04:00

In this article we are going to see what debt monetization is all about, since, lately, there has been a lot of talk about the Fed having to monetize the Treasury’s debt.

Our example’s imaginary government needs to spend about $5000 over a year, but its income is only $4000. Thus, our imaginary government will be forced to run a $1000 deficit, which would need to be funded somehow.

At this point, the Treasury comes into play, taking the task of issuing and selling the $1000 of bonds (IOU’s) to the public, to help the government cover its expenses. Following this process, the private sector will hold $1000 in bonds, but this has the effect of reducing the money supply (less money available for consumer spending), and puts upside pressure on the interest rates.

The imaginary Central Bank (CB) does not want this to happen, so they will step in to the market, and buy $1000 worth of bonds from the private sector. The CB’s purchase increases the money supply by $1000 (excluding the multiplier effect), something that sends yields lower again, to where they were before the bond’s auction.

Everything should look normal by now, but things are not really that good on the inside. The CB increased the money supply by $1000, or considerably more if the multiplier effect is included, which is a huge sum compared to the size of the economy. This will cause inflation, because in the shorter term it shifts the AD (aggregate demand) line to the right, corresponding to higher prices, so long as the AS (aggregate supply) holds steady.

The logical justification of this would be the government uses an extra $1000 to fund spending, thus increasing the demand side of the economy. However, in the short-term, the supply side lags the cash drivers, thus a new equilibrium point is reached (E’), in the short-run, which corresponds to higher prices (P).

This is important because it is happening in the economy right now. Most governments are running deficits (from which some are huge) in order to support the demand side and kick-start the economy. However, deficits – especially the ones monetized by the CB - have a strong inflationary pressure built in, and send the local currency spinning lower. Does these sounds familiar? Think of the dollar now, and we get a very clear picture.

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The China Story: Fact Or Fiction?

2009-07-18T10:55:00.001-04:00

Should the market expect a strong bounce from the global recession, helped by China?

Not likely.

Should the market expect a slow and sluggish recovery period, with lots of “green shots” similar to the one we have now?

Most likely.

If current market valuations are driven higher by green shots, then China is at the tip of the arrowhead, being solely responsible for much of the recent rallies in global markets
From the first few months of the credit crisis, during the summer months of 2007, analysts were saying that the economy will recover relatively quickly (Q1 2008 was estimated), as China and the rest of the emerging economies would drive up demand, helping the developed economies recover.

Time passed, Northern Rock and Bear Stearns bankrupted, but still, China (or any other emerging country) failed to sustain the demand side of the global economy. This caused the recovery date to be delayed, to somewhere around the last quarter of 2008, but still China was the one which should pull the global economy out of contraction.

The global economy did not recover in fourth quarter of 2008, but Merrill Lynch, Lehman Brothers, Washington Mutual and AIG continued the flow of famous bankruptcies, which sent the global markets into a backspin.

Today, we are at the beginning of the third quarter, 2009, two years after the credit crisis began, and also two years prior to the day in which China should have saved the global economy. Despite this, the main triggers of the credit crisis (housing market, default rates, over-leverage) seem far from over.

Banks still continue to file for Chapter 11 (read CIT, which would be the fourth biggest U.S. bankruptcy), and, low and behold, China has still not saved the global economy, albeit the analysts are still forecasting this would happen in the next quarter.

On what basis are these forecasts built? On the fact that the Chinese economy grew 7.9% in Q2, much more than expected? For most countries, such a growth rate seems almost mythical, but this is still far below the growth rate the Chinese economy saw the last ten years.

In addition, in order to keep the economy running, the Chinese Government, together with the central bank, run very loose fiscal and monetary policies. That loose, that the Chinese money supply grew by a massive 30% from a year earlier, while new loans increased by almost three times in just one year.

Economics 101 says that the money supply should expand at roughly the same pace as the economy (that is 8% in China’s case), anything bigger would spark massive inflation. Moreover, having new loans expand at such a strong pace raises some questions about the creditworthiness of some of the borrowers, and the defaults rate associated with them. Does this all have a familiar 2007 kind of tone to it, or are we just imagining that we have walked the over-leveraged, consumer fueled, path before?

On top of the inflationary problem, the question is how much time the Chinese economy can be developed while relying on internal credit, and how much can this help the global economy; China expanding internally does not help the global economy. The answer to this question remains in the hands of the international consumer, and their thirst and/or ability to obtain credit to start the consumption growth engine.

That will require lower interest rates, a lower value Usd, and by default a reversal of the ‘Strong Dollar’ policy that the U.S. administration is candidly trying to put out there as the message of comfort for holders of U.S. debt.

The China growth story will not unfold until the Fed deals with 10 year Treasury note yields; until they, and by default the Usd, are reduced, the China story may be more of a Fairy Tale than a Non-fiction Bestseller.

Trade Desk Thoughts: The Relationship Between Crude Oil And Cad

2009-07-16T00:32:00.002-04:00

Historically speaking, crude oil and the Canadian dollar have had a very strong relationship, most of the time, the two assets having a high degree of correlation.

This can be explained by the fact that Canada holds the second biggest oil reserves in the world after Saudi Arabia. Moreover, a large amount of these oil reserves are pumped into the United States, making Canada the biggest energy source for the U.S. economy. Thus, investors focus on crude oil prices to gauge the Cad’s direction of trading.

The correlation between crude oil and Cad was pretty easy to exploit in time, but all this came to an end over the last few weeks as crude oil began to quickly drop while the Canadian dollar declined only a few basis points throughout the same period. Most likely, this happened because of two different fundamental drivers: oil dropped as the market was re-pricing the outlook of the global demand, while Cad traded mostly range-bound, together with the dollar index and the other major currencies, as it seems the financial market saw more dollar than it would ever need (thus the market stayed in risk-aversion mode only for a short period).

The attached chart shows how the cad and crude oil have behaved over the last 15 months (from 03.01.2008 to 07.14.2009), while the secondary chart shows the weekly correlation between the two. The green area denotes the periods when the implied correlation was between -0.5 and -1.0, which are the phases when crude oil can be used to forecasts Cad’s direction. As a note, the extended periods when Crude oil and Cad had no correlation or moved in the same direction - as the one we have right now, denoted by the fact that the correlation index swings between -0.5 and 1.00- happened only when the market reversed the prior trend.

BoE With Pound Inflation Headache

2009-07-14T06:11:00.001-04:00

The last few months of trading showed a very weak U.K. economy, something that has been reflected directly in the pound’s value.

Currently, the U.K. economy faces one of the strongest contractions on record, while the government runs a massive deficit that is forecast to reach 12% of the economy in the next few quarters; by far the biggest among the developed economies. Even the BoE’s quantitative easing plan has not work as planned, since even if the Bank bought roughly 20% of the entire Gilt market, the current yields are still above the ones when the QE program was announced, TheLFB-Forex.com Trade Team said.

All this had put the pound in a negative light, something that was very well observed during recent risk-aversion phases, when the pound was the first pair to be sold, and usually at the strongest pace. However, things may be starting to look positive for sterling once again, since according to the latest TheLFB-Forex.com Trade Team reports, the BoE might have misjudged its inflation forecast.

In a little more than a year, the Bank of England reduced the interest rate by 500 basis points, from 5.50% in December 2007 to 0.50% in 2009. However, most of the easing came during the second part of 2008 and early 2009, as the BoE reached record low interest rates based on forecasts that inflation will “undershoot” the 2% target. Since then, months have passed, but the CPI read still holds above the 2% target.

The BoE issues a quarterly inflation report, and according to the latest three issues, May’s CPI (which was sitting at 2.2%) is in the upper range of the BoE forecasts. To make matters worse, according to the same projections, the CPI downfall should come to an end over the next few months, and then slowly move higher, which means that soon, the BoE will have a negative inflationary policy, while inflation reads will be already going the other way; higher

For comparison, while inflation reached 2.2% in the U.K., the year-over year inflation is negative in the U.S., and slightly above the 0% line in Germany, even though in the U.K. and U.S., the CPIs behaved in a fashionable way over the last few years.

The BoE problem with inflation continues in the food department it seems, TheLFB-Forex.com Trade Team said. Analyzing the CPI components, a problematic trend emerges, even from the initial view; food prices are up by a huge 8% year over year in May, in a period when the BoE worries about deflation. Again, comparing this numbers with the German or the U.S. food prices, which are both below the 2% benchmark, shows again that the BoE has been wrong in its forecasts, and inflation will become a big problem once the economy starts to recover.

For now, the pound’s outlook is mixed as the U.K. economy faces both medium and long-term problems: a huge deficit and inflation picking up strongly over the next few quarters. Both of these two problems work in different direction, since the deficit puts downside pressure on the pound as it denotes an expansionary money supply, while a high level of inflation will force the BoE to raise rates, something that should strengthen the pound. In the short term though, the market looks to want to hold the short-side of the pound, as it seems traders are now more focused on the huge deficits and on the political dead-lock.

Trade Desk Thoughts: Oil Falls, Majors Hold

2009-07-09T07:48:00.000-04:00

Oil has plunged a little more than $13 over the last seven days of trading, making it the strongest pull-back the commodity markets has seen so far this year. Much of the downside action came as clear sings emerged that the global economy is not in the shape the market believed it was.

Crude oil has a tied connection with the global business cycle, as it is used as world’s main source of energy, and business expansion is reflected in the speculative interest in crude trade. Investors gauge the world growth rate to forecast oil consumption, and based on that determine a potential price for the raw material.

On Thursday, crude oil managed to post some small gains, shortly after the IMF issued a report in which it upgraded the global growth forecast for 2010. According to the Fund, the world’s economy is going to “expand” 2.5% next year, but, as a side-note, a global growth rate smaller than 3% is seen as a contraction, TheLFB-Forex.com Trade Team notes. It also forecasts contraction to be maintained in 2009, and has the Euro-zone as the weakest major economy.

Oil’s current downturn and currency correlation has been quite interesting to observe. Most of the time, when oil retraces, it sends a strong wave throughout the forex and the equity markets, in the form of risk-aversion. However, over the last few days, a time in which crude oil has declined at a strong pace, the major currencies and equity markets, posted only limited downside action.

This may be a sign that the market is shifting its correlation/focus towards regional earnings season updates, and less towards the global growth story; time will tell. It will be interesting to observe over the next few days if the dollar will be able to move without its close oil link.

The Implication Of The IMF Bonds And Their Aftermaths

2009-07-07T16:10:00.000-04:00

Extensive reports had been written recently period that the IMF is preparing to have its first bond issue in order to raise as much as $500 billion to help the emerging economies avoid a collapse.

The amount of money that the IMF intends to raise can be compared to the GDP of the 80 poorest countries in the world; that too reaches $500 billion. However, much of the $500 billion needed will come from credit lines from the major economies, with the remaining being funded by issuing bonds.

The Fund plans to issue the new bonds denominated in special drawing rights (SDRs), which is a synthetic currency made up by the dollar (44%), the euro (34%), the Japanese yen (11%) and the British pound (11%). However, the maturity of these bonds is still unknown, with some saying that they will be issued for a shorter period, up to 18 months, while other say it will be as long as 5 year.

The IMF’s bonds have strong implications for the financial market and in the political world. China has pledge for a long time that the world should seek an alternative reserve currency to the dollar, saying that the SDRs should be appropriate.

To some extent, China and the other emerging economies obtained a clear political victory over the developed world; up to now these were the countries to lobby the IMF to issue bonds. Consequently, it is China 2 – U.S. 0, since China will manage to diversify from the dollar (something it has talked and planned for a long period) and at the same time it will manage to impose its view in the world.

In the financial market, some argue, among them TheLFB-Forex.com Trade Team, that the IMF bonds might change the behavior of the Treasury market, mainly because central banks now have a realistic alternative to the greenback.

One of the most important aspects of the newly formed IMF bonds, is that they may raise the yield of the U.S. Treasuries, since demand for U.S. debt is likely to weaken. Foreign central banks hold an important part of the debt issued by the U.S. Treasuries, but this is likely to change when central banks have an alternative.

From now on, the U.S. Government’s debt will have to face and challenge the bonds issued by the IMF, a race that seems lost. However, it should be noted that there is no secondary market for the bonds issued by the IMF, only central banks will be able to buy and trade them. This means that the U.S. Treasury Note would still remain the market’s favorite instrument when risk-aversion comes into the financial market.

A very important note is that a central bank can simply buy IMF bonds without any prior notification from the Government, or any other national institutions. Since the new IMF bonds are seen as foreign exchange reserves, any central bank can simply sell some of the assets that they already hold (such as U.S. Treasuries) and buy instead the bonds issued by the IMF.

One way or the other, the IMF bonds start to appear as a contender to the status of the U.S. dollar as a reserve currency. Maybe, somewhere in the future, the dollar will need to move over and share the throne, because if the central bank Treasury market is being usurped there may be no end to it.

How does 660 Eur per ounce of gold sound? Or 38 Gbp per barrel of oil? Maybe we will buying a bushel of corn in Jpy before we know it.

Global Unemployment Rates Bouy The Usd

2009-07-07T00:22:00.002-04:00

Over the last quarter a rather grim picture from the global labor market revealed
itself, as the unemployment rate rose to multi-year highs in most economies.

Probably the most important headline of the previous week was that the unemployment rate moving to 9.5% in the U.S., the highest level since 1983. The same thing happened around the globe; the unemployment rate surged to record high values.

For example, in Spain where a massive real estate bubble just burst, the unemployment rate moved to a surprisingly high 18.7% in the second quarter of 2009, up by more than 8% in one year.

A rising unemployment rate has a wide list of negative effects in the real economy, TheLFB-Forex.com Trade Team said. The most evident effects are seen in the credit market, where there is a tight relationship between the unemployment rate and the default rate.

The impact will also be heavily felt in the consumer market. When consumers follow a rising stock market and see real estate income, and/or appreciation they drive up the spending rate.

However, when all this reverses, consumers cut all unnecessary spending and start saving to obtain some degree of financial stability. Consumers reducing their spending will have a negative impact on the employment situation, especially in those economies that spending makes up about 70% of the growth rate.

Moreover, macroeconomic data had shows that deflationist pressures tend to rise as the unemployment rate decreases. However, TheLFB-Forex.com Trade Team notes that, this relationship is reliable only on the short-term, and it will still cause some headaches at the Fed, and at the other major central banks over the next few quarters.

As seen in the attached chart, every major economy saw its unemployment rate rise after the third quarter of 2008, and some say this will continue even beyond 2010. In addition, the huge slowdown in the global trade had also started to affect the emerging economies, something that was reflected in the unemployment rate.

Even the infamous Chinese economy has started adding jobless numbers into the economy, something that pushed the unemployment rate up to 4.3% - a multi-year high. The same situation was seen in most emerging economies, something that yet again suggests the weakness seen in the global labor market is a longer-term problem, rather then a short-term imbalance.

It can also be seen in the equity market’s inability to move higher, and by default that same unemployment rate increase, will empower the Usd; when equities go lower, the dollar goes higher.

ECB Press Conference Analysis

2009-07-03T00:29:00.001-04:00

At the ECB press conference, held after the announcement to hold the minimum bid rate at 1%, as expected, Mr. Trichet re-iterated on Thursday the same messages as in the last few press conferences. The euro-area economy is going through a contraction period, which is likely to continue for the time being, and interest rates are poised to remain at very low levels, until the expected gradual recovery starts to threaten the inflation target.

However, there were some small differences from the past press conferences, like the fact that the risk to the economic outlook is balanced, which represents a major upgrade from the comments in the past few meetings. Remaining on the same tone, the ECB gauges the outlook for inflation as balanced too, suggesting that for now, neither inflation nor deflation are major concerns.

In addition, Mr. Trichet announced that the bank will begin its asset buying program in the next few days. The ECB is set to buy up to 60 billion euros in covered bonds, something that may help re-launch the European mortgage market. Last week, the ECB ran the biggest open market operation on record, by pumping 442.2bn euros into the financial system, at a fixed 1% interest rate with a maturity of one year. TheLFB-Forex.com Trade Team calls this a real bargain, which should replenish most European banks confidence and balance sheet levels.

• The Governing Council decided to leave the key ECB interest rates unchanged
• The current rates remain appropriate taking into account all the information and analyses that have become available
• Economic activity over the remainder of this year is expected to remain weak
• Looking ahead into next year, after a phase of stabilization, a gradual recovery with positive quarterly growth rates is expected by mid-2010
• The risks to the economic outlook are balanced
• There may be stronger than anticipated effects stemming from the extensive macroeconomic stimulus being provided
• Concerns remain relating to a stronger or more protracted negative feedback loop between the real economy and the turmoil in financial markets
• Annual HICP inflation was -0.1 % in June
• Further decline in annual rates of inflation was anticipated and reflects primarily base effects resulting from past sharp swings in global commodity prices.
• Annual inflation rates are projected to remain temporarily in negative territory over the coming months, before turning positive again
• Risks to the outlook for inflation are broadly balanced
• On the downside they relate, in particular, to the outlook for economic activity, while on the upside they relate to higher than expected commodity prices
• In May, the annual growth rate of M3 declined further to 3.7%, with that of loans to the private sector falling further to 1.8%
• This concurrent deceleration supports the assessment of a slower underlying pace of monetary expansion and low inflationary pressures over the medium term
• The flow of bank loans to non-financial corporations and households has remained subdued, reflecting in part the weakening in economic activity and the continued low levels of business and consumer confidence
• In this respect, it is important to note that past reductions in key ECB rates have continued to be passed on through lending rates to both non-financial corporations and households
• Banks should take appropriate measures to strengthen further their capital bases
• As the transmission of monetary policy works with lags, our policy action should progressively feed through to the economy in full
• Hence, with all the measures taken, monetary policy will provide ongoing support for households and corporations.
• The Governing Council would like to recall that the Eurosystem provided a significant amount of liquidity to euro area banks at its recent first 12-month longer-term refinancing operation
• Once the macroeconomic environment improves, the Governing Council will ensure that the measures taken are quickly unwound and that the liquidity provided is absorbed

Range-Bound Equity Markets? Take A Look At The Fx Market

2009-07-01T06:57:00.001-04:00

The rally started back in March was fueled mainly by the view that the world economy will recover as emerging economies and consumers would sustain the demand side of the developed economies.

However, over the recent weeks, both theories faced reality, as the eagerly awaited consumer recovery refused to happen. The emerging economies demand, mainly Chinese demand, is enough only to sustain the country’s huge production capacity, without implying any huge foreign imports. To sustain these claims, the attached chart from RBC Capital Markets shows that the decline in Japanese, or in U.S., GDP individually, is big enough to offset the gains made up by the Chinese economy, while the rest of the emerging economies barely count.

These two points would suggest that the rally that started in March is becoming unsustainable; reasons that fueled it are now disappearing into nothing but fading hopes. Further clues that point in this same direction are the poor expected earnings numbers to come over the next few quarters. Add to that the fact that both manufacturing and the service sides of the economy remain in a contraction phase, and have a rising unemployment rate, and all does not look at all sustainable at the projected growth rates.

TheLFB-Forex.com Trade Team argues that this may force the equity markets to consolidate around the current values until the global perspective improves once again, something that would require the financial markets to re-price such an event. Moreover, the continuous drop in the market’s implied volatility confirms the view that the market is going to remain in a range-bound fashion for the time being.

Ultimately, range-bound equities are likely to influence the trading activity in the currency market, something that would make the dollar index swing around the 80.00 area, as it has been doing for a few weeks now. Moreover, the currency market might come down to a regional story as long as the equity markets trade side-ways.

The aussie would have the best perspective since Australia is the only major economy that has avoided a recession so far, while the Japan would be the weakest economy fundamentally speaking. The swissy also has a relative good macroeconomic perspective, but still not too many trade desks would want to buy the Swiss franc, not as long as the SNB intervenes regularly into the fx market. The summer may have doldrums, but the order flows are revealing an interest in moving things, but at very specific times, and for very specific reasons, and that is the way things are likely to stay until a new fair value on Debt/Growth ratios is found.

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What To Look For Ahead Of The London Open

2009-06-30T00:41:00.001-04:00

In the forex market, the London open is often cited as one of the most important moments of the day, since the market liquidity is very high and most trends are built around this time of the day. The reason is to do with the fact that European markets are open through part of Asian trade, and also part of U.S. trade, and therefore pick up a large slice of global trade momentum.

As such, gauging the market’s direction at this time of the day is very important since a trader can position themselves on the right side of the trade, or an institutional trade desk can profit from the increased market volume to more easily achieve their goals unhindered. The following items are some of the things TheLFB-Forex.com Trade Team follows around the London open:

1. The direction of the S&P futures. This is probably the best indicator of market’s state towards risk: aversion or tolerance. S&P futures posting significant gains or declines overnight will certainly be reflected in the FX market.

2. The direction of the Asian markets. Together with point 1 in our list, spot equity markets can be used to determine the trading direction of the greenback. If, for example the Nikkei opens in the green, but throughout the trading session posts significant declines, it shows that the market may want to get away from risky assets, and buy instead the safety of the bonds, via the dollar.

3. European equity open. More often than not, the open of the European cash markets (mainly the German Dax and the U.K. FTSE) follows the direction of the overnight Asian markets. However, sometimes it happens that the European cash markets break free from the pattern of futures market trade, which is quickly reflected in the FX market.

4. The direction of the commodity market. The dollar is seen as the “counterparty” of the commodity market, since all raw materials are priced in Usd. As such, higher oil and gold will automatically open short dollar positions, while lower commodities are usually translated into a higher value of the dollar index.

5. Keep a close eye on the news calendar. Usually, in days when the market awaits an important news calendar, the major pairs fail to break any important price points and waste most of the time moving side-ways. However, on other days the market moves in a very volatile fashion, sometimes without a clear direction around the news release, especially around important reports like interest rates decisions. The best would be to adjust your trading style and risk to ant red flag calendar release days.

6. Technical analysis/pattern recognition – Most trades in the FX market are based around technical or automated analysis; things like support and resistance are not anything new. However, a number of traders (especially the ones with a lot of screen time) are able to recognize patterns that are repeated around the London open.

The Truth Is Just Too Painful To Handle

2009-06-26T18:51:00.001-04:00

The recent reports issued by the U.S. Treasuries showed that, despite recent claims, foreign buyers still show their interest in U.S. debt.

Treasury auction bids are usually split in two, direct and indirect bids, mainly for statistical purposes. The difference between the two is easy to understand, direct bids come through primary dealers, while indirect bids come from foreign sources, avoiding the primary dealers.

Usually, the market uses indirect bids to gauge the foreign central banks’ interest in U.S. debt, but as TheLFB-Forex.com Trade Team notes, this view may be wrong, since indirect bidders account for a large class of foreign investors, which includes foreign financial institutions, brokers and central banks.

Over the last week, indirect bidders for treasuries surged from the long-run 25%-30% average to a whopping 60%, something that sent a real shockwave through the financial market, since it showed that foreign investors still buy dollar denominated assets. However, how most of the financial press said that the Treasury changed without any signs or explanations the way it accounts for indirect bids. This has caused foreign demand for U.S. debt appear curiously strong, even though China and other important holders of U.S. debt complain rather often about the dollar’s weakness and announced publicly that are looking to reduce their holdings.

The Treasuries actions raise some questions because it tries to inflate foreign demand at a time when most market participants question the fate of the ever-growing U.S. deficit. These actions look like someone is trying to hide the truth, a painful truth that the economy is running on huge debt that no one is looking to finance, especially at the current interest rates. The same pattern – hiding/modifying the truth – could have been observed with other key economic reports too, like the CPI or M3 during a period when the market was looking to them for guidance. Currently, the Fed is among the only central bank in the world that does not publish the M3 numbers.

Global Recovery Doubts?

2009-06-25T22:33:00.000-04:00

The financial market continues to trade mixed, as investors raise doubts about the global recovery.

One day up, the other down seems to be the latest trend in both the currency and the equity market, as investors move in and out of risk-aversion. This has made the gains observed in the equity markets come to a sudden stop, allowing the S&P futures to retrace for the first time since the trend started in March.

However, the direct consequence in the foreign exchange market was that the major pairs failed to find a direction to trade over the last few weeks. To some extent, the link between the dollar index and the S&P futures, which could have been used very easily by investors until now, seems to have weakened substantially since the beginning of June. This can be explained by the fact that the market saw more dollar strength than it (ever) needed since the beginning of the credit crisis, and now investors are beginning to back away from the old greenback as the Treasury digs deeper hole for the U.S. deficit.

The dollar is under huge pressure right now, as countries that have noticeable amounts of dollar denominated assets are looking to diversify. To make matters worse, this happens at the time when the Treasury is trying to sell even more assets in the form of debt, something that raises big questions about the future of the dollar. For now, TheLFB-Forex.com Trade Team sees only two solutions: either the U.S. Treasury hires a very good advertising/PR agency to make the dollar look like the king of the market once again, or stand behind the pledge when saying that the Treasury is aiming for a strong dollar policy.

Fed Expected To Keep Rates On Hold, But What Is Going To Be In The Statement?

2009-06-23T22:21:00.001-04:00

On Wednesday, the market expects the Fed to maintain the Federal Funds Rate at 0.25%, but this time the two-day meeting will probably raise more questions than the previous ones.

By a huge percentage, the market expects the Fed to maintain the key interest rate at 0.25% as the global economy maintains a roughly similar pace of contraction as in the prior period. However, over the last few months, a number of key macroeconomic reports have indicated that consolidation may be near record low levels, something that has the Fed along with most market participants believing that the pace of contraction is starting to ease.

This has created a real frenzy in the market by only focusing on “green shot” signs. Even though this is what the Fed expected to happen, once the market started to price in the signs of recovery, a relative strong increase in demand and thus inflation has begun to happen, creating a real problem for the world economy.

A few things that the Fed has to face on Wednesday, when it releases the FOMC statement are Treasury yields rising at a strong pace over this last month, the dollar declining, and oil more than doubling its price from the low touched earlier this year, something that has the potential to choke the global recovery.

To some extent, the Fed is now between a rock and a hard place, since a statement that can be interpreted as positive may further send the Treasuries higher/dollar lower, while the market may have a similar reaction to a more neutral statement, leaving traders to consider that the Fed may not be affected by the recent gains in Treasury yields. At the same time, a downbeat statement compared with the one released in April may have investors thinking that the market is returning back to a global contraction phase again, sending it back into risk-aversion mode. It will certainly be interesting to see how the Fed addresses this problem, especially when it needs to provide signs of financial/economic stability, while still anchoring the longer-term yields.

However, even though the market interprets any recent report as a sign that the recession is easing, some of the major imbalances that led the global economy towards the credit crisis in the first place are still not resolved or any vital steps being taken towards resolving them. Mainly, the default rate of U.S. mortgages is still high, the U.S. household savings rate remains at very low levels and the already low Fed Funds can only be sent even lower. The U.S. fiscal deficit is still high and unfortunately is continuing to head even higher. Maybe, somewhere in the future the Fed may want to address these issues too, before another bubble begins to form.

The Fed And The Repo Market

2009-06-22T07:12:00.001-04:00

The Fed is looking to change the way overnight markets works, achieving one of the most important changes in interest rate recent history. The Fed, under Bernanke’s reign, is going throughout some major changes that some say have been needed for a long period of time.

Mr. Bernanke has managed to free the Fed from the view that the market is always right, a view that had a great role in the credit crisis. Other important changes that the Fed went through include now a much more transparent central bank, able to properly anchor market’s expectations, and the Fed’s ability to pay interest on the deposits made.

The Fed is looking at ways to re-organize the repo market, also known as the overnight market, which is the Fed’s most important lever over economic business cycles. Currently, the Fed uses a number of private banks as clearing houses for the repo market, however, this system proved to be obsolete during the credit crisis, TheLFB-Forex.com Trade Team commented.

Throughout the overnight market, the Fed controls the effective federal funds rate and thus the refinancing cost. In this market, banks and other financial institutions access liquidity to meet the daily demands, which include daily customers’ activities (like transfer and withdrawals) and to meet the Fed’s minimum reserve requirements, which is another important lever of the central bank, together with the Fed Funds Rate.

In the repo market, banks that have excessive reserves available compared to their daily needs will lend to banks that require additional capital to meet their daily operations requirements. The average rate at which these operations occur is called the Fed Funds Rate, and is usually very close to the Fed’s targeted rate set by the FOMC.

In order for these operations to happen, a number of clearing banks supervise the market, and set the collateral and the payment requirements. However, this system showed its downside during the credit crisis, especially when Lehman collapsed, as a number of clearing banks (read JP Morgan) raised the collateral demanded on Lehman, further sending the bank into a downspin. Some argue that these actions were the final nails in Lehman’s coffin, and were made deliberately.

Currently, the Fed is trying to change this, by implementing a non-profit organization to handle the overnight market operations. Such a measure is already used in the Euro-area, where the European repo market helped the regional financial system weather the credit crisis.

Such a measure taken by the Fed does not have any direct implications in the forex market, but it will help the U.S. financial system achieve a more stable status, which in the long run might help to make the credit crisis an easier thing to overcome.

Financial Sector Re-Valuation: Forex Impact

2009-06-18T13:06:00.001-04:00

The financial sector might still face a difficult period ahead, TheLFB-Forex.com Trade Team notes, as the U.S. administration is trying to impose stricter rules, while a large number of banks may still have to face further sub-prime/credit-crisis write-downs.

Consequently, the rating agency S&P downgraded 18 U.S. banks (of which five were moved into the naughty corner; to default levels) after earlier this week Moody’s downgraded another 25 Spanish banks.

Moreover, both the ECB and the S&P issued a warning this week that European banks might continue to faces losses this year , and next, continuing the trend started in 2008. According to the ECB, losses in the European financial system might reach $280 billion by 2010.

The credit crisis showed that risk is spread systematically throughout the financial system (remember now, “Financial innovation is good”), and now these losses are likely to be reflected in the U.S. bank balance sheets. But for now, U.S. financials are sheltered behind the law that allows them to value illiquid assets (toxic waste) using the bank’s own valuation models.

Additionally, the new financial regulations that President Obama’s team is trying to impose will probably reduce, even more, the sectors’ profit margin and will inflict tighter regulation; something that investors will certainly not like.

As such, TheLFB-Forex.com Trade Team notes, the strong uptrend that the financial sector experienced lately might come to a halt, after the XLF index outperformed the broader S&P 500 over the last three months of trading. Moreover, it is hard to believe that the U.S. markets can advance without the financial sector in the front line, especially in the current market circumstances.

Therefore, the U.S. equity market may well spin its wheels through the summer, as the financial sector re-alignment continues to take place; something that stock market bulls had hoped was already baked into current valuations.

The Three States Of The Financial Market: It Is All About Risk

2009-06-17T11:51:00.000-04:00

In its natural stance, the financial market has three major attitudes towards risk, which models its behavior and actions throughout each of the global trading session. The three are; risk aversion, risk tolerance and risk-neutral.

Risk-aversion is characterized by investors selling assets considered risky, and swapping them for the safety of the bond market, mainly U.S. Treasuries. Risk-aversion can be seen relatively easy; commodities decline as investors consider that consumption will slow, while the S&P futures also head lower. In the currency market, risk-aversion strengthens the dollar, as investor sell foreign denominated assets to buy U.S. Treasuries. In this period, higher yielding currencies are the one being sold the most.

The risk-tolerance phase is seen when Treasuries are sold as investors are looking for higher yields. In periods of relative calm and positive macroeconomic reports, traders abandon the safety of the bond market and invest their capital in stocks, commodities and foreign currencies, thus in this period the dollar is sold. Usually, bull markets are characterized by risk-tolerance phases and in this period S&P futures head higher, together with the euro and the rest of the pack.

In most cases, risk-neutrality happens when the financial market moves side-ways, unable to push anywhere decisively. This period is characterized by a redistribution period, as investors shift their assets between the various financial instruments to prepare for the next leg (risk aversion or tolerance). The main difference being that the shifts are not only session-by-session, they literally happen hour-by-hour. Sentiment is seen to change from one to the other, empowered by the relentless flow of automated trades that trigger as a contingency play, as each individual market accepts risk neutrality.

The sideways moving market tends to be the more volatile as the channels are traded, and fair value sought at each regional market open. June has been a risk neutral month; the equity markets are unable to attract enough volume to make a stance on risk, and therefore the currency markets spin their wheels each day as dollar values are fought over.

Interest Rates Or Growth; What Gives?

2009-06-16T13:20:00.000-04:00

With the recent green-shots in the global economy taking root it seems, the major central banks now have to face a difficult situation; keeping the yields on long-term bonds at relative low values.

Most market participants consider that inflation will pick up strongly in the coming quarters, in-line with the major central banks currently running strong expansionary policies. Historically speaking, most times that a central bank intervenes in the debt market inflationary expectations rise at a strong pace – Japan of the 1990’s being the only exception.

As traders price in high inflation they build in to fair value the requirement of additional yields on Treasuries, especially on the longer-term maturities, to counter the effects of money printing and asset depreciation. However, this has negative effects in the real economy, not only do yields on Treasuries rises, but on every financial instrument linked to the bond market; corporate bonds, and especially consumer and housing credit, including mortgage rates.

Consumer and housing credit pose the biggest threat to any global recovery; consumers pay more on their mortgages and credit costs, and that leaves less money to spend or save. Higher interest rates are directly linked to higher default rates as well.

For now, the major central banks have two big options to use as an exit strategy. The first would be to increase the quantitative easing programs, something that does not seem likely, since almost no central bank would obtain a substantial increase in their available funds at this point in time. Even a small increase would make most market participants think the bank had its hands tied.

The other option a central bank has is to pledge that it will maintain overnight interest rates at low levels for a longer period of time than may seem prudent, something that further fuels inflation expectations, whilst trying to address the confidence requirement that consumers need to borrow, whilst at the same time creating the pool of liquidity that regional and commercial banks can dip in to at fair value rates.

However, before any central banks has to search for an exit strategy, the global economy has to show some solid signs of growth, and maybe take the lead from the emerging markets who look to be capable of drawing on the higher savings rate to get consumers confident, and to get rates contained.

The Fed looks to be the region that will have an interest rate headache for the longest period; the printing, and key to this, the subsequent re-buying, of new notes, has inflationary pressures inherently built in. Getting out of a quantative easing program is very likely to be at the expense of forward growth, and at the expense of affordable consumer interest rates.

The Dollar’s Future As A Reserve Currency

2009-06-15T15:25:00.001-04:00

A lot of talk has been heard lately regarding the dollar’s outlook as a major reserve currency, much of which has been initiated by Chinese and Russian officials, who tried to impose their global status at the international level in regard to the amount of U.S. debt held.

Despite this, the recent actions make the talk look like nothing other than empty words, as the two countries try to push more hot air into a balloon flying in a very cold environment. Despite all the recent accusations coming from Chinese officials, China still kept the same buying pace of U.S. debt, while Russia showed its support for the U.S. dollar during the G8 weekend, after it announced its plans to reduce its exposure towards U.S. denominated assets, something that caused a little shock in the financial market last week.

Ignoring the recent talks coming from China and Russia, TheLFB-Forex.com Trade Team argues that diversifying from the dollar can be really challenging for the vast majority of central banks. Right now, the only feasible alternative to the dollar as a reserve currency for now is the euro. However, what exactly a central bank would do with the euro, when the business relationships including trade balance and money transfers, are relatively low within the 16-nations, and the currency channel is illiquid most of the time.

A case in point would be Canada, of which a staggering 80% of its exports reach the U.S. economy, while only 4% of its exports and 6% of its imports are toward the Euro-area. The big question is, what could the BoC with its newly found euro reserves, when the liquidity in the euro-cad is very thin. Even the Chinese central bank would not have too many things to do with the euro, since the trade balance between the Euro-zone and China is rather small, and considerably less than 10% of the total Chinese balance.

One of the most important aspects is that, in order for a central bank to calculate a cross rate, it first has to triangulate the exchange rate to the dollar. Obviously, if the central bank is planning an intervention in the currency market (which by the way are done very often, especially for minor currencies) they would have to sell or buy dollars against the national currency, rather than euros, yuans or any other currency.

TheLFB-Forex.com Trade Team believes that the recent talks of the U.S. dollar losing its status as a reserve currency are greatly exaggerated. For now, the dollar’s status is safe, even though it is expected that the greenback will lose a few percentage points as central banks try to hedge its declines. However, this is far from the dollar losing its reserve status – as some say.

Is Mr. Inflation Coming Back To Town?

2009-06-14T11:34:00.002-04:00

An increasing number of market participants are considering that inflation is going to pick up very strongly over the upcoming period.

There are a number of signs that the market is preparing for such an event, but the most important one came from the commodity and Treasury markets. First, since the beginning of March, oil has more than doubled its value, making the current bull market the second most powerful on record. At the beginning of March, oil was trading at $32 per barrel, while on Thursday the oil market briefly tested the $73 area, which means that oil rose nearly 110% in thee months. The strongest bull trend on recorded happened in the early 1990’s, when oil gained more than 150% in a three month window, TheLFB-Forex.com Trade Team notes.

Over the last few years, oil was responsible for a large portion of the increases seen in the CPI reports. This was best seen during the summer months of 2008, when inflation reached multi-year highs in the most developed countries as oil was heading towards the $150 level. As such, TheLFB-Forex.com Trade Team expects inflation to pick up again in the coming months.

Further inflation evidence comes from the Treasury market, where the spread between the medium and longer term debt instruments is trading near the highest level on record. Mainly, the spread between the 2-year and the 10-year Treasury notes reached 2.60% in the last few weeks, even though its long-term average sits somewhere around 0.60%. TheLFB-Forex.com Trade Team said that the high spread shows that investors are demanding additional protection against inflation, as they think the Fed will be one step behind.

Remaining in the Treasury market, the 5-year breakeven spread has reached 1.90%. The 5-year breakeven spread measures the difference between 5-year conventional note and the 5-year TIPS notes, which are protected against inflation. The higher the spread between the two instruments, the higher investor’s prospects are that inflation will pick up. Moreover, the 5-year breakeven spread is the central banker’s preferred way to gauge inflation expectations over the longer term.

In the forex market, the currencies that usually have a higher interest rate backing their value will be the best performing ones during a global inflation event. As such, prospects really look for currencies like the aussie, pound (even though it is not the case right now) and more specifically for the emerging currencies.

Trading Is About Managing Risk, Not Positive Trades

2009-06-10T07:30:00.000-04:00

One of the biggest issues a trader has to learn even from the first days of trading, but usually only after multiple blown accounts, is how to manage risk

Many traders just focus on the reward, and do not concentrate enough on the risks that go hand-in-hand. One issue many traders seem to pass by is that risk and reward are directly proportional, meaning that as one increases, the other does too. Moreover, the relationship between risk and reward has more of a fat tail behavior; the link between risk and reward decreases at high levels.

A forex trader should avoid taking trades with an associated risk bigger than 2% of their trade account, it will take more than 5 years of experience to find a rare opportunity that sets once in every while that risking more has proven to be previously advantageous. From personal experience, new traders should focus on small risk-trades, ranging from 0.5%-1.0% of the available account balance.

Even though these particular trades would not produce the same financial reward, they will keep a new trader in the game for longer, and will build a solid knowledge base that a career can be built upon. With some retail brokers offering now micro and mini lots (1K and 10K trade lot size) that cost a few dollars, and sometimes pennies to put on, a new trader does not need an account stacked with thousands of dollars just to learn to trade and manage risk.

A trade has two possible outcomes – either you win or loose. As such, in a control environment, a trader has a 50% chance to lose the next trade. Chances for 2 consecutive trades with the same outcome (win or lose) are 25%, while chances for three consecutive traders with the same outcome reach 12.5%. Even though the percentage is relatively small, new traders chase the game defying logic, and defying money management in the fear of loss gamble that comes with poor money management.

A good trader should psychologically prepare for such events during the intra-day set-ups. Too much risk can kill an account very quickly, especially for new traders who tend not to control their emotions too well, if at all. If someone is looking for risk-free trades in the financial markets, he or she should better look at a savings account, but with that being said, the other extreme is taking risk that is not at all justified.

Start with the stop area, and note the pip loss potential, 40 pips for example. Each pip costs $1 of a mini lot trade when trading Usd based pairs. On a $5000 account balance a 2% risk equals $100; with a 40 pip Stop the risk is 2.5 mini lots per trade. With 2% being the absolute maximum exposure at any one time, it also means that no new trades can go on until the original position has hit profit and the Stop moved to break-even.

Overleveraged trading is thrilling to some, while the idea of a casino type Lotto win is all consuming to others. Forex however, is a business; leave the gambling to the Thursday night card school, get a Plan, and get serious about managing risk because without it the game soon ends.

The U.S. Toxic Asset Plan – The Greatest Plan That Never Lived

2009-06-08T06:23:00.001-04:00

The plan that was built and designed to save the world from an imminent implosion of the famous U.S. toxic plan is starting to look just like a distant memory, since U.S. officials are planning to halt its application.

The Treasury, under Mr. Geither’s leadership, was planning to use the U.S. Toxic asset plan to help banks get rid of the toxic assets locked on bank’s balance sheets. The plan was supposed to find the best price for the toxic assets in an auction sale, were hedge funds and banks would had bid with a staggering majority of funds taken from the Federal Deposit Insurance Corporation.

However, the plan fell short because both banks and other financial institutions appeared reluctant to join the toxic asset plan because of fears that Congress would impose pay caps to the companies’ executives if funds were used. That is not the smartest decision; to threaten the pay check and eventually the position of the person in charge of making important decisions, when you are trying to reach an agreement with them is a little hard to implement.

In addition to investors’ reluctance to join the program, government officials look ready to halt the U.S. asset plan. Recently, the FDIC postponed a pilot sales program, which was supposed to benchmark the system. Moreover, Treasury officials said that banks can now raise enough capital individually, making the program look ineffective.

TheLFB-Forex.com Trade noted that, to some extent, the U.S. asset buying plan was one of the greatest plans that did not see the light of day. Even though the plan provided strong support for the equity market when it was announced, it looks like it was nothing more than hot air. For now, the Treasury can change its focus once again towards the U.S. debt mountain, adding some more hot air to that instead, with public displays of a “Strong Dollar Policy”. From what the financial market have witnessed over the course of the last decade, empty words and wild talk seems to be the way forward. And now to the bubble-mobile, we have another boom cycle to create.

Mortgage Rates, The Fed And Treasuries

2009-06-08T05:35:00.001-04:00

On Thursday, U.S. mortgage rates reached the highest level in 2009, as investors are leaving the market before the Fed does.

A few months back, in March, the Fed had pledged to use up to $1.25 trillion to buy debt from the financial markets. This decision was taken to send the bond yield lower, something that will help the economy (including consumers, companies and the government itself) whether the credit crisis more easily, TheLFB-Forex.com Trade Team said.

However, the decision to intervene in the debt market with such a huge sum (about 5% of the size of the U.S. bond market) raises some concerns that the Fed will cause hyperinflation in the long run. As such, investors are demanding higher yields from the market to prepare for such an event. Additionally, as the economy recovers the Fed will have to raise the interest rate, something that again makes investors seek higher yields. That’s not the case right now, even though the market is preparing for such events (especially the hyperinflation one). The spread between the 2 year and the 10 year Treasury notes is trading near the highest level on record, suggesting again that the vast majority of investors think inflation will be very strong in the long run.

However, neither a high level of inflation nor the economy recovering are possible in the next few months, and this does have a strong effect in the real economy, because mortgage/loan rates are rising with the Treasury yields. This certainly has the potential to slow the recovery, and even more, to take away precious buyers from the housing market since mortgages are again rising. TheLFB-Forex.com Trade Team notes that the U.S. economy will never be able to recover unless the housing market at least finds a bottom.

The ECB Press Conference: “Independence Fears”

2009-06-04T22:08:00.000-04:00

At the ECB press conference, the central bank updated its forecasts for 2009 and 2010. According to the ECB’s staff projections, the economy will contract a whopping -5.1%, to -4.1% in 2009, much worse than the previous projections, released in March, which expected the economic activity to contract between -3.2% and -2.2%. The 2010 growth projections were also revised lower, from -0.7% to 0.7% in March, to the current forecast of -1.0% and 0.4%.”

“Inflation expectations were left mainly unchanged at the current ECB staff projections report. TheLFB Trade Team said. “The ECB expects CPI inflation to range between 0.1% and 0.5% in 2009, but to pick up a stronger pace in the 2010, ranging between 0.6% and 1.4%.”

“Overall, Mr. Trichet press conference was more bullish than usual, and said for the first time that the pace of contraction is easing in the global economy. However, Mr. Trichet also warned that growth is expected to pick up only in 2010 (and thus the poor 2009 GDP projections) when asked about the recent green shots in the financial markets. Except for this, the introductory statement did not provide any new information.”

“The Q&A session had two main themes: the new covered bond buying program and the recent comments made by Germany’s Chancellor Angela Merkel. Additionally, from time to time Mr. Trichet received questions about the fate of the Baltic economies, mainly Latvia.”

“The President of the ECB refused to give away too many details on most questions, mostly providing partial answers and most of the time dodging the essential of the inquiry. About the new asset buying program, Mr. Trichet said that the program’s size is 60 billion euros, and does not want to provide any additional information.”

“However, when asked about Angela Merkel’s recent comments, in which she complained about the decisions taken by the Fed, BoE and mainly by the ECB, Mr. Trichet said only that he had a conference call with Germany’s Chancellor in which she assured that the bank’s “fears independence” is not at risk in any way. In the following few questions, Mr. Trichet only reiterated this answer that the bank’s independence is not at risk.”

In the forex market, the major currencies plunged compared with the dollar after the ECB’s interest rate decision. As Mr. Trichet provided his statement, the euro retraced earlier declines, but then started to move lower once again. For now, the currency market appears to be looking for a solid anchoring point.

• The Governing Council decided to leave the key ECB interest rates unchanged at 1%
• The current key ECB interest rates are appropriate taking into account the decisions of early May, including the enhanced credit support measures, and the information and analyses which have become available since
• Economic activity weakened considerably in the first quarter of 2009. Economic activity in the euro area contracted by 2.5% quarter-on-quarter, after a decline of 1.8% in the fourth quarter of 2008
• Activity over the remainder of this year is expected to decline at much less negative rates. After a stabilization phase, positive quarterly growth rates are expected by mid-2010
• The risks to the economic outlook are balanced
• On the positive side, there may be stronger than anticipated effects stemming from the extensive macroeconomic stimulus under way and from other policy measures recently taken
• Confidence may also improve more quickly than currently expected
• On the other hand, a stronger impact on the real economy from the turmoil in financial markets, more unfavorable developments in labor markets, the intensification of protectionist pressures and, finally, adverse developments in the world economy stemming from a disorderly correction of global imbalances, may impact the outlook
• With regard to price developments, annual HICP inflation was, according to Eurostat’s flash estimate, 0.0% in May, compared with 0.6% in April
• Annual inflation rates are projected to decline further, and temporarily remain negative over the coming months, before returning to positive territory by the end of 2009. Such short-term movements are, however, not relevant from a monetary policy perspective
• Any threat to price stability over the medium to longer term can be effectively countered in a timely fashion
• As has been emphasized many times, the Governing Council will continue to ensure a firm anchoring of medium-term inflation expectations
• The latest data confirm the continued deceleration in the pace of underlying monetary expansion and thus support the assessment of moderate inflationary pressures
• In April, the annual growth rate of M3 declined further to 4.9% and that of loans to the private sector to 2.4%
• The latest developments in M3 components continue to reflect to a large extent the impact of past reductions in key ECB interest rates.
• Regarding fiscal policies, the latest projections by the European Commission point to a sharp increase in the euro area. The deficit ratio is projected to rise to 5.3% of GDP in 2009 and further to 6.5% in 2010, from 1.9% in 2008, with the debt ratio exceeding 80% of GDP in 2010

Markets Prepare For ECB and BOE Interest Rate Decisions

2009-06-03T07:41:00.000-04:00

The European Central Bank (ECB) and the Bank of England (BOE) are expected to keep rates on hold, after reducing the monetary policy stance at a record pace over the past year. Both central banks have the policy rate at the lowest level on record, in order to help the economy recover from what seems to be the biggest downturn since the Great Depression.

The Bank of England is expected to keep rates on hold at 0.50%, the lowest rate in the bank’s three century history. Also, the central bank is seen maintaining the current asset purchase program at 125 billion pounds, after it was extended at the previous meeting by 50 billion pounds.

TheLFB-Forex.com Trade Team noted that the U.K. economy saw the first signs of recovery in May, as the price of houses unexpectedly increased, while the service side of the economy expanded for the first time in a year. This may lead to the U.K. central bank to provide a bullish statement tomorrow, since the bank has already said that the recession is easing in its latest minutes. Additionally, the most bearish member in the voting committee, Mr. David Blanchflower stepped down on 1 June, which might uplift the overall view of the committee on the economic outlook.

At the ECB, things are a little different. The European bank has just announced a new (and small, related to the size of the economy) quantitative policy, and has already received criticism about this. At the last meeting, the European Central Bank announced a plan to buy up to 60 billion euros in covered bonds, in order to help the market recover and lift the inflation expectations. However, the bank’s decision received strong criticism from Angela Merkel, Germany’s chancellor. These comments seem even stronger since the German government has been known to never comment on the central bank’s monetary decisions. Currently, Germany is the biggest economy in the Euro-area, and the ECB was built on the Bundesbank’s legacy.

As such, the ECB is expected to keep the interest rate at 1%, while chances are very small that the central bank will expand its plan to buy covered bonds. TheLFB-Forex.com Trade Team expects Mr. Trichet to put emphasis on the global recovery and on the recent developments in the commodity markets.

Baltic Countries Continue To Struggle

2009-06-02T13:19:00.001-04:00

Even though it seems the global economy is on its way towards recovery, overall, not every country is enjoying the comeback.

In the European Union, the Baltic country of Latvia is enduring a very tough period. The economy contracted a whopping 18% in the first quarter from one year earlier (in nominal terms), while TheLFB-Forex.com Trade Team expects the GDP to shed a quarter of its value by the end of the credit crisis. The unemployment rate surged to 17.4% in April, from 6.1% one year earlier. By every standard, the Latvian economy is in terrible shape. TheLFB-Forex.com Trade Team argues that the economic contraction is even greater than the one experienced by the U.S. during the Great Depression.

However, things have not been always like this. For years, the three Baltic States (Latvia, Estonia and Lithuania) had the strongest growth rate among the developed economies, especially Latvia, which averaged double digit expansions during the 2005-2007 periods. As a consequence, the three countries came to be known as the Baltic Tiger.

However, it all came to an end during the credit crisis as the huge current account deficit, (bigger than 20% of the economy) net outflows of cash and double digit inflation choked every small attempt of economic recovery, TheLFB-Forex.com Trade Team noted.

These days, a growing number of economists, including the IMF, say that Latvia should devalue its currency. This would send the Latvian Lat much lower against the dollar and the euro as the central bank tries to inject money into the real economy.

Commodity Markets Push Canadian Dollar Higher In May

2009-06-01T06:30:00.000-04:00

The financial markets saw some strong trends in May, as more and more investors became bullish on the global and equities

The most important rally observed in May, that had widespread influence over the financial markets, was the in raw materials. Crude oil, gold and metals surged as demand from China and the other emerging economies were stronger than expected. Some analysts even suggested that China is using its huge FX reserves to buy and deposit cheap commodities, instead of buying Treasury notes. However, this theory fades as recent reports showed that China still bought Treasuries in the last part of year, despite the complaints issued by top Chinese officials.

Together with oil, the cad experienced the strongest monthly decline since the 1950’s, in May. The Canadian dollar was pushed higher against the dollar as crude oil surged. The cad has a close correlation with the energy markets, since energy products are Canada’s main export products. The Canadian dollar weakened only 2 weeks out of the 13 since the rally in the equity and commodity markets started, in early March, something that suggests the pair’s strength, TheLFB-Forex.com Trade Team said.

The pound also saw some strong upward pressure during the previous month of trading. The pound gained more than 9% in May, much more than the S&P 500 index, which returned 5.30% over the same period. TheLFB-Forex.com Trade Team said that currencies outperforming equity markets happen very rarely. The pound was driven higher as evidence is mounting that the decline in the U.K. housing market is slowing, even possibly reaching a bottom, they added. Both the U.K. and the U.S. economies were hit very hard by the housing market decline, and traders are now betting that the economy will recover with the housing sector. Moreover, a number of investors are speculating that inflation will surge in the coming period in the U.K, which also empowers the pound.

Choking Global Growth Before It Even Happens

2009-05-29T13:41:00.001-04:00

Most market participants agree that the global economy is recovering, but chances are that some are expecting a recovery that is too strong for the current circumstances.

As investors judge that the global economy is improving, more short positions are taken against the dollar and treasuries, while long positions are build in the commodity market. This has made commodities such as gold, oil and copper enter into a real bull market.

However, TheLFB-Forex.com Trade Desk has stated over the last period, that the strong rise in crude oil threatens to dampen the economic recovery even before it happens. Oil is known to have a strong link with the world’s GDP, since in order for the global economy to develop, it needs an energy source. Unfortunately, oil is the only viable energy source available right now, despite its large list of detriments.

Academic studies have shown that a 10% increase in crude’s price can reduce the global output by 0.5%, by its direct effect on inflation, consumption and unemployment. During the December to February period, crude oil prices averaged $45 a barrel, while in March and April, the average price rose to around $50 per barrel. The gains seen in the crude oil market over the two periods dampened the global output by around 0.5%, since crude oil’s prices rose a little more than 10%.

However, nowadays crude oil is trading at $65 per barrel, which represents a 45% gain from the December-February period, and a 30% gain from the March to April episode. Translated, it would mean that if crude oil averages $65 a barrel in the coming months, as it trades right now, the world GDP will be slowed by full percentage points over the next few quarters.

This does not look to good, since the latest forecasts of the International Monetary Funds point out that the global economy will contract 1.3% in 2009, while it slowly recovers by 2010. Strong gains in the crude oil market, or strong volatility, have the potential to further delay the recovery period, or in an extreme case, crude oil can send the global economy back to the contraction phase.

Housing Market Still Far From Stabile

2009-05-29T03:17:00.000-04:00

Even though most investors are confident about the global economy recovering in the second part of the year, the equity markets cannot find the strength to break above the highs set at the beginning of May.

The major equity indexes saw strong buying orders during March and April, and some more during the beginning of May. However, the financial markets ran out of steam pretty quick, as a number of releases failed to hit the market’s expectations. Some of those releases are coming from the housing market, were the contraction seems to be going forward uninterrupted.

Today, a report showed that new home sales rose 0.3% in April, to 352,000. Even if most market participants interpreted the releases as signs that the housing market is stabilizing, things are not too rosy.

Speaking from a statistical point of view, a 0.3% increase is close to nothing. Not to mention that such a small variation can simply be ignored, because even the smallest slip would produce a bigger fluctuation. In April of this year, new home sales were just a third of what they used to be back in 2004 and 2005, at the height of the market. “This clearly denotes the magnitude of the downfall, and a gain of 0.3% month-over-month, is just a plain number. Nobody expects the housing market to return to its 2005 activity, but the whole industry cannot survive with only pieces of what it once had been,” TheLFB-Forex.com Trade Team added.

Another problem with the housing market is the huge number of inventories. The latest release points out that inventories are holding at 12 month highs, but TheLFB-Forex.com Trade Team considers that this number does not reflect the real market-situation. In such a poor housing market, one question rises, which owner would sell its house at the current prices? Not too many. A quick conclusion would be that one of the initial causes of the credit crises, the housing market is still far away from a sustainable recovery.

Two Different Views, One Conclusion: Bye-Bye Dollar

2009-05-27T12:36:00.001-04:00

The currency market is currently running on two different views, but both are pointing to dollar weakness in the medium to longer term.

The first outlook is that the economy is starting to recover, or just initiating the expansion period. This view is fueled by the recent releases, which point out that consumers are actually holding strong.

TheLFB-Forex.com Trade Team said that, when the awful first quarter numbers were printed, the financial markets found strong support in the fact that consumer spending increased during the first three months of the year. Yesterday, a report showed that consumer confidence increased at a record pace in April and May, which are the first two months of the second quarter. This made investors optimistic once again about the global recovery theme, and furthermore made some investors bullish. According to TheLFB-Forex.com Trade Team, the U.S. economy might be on the path to recovery by the second part of 2009.

As the U.S. and global economies recover, institutional traders become more risk-tolerant, meaning that they will abandon the safety of the U.S. dollar for the yield of foreign assets. This should empower the euro and the rest of the major pairs, in the long run. If this holds true, some are saying the euro might break the 1.6000 by the end of the year.

The other important view that is influencing the currency market is that the global economy is heading towards a period of massive inflation in the next few years. This outlook is fueled by the fact that the U.S. government is running a huge deficit, by the ultra-low level on the Fed Funds and by the huge size of the Fed’s balance sheets. All three taken individually are known to spark massive inflation in the medium to long term (around two years), but now these three forces are working together.

A good way to gauge inflation expectations is to calculate the breakeven level between Treasury notes and similar maturity TIPS notes. Both the spread between 5-year and the 10-year notes increased at a record pace since March, when the equity rally first started.

In periods of high inflation, the greenback looks rather weak. This happens because investors are looking for ways to beat inflation by investing in foreign denominated assets (especially those of emerging economies), and in commodities.

The Link Between The S&P And The Currency Market

2009-05-26T06:54:00.000-04:00

After a very light day of trading on Monday, the currency market experienced a strong overnight session this Tuesday. The dollar was the clear winner of the overnight sessions, strengthening not only against every other major currency, but against the minor currencies too.

It is interesting though, that the currency market lost its close link with the S&P futures over the last period of trading. The S&P moved only a limited number of points, while the currency market saw some huge swings. For example, last week the S&P had a 50 points range (0.55%), while the major currencies had one of the strongest weeks of 2009. The same case occurred overnight, when the S&P futures declined only 2.60 points, while the euro and the pound declined as much as 140 pips.

However, TheLFB-Forex.com Trade Team noted that, even though the correlation between the dollar index and the S&P futures has decreased lately, the currency market does not have the strength to reverse the current trend on its own. Such a move would require the cooperation of the Treasury and of the Equity markets.

TheLFB-Forex.com Trade Team argues that over the last few days of trading, the uptrend observed in the currency market needs to be retraced first, allowing a number of investors to switch to the bull camp. As soon as the currency and the equity markets hit an important swing point, the dollar may resume its decline while the S&P futures may continue to gain helped by the global recovery.

The Dollar And The Emerging Currencies

2009-05-25T13:07:00.001-04:00

The dollar index saw a day of light strengthening during the Monday session as the U.S. financial markets will be closed today. The New York Stock Exchange will be closed for business, but the NYMEX will remain open providing the daily oil fix.

The current overnight session offered the dollar the possibility to retrace some of the strong declines seen in the previous week of trading. However, the light volume observed in the financial markets (including the currency market) was too small for the dollar to break any important price points, such as the 81.00 resistance area on the dollar index. So it would not be a surprise to see the dollar’s strength continue within the next few days, as it tries to retrace some more ground. As a note, TheLFB-Forex.com Trade Team notes that, some pairs may look a little overvalued in the short-term.

As the dollar declined and investors turned more bullish on the global economy over the last few weeks of trading, emerging currencies were able to post their first gains this year. This is a big relief for some emerging countries, since a significant percentage of the public and private debts are denominated in foreign currencies. According to TheLFB-Forex.com Trade Team analysis, some of these emerging currencies may offer important opportunities, due to their strong international positions and due to their huge swap (especially compared with the dollar).

The best three performing currencies of the last few months are the South African rand, Turkey’s lira and the Brazilian real. Each of these currencies pay a swap bigger than 9% against the dollar, which should attract some strong inflows of capital in the mid to long term. Additionally, a number of analysts, including TheLFB-Forex.com Trade Team, forecast that inflation will pick up later this year, something that should further increase the spread between the dollar and the emerging currencies.

Who is next on the list?

2009-05-21T22:29:00.000-04:00

The financial markets saw a short-lived shock today, when the rating agency S&P announced that it downgraded the outlook of the U.K. economy.

According to the S&P’s statement, the U.K.’s downgrade is a consequence of the huge public deficit, projected to reach a whopping 12% this year, a huge number by any standards. For example, the European Union triggers the excessive deficit procedure if it passes the 3% level, something that the U.K. deficit has broken for a while.

Over the last period, the three major rating agencies have taken a pro-active stance. A large numbers of banks are under review in Asia, while more than 30 Spanish banks will probably see their rating reduced in the following weeks. At the beginning of March, Moody’s put both Bank of America and Wells Fargo on the radar.

The big question now is who may be next on the rating agencies’ list? Because the forex market is influenced in a great way by a country’s downgrade rather than individual stocks, we shall examine the macroeconomic environment to see who may follow.

Following the template set by the U.K.’s downgrade, the first countries that appear under TheLFB-Forex.com’s radar are Italy and Greece. Of the two, Greece already saw its debt rating downgraded in January, so a second one is not likely real soon because of the short timeframe.

However, Italy may very well be the next victim for the rating agencies. Italy, along with Spain has been seen for a long period as the epicenter of the credit crisis in Europe. Spain has already had its debt downgraded (with Greece), so it would not be a surprise if Italy would be next.

To further strengthen the case, Italy is currently running a huge public deficit, reaching up to 105% of the GDP, one of the worst in the world. Currently, forecasts are that the government deficit will reach 5% this year. At the same time Italy’s trade balance, another strong indicator about the country’s finances is $52 billion, again one of the biggest in the world.

If TheLFB-Forex.com’s assumption holds true, and Italy does indeed have its debt rating downgraded, then the euro will see a strong wave of selling orders. Depending on the timing, the market could have an even stronger reaction that the one seen today.

The S&P has downgraded the outlook on the U.K. economy

2009-05-21T13:28:00.000-04:00

The U.K. financial markets came under a lot of stress this morning, after the S&P announced that it downgraded the U.K. economic outlook to negative from stable.

According to the S&P’s statement, the downgrade follows the poor state of the U.K.’s public finances. The government’s deficit is forecast to reach 100% of the GDP in the following year. To make matters worse, this year’s deficit will reach 175 billion pounds, nearly 12% of the economy. However, most analysts say that the actual number might be even bigger as the government tries to fight the aftermath of the credit crisis.

For now, the U.K. economy still retains its top-notch triple-A rating, but the S&P warns that the U.K’ high level of debt is incompatible with the current rating.

In recent weeks the rating agencies have started to act preemptively, something that has not happened over the last few years. Earlier this week Japan’s foreign-currency debt was downgraded by Moody’s, while the same rating agency put most of the Asia’s financial system on review for a possible downgrade. Furthermore, Moody’s is also preparing to downgrade 34 Spanish banks, including Santander, one of the largest banks in the world.

Most likely, more countries will see their debt rating downgraded in the coming period, as public deficits are set to increase substantially.

TheLFB Wednesday Currency Report

2009-05-20T22:29:00.000-04:00

Oil hit another milestone, as did the cad, breaking and holding above the $61 per barrel benchmark.

Commodities, led by crude oil are gaining ground fast as investors are becoming even more bullish on the global economy. To further feed these feelings, a report showed today that crude oil inventories dropped over the last two weeks, suggesting that demand is picking up again. Most market participants believe that the economy will bottom in the current quarter, something that goes hand-in-hand with demand for crude oil (energy) picking up, as the economy is expanding.

TheLFB-Forex.com Trade Team notes that the strong gains in the crude oil market empowered the Canadian dollar during Wednesday’s trading session. The cad was able to break below the 1.1490 level, which acted as support for almost half of year.

The pound outperformed the entire market again on Thursday, something that seems to have become a trend lately. At the time this article was written, the pound had gained 220 pips, breaking above the 200-day simple moving average for the first time in almost a year. It appears as though the pound’s strength comes as institutional traders consider the pair undervalued, something that TheLFB-Forex.com Trade Team have stated in the last few weeks.

The Japanese yen again became a safe heaven, after a release showed that the Japanese economy contracted 4.0% in the first quarter, the most on record. Some argue that, Japan’s lost decade has now become decades, since real GDP has fallen back to the 2003 level, while nominal GDP has fallen to 1992 levels…

Markets Preparing For Inflation?

2009-05-20T01:43:00.000-04:00

The financial market is going through some major changes, which are likely to influence the outcome of the economic activity over the coming periods.

Currently, most market participants expect the pace of contraction seen in the global economy to slow, while a small group of investors even anticipate a number of positive signs of growth in the upcoming quarter. With this being said, the financial markets expect demand to pick up again, led by emerging countries like China and Brazil whereas the developed world is to lag behind.

Another important change that the financial markets are experiencing these days is the fact that inflationary expectations are coming back to life, and very fast. The inflation breakeven level, or the spread between the 5-year TIPS and the similar maturity Treasury note, experienced a sudden shift in sentiment since March, when the equity rally first started.

TheLFB-Forex.com Trade Team notes that in March, the breakeven rate was standing at -0.20%, meaning that investors expected a rather prolonged period of disinflation and/or deflation. However, things have suddenly changed with the equity rally. Right now, the same breakeven spread sits at 0.60%, a sharp change in just a little more than two months.

The market’s inflation expectation is fueled by the strong expansionary policies ran by the Fed and the other central banks, and by the gains seen in the commodity markets. TheLFB-Forex.com Trade Team commented that oil rose nearly 80% from the low reached earlier this year, something that will soon be reflected in the monthly CPI numbers. Moreover, the quantitative easing policies, to expand the monetary base by intervening in the bond market, will also add to inflationary pressures.

Monday’s Currency Report: The Euro and The GDP

2009-05-18T20:47:00.000-04:00

In a day in which the major currencies posted strong gains against the dollar, the euro barely moved.

The main drag on the euro seems to be the very poor GDP reports seen last week, which pointed out that the economy contracted much more than expected. To make matters worse, the German economy, which is seen as the regional benchmark in Europe, contracted the most on record, at 3.8%.

At the time this article was written, the pound, aussie and the cad each gained 150 pips, while the euro advanced only 50 pips. The dollar’s decline started during the European session and was extended during the U.S. trading hours, as the S&P futures recovered from the declines seen in the early part of the overnight session.

TheLFB-Forex.com Trade Team notes that the dollar index declined only 30 basis points reaching the 82.68 area. Even though the dollar lost ground against every possible currency, except for the Japanese yen, the index’ decline was tempered by the small gains posted by euro. The dollar index has a big exposure to the euro, and tracks every move made by the euro, be it small or big.

However, as long the global economic recovery story seems to continue, the outlook of the majors’ currencies remains to the upside. As investors become increasingly eager to take risk on their balance sheets, they will abandon the safety of the greenback for higher yields. TheLFB-Forex.com Trade Team argues that in the coming quarters, inflation will again be seen in the CPI numbers because of the present expansionary policies and this will further accelerate the dollar’s decline.

The Euro And The Recent Green Shoots

2009-05-13T03:37:00.001-04:00

The tide may have turned for the euro, as the recent green shoots prompted currency traders to shed the dollar’s safety for the yield of more risky assets.

After more than six months of heavy selling, the single currency managed to retrace almost 38.2% of the strong downtrend that started with the credit crisis, in July 2008. TheLFB-Forex.com Trade Team notes that most of the upward pressure came during the last nine weeks of trading, mirroring the rally seen in the equity markets, as institutional traders tried to diversify their holdings to other classes of assets including denominations in foreign currencies.

However, these days, the euro might see even more support coming, as a number of traders build dollar-short portfolios, as the global economy recovers from what appears to be the worst recession since the 1930’s. A number of prominent financial ‘guru’s’ have come out in favor of the euro against the dollar.

These claims are in-line with what TheLFB-Forex.com Trade Team have said over the last few weeks. The dollar’s outlook is starting to appear grim once again, and once the global economy recovers, the major central banks will have to tackle inflation once again. To some this may appear as distant, but the market is already pricing in such a scenario.

Most likely, inflationist pressure will come from the crude oil market, where oil may surge once the global economy is on its way to recovery. This in turn will be reflected in the CPI, but unlike the summer of 2008, central banks are now targeting an expansionary policy, which should add some further points to the CPI data. One must think that right now some central banks are way off from their inflation forecasts made earlier this year. If this holds true, the euro may continue its rally as the ECB returns to its inflation targeting rhetoric.

The ECB Press Conference: Bank Decides To Initiate Open Market Bond Operations

2009-05-07T22:15:00.000-04:00

• The Governing Council decided to reduce the interest rate on the main refinancing operations of the Euro-system by a further 25 basis points and the rate on the marginal lending facility by 50 basis points, to 1.00% and 1.75% respectively.
• Current key ECB interest rates are appropriate taking into account all available information and analysis
• The ECB will conduct liquidity-providing longer-term refinancing operations with a maturity of 12 months
• The operations will be conducted as fixed rate tender procedures with full allotment […] the fixed rate may include a premium to the rate on the main refinancing operations, depending on the circumstances at the time.
• The Governing Council has decided in principle that the Euro-system will purchase euro-denominated covered bonds issued in the euro area
• Furthermore, the Governing Council has decided that the European Investment Bank will become an eligible counterparty in the Euro-system’s monetary policy operations
• These decisions have been taken to promote the ongoing decline in money market term rates, to encourage banks to maintain and expand their lending to clients, to help to improve market liquidity in important segments of the private debt security market, and to ease funding conditions for banks and enterprises.
• Today’s decisions take into account the expectation that price developments will continue to be dampened by the substantial past fall in commodity prices
• The latest economic data and survey information suggest tentative signs of a stabilization at very low levels, after a first quarter which was significantly weaker than expected
• The world economy, including the euro area, is still undergoing a severe downturn, with the prospect of both external and domestic demand remaining very weak over 2009 before gradually recovering in the course of 2010
• This weakening in the first quarter appears to have been significantly more pronounced than projected in March
• On the downside, there are concerns that the turmoil in financial markets could have a stronger impact on the real economy, as well as that protectionist pressures could intensify
• At the same time, there may be stronger than anticipated positive effects due to the decrease in commodity prices and to the policy measures taken.
• The decline in inflation since last summer primarily reflects the sharp fall in global commodity prices over this period.
• Signs of a more broad-based reduction in inflationary pressure are increasingly emerging.
• We expect to see headline annual inflation rates declining further and temporarily remaining at negative levels for some months around mid-year.[…] short-term dynamics are, however, not relevant from a monetary policy perspective
• The latest data confirm the continued deceleration in the pace of underlying monetary expansion
• Month-on-month developments in M3 and its components have remained volatile, with data for March showing a contraction in most of the respective outstanding amounts
• The outstanding amount of MFI loans to the private sector contracted further in March, reflecting mainly a negative flow of lending to non-financial corporations
• All in all, since the intensification of the financial crisis in September 2008, the Euro-system has taken a series of measures that are unprecedented in nature, scope and timing.
• We have observed a clear decline in key money market interest rates that euro area banks typically use as benchmarks to reset floating rate loans and price new short-term loans
• Monetary policy has provided ongoing support for households and corporations.
The Governing Council decided to intervene in the Euro-area’s bond market. The European Central Bank will buy up to 60 billion of covered bonds, which are financial securities backed by the cash flows from mortgages. To some extend, covered versions are the European version of the ABS instruments, only much safer. Mr. Trichet also mentioned that the intervention in the covered bond is not a quantitative easing program, but an “enhance credit support program”.

Additionally, the Council members decided that the European Investment Bank will be able to bid in the bank’s open market operations. This means that the ECB will open its doors to government debt instruments, something that was out the bank’s reach until now. The bank also decided to increase the open market operations’ maturity up to 12 months, which can be use by banks to strengthen their balance sheets and unload most of their toxic assets.

TheLFB-Forex.com notes that the euro traded very volatile during the press conference. In the first 15 minutes, the euro plunged 90 pips and recovered everything back. The single-currency gained 150 pips and almost touched the 200-day moving average during the press conference as Mr. Trichet said that he cannot exclude lower rates, but the current one are appropriate.

What To Expect From The ECB And BoE

2009-05-06T22:45:00.000-04:00

The currency market is anxiously awaiting the interest rate decisions from the Bank of England and the European Central Bank, which will be released tomorrow morning. The BoE is expected to keep rates on hold and say that it will continue the asset buying program, while the ECB is expected to reduce the key interest rate by 25 basis points.

Additionally, market participants anticipate that the ECB will introduce a new quantitative method, even though the market is still not sure exactly how, since the ECB cannot intervene in the government bond market as the other central banks do. Instead, the ECB members have repeatedly said that the bank is already adopting a quantitative easing method by providing unlimited funds to the European banking system. Most market participants do not consider this to be a quantitative easing method.

Over the past few weeks, a number of ECB members expressed their opinion that the lowest threshold in the Euro-area should be 1%, and anything lower would simply disrupt the inter-banking lending. If Mr. Trichet expresses this opinion tomorrow, the euro may receive a boost, TheLFB-Forex.com Trade Team said. They also added that this might substantially improve the euro’s outlook over the medium and long term, if the recent positive global economic news reports are added to the equation.

On the other hand, it seems that the BoE has already reached the limits of monetary policy. The bank has limited room to further reduce the interest rate, if any, as the voting members saw strong deflationary pressure that threatened to “undershoot” the inflation target.

However, TheLFB-Forex.com Trade Team notes that in the November inflation report, the BoE forecast the CPI read to stand somewhere slightly above the 1% benchmark level, but the inflation gauge was release at 2.9% in March, and even rose a few basis points in February. Some analysts are arguing that the BoE decision was oversized, something that might cause strong inflationary pressures over the medium to long term, and will support the pound’s value.

The Libor Rate Falls Below 1%, A Record Low

2009-05-06T06:36:00.001-04:00

The three month dollar Libor rate fell to 0.99% this morning, breaking, for the first time, below the 1% benchmark rate. Libor or London Interbank Offered Rate tracks the interest rate at which banks borrow unsecured funds from the money markets. Currently, it is estimated that roughly more than $350 trillion worth of loans worldwide are linked to the Libor rate.

The Libor rate saw a strong uptrend in the first phase of the credit crunch, as the uncertainty regarding the health of the financial system was reflected in the money market rates. The Libor rate peaked at 4.818% in November, but the decision taken by the Fed and the other central banks helped alleviate the inter-banking strains. In particular, the main factors that influenced the Libor rates were the Fed’s decision to offer dollar swaps with the other major central banks and pledge to sustain the balance sheets of any other falling banks, so the Lehman situation will not be repeated.

TheLFB-Forex.com Trade Team notes that the timing is even more interesting, since today the market expected the stress test results. “According to the latest rumors, ten out of the 19 banks tested will be asked to increase their capital base, something that should have had a negative effect on the market, but so far it has not”, TheLFB-Forex.com Trade Team said.

Having the Libor rate drop to a record low level, more optimism is being injected into the equity markets. The main indexes from the U.S. and Europe erased the declines seen in the first two months of the year, helped by optimism that the global contraction is slowing down. The record low Libor rate should further strengthen the case, since it helps businesses and consumers’ access credit and liquidity with more ease, something that was not the case over the last year.

Analysis Of Monday's Trading Session

2009-05-04T22:37:00.000-04:00

The currency market again saw a day of dollar selling on Monday, but the majors posted only modest gains against the Japanese yen, if any.” The main reason might be the closed Japanese trading session, which reduced significantly the liquidity of the Japanese yen in the foreign exchange market”, TheLFB-Forex.com Trade Team noted. Consequently, the Usd/Yen traded in a 25-pip channel during the overnight session, which eventually gave way as the yen plunged towards the support area formed by the 20 and the 200-day simple moving averages.

The Asian session saw the major pairs gain ground, but the London open reversed the trend and sent the pairs below the Sunday open price. The dollar was again sold shortly before the U.S. open, as the market expected the recent positive news to continue with today’s pending home sales and construction spending reports. The market expectations were overwhelmed when both releases printed better than the expected numbers.

Having the major pairs break above important price points of the last six months of trading it starting to look like the currency market is pricing in a gradual recovery of the global economy. However, both the dollar index and the financial markets will have a big test coming in the following periods, as three central banks are expected to announce interest rate decisions this week plus the results of the banks stress test.

The Story Of The First Quarter GDP

2009-04-30T23:07:00.000-04:00

The GDP report revealed a story of two tales, one in which consumers are the main character and has a happy ending and another where businesses came to the spotlight, but does not have the same happy ending.

The quarterly data showed a surprising 2.2% up-tick in consumer spending, something that indicates that consumer expenditures, which account for two thirds of the economy, remain resilient. At the same time, inventories dropped at a record $103.7 billion annual rate last quarter, which had a major negative influence over the nominal GDP numbers.

“If we take into account that consumer spending rose in the first quarter despite the tight credit conditions, and that business’ shed almost all the available stocks, we may see some positive surprises in the second quarter” TheLFB-Forex.com Trade Team said.

However, despite all the recent positive news, the economy kept contracting at a very strong pace making the current recession the worst in the last half of century. The business side of the economy shows a rather weaker picture, the GDP report points out.

“Business fixed investments plunged 37.8% in the first quarter, the most on record, while nonresidential and residential construction saw a double-digit plunge. Moreover, companies cut expenses on equipment, software and construction projects at a 38% annualized rate,” TheLFB-Forex.com Trade Team said.

“These numbers show the weakness of the corporate environment, which is struggling to survive,” TheLFB-Forex.com Trade Team noted. “Most likely, corporate bankruptcies are heading toward a record this year,” they said.

The GDP numbers are still weak, and do not show a substantial improvement from the previous quarter. However, the financial markets focused mainly on the unexpected rise in consumer spending. It will be interesting to see how spending will evolve in the coming period, giving that unemployment is still rising at a very fast rate, credit markets are still tight and most importantly, the U.S. savings rate is at very low levels.

The Challenges Of The PPIP Program

2009-04-30T23:06:00.000-04:00

The Treasury might have scored a big victory recently, since the Public-Private Investment Program, or PPIP, drew bids from more than 100 fund managers. The PPIP program plans to attract private investors that are able to raise more than $500 million in capital to bid for the “illiquid” assets.

“Most likely, some of these potential buyers will be rejected by the Treasury’s term and conditions. However, the remainder would still be able to create a sizable market for the distressed assets,” TheLFB-Forex.com Trade Team said. “By having such a big number of possible bidders, the Treasury might come up with a more realistic price for the toxic assets, one that would also encourage the banks to sell them,” they added.

“The timing may be very good, if all the recent positive news continues in the coming period. If the fund managers perceive that the economy is recovering, they may place some very high bids for the banks’ assets, as theoretically their value will recover with the economy,” TheLFB-Forex.com Trade Team said. “The only problem would be, in this case, to convince banks to let their assets go, and write-down additional losses.”

On the other hand, the main condition for this to happen is that investors must think the economy is bottoming at the time the toxic-assets auction process starts. If not, bids may be lacking, especially at the first auctions, something that might have a negative impact over the entire program.

Additional problems could come from the fact that the recent changes in the market-to-market accounting rules turned many (if not all) of these toxic assets into winners, since now banks can value illiquid assets using their own models. The question that rises now is why would a bank actually want to write-down a loss (the difference between the book value of the asset and the auction’s price) and more specifically, sell it when the bank can be certain that at some point in time the asset will recover its original value?

Mr. Trichet’s Comments And The Euro

2009-04-29T13:27:00.000-04:00

The currency market continued to march inline with the S&P futures today, as has been the case lately. S&P futures, together with the overnight spot equity markets can be a very good gauge of the overall risk-aversion phase, which tends to have a strong influence in the currency market.

However, the euro had a slightly different pattern during the overnight session. The main reason seems to be recent comments made by Mr. Trichet, which declared that lowering interest rates is not always the best path to fight a global recession.

“In other words, Mr. Trichet re-affirms what the ECB members had been saying lately, that the key interest rate may not be going lower than 1%” TheLFB-Forex.com Trade Team said. “This, in turn, had a strong effect in the currency market, since the spread between the Fed and the ECB is likely to remain at the current level,” they added.

Moreover, Mr. Trichet showed his support for the ECB actions, saying again that different situations require different actions. In the past meetings, the Chairman of the ECB has stressed empathy for the inter-banking markets, which are lower in the U.S. on short-term maturities, but on the long term, yields are lower in the Euro-area.

“It appears as though it was Mr. Trichet’s comments, in part, that helped the euro be the best performing currency of the day, after on Monday the single currency was sold heavily,” TheLFB-Forex.com Trade Team said. “On positive equity markets, the euro might advance in the coming days, as the Fed appears ready to print additional dollars, while the ECB looks resilient,” they added.

The Link Between “Positive Economic News” And Consumers’ Wallets

2009-04-27T00:04:00.001-04:00

Some analysts are beginning to argue that the equity markets have bottomed, and are currently in a bull-run that will continue in the coming periods, while the economy has reached a vital turning point. The main arguments for these claims are recent reports, which, overall, have beaten analysts’ expectations. However, an overview of the vast majority of these reports will only suggest that the economy has merely bounced from its low, and the overall economic data is still not very encouraging.

Friday gave us another example, when the European equity markets and the euro rallied after the German Ifo Business Climate rose 1.5 points from a 26-year low.” It depends on what the market is focusing on, either, that the index is at a record low, or that the index rose 1.5 points,” TheLFB-Forex.com Trade Team said.

However, these so-called “positive reports” come at an expensive cost. In order to see the pace of economic contraction slow (as is being suggested in some circles), the government will run a huge deficit over the medium to long term. “This means that the government will cut costs as much as it can once the economy is in a recovery phase or in some cases even before, and will probably raise taxes to raise additional cash,” TheLFB-Forex.com said.

"According to government projections public deficits are likely to stay at very high levels for years to come from now, something that will be reflected in consumers’ wallets, and their lack of action in pulling out cash. The administration is looking at a 12% budget deficit, something that will require more promisory notes to be printed, bound, and issued, with the likely outcome being that they are then bought back at a huge forward cost by the Federal Reserve".

"The Debt/GDP ratio in the U.S. is also likely to weigh on market sentiment, but so long as equities are held in their current range the Usd will continue to get bought. A break higher in equities however will send the dollar lower, the positive side of economic stories will be all that are heard, and consumer wallet action will increase. A short equity market break will lead to a continuation of the last twelve months of scambling to find fair value, both on the dollar and on consumer wallet action" the Trade Team said.

Ahead Of The IMF Meeting

2009-04-25T04:01:00.001-04:00

The IMF meeting is fast approaching and it will be very interesting to see if the 185 member countries will actually expand the IMF’s resources to provide credit, as it has been promised in the past G7 and G20 meetings.

The issue is very important, since the latest reports of the institute compares today’s emerging economies with the ones seen during the 80’s and the late 90’s when Latin America defaulted, and Eastern Asia saw its own currency crisis (which by the way was doubled as the “IMF crisis”).

“Most likely, the report is referring mainly to Eastern Europe, to which most European countries have a sizable exposure. Countries like Austria, Italy, Belgium, Sweden, and to some extent France and Germany will experience the full consequences of a crisis in Eastern Europe,” TheLFB-Forex.com Trade Team notes.

“Add to that Latvia and Lithuania just saw their debt rating downgraded by Moody’s, and both countries have a negative outlook. If Latvian debt gets downgraded again, it will reach speculative or junk grade, meaning that the country has a limited chance of issuing bonds to fund its deficit,” TheLFB-Forex.com Trade Team added.

The IMF should intervene in such cases, and has done up to now for Latvia and the rest of the Eastern European countries. However, the IMF is running out of funds, something that may compromise the institute’s future plans.

U.K. Deficit Continues To Expand

2009-04-22T14:24:00.000-04:00

The Chancellor of the Exchequer, Alistair Darling, forecast a 3.5% contraction in 2009, making it the biggest deficit since World War II. The current projection, of 3.5% is twice as big as the November estimates when the global economy entered into a strong contraction phase.

Currently, the Treasury projects that the country will run a 146 billion pound deficit this year, the biggest on record. This will put upside pressure on the gilt’s yields, meaning that investors will demand more money to fund the U.K. deficit. However, the Bank of England has already acted to counter this, by having direct (and public) interventions in the gilt markets, the U.K’s government instrument to borrow from the financial markets.

For now, the U.K. economy outlook is lying to the downside. Earlier in the day, a report showed that the labor market hit the lowest level in a decade, as the unemployment rate hit a 12-year high. Currently, the OECD estimates that the U.K. economy will contract 4% in 2009, slightly less than the U.S. and the Euro-area

During the Chancellor’s press conference, the pound plunged against the other major currencies. The pound lost 180 pips in less than 30 mins against the dollar, and 100 pips against the euro in a similar period.

The IMF And The Financial Sector

2009-04-22T14:21:00.000-04:00

The International Monetary Fund (IMF) recently released a report saying that losses from the credit crisis might reach $4.1 trillion by the end of 2010. Losses stemming from U.S. real estate will reach $2.7 trillion, up from the previously forecast $2.2 trillion in January.

“From these huge sums, the IMF estimates that banks will support much of the losses, around $2.5 trillion,” TheLFB-Forex.com Trade Team notes. “Pension and hedge funds will probably be forced to write-down the rest of the sum”.

“Since the beginning of the credit crisis, the IMF has constantly increased the estimated losses from the financial sector. If the situation in the financial markets continues to deteriorate, mostly due to the situation in the credit markets, the estimated losses will again revised higher in the next Global Financial Stability Report,” TheLFB-Forex.com Trade Team said. “It’s also worth nothing that the IMF said the crisis had reached both households and corporations, something new from the previous report”

In the mean time, markets are starting to wonder how much of the recently reported bank earnings have been influenced by the new accounting rules, which allowed banks to value illiquid assets at their own valuation. For example, Goldman Sachs managed to shed December from the earnings report, avoiding a $1.3 pre-tax loss, while Bank of America’s earnings report was lifted by $2.2 billion by Merrill Lynch. Some estimate that almost half of the reported earnings were influenced by one-time events, such as new accounting rules. No wonder the bank’s default swaps had a small rally over the last few days, taking into account the real situation of the sector.

The Slow Recovery Of The U.K. Economy

2009-04-20T22:37:00.000-04:00

Even though it seems that the pace of the global recession is starting to slow down, the U.K. economy might continue to struggle during the upcoming periods.

The main reason of worry is that the U.K. economy cannot afford to spend anymore, as the outlook on public finance is getting incredibly grim. During the last weekend, the Treasury said that the government is building provisions to cover the losses stemmed by the financials’ rescue package. Up to now, Britain is the first to admit that the taxpayers will support to banking system losses, even though more countries decided to invest funds in the banking system.

Treasury officials avoided providing an exact value for the government’s provisions, but it is speculated that it will be as big 60 billion pounds, or $87 billion. By these numbers, the U.K. deficit is being forecast to reach 11%, the biggest deficit on record.

“Such a big deficit puts immense pressure on public finance,” TheLFB-Forex.com Trade Team notes. “Most likely, the central bank will have to intervene somewhere in the future and buy gilts, something that will probably make inflation run out of control in the medium to long term.” they added.

“Additional pressure will come from the fact that the government now has its hands tied, since it cannot spend its way out of the recession as has been tried already. If things get worse in the real economy, the U.K. economy is likely to sink to very deep levels.” TheLFB-Forex.com Trade Team said. “We have to note that almost every major recession has had a period when things appeared to improve, but then suddenly the downturn intensified.”

Returning to the currency market, the pound plunged 250 pips today, being one of the worst performers of the day together with the aussie. Moreover, the pound broke below the trend-line that held, until now, the upside trend. If institutional traders shift their focus to the poor state of the U.K.’s public finance, the pound might lose ground rapidly compared with the other major currencies.

The Chinese GDP And The Aussie

2009-04-16T22:31:00.001-04:00

During Thursday’s trading session, the aussie was outperformed by every other major currency. So far, the main reason seems to be that demand for raw materials is likely to fall as the Chinese economy grew at a slower speed than expected.

“Commodities make up the biggest percentage of the Australian export market. As such, the aussie is very vulnerable to any change in the raw materials demand outlook.” TheLFB-Forex.com Trade Team members said. “Raw materials exports make up 35% of the balance of payments. Additionally, out of the top 10 merchandises exported by Australia, seven are raw commodities.” TheLFB-Forex.com Trade Team added

To further strengthen the case, China is the largest export market for Australian exports, so it is easy to understand why the weaker than expected Chinese Q1 GDP had the strongest effect over the Australian currency.

The Australian dollar lost 80 pips against the greenback, after managing to break above the Wednesday’s high during Thursday’s Asian session, while it lost 85 pips against the yen. However, the aussie’s positive days are far from over. The currency will rally when the commodity market actually starts moving higher.

ECB Starts Expectations Anchoring Campaign

2009-04-16T02:55:00.001-04:00

It looks like the Euro-area is in an “expectations anchoring” campaign about their future monetary policy. Today, council member Axel Weber said that the he does not see the key interest rate below the 1% benchmark.

“Being the Chairman of the biggest European central bank, Axel Weber certainly has a lot of influence in the voting council,” TheLFB-Forex.com Trade Team had said. “Additionally, the ECB was built on the Bundesbank legacy, something that gives even greater influence to Weber,” they added.

Anchoring expectations was a technique used very often by the Bundesbank, and now the ECB is relaying on the same instruments. As such, Weber’s comments can be relied upon, especially when other voting members have said in the last few weeks that the ECB is not likely to go below 1%.

The problem the ECB is facing right now is that the bank’s deposit rate is at too low a level, something that may hurt the inter-banking market. Banks that have excessive overnight cash have two primary options either lend it to another bank or deposit it at the ECB’s facilities. Weber sees that if the key interest rate falls below the 1% benchmark, banks will refuse to lend the excessive reserves simply because the transaction costs will be too high.

TheLFB-Forex.com Trade Team notes that if Mr. Trichet announces that the central bank will not cut interest rates to less than 1%, the single-currency might receive a boost. Currently, the ECB is the only major bank that appears reluctant to reduce the interest rate below the 1% threshold.

European Leveraged Buyout Defaults May hit 15% In 2009

2009-04-14T22:16:00.000-04:00

The financial markets were forced to absorb news that came from the rating agencies today. Even though the stock markets look as though they may have found a bottom, temporary or not, the credit market still has some downside risks.

Standard & Poor’s (S&P) announced that leveraged buyout defaults might reach 15% in Europe this year. Leveraged buyouts, or LBO’s, are complex financial instruments where a company borrows money (the lever) to acquire a rival company. The assets of the acquired company are used as collateral for the loan. According to S&P’s projections, approximately 100 companies might default this year, from which most are companies that issued LBOs.

TheLFB-Forex.com Trade Team notes that the forecasted 15% default rate is a record high, beating the 2001 downturn. “Credit markets are still suffering from the current crisis, and this is reflected in the number of companies expected to default later this year.” TheLFB-Forex.com Trade Team said. “To make matters worse, governments are issuing huge amounts of debt to fund their stimulus packages, something that increases the spread between the corporate and government credit costs”

“According to the latest data coming from the corporate debt market, the overall quality dropped to the lowest level seen over the last few decades,” TheLFB-Forex.com Trade Team added. “The number of companies that saw their rating downgraded reached 13.8% in 2009, while only 0.5% companies saw their debt upgraded. Taking into account the rising wave of unemployment, and the declines experienced in consumer spending, it’s not hard to see this trend continuing over the next quarter.

Oil Prices Drop After Forecast Revision

2009-04-14T06:28:00.000-04:00

Crude oil declined $1.50 today, or 2.90% as the International Energy Agency reduced its demand forecasts for the current year, once again.

The agency reports that global demand is likely to fall this year by 2.4 million barrels to 84 million barrels per day, citing the highest inventories over the last 16-years. Much of the downward projections came after first quarter GDP data was worse than initially forecasted. TheLFB-Forex.com Trade Team notes that the pace of oil output reduction is close to the pace seen in the 1980’s.

“The high level of inventories reflects the poor state of the global economy. Currently, crude oil is one of the main sources for energy. A low level of consumption shows that businesses are reducing production, thus add no new value to the economy,” TheLFB-Forex.com Trade Team said. “The forecast downgrade had a direct effect on the currency market, halting the Canadian dollar’s strength to some extent,” they added.

“In a day when the dollar was sold across the board, the Canadian dollar posted just some modest gains. The cad declined 40 pips today but was outperformed by every other major pair. However, oil’s decline did not provide a base for the dollar. Currently, the fundamentals of the Treasury market are supporting the dollar’s decline” TheLFB-Forex.com Trade Team commented.

It looks like the Canadian dollar will have to choose a direction to trade without a strong commodity backing it. For now, the cad is trading barely above the 1.22 support level.

How Low Will The ECB Go?

2009-04-12T21:03:00.001-04:00

After cutting interest rates less than expected at the last meeting, the European Central Bank’s leading members appear to be giving a clear signal over what the bank should do next.

In the latest interview, the governor of the Austrian central bank Ewald Nowotny said that the key interest rate should not go below the 1% level. This statement backs what other key ECB members have said over the past few weeks. Among them, the Vice-President of the European Central Bank said that the key interest rate could move somewhat lower, but in a “measured way”. Additionally, Axel Weber, which leads the Bundesbank, said that 1% is his personal bottom line.

Putting the pieces together, it appears that the ECB does not want to cut below 1%, even though the bank adopted a number of quantitative policy measures. “Despite having a much higher interest rate than the Fed, the money market rates in Europe are lower then in the U.S., and this gives the ECB more space to maneuver.” TheLFB-Forex.com Trade Team added.

“If the ECB decides not go any lower than 1% and MR. Trichet or any other of the voting members makes this official, the euro may find very strong support.” TheLFB-Forex.com Trade Team added. “The single currency might strengthen not only against the dollar, but against a whole range of currencies, especially against the pound” they said. “However, this would also have a side-effect, since the euro will gain ground against the Eastern European currencies, which are ready to sink in a pool of foreign denominated debt.”

TheLFB-Forex.com Trade Team notes “Since every other major central bank reached the lower limit of the monetary policy, the ECB policy measures are more important than ever for the euro’s valuation.” Keep an eye on what the ECB members are saying, you never know when the euro might take off”.

BOJ Monetary Policy Meeting Produces Nothing New

2009-04-07T22:13:00.000-04:00

The Bank of Japan policy meeting came and went, but nothing substantial really happened. The bank decided to maintain the overnight call rate at 0.10% - the lowest among the industrialized world – while it expanded, once again, its accepted collateral.

“The yen plunged 80 pips ahead of the interest rate decision, but this was most likely a serial correlation move, since it was seen in the other major pairs too”, TheLFB-Forex.com Trade Team said. “The BoJ’s interest rate meetings are really non-events that fail to move to market” they added.

The decision to accept, as eligible collateral, municipal and government bonds will help small and medium banks by increasing their liquidity. This comes after the BoJ began widening its collateral base recently, to facilitate Japanese banks in order to provide credit lines for the business holders and consumers.

TheLFB-Forex.com Trade Team notes, “The Japanese economy is in a bad shape. Some private forecasts point to the economy contracting up to 5% this year, as exports continue to plunge and internal demand slows. Furthermore, the economy is susceptible to external pressure, since exports make up a big percentage of the economy. The correlation between the Japanese GDP and its export market one quarter earlier approached 70% over the last decade.”

Today, TheLFB-Forex.com Trade Plan paid 80 pips on the yen, in a trade that started during the early Asian session and ended during the mid-European session.

U.K. Economy Under More Pressure

2009-04-06T22:44:00.000-04:00

The pound starts the week underperforming the major currencies, after failing to break above the 1.4950 resistance level. The pair failed two other tests in January and February, the present one being the third in-line. In the mean time, the pound’s decline triggered the TheLFB-Forex.com Trade Plan short numbers, gaining traders 100 pips with practically no draw-down.

During Monday’s session, the pound plunged 0.96%, considerably more than the other major pairs. The pound rose 0.8% during the Asian session, but these gains were easily reversed during the U.S. session, as the market re-entered in a risk-aversion mode. Currently, the pound has formed a bearish engulfing pattern on the daily chart, as it bounced off the 1.4950 swing area.

The pound’s decline comes as a number of voices were raised about the U.K.’s ability to fund its budget deficit. According to the latest forecasts, the U.K. government might be facing a 10% deficit this year, the biggest among the developed countries. To make things worse, the Institute for Fiscal Studies said that the government will have to raise the income tax by 8 percent, to bring the government budget to a more normal stance by 2015-2016, something that is very unlikely to happen. Previously, the BoE governor, Mervyn King, also complained about the poor state of the U.K.’s borrowing market.

TheLFB-Forex.com Trade Team notes that the BoE will be forced to intervene in the primary bond market, by buying gilts unsold to private investors. This will embark the BoE on a true quantitative easing policy, unlike the current policy that now involves only buying corporate bonds. “On the medium to long term, most likely, the pound will be a certain victim of the huge U.K. deficit, since the central bank will have to print money to bring the yields down” TheLFB-Forex.com Trade Team said. “The U.K. economy and pound will suffer even more if the global downturn intensifies, since it will force the government to borrow more”

The Press Conference Bullet Points And Analysis

2009-04-02T22:21:00.001-04:00

• The Governing Council decided to reduce the key ECB interest rates by a further 25 basis points
• Today’s decision takes into account the expectation that price pressures will remain subdued
• The latest economic data and survey information confirm that the world economy, including the euro area, is undergoing a severe downturn
• Economic activity has weakened markedly in the euro area, as domestic demand has contracted in parallel with the downturn in the world economy
• Available data and survey indicators suggest that economic activity in the euro area has remained very weak in early 2009. It is likely to remain very subdued for the remainder of the year
• There may be stronger than anticipated positive effects due to the decrease in commodity prices and to policy measures taken
• On the other hand, there are concerns that the turmoil in financial markets could have a stronger impact on the real economy
• Annual HICP inflation has fallen further, from 1.2% in February to 0.6% in March
• The decline in inflation since last summer primarily reflects the sharp fall in global commodity prices over this period
• We expect to see headline annual inflation rates declining further in the coming months and temporarily reaching negative levels around mid-year. Such short-term movements are, however, not relevant from a monetary policy perspective.
• Annual HICP inflation is expected to remain below 2% in 2010
• Available indicators of inflation expectations over the medium to longer term remain firmly anchored
• The latest data confirm the high month-to-month volatility of developments in M3 and its components observed since the intensification of the financial turmoil
• The pace of monetary expansion in the euro area has continued to decelerate markedly
• Developments within M3 clearly reflect market participants’ specific investment responses to the intensification of the financial turmoil
• The flow of MFI loans to non-financial corporations and households has remained very subdued
• The decline in short-term lending may be indicative of a reduction in loan demand related to the weakening of economic activity.
• Regarding fiscal policies, it is necessary that countries’ commitments to a path of consolidation in order to return to sound fiscal positions are credible, respecting fully the provisions of the Stability and Growth Pact
• This is essential to maintain the public’s trust in the sustainability of public finances, which is important both for the economy to recover and for supporting long-term growth
• Many countries will need to specify further credible consolidation measures for 2010 and beyond

The questions and answers section took off with Mr. Trichet appearing very casual and relax, speaking about the future monetary policies. The Chairman of the ECB said that the present 1.25% is not the floor and does not exclude sending the key interest rate any lower.

At the same time, Mr. Trichet outlined that the deposit rate, which is currently sitting at the 0.25% will not be reduced any more. This implies that the monetary channel between the three main interest rates (deposit, key and lending) will shrink at the following meetings. Even though it did not explicit specify the decision that backed the 0.25% interest rate, Mr. Trichet said that the decision was taken unanimously.

Unlike at the other press conference, Mr. Trichet referred to the Fed, by saying that the money rates in the Euro-area are lower than in the U.S., despite the interest rate spread. Mr. Trichet also said that currently, the ECB’s balance sheet is larger than the Fed’s when compared with the GDP size. Most likely, these comments came as the ECB received strong criticism for not doing more to fight the credit crisis.

Most market participants expected the ECB to announce a new quantitative easing policy today, probably a possible intervention in the corporate debt market. However, Mr. Trichet said that full details would be disclosed at the next meeting, which will be held in 7 May. Additionally, Mr. Trichet put a lot of empathy on the fact that the bank is already in a non-standard method, being the first central bank that adopted quantitative easing methods by providing unlimited funds to banks.

What To Expect Tomorrow From The ECB

2009-04-01T22:05:00.001-04:00

Tomorrow, the market expects the ECB to reduce the Minimum Bid Rate by 50 basis points, down to 1%. Since the current rate cut cycle has begun, the ECB reduced the key interest rate by 275 points or 325 basis points if tomorrow’s projections come true.

Additionally, most market commentators have said that tomorrow the ECB will announce a new quantitative easing plan, to buy corporate debt. This assumption came after Mr. Lucas Papademos suggested such a move may come from the European Central Bank, echoing Mr. Trichet, which said at the last press conference that the bank is judging to implement new “unconventional measures”.

If the ECB will adopt this measure, to intervene in the corporate debt market, the euro might get some strong support. Until now, the ECB is the only major central bank that did not directly adopt a quantitative easing method, even though Mr. Trichet said that the bank actually may in the future.

The Chairman of the ECB referred to the measures to provide unlimited liquidity to the banking system from the Euro-area, instead of doing auctions, and in the same time increase the assets that it receives as collateral.

On a slightly different note, a Bloomberg report shows that the ECB might start buying Eastern European currencies, like the Polish zloty and the Romanian Leu, to help the regional economies recover faster. Over the last two quarters, or so, the local currencies’ plunge had been a real threat for the region’s economy. In case of a possible intervention, the ECB might avert a possible crisis in the region, something similar to what happened in 1998 in Asia.

Ukraine and the Impossible Trinity

2009-04-01T13:18:00.001-04:00

Ukraine announced it will impose strict rules on the capital movement, while also forcing banks to quote the national currency, the hryvnia no lower than a limit set by policy makers.

These moves are meant to stop or at least to reduce the strong capital outflow that threatens the Ukrainian economy, as is the case with most other emerging economies. However, this also drives the country near to a default scenario.

Over the last few months, the hryvnia has lost almost 40% of its value against the dollar, as investors turned the inflows looking for a higher yield, into outflows looking for nothing more than safety. The National Bank of Ukraine lost one third of its reserves during this period, as it tried to curb the currency’s decline.

What the Ukraine is currently trying to impose, strict capital flows, is certainly not what investor’s want to see or hear. Additionally, the country is running through a “small” political crisis, being lead by a President that is pro-Europe, while the government is pro-Russia, something that has the potential to disrupt the country’s fragile stability (if it has not done so already). Along with the current political struggle, the Ukraine now faces another problem, called the impossible trinity.

During the early 1980s, when the foundation of an open economy was being laid, economists developed the so-called impossible trinity model, which states that a country cannot control its monetary policy, its currency and its capital movements simultaneously. In order to function properly, a country has to give up to one of the three.

However, this is exactly what the Ukraine is trying to achieve these days. Until now, the Ukraine controlled its monetary policy and had a free, tradable, currency, as most open economies do. However, now it will also control its currency and its capital flows, trying to achieve something that no other country has achieved for the long term.

In a normal open economy, as investors pull money out of the country, the local currency depreciates, until a certain point when it is not profitable (or justifiable) to depreciate the local currency. Because the Ukraine will keep the hryvnia at artificial high rates, it will create an incentive to draw more money from the country, until the point when the government runs out of funds. Secondly, by keeping the currency rate at an artificial level, it makes the exporter’s life harder, while encouraging imports, expanding the trade deficit.

In this case, I have the impression that the Ukraine is heading towards a very hard social and economic crisis, which will ultimately end up as a political crisis. This comes, after the rather fragile economy passed through a similar situation in 2004. The impossible trinity is among the few economic concepts that have never failed, until now, and the history of economic crises reminds us of that.

A Possible ECB Intervention In The Corporate Debt Market

2009-03-30T22:36:00.001-04:00

Following the European Central Bank’s tradition to pre-announce its important decisions, the Vice President, Lucas Papademos, said last week that the central bank could start buying corporate bonds. This comes after Mr. Trichet announced, at the last interest rate meeting, that the bank is preparing to adopt a new set of “unconventional” policies.

According to Mr. Papademos, the ECB could intervene in the secondary corporate debt market to bring yields down. A similar decision was taken by the Bank of England, which decided to use up to 75 billion pounds to buy corporate debt, and more recently, by the Bank of Japan. At the same time, the Fed decided a slightly different approach, to buy government debt and mortgages.

Most likely, the ECB are preparing to take this stance because they cannot intervene in the government debt market, unlike the other central banks. This happens because the ECB is formed by 16 countries, and such a move would raise many technical and fundamental problems regarding what country’s debt to buy, and in what quantity.

In Europe, a staggering majority of private loans are issued by commercial banks. As the credit crisis struck the financial world, banks began de-leveraging their balance sheets and cutting back on new lending programs. A possible ECB intervention would loosen the tight credit conditions, to some extent.

Market participants expect this measure to be announced this week, at the ECB press conference. However, its effect in the currency market is still unknown because of the lack of any further details about the plan itself. However, if the ECB disappoints, the euro will probably see strong selling pressure.

The U.K. Dilemma

2009-03-26T22:06:00.001-04:00

Even though the U.K. economy is shrinking at a very fast pace, around 1.5% in Q4, the U.K. Prime Minister gave in to the idea of a new stimulus package.

Currently, the country’s outlook is rather gloomy, having the most important economic indicators near record lows. Retails sales continued to decline in February, while sales of small stores dropped the most since 1986, when records first began. Mortgage approvals are holding barely above record low levels, while unemployment claims jumped in February the most on record sending the jobless rate to a decade high. Private forecasters have said that the U.K. economy will shrink between -3% and -4% this year.

Despite the very poor outlook surrounding the economy, the governments’ hands appear to be tied. Both the Chairman of the Bank of England (BoE), Mervyn King, and the Chancellor of the Exchequer, Alistair Darling, have expressed their concerns about the deterioration of the public finances.

On top of this, yesterday, the U.K. Treasury failed to sell all the intended gilts at auction for the first time in seven years. This shows that investors are finding the debt issued by the U.K. government overvalued.

Every time the Treasury fails so sell its debt, it adds an additional burden on the taxpayers’ shoulders as investors request higher yields to be paid. A new stimulus package would imply that the Treasury has to sell even more debt, something that would have a substantial effect on the gilt’s value.

German Economy Set To Contract?

2009-03-24T22:04:00.000-04:00

The latest forecast for Germany points out that the economy might contract a whopping 6% this year, as the credit crisis reduces foreign demand for German made goods.

Commerzbank, one of the leading German banks, said that the German economy might contract 6% to 7% in 2009. At the same time, Deutsche Bank and BNP Paribas project a 5% contraction in 2009 for the German economy. The German Institute for Economic Research estimates that the economy will contract between 4% and 5% this year.

By far, these estimates are the worst for any European economy, including the much-spoken-about Eastern Europe. Among the developed countries, only Germany and Japan share such an downbeat forecast.

As was said before, the export component is the biggest drag on the German GDP. Until now, exports have dropped by 20%, while the outlook clearly lies to the downside. Even if the global economy would miraculously bottom, demand and thus exports would still need some time before picking up again. Exports account for almost 40% of the German GDP.

Obviously, Germany is not the only victim of the credit crisis in Europe. Today, the Czech government collapsed, by gaining a no-confidence vote from the parliament, while just yesterday, the Hungarian government resigned. Wonder who will follow next?

The Toxic Asset Plan

2009-03-24T07:12:00.001-04:00

Today, the equity markets around the globe rallied as the Treasury was unveiling its plan, meant to save the financial system.

Overall, the plan looks simple, since its only scope is to provide liquidity in the secondary market. This is because the Treasury treats the current credit crunch as a liquidity problem, and (still) considers the banks’ assets fundamentally sound.

The newly announced plan proposes to use the taxpayer’s money to leverage the investors’ funds, up to 6:1 for a loan, and 1:2 in order to buy the assets. In addition, these loans will be insured by the FDIC, so in essence, investors would support only a very small fraction of the actual cost of the distressed asset.

However, this still does not guarantee that investors will overpay for these assets, because the private investors will be the ones to suffer the first losses. Therefore, it will be in the investors’ best interest to come up with a low bid for the toxic assets, reducing their risk exposure.

In this case, banks will not be tempted to sell their assets. It would seem that, if these assets are really worth something (the Treasury treats them as fundamentally undervalued), why would banks want sell them at huge discounts. Secondly, many of these assets are still overvalued on the bank’s balance sheets. Even if the bank would want to sell them, they would have to write-down their value first, something that might not be too good either for the bank or for the overall system because it will trigger systematic write-downs.

With a bit of luck, maybe the new asset plan will get some traction in the financial markets otherwise today’s rally might turn around very quick. Additionally, as some market commentators have pointed out, it might be among the administration’s last shots at saving the financial markets.

One-step forward or one-step back?

2009-03-20T04:01:00.001-04:00

The Fed’s decision to buy up to $300 billion of long-term Treasuries and double the purchases of mortgages to $1.45 billion was a surprise to most market participants.

The surprise is even bigger, if we add that just two weeks ago the Chairman of the New York Fed, seen as the second man in Federal Reserve, said “at this point in time the Fed has judged buying long-term Treasuries is not the most efficient means of easing financial market conditions”. This is a huge change in just two weeks, and it certainly raises some questions as to why the Fed made this decision, if it is not efficient.

Moreover, Mr. Bernanke has build an academic reputation as a supporter of the inflation targeting regime, which implies that the central bank must be as clear as possible in its actions. The Fed’s past actions have proven that the central bank follows these general guidelines, since the central bank has anchored expectations pretty well (until now).

In the last few years, the Fed has gone through some major changes with Mr. Bernanke at the rudder, and has mostly, managed to break free from the Greenspan era, when market participants focused on how many times the Chairman blinked, or where he looked when he spoke, rather than what he actually said. Mr. Greenspan spoke most of the time in “riddles” that gave some major headaches because the message was never fully understood.

The decisions taken yesterday (to intervene in the debt market without anchoring the market’s expectations first) remind us of the Greenspan era, something that is not very positive from my point of view. Yes, it was a true shock and it had clear effects in the financial markets, but it is still a question of how positive these effects will be in the long-term. If, supposedly, the market/economic conditions continue to deteriorate, the market will expect the Fed to provide another shock. If the FOMC fails to provide it, the financial markets will be very disappointed.

Another problem with the Fed’s statement issued yesterday is that it does not clarify how they have chosen the sums. Why they chose $300 billion for Treasuries, and $750 for mortgages is still unknown, but my guess if that the officials will clarify this at some point in the future, since this is not such a major issue.

The overall conclusion would be that the Fed had communication issues yesterday, and from my point of view took a step backward instead of the forward. Referring to the actual decisions taken yesterday, the markets still need time to clarify how effective they really are.

U.K. Financial Regulations

2009-03-18T21:54:00.001-04:00

The era of “free and unregulated” markets and financial institutions may be over, or at the least, its sunset is quickly approaching as regulators try to avoid further crises in the financial system. The U.K.’s Financial Services Authority released a 122-page report today, which included some of the new rules that will shape the U.K. financial system in the coming years.

The two most important conclusions of the report were that the European Union should form a new regulatory authority, which would supervise the European banking system for systematic risks and exposures. The second important change highlighted in the report is that a clearinghouse should be formed for the mortgage market.

The new regulations package comes as an increasing number of U.K. banks have failed and required to be nationalized by the government, including the biggest national banks. Before the credit crunch, London was seen as the second biggest financial center in the world, closely following New York.

One idea that might prove to be very beneficial for the financial system is that the regulator arm of the law, the FSA, should also regulate financial products and not just financial institutions. This would imply that regulators would have direct access to the investment vehicles that first drove us into the credit crisis, something that might prove to be beneficial over the long term.

Other proposals included in the FSA report suggest that banks should limit their borrowing cap, in an attempt to reduce the likelihood of overleveraging loans, while at the same time, banks should increase the percentage of high-quality assets (theoretically, government issued debts). Among other things, these two decisions would reduce substantially the bank’s profit margin, but it would also increase the overall safety.

However, rules are meant to be broken or at least to search for a way around them. I entirely support stricter rules over the financial markets, but regulators should act preemptively, something that hardly ever happened until now.

Preparing for the BoJ

2009-03-18T21:53:00.000-04:00

Financial markets will be waiting for the Bank of Japan’s (BOJ) press conference during the upcoming Asian session. The press conference follows closely behind the bank’s two day meeting.

The bank’s task will now be to stimulate a falling economy, but without the help of monetary policy. The ultra-low rate of 0.10% stops the BoJ from lowering the interest rate any further, practically putting conventional monetary policy on the sideline. As such, the bank must conceive new ways to stimulate the economy, and help the Japanese financial system. In past meetings, the bank referred to the measures taken as “exceptional for a central bank”

Some of these measures include providing dollar liquidity, intervening in the corporate market, and extending the range of assets accepted as collateral. Additionally, the central bank pledges to buy preferred shares issued by banks, and buying publicly listed shares held on the bank’s balance sheets. However, the last two actions failed because of the Japanese corporate business environment which led to the appearance of zombie banks during Japan’s “lost decade”.

In a new attempt to help the financial system, the BoJ announced that it would provide as much as $10 billion in subordinated debt. Subordinated debt, or junior debt, is among the riskiest forms of lending. In case of a bankruptcy, subordinated debt is the last that gets paid (if funds are still available); on the other hand, senior debt is the first to be paid in case of a bankruptcy.

There have been no further details about the new BoJ plan, but it will most likely be included in the upcoming statement. Chances are that the bank will ask the BoJ staff to analyze the implementation, as has been the case in the past.

The success of the new subordinated lending program is not assured. One reason is that it will hit the same Japanese corporate environment, in which banks refuse any help from the government so as not to affect their reputation. In a time when most of the U.S./European financial systems have survived only by being helped by the government, it is hard to envision any investors actually considering their reputation.
However, past experiences have proved the inflexibility of the Japanese corporate environment, so another failure would not come as a surprise.

The Chinese Conundrum

2009-03-15T20:14:00.000-04:00

Before the G20 conference this past weekend, top Chinese officials had complained about the safety of the U.S. Treasuries.

Being by far the largest U.S. bondholder, China has a lot of influence over the debt market. It is said that, the People’s Bank of China holds up to $1 trillion in Treasury notes and government-backed debt, issued by public/private entities like Freddie and Fannie.

It is easy to see why the Chinese government is concerned about the fate of U.S. debt, since such a huge amount of debt holds two major risks: interest rate risk and currency risk. Bonds have a unique relationship between its price and yield, as one rises the other drops. As such, if the yield rises on a bond, its price would fall. Here is where the Fed comes in play.

Eventually, the Fed would have to raise the interest rate, even though this might not happen in the near (or medium) future. A higher interest rate would drag the price of U.S. Treasuries lower, while increasing its yield. From such a move, the Chinese foreign reserves would take a hard hit, because U.S. bonds will lose their value.

Another hit that China might take comes from currency risk. U.S. Treasuries are denominated in dollars, and a steep depreciation of the greenback would pose a huge risk, even though many say the Usd/Cny rate is manipulated.

Neither of these two outcomes are likely to happen in the short term, but as the credit crisis comes to an end and things start to return to normal, money will start pouring out of the U.S. economy in search of higher yields. As such, the dollar and Treasuries will be certain victims, something that should worry the Chinese officials.

Currently, Chinese officials cannot do too much about it, but in time, they will have to begin to diversify from U.S. debt. One of the golden rules of building a successful portfolio is to diversify, something that they have not done, and now the State Administration is paying the price for this. Most analysts say that, President Obama will have a huge problem funding the federal deficit if China was not buying Treasuries.

Euro-zone rate cuts may be nearing an end

2009-03-10T21:52:00.001-04:00

A rather surprising announcement was made today by Mr. Axel Weber, the head of the Bundesbank. The Chairman said at a press conference held in Frankfurt that he sees no need for interest rates to fall below 1%.

Being the largest central bank from the Euro-area and one of the initial founders of the European Central Bank, the Bundesbank certainly has a huge influence over the monetary policy of the ECB. As such, Mr. Weber’s comments can easily be taken as the position of the ECB.

Additionally, the Bundesbank has changed the face of monetary policy by managing to keep inflation down at a time when every major economy in the world had double digit Consumer Price Inflation (CPI). The Bundesbank’s strategy was to anchor expectations by using public speeches and appearances, a strategy that was later used by most central banks to guide expectations (and is still being used).

Over the past few months, ECB officials have repeated that they do not see the need to send the interest rates too low, because it would risk drying up the inter-banking funds. However, this view is not shared by most market participants, who strongly believe that the ECB is way behind the curve on lowering rates.

The main “counterexample” for the ECB’s actions is the Fed, which cut rates as much as it could at a breath-taking pace. The Fed’s view is influenced by a number of academic papers, which say that if the Fed would have cut more in the 1930’s, the U.S. economy may have avoided the Great Depression. This view is strongly supported by Mr. Bernanke, but Nobel winner Paul Krugman has stated lately that this strategy has failed to do anything new. Additionally, the U.S. economy is starting more and more the look like Japan of the 1990’s.

Can The ECB Cut More Than Expected

2009-03-05T10:21:00.000-05:00

Tomorrow morning every market participant expects the ECB to reduce the overnight lending rate by 50 basis points, down to 1.50%.

The road to such a low rate was somewhat lengthy for the European Central Bank, compared with the other major central banks, of which almost all are preparing to adopt a quantitative easing strategy.

Until now, the foremost members of the ECB’s voting council have excluded the possibility for very low interest rates. In their opinion, low, real, inter-banking rates would create a liquidity trap, which means that the central bank would reach the limits of monetary policy. At the same time, a liquidity trap would drain any lending in the inter-banking system because of the losses banks would have to take when they borrow or even when they lend. In other words, it would be cheaper for the bank to keep the money for itself than to lend it to another bank, something that has widespread negative effects in the real economy.

For this reason, the Eonia Swap market is pricing in a 0.75% interest rate in the following 3 to 12 months, after which traders expect the bank to begin to slowly raise the key interest rate. Interesting enough, the same Eonia Swap rate, which to some extent is the future market for the ECB rate, began to price in a 1.25% interest rate for tomorrow’s meeting, since the last part of January.

This means that the spread between the forecasted interest rate and the 1-week Eonia Swap rate is -25 basis points, the largest in the current rate cut cycle. This is a sign that prime banks, the ones that trade in the Euro-area inter-banking system, expect the ECB to cut 75 basis points tomorrow. At past meetings, the spread between the two rates was positive.

Also tomorrow, the ECB is expected to update its growth and inflation projections for 2009, also known as the “staff projections”. As has been announced by Mr. Trichet in his speeches, the forecasts will be downgraded considerably from the previous numbers, something that might have a negative effect on the euro’s valuation

ECB And BOE Face Tough Decisions

2009-03-03T22:10:00.001-05:00

Ahead of the interest rate decisions on Thursday from the two major central banks in Europe, the ECB and BoE, the market is looking for a direction where the two might be heading.

In mainland Europe, the ECB’s task is becoming tougher as the credit crunch intensifies, on top of the strong criticism it receives from almost every economist because it reduced the interest rates at too slow a pace.

One of the main concerns of the ECB is to reduce the spread between the German Bunds, which are seen as the safest from the region, and the rest of the member countries, especially Greece, Ireland, Spain and Italy. The ECB cannot intervene directly in the Euro-area debt market, but it can influence the demand and the supply side in the secondary market.

Even though the EU regulations are out of the ECB’s reach, the central bank might get help from them. The European Union treaty forbids any member country to have a budget deficit equal or larger than 3% on the long term. To some extent, this means that the government should follow strict fiscal policies, something that would help bring the yields on the government debt somewhat lower.

Additional help might also come from the European Union to reduce the government yields in Europe. Following a call from Germany last week, today, commissioner Almunia said that the EU would not let down any Eastern European state in case its situation worsens and it will bail it out the country before any international institution will, like the IMF. In the last few weeks, investors grew more nervous about the fate of Eastern Europe.

In the U.K., things are starting to point to the BoE will join the Fed and the BoJ into quantitative easing. Today, the Chancellor of the Exchequer, Alistair Darling, said that the central bank has a green light from the government in expanding its balance sheets. The BoE has the approval to print up to $283 billion that would be used to buy government debt and presumably, some high graded corporate debt. In the two day meeting, the Monetary Policy Committee is expected to announce if this measure was approved, with most market participants saying that this decision would be approved very easily.

Financials continue to struggle

2009-03-02T22:53:00.001-05:00

The financial stocks continue to drag the major market indexes lower, as their fate becomes more uncertain with each passing day.

Today’s victims in Europe were clearly HSBC and Lloyds, which both lost more than 15%. Lloyds has depreciated about 90% from one year ago, while HSBC lost 44%, a smaller decline because the bank is among the few that still reports profits and refused any government help. In the U.S., Citigroup and Bank of America plunged 20% and 14% respectively today. The selling wave came as AIG received its fourth bailout from the U.S. government. Some of the details from the first three bailouts are still uncertain, and a rising number of analysts say that in this deal profits are privatized while the risks are being nationalized.

AIG’s shares have plunged 99% over the last year going above the borders of bankruptcy, to some extent. However, today, the insurer got a very good deal. It managed to change the conditions on a 40-billion investment made earlier by the Treasury, exchanging preferred shares to non-dividend paying shares. On top of this, the Treasury will buy another $30 billion worth of AIG shares, which will most likely be dividend-free, and shrink some previous credit lines from the Treasury in exchange of some illiquid and most likely worthless assets.

From one point of view, it looks like AIG booked a very good deal today. However, the question that comes to everyone’s mind right now is if this would be the last bailout AIG gets, and how good this deal was for the taxpayers. According to the latest forecasts, the downturn will continue well into the third and the fourth quarters, so it is hard to expect any improvements in the financial markets, something that would eventually really help the banking sector.

Eastern Europe Debt Cut Lower

2009-02-26T22:08:00.001-05:00

Two Eastern European states saw their debt-rating cut lower, near the default risk in the last days. Ukraine and Latvia saw their debt rating downgraded by S&P, to CCC+ and BB+ respectively.

According to the default swaps contracts, the market sees a high probability (above 50%) that Ukraine will default over the next year, reaching a 92% chance that the country will default within the next five years. Currently, Ukraine's debt is the most expensive in the world to protect. Consistent with the default rates study over the last three decades, about 25% or one quarter of the bonds with the C rating default.

How it was said in almost every article regarding the fate of Eastern Europe, the biggest problem in the area is the high degree of debt denominated in foreign currencies. Having the local currencies plunged in double digits percentage, foreign debt is a huge problem. In particular, the Ukrainian grivna has fallen 50% against the dollar in the last few months, multiplying the country’s problems.

The S&P downgrade came even though the IMF said no Eastern European country is near the default level, or in talks with the monetary fund for another loan. However, if Ukraine will default in the next few months, problem will arise for all the Eastern Europe, since investors see a high correlation between the regional economies.

One should asses that, if a country will default on its own debt, it will close the last door that leads to recovery. In addition, the consequences of such an action would be felt for years in row, so practically, the real chance of a country to call for bankruptcy is very small.

Do Not Trust The Fed Funds

2009-02-26T22:07:00.000-05:00

Traders in the Fed Funds Futures see the overnight Fed rate reach 0.50% by November 2009, while by May 2010, currently the longest maturity, traders see the overnight rate reach 1%.

Currently, there are two possibilities running in the market. First would be that Mr. Bernanke does not want to repeat the mistakes made in the past, keeping the Fed Funds too low for too long and creating another bubble. Adding to this assumption is that fact that some investors are afraid that the ultra-low interest rates, together with the Fed expanding its balance sheets, will mean that the CPI read will go untamed as the economy recovers. However, at this point this is only an assumption, since the Fed is currently fighting deflation.

The second possibility that might explain why investors look at the Fed to raise interest rates over the next period is that, according to the latest forecasts, the economy is projected to pick up again in 2010, with a 2% growth rate. However, there are big questions as to how someone can really expect that to happen when every release is pointing to a deterioration of the current situation. Recently, the markets were trembling on rumors about the nationalization of banks. If you ask me, we have not even reached the middle of the crisis. By expanding this assumption, we could say that the Fed Funds Futures market has not fully priced in all the essential information, or expects a certain improvement in the current condition. We could say this is a typical contagion situation.

Speaking from a fundamental point of view, expecting the Fed to raise rates in the following period is a little too much. Mr. Bernanke is a follower of the inflation-targeting regime, even though we cannot speak of such a thing right now. However, monetary policy practice has shown that anchoring expectations is one of the most important tools a central bank has. As such, in his recent speeches, Mr. Bernanke assessed that the Fed Funds will remain low in the following period. If any sudden changes appear in the Fed’s monetary policy, the Chairman will certainly anchor expectations in his speeches and public appearances, since the financial markets do not like surprises. Nonetheless, the Fed Funds is set to remain low for a long period.

The U.K. Recovery Plan

2009-02-24T22:27:00.000-05:00

The U.K. government is trying at all costs to kick-start the economy, which includes expanding the lending programs throughout the nationalized banks and obligating the others to start lending.

The government plans to swap 4 billion pounds worth of preferred Lloyds shared to non-voting shares, to help the bank dodge paying 480 million pounds in annual interest rates. Instead, this money would be used by the bank to lend to its customers.

According to the latest HPI report, for the month of January, the average price of a house in the U.K. is roughly 150,000 pounds. This means that, Lloyds could potentially help up to 3200 families buy new homes, something that would probably give a small push forward in the housing market.

In addition to these funds, the U.K. government plans to lend 14 billion pounds throughout Northern Rock, the first bank that failed from the credit crunch, now also nationalized. This is a big shift from one year ago, when the U.K. authorities pledged to reduce the lending programs of the bank. The allocated funds should theoretically be enough to influence the demand side in the housing market. In January, U.K. banks approved only 23.4K new mortgages, down from an average of over 100K mortgages approved one year earlier.

Another significant boost the banking system would get is an insurance scheme, meant to stop any losses stemming from toxic assets. Even though the numbers are not official yet, news sources speculate that Lloyds and RBS would unload together around 500 billion pounds in toxic assets. For this to happen, banks are expected to pay a 3% to 4% fee, increase their mortgage approvals and take the first amount of losses. If we follow the guidelines set by the U.S. authorities, the financial institutions would support the first 10% of toxic asset losses and the rest would be absorbed by the Treasury.

Even though these projects are in the initial phase, they have the strength to influence the pound’s overall behavior. Up to now, the U.K. currency has been very sensitive to any news regarding the financials, and an improvement (or deterioration) would definitely influence it.

International Monetary Fund in Asia

2009-02-23T22:14:00.001-05:00

Learning from the mistakes made in the past, Asian countries have come to an agreement to set up a currency fund to defend the local currencies. Thirteen Asian countries, including Japan, China and South Korea will contribute to form a $120 billion rescue fund.

About ten year ago, south East Asia passed through a severe crisis as their local currency took steep plunges in a very short period. Back then, the IMF bailed out the economies of a number of countries by issuing loans worth of $100 billion and imposed some very strict conditions.

These days, the Asian countries want to avoid, at all costs, errors made in the past. This fund is meant to protect the currency of only some of the countries, but not all at the same time. However, it is very unlikely a speculative attack would be initiated against the Chinese Yuan, since China has the largest foreign reserve in the world, or against the Japanese Yen, which is one of the most traded currencies in the world.

Japan has expressed an interest to protect the Asian and other emerging currencies. A few weeks back, Japan had agreed with the IMF for a $100 billion loan, which would be used to protect the emerging economies on the brick of a crisis. Overall, this is not a big surprise that Japan would express such an interest, since a large bulk of its exports goes to the emerging economies. Japan exports to China, and the ASEAN countries, almost as much as it exports to the U.S. and the Euro-area put together.

The plan to create a common pool of foreign reserves is very good, and it might create an initiative to take another step forward, maybe towards a better inter-state cooperation. However, things go very slow between Asian countries, so it will be very interesting to observe how things will evolve. Until now, most of the Asian emerging currencies have endured some strong declines in the last period, as investors exit their investments.

Housing Plan Unveiled

2009-02-20T02:05:00.001-05:00

Equity markets are still trading mixed, even though the U.S. administration unveiled the first plan that aims directly at the rising level of foreclosures.

Up to now, this is the first attempt to help homeowners since the housing market had topped, back in 2006. Some say that, if this plan would have come one year ago, the current situation might have looked much better than it does currently. Falling home prices, together with the rising number of foreclosures were among the key factors that stayed at the base of the credit crunch.

Most likely, investors are luke warm towards the new housing plan because some key points remain unanswered. The biggest question is how exactly these additional funds will reach homeowners outside Freddie and Fannie. The government hopes that the extra funding will determine lenders (the big banks in our case) modify the loan conditions to help homeowners.

However, more likely than not the banks have already made their analysis some time back, before this announcement was made public, and had already taken the decision on which mortgages to foreclose on, and on which to help refinance. The big question is, if some extra cash coming from the government will sway banks to refinance the home loans. It is suggested that, the actual sum per household will not be that big.

Another problem is how exactly the government will work its way in the security market. Many of these mortgages have been repackaged and sold to private investors. To some degree, the government would eventually have to compensate the bondholders too, on top of the originating banks.

Overall, most financial analysts have a good opinion about the housing plan, but its actual implementation is still a question. As additional details become available, or eventually some results, markets might start buying the news, and see some decent trends in the equity markets.

Ahead Of The BoJ

2009-02-18T22:02:00.000-05:00

Tonight, the financial markets await the Bank of Japan to present its latest monetary policy decisions, or better said, the bank’s way of aiding the economy without using conventional monetary policy.

The BoJ’s overnight call rate is already at unusual low levels, 0.10%, something that leaves the central bank’s hands tied, unable to use monetary policy to stimulate the economy. As such, the central bank will try to kick-start the economy using less conventional methods, such as buying corporate debt and buying shares from the main Japanese banks.

Earlier, the bank said it would use up to $11.0 billion in order to buy publicly traded shares held by local banks, and another $33.0 billion to buy corporate bonds. The two decisions would theoretically strengthen the Japanese financial system, first by consolidating the bank’s balance sheets and increasing liquidity, and secondly it will bring down the spreads on corporate bonds.

The Japanese financial system is heading towards a demanding period, the end of the fiscal year, on March 31. Usually, around this time of year, the liquidity in the financial system dries up, something not beneficial for the economy. The lack of credit, and thus liquidity, stemmed from the credit crunch, together with the end of the fiscal year will put additional strains for the economy.

The fourth quarter GDP contracted 3.3%, the most since 1974 and a couple of times more than its U.S. or European counterparts. According to the BoJ forecasts, the economy is expected to contract in the following two years. Most analysts agree that, Q1 and Q2 might be even worse than the last quarter, something that would demand even more action from the BoJ.

Eastern Europe

2009-02-17T22:28:00.002-05:00

The latest drag for the Euro-area appears to be the Eastern European economies, which had their financial system hit very hard by the credit crunch.

A rather large number of European banks have exposure to Eastern Europe, including Raiffeisen, Erste Group, Societe Generale, RBS and UniCredit SpA. As such, any problem that rises in the emerging European countries will create problems in the main-bank, or mother-bank.

Banks with subsidiaries to the Eastern European market have tried to cut back their exposure lately, reducing the available funds for the local branches. Therefore, the local central banks were the only ones able to provide the much-needed liquidity, but so far they appeared to be overwhelmed by the demand side. The IMF was just a call away, which had to bail out some countries with $50 billion.

The problems the economies face are huge deficits (much higher than the European Union’s target of 3% of GDP) and ratings downgrades from the major rating agencies. From one point of view, these deficits are a rather huge problem since the Eastern economies grew in the last years at a very strong pace, outperforming by far the Western economies, but still run quite large deficits. Economics 101 says that deficits must be run mostly during the slowdown periods, to help kick start the economy, not when the economy is booming, or you will risk overheating it.

The biggest problem with the Eastern European economies is that their debt is denominated in foreign currencies. Consumers have been lured by the ultra-low rates on foreign currencies, compared with the local ones. In Hungary, the official interest rate was 10%, Poland 7%, Ukraine 16% and Romania 11%.

Investors running from the country, creating a net outflow of cash, will ultimately depreciate the local currencies. The Hungarian Forint and the Polish Zloty tumbled at record speed in the past months, reaching the lowest value seen in the last few years. This adds pressure on consumers, making them choose between defaulting on their loans, which would put additional stress on the banking system, and cutting back their expenses, which would ultimately affect the economy.

However, up to now, these problems have not materialized despite the currency plunge. Still, the default rate has not risen dramatically in percentage terms, and retail sales have fallen, but in-line with the declines seen in the Euro-area. From where we stand right now, it still appears to be a liquidity problem in the Eastern European economies, rather than a solvency problem, as in the Western economies. Liquidity problems have been caused by foreign banks that reduced their funds for the local branches, and by investors withdrawing their portfolio investments. Even so, it should be noted that the line between liquidity and solvency problems is very thin.

It's A GDP Story

2009-02-17T22:28:00.001-05:00

The last few weeks showed some very poor quarterly results from the developed economies. Among the leading countries, the Australian economy is the last one still pointing to a positive GDP, but some say the economy might contract as well.

Tonight, a report showed the Japanese economy contracted 3.3% in Q4 from one quarter ahead, the most since 1974. In comparison, the Japanese economy averaged a 0.5% quarterly growth rate over the last four years. The record slump came as exports, the countries main source of income, tumbled at a very fast speed in the latest months. Only in December, exports plunged a record 35% from one year earlier.

Very poor reports come from all over the world. The Confederation of British Industry said that it expects the U.K. economy to contract 3.3% in 2009, downgrading their earlier projection from -1.7%. The huge revision comes as the international conditions had become even tougher, and up to now, the actions taken by the BoE and the government seemed to have fail.

If these forecasts hold true, financial markets will probably experience new chapters of risk-aversion. However, this might be more visible in the currency market, especially in the euro and in the pound’s value, than in equity markets, which seem very resilient to move any lower. In the currency market, usually the yen is the currency that denotes risk-aversion, but after a strong series of comments from top Japanese officials about the yen’s strength, the currency appears to move only up. As thus, the euro and the pound might break very easy under the 1.27 and under the 1.40 support levels.

Treasury's Money Supply

2009-02-12T22:15:00.000-05:00

The latest reports show that the Fed is preparing to add four new primary dealers, as the Treasury is set to auction up to $2.5 billion this year, in order to raise cash for the much needed stimulus programs.

Primary dealers are the main bidders for U.S. debt, issued periodically by the U.S. Treasury. Currently, there are 16 primary dealers, including all the big names from the Wall Street, the lowest number on record, preparing to bid for what will probably be the biggest amount of treasuries ever sold. From the primary dealers, treasuries pass into the secondary markets and become marketable. In other words, primary dealers are the main market makers for U.S. debt.

By adding four new dealers, the Fed will try to reduce the spreads in the primary market, as some traders have complained lately that the market has become rather illiquid, with relatively small volumes. An illiquid market means the government would have to pay more at its auctions, and this is not too good when you are preparing to sell a record amount of debt.

The Treasury is preparing to borrow up to $2.5 billion of debt this year, almost four times more than the amount of debt issued in 2008. This means that for every basis point, the government will have to pay $250 million per year in interest, or $70,000 per day.

The huge amount of debt issued might be another reason the Fed wants to start buying longer-term debt. This way, it will reduce even further the yields on the Treasury bonds, helping the government pay less in annual interest, and at the same time sending the mortgage and commercial paper lower (in theory, that is).

All this debt come at a huge cost, and most likely, the dollar will be sacrificed. Having the Fed buy U.S. bonds, the printing press will once again start working day and night, increasing the money supply at a strong pace. From economics 101, when the supply surpasses the demand side, the price has to fall somewhat lower until a new equilibrium point is met.

Emerging Markets Still Under Pressure

2009-02-10T22:27:00.001-05:00

Emerging markets continue to be under pressure, as global economic fundamentals weaken from one month to the next. The latest forecast shows a rather hard year ahead for more and more economies.

In the last few years, as global merchandising boomed and the banks found enough cash for almost every loan request, the emerging markets thrived. Their economies were in a so-called “catch up process”, in which the country usually run huge deficits (both public and private) as living standards improved. Moreover, these deficits were usually denominated in a foreign currency, as was the case with Hungary and Iceland.

Now, the emerging economies are paying the price for their large macroeconomic imbalances. The majority of emerging currencies plunged at a strong pace in the last year, as risk-aversion made foreign investors pull out their money. On average, most emerging currencies plunged around 30-50% in the past year, and these declines have continued in 2009.

Since the emerging markets built their economic growth on foreign debt, the recent plunge in the local currency value raises even more problems, as the country struggles to pay its periodic installments. This was the case of Iceland, Hungary and now Russia, all of which have been punished by the financial markets.

The outlook is very austere too for the emerging economies. Russia’s economy is forecast to contract by 1% in 2009, the South Korean economy a little over 2%, while the Hungarian economy is expected to decrease by 3.5% in 2009. As such, the IMF’s struggle to raise more cash for 2009, to be able to help the bleeding economies is welcomed these days. Most likely, a number of emerging economies will default in 2009. The rumors during the last few days, is that Russian banks are looking to restructure their debt and these rumors seem to have merit.

Interest rates Vs. Yields

2009-02-09T22:28:00.001-05:00

Even though the Fed has pledged to maintain the key interest rate at very low levels for an extended period, the yield on the longer loan instruments rose at a strong pace in the last month.

In the financial markets, governments and corporations use bonds to issue new debt and finance their activity. The yields on these bonds represent how much the entity would have to pay for its loan, so a lower interest rate is in its advantage. In order to conduct the monetary policy, the Fed influences only short-term rates, up to a year. However, the Fed has no direct control over the longer-term yields, but it tries to influence them through a whip effect.

Moreover, these longer-term bonds, such as the 10 and the 30-year, have risen quite spectacularly lately. From the beginning of the year, the yield on the 10-year bond rose by 30%, from 2.40 to 2.90 points, while the yield on the 30-year bond rose 35%, from 2.81 points to 3.68 points

As the yields on the U.S. government debt rises, it raises the marginal cost of holding cash reserves, and thus it undoes the Fed’s rate cuts. In addition, these higher yields are sent all over the market, raising the cost of mortgages, personal loans and adds a crucial weight to the U.S. debt, especially now, when the 2009 budget deficit forecasts are measured in $ trillions.

Lately, there have been strong speculations that the Fed would be tempted to start buying treasuries in the primary and in the secondary markets with a maturity longer than a year, in an attempt to further expand its balance sheets. Nevertheless, this holds a major problem, because it will assure investors that they will be able to find a counterpart in the Fed, tempting sellers to sell at a higher price. In other words, the Fed is willing to assure the demand side, disrupting the supply-demand relationship.

If the Fed will really start buying long-term treasuries, its implications in the currency market would be adverse. Firstly, it would allow investors to run out of dollar denominated assets in other risky assets, searching for a higher yield, which would be dollar negative. During this time, the yield on treasuries will remain relatively flat, or it will head somewhat lower (which indicates risk aversion), but still the dollar would lose ground.

BOE Policy

2009-02-08T22:44:00.000-05:00

As the Bank of England is reaching the shores of conventional monetary policy, it now tries to use and implement new measures in order to pull the U.K. economy out of the recession.

Starting this week, the BoE might start buying commercial paper, in order to bring the borrowing yields down to levels that are in-line with normality. In normal market conditions, which we are currently not, central banks operate through buying and selling government issued debt. Now, the major central banks from across the world have expanded these rights.

From now on, the Bank of England would be a major player in the corporate debt market. The BoE plans to act both in the primary and in the secondary corporate bond market. This, in turn, will help the corporate environment by bringing the yields down on existing bonds (throughout the secondary market), and assure cheap liquidity in the primary market.

This decision will certainly aid the U.K business environment, helping some companies avoid debt rating downgrades and running out of cash. As such, the U.K. financial system might gain some more strength, which should theoretically help the U.K. pound. Until now, the sterling has been responsible for both positive and negative news streaming out of the U.K. financial system.

The pound’s outlook lies on the upside in the following period. The market (and thus the pound) might get a big push forward from the stimulus plan vote, which will help the markets buy risk, and sell the safety of the dollar. In the short run, the 1.48-1.49 level will be very important for the pound. In that area, the pair faces an important swing area and a trend-line that holds the pair from early November. If it breaks higher, the pound has a clear path towards 1.53-1.55 area.

ECB Press Conference Analysis

2009-02-05T21:45:00.001-05:00

• The Governing Council decided to leave the key ECB interest rates unchanged
• the latest economic data and survey information confirm that the euro area and its major trading partners are undergoing an extended period of significant economic downturn
• external and domestic inflationary pressures are diminishing
• we continue to expect inflation rates in the euro area to be in line with price stability over the policy-relevant medium-term horizon
• the Governing Council will continue to keep inflation expectations firmly anchored in accordance with its definition of price stability
• overall, the level of uncertainty remains exceptionally high
• economic activity throughout the world, including in the euro area, has weakened substantially
• Foreign demand for euro area exports has declined, and domestic factors, notably very low confidence and tight financing conditions, have adversely affected domestic demand. Taken together with other available economic data for the euro area, this points to very negative quarter-on-quarter real GDP growth in the last quarter of 2008.
• continue to see persistent weakness in economic activity in the euro area over the coming quarters
• the very substantial fall in commodity prices seen since the middle of 2008 should support real disposable income, and thus consumption
• the outlook for the economy remains surrounded by an exceptionally high degree of uncertainty
• risks to economic growth remain clearly on the downside
• annual HICP inflation continued to decline in January 2009, falling to 1.1%, according to Eurostat’s flash estimate, from 1.6% in December 2008
• lower commodity prices and the prospect of weak demand confirm our assessment of mid-January that inflationary pressures in the euro area are diminishing
• headline annual inflation rates are projected to decline further in the coming months, possibly reaching very low levels at mid-year
• inflation rates are expected to increase again in the second half of the year
• turning to the monetary analysis, the latest evidence confirms a continued deceleration in the underlying pace of monetary expansion in the euro area
• M3 and, in particular, the components of M3 that are most closely related to the ongoing financial tensions – such as holdings of money market funds – have shown high month-to-month volatility of late
• the intensification of financial tensions since September 2008 is leading to significant substitution among the components of M3.
• the flow of MFI loans to the private sector moderated in the course of 2008, largely on account of weakness in loans to households, especially for house purchase
• outstanding MFI loans to non-financial corporations contracted for the first time since the onset of the financial turmoil, confirming the significant weakening of corporate credit at the end of the year after a long period of dynamic growth
• the substantial reduction in key ECB interest rates since October 2008 appears to have been passed through to lower bank lending rates, thereby easing financing conditions for companies and households.
• there are some indications that the pace of tightening of bank credit standards is stabilising, albeit at high levels by historical standards
• the European Commission projects in its January 2009 interim forecast a substantial rise in the average euro area government budget deficit, to 4.0% of GDP this year, from 1.7% in 2008
• this rapid deterioration of the fiscal position is broad-based among euro area countries and is due to the economic downturn
• in 2009 seven euro area countries are currently expected by the Commission to exceed the 3% of GDP reference value for the budget deficit
• it is therefore essential that governments return to a credible commitment to medium-term budgetary objectives as soon as possible.

The ECB press conference continued in the same downbeat tone, as it did in the last meeting. The ECB forecasts are rather poor, saying that the economic downturn might continue over the coming quarter. The euro-area economy is affected by the same credit crunch as its main trading partners. However, Mr. Trichet put a lot empathy in the last few meetings (as in the one held today) that each central bank acts in its own universe, and each of these universes are different in its own way.

As such, the Governing Council had again re-stated its resilience for 0% interest rates, but dodged any question that would demand any other clarification on the 0% benchmark. Currently, there is a debate going on if the ECB is referring to the targeted rate or to the overnight rate, but Mr. Trichet avoided clarifying this issue.

Despite the ECB refuses to adopt a low interest rate, trying to avoid a liquidity trap, Mr. Trichet said the bank adopted a “non-standard quantitative easing” by accepting commercial papers, expanding its balance sheets and by allowing banks to pledge for unlimited funds through its open market operations. The President of the ECB also noted that inflation expectations are different on the two sides of the Atlantic, mainly because the ECB has a quantifiable target, of 2%.

What is more important, Mr. Trichet said is that the current 2% is not the downside limit, and he does not exclude cutting rates again in March. During the press conference the euro had a 60-pip range, but still was not able to break decisively anywhere.

What To Expect From The BoE And ECB Tomorrow

2009-02-04T22:09:00.001-05:00

Tomorrow, the ECB and the BoE are expected to announce their monetary stance for the period ahead. The BoE is expected to reduce rates down to 1%, the lowest rate ever seen in the bank’s 3 century history, while the ECB is expected to hold rates at the current 2%.

However, most analysts agree that the ECB will resume cutting rates in March, at the next interest rate meeting. There is a lot of weight put on this particular meeting, because the ECB will update its staff projections. The euro area economy is forecasted to contract by up to 2.5% in 2009 by some analysts.

At the same time, the U.K. economy is projected to shrink by 2.7% in 2009, while the downturn will continue until the fourth quarter, the Niesr research institute said today. Despite this, the sentiment regarding the future path of U.K. monetary policy is starting to change little by little. According to the minutes of the latest BoE meeting, the Governing Council will not reduce the overnight interest rate any lower, if there is not an observable deterioration of the U.K. fundamentals. As such, the BoE says it acted preemptively until now.

It is very likely that the ECB will continue cutting below the present 2% rate, while the BoE will appear more reluctant to reduce the interest rate any lower. This should influence the Eur/Gbp parity in the medium to long term, dragging the pair lower, as the rate differential shrinks. However, a lot of emphasis will be put on Mr. Trichet’s press conference, which will probably spark a lot of intra-day volatility

The Pound Party Comes To An End

2009-02-03T03:01:00.000-05:00

Even though the dollar posted some large gains last week against the majors, the pound was shielded from it, until today.

The pound rose nearly 850 pips last week, or a little more than 7%, in a time when the euro, aussie and the swissy plunged to multi-month lows, holding very closely to the current lows. The pound-buying spree came shortly after Barclays’ Chairman announced that the bank would post record revenues in 2008, despite that it refused any government aid.

Not only did the pound strengthen, but the entire U.K. financial sector was pulled higher. U.K. banks, led by Barclays, almost doubled their value in the last week.

However, the party came to an end today, when investors soon find out that things are not so rosy. Moody’s cut Barclays’ long-term debt rating two grades lower, down to Aa3. The rating agency said the bank might face another round of write-downs and losses stemming from the financial system, but the bank’s outlook remains stable, citing its strong core tier reserves. The news struck both the financial system and the pound, which tumbled almost 400 pips today before the U.S. open, during which time the European pairs barely moved.

The recent events show that the country’s financial stability has great impact over the local currency. As the credit crunch progresses, we might experience other strong declines/appreciation based on the financial system’s outlook. It should also be noted that, in the past, the euro reacted on negative news coming from the European financial system as well.

Regarding the pound’s outlook, it might now return to its close correlation with the euro and the rest of the majors. Later this week, the Bank of England is expected to cut interest rates 50 basis points, down to 1%, the lowest rate in the bank’s 3 centuries of history, something that might have a negative effect on the Sterling.

IMF Is Preparing For A Bad Period Ahead

2009-01-30T14:36:00.000-05:00

The International Monetary Fund, the organization that monitors the global financial markets, is planning to borrow $100 billion from Japan and another $150 billion through its first bond sale.

The IMF has played a key role in the latest financial crisis, some even saying than was necessary. During the Asian currency crisis, in 1997, the IMF was seen by many as being guilty for the magnitude of the crisis. The Asian Financial Crisis also remains in historical terms as the IMF Crisis.
However, it was the IMF that provided the funds needed for the Asian economies to recover. The same thing happened in the past year, when Iceland, together with other eastern European states, knocked at the fund’s gate for additional cash reserves.

Now that things appear to be going from bad to worse, the IMF tries to raise more cash, as it seems more countries might need to access money from the IMF. In the last few months, there were some intense speculations that Romania would need to borrow up to $6 billion to cover some of their current expenses. However, it looks like the Romanian government is going to take the needed money from the European Union, from a recently created fund to help the emerging economies. Adjusting from the Asian Crisis experience, the IMF imposes some strict fiscal and monetary rules that might not be approved (or accepted) by all governments.

The IMF hunt for cash and liquidity means that the fund is preparing for another wave of countries nearing bankruptcy. From time to time, a look over the emerging currencies might not be so bad, because they tend to drop very fast. In the last half year, the Hungarian forint, Romanian RON and the Polish Zloty lost at least 40%.

From Banking to Auto's

2009-01-27T22:45:00.001-05:00

After nationalizing most of the banking sector, the U.K. government has shifted its attention to the auto industry. The lifeline would be offered for producers developing low-emission vehicles and training programs for some workers.

However, almost none of the major U.K. car manufacturers target such a market, yet. U.K. cars are usually stylish cars, with big petrol engines like the Bentleys, Range Rovers and Jaguars, all of which burn lots of petrol, some more than others, such as the Bentley.

This decision shows the strong determination of the U.K. government to save the country for a prolonged recession. Estimates are now running as low as -2% for the 2009 GDP and this number will probably be revised lower, if the situation from the financial sector and the labor market continues to weaken.

The British authorities have already committed to shore up most of the financial sector, buying the three biggest U.K. banks. Just last week, the Royal Bank of Scotland had gave up a 70% stake to the U.K. government. In the long run, the recent actions taken might help the U.K. economy recover faster than expected, or at least show some signs of vigor ahead of the other major economies, which would be reflected in the pound’s strength. However, at this point these are just speculations…

The Bubble Years And The Bubble Economy

2009-01-27T02:20:00.001-05:00

Mr. Bernanke suggested in the last period, that the Fed might start buying longer-term debt. Tomorrow, the Fed may discuss this option, and possibly implement it. This means the Fed will further enlarge its role in the market, something that may not be a good thing.

In normal markets, the Fed acts in the short-term debt market with a maturity up to a year (also called Treasury bills). This happens because the Fed needs to be in control of the overnight lending rate, or the rate at which the primary banks trade funds. By buying and selling T-bills, the Fed has control of the rate most of the time, controlling the whole economy and the business cycle throughout.

However, in these unusual days, the Fed has reached the limits of conventional monetary policy. The short-term interest rates are as low as they can get, leaving the Fed with no room to move. In this environment, the Fed is expected to start buying longer-term debt, up to 10-years.

The immediate implications of this move will be that the yields on the longer-term bonds will move lower, as the price is driven up. This should steadily promote markets taking more risk, as the yields drop considerably. The search for revenue/profit will overtake most of the fear in the market, but this will happen slowly. In addition, some say the Treasuries already show bubble-like behavior.

As the economy recovers, the Fed will eventually have to lift rates again. If treasuries are really on a bubble, as some suggest, a possible rate hike from the Fed would be catastrophic for the economy, sending the yields higher in a snowball effect, obstructing the financial system once again. If the Fed will really go into the market and buy longer-term bonds, then it should develop an astonishing exit strategy from the ultra-low rates, to avoid another bubble.

One should think that the world economy has reached its current condition by facing two strong bubbles in just a few years. First, it was the tech-bubble and then it was the housing bubble. Now, we could be heading towards a Treasury-bubble.

BoJ Interest Rate Analysis

2009-01-22T21:59:00.001-05:00

In the early hours of Thursday, the BoJ released its 2009 and 2010 updated forecast in the monetary policy statement that followed the interest rate decision.

The members of the policy board estimated that the economy will contract by 2.0% in 2009, even though the initial forecast, dating back to October of last year indicated a 0.6% expansion. The 2010 forecast was also revised lower, from 0.1% in October to -1.8% now. However, the policy board expects the GDP to pick up again in 2010, having the economy expand by 1.5%.

The bank has also shifted lower its inflationary view. The bank estimates the CPI read will show deflation in 2009. The bank expects the CPI to come down to -1.1% in 2009, from the estimated number of 0% in October. In addition, the bank also expects the CPI to remain under the 0% benchmark in 2010.

The BoJ issued a very downbeat forecast, which shows that the Japanese economy will again face deflation, something that the bank has tried to fight for years and never succeeded. In all probability, the central bank will try again to implement a quantitative easing approach, buying a wide array of debt instruments to bring yields down.

Most likely, the BoJ will focus on corporate debt to bring yields down, making it easy for the corporate environment to borrow and access liquidity. At the same time, these measures will drastically expand the monetary base, adding inflationary pressures (even though this has never succeeded in practice by the bank).

Furthermore, in order to shift to the upside the inflationary expectations, the bank will be temped to intervene in the currency market, as it has done before. In the past few weeks, top Japanese officials complained about the yen’s strength, and said an intervention is very likely. This is no surprise, since yesterday the yen reached a 13-year low against the dollar, choking exports.

Usually, central banks disappoint very rarely, and are committed to what they say and preach. In the medium to long term, expect strong yen rallies on positive U.S. future numbers, and some unusual resilience to break lower, on negative equity markets.

BOE Meeting Minutes

2009-01-21T22:24:00.000-05:00

Today, the minutes from the BoE meeting held on 7-8 January were released. The report showed that the vote was not unanimous, with eight votes for a 50 basis point rate cut, and one for a larger, 100 basis point rate cut.

Apart from this, the January meeting brought something new. It was the first time in the current easing cycle that the bank discussed to leave the interest rate unchanged.

Until now, the bank’s assessment was that the inflation read is in big danger of “undershooting” the bank’s target, now it seems some parts of this risk have vanished, helped by the on-going rate cuts and a huge depreciation in the pound’s value. The central bank’s view is now that the risk is somewhat balanced.

In the last few lines of the minutes, the bank inserted a vital clue that helps anchor future expectations. The minutes show that the bank has acted preemptively until now and, in case the economic outlook does not shift any further to the downside, it would be wrong to view any rate cuts forthcoming.

However, the Committee voted for a 50 basis points rate cut, in order not to damage the market’s confidence in the financial system and in the real economy. A detached vote came from Mr. Blanchflower who called for a 100 basis point rate cut. As a note, most market participants are used to Mr. Blanchflower’s bearish view, so this vote can be easily ignored.

The meeting’s minutes came at a good moment for the pound. The pair shed 1/3 of its value in the last year, falling more than during the “Black Wednesday” event, when the U.K. was forced to abandon the European Exchange Rate Mechanism.

An additional look on the daily chart shows that since the pound has traded freely, after the 1992 occurrence, it never went any lower than the 1.40 area. This suggests that the pound may see, in the short-term at least, some upward pressure, bouncing off a very strong support area, also sustained by a fundamental shift.

European Commission Updated Projections

2009-01-19T07:32:00.001-05:00

The European Commission, the institute responsible for the European legislation and its implementation, today cut the Euro-area’s growth forecast to -1.9% for 2009.

The European Commission’s forecast is the grimmest report from a public institution. The previous forecast from the same institute, issued just two months ago, in November, said the economy would expand by 0.1% in 2009. The current estimates released by the ECB, known as the staff projections, points to a 0.5% contraction in the Euro-area in 2009. However, as Mr. Trichet said during last week’s press conference the staff projections are going to be drastically lowered in March.

The European Commission also said that the Q4 GDP growth is expected to be as low as -1.5%. Even though this is a very negative and worrying number, it looks like it is surprisingly close to the other three major economies’ forecasts. The Q4 GDP numbers for Japan, U.S. and U.K. are expected to range from -1.5% to -2.0%, the worst in the last few decades in some cases.

Furthermore, the ECB’s Governing Council member George Provopoulos, said in a interview that it is off the mark to expect the bank to cut interest rates to 1%, or below. In the last few weeks, the ECB members have repeatedly said that the central bank would try, at all costs, to avoid reducing the overnight rate too much, something that would create a liquidity trap. However, George Provopoulos, who is also the Chairman of the Bank of Greece, did not exclude further rate cuts in the future, and neither did Mr. Trichet in his interest rate speech, last week. It should also be noted that the ECB was focusing on inflation in July, and only a few weeks later the bank conducted its first rate cut.

Lower Debt Ratings Seen In Europe

2009-01-18T20:36:00.005-05:00

The economic situation in many developed countries is starting to become tougher and tougher, requiring the government to raise cash from private investors to funds its expenses. However, raising debt together with today’s uncertainty, regarding the economic future and prospects, makes some ratings companies cut the debt rating lower.

Greece had its sovereign debt (government bond) rate cut down by S&P today, one grade lower, to A-, but with a stable outlook. Currently, Greece holds the lowest rating from the Euro-area according to the S&P’s rating system. Using the Fitch’s rating system, Greece holds an A investment grade, also with a stable outlook. According to the Fitch’s grades, only Cyprus has a lower debt rating than Greece.

The debt ratting system is very useful for investors, helping them gauge the default risk of a bond issuer. As such, a lower yield means that Greece would have to pay more for its debt. Among other things, the immediate implication of this decision is that the yield spread between the members countries of the Euro-area will further increase. Some say, this may create tensions in the Euro-area, as some countries would have easier and cheaper access to debt than others.

Also in Europe, Spain and Portugal face a similar situation. Both countries are threatened with downgrades from the main rating agencies. Spain faces a severe crisis currently, generated by a large housing bubble. In the last few months, the unemployment rate rose from 9% to 13% in Spain, currently the highest rate from the Euro-area.

Usually, a lower debt rating should affect the euro, since this means investors will be less tempted to send money into the Euro-area. Nevertheless, it also should be noted that, the same agencies initially rate the U.S. mortgage debt with AAA, the highest a bond can get. That AAA debt is now sitting at the heart of the credit crunch, much of it being seen as toxic debt.

Industrial Production Awaiting A Synchronized Bottom

2009-01-18T20:34:00.000-05:00

According to the latest reports coming out of the major economies, industrial production took a deep plunge recently. As observed in the attached chart, Japan seems to be the most affected until now, while the U.K. production seems to be in the worst shape.

The slump seen in the industrial production has multiple effects in the economy. Firstly, and mostly, it denotes that businesses have cut back on spending, something not good for the economy, especially at this time. Secondly, many producers will start to cut costs as much as they can. More often than not, the work labor represents the biggest fixed expenditure for most businesses because it does not matter if the employees work or not, but they would still need to get a (minimal) wage.

The strong declines in production output were very well seen in the PMI releases, which currently are at record low levels for the four economies. To some extent the downtrend observed in exports and imports also point to declining production since it denotes the demand side is shrinking.

Since 2002 U.K. had the weakest growth as a result from not being able to add any new value to the economy, while Japan had the strongest growth in industrial production, approximately 25%. Japan also had the biggest contraction in the industrial output during the 2001 recession and during the current one. Only in the last year, Japanese industrial production dropped 15%. Industrial production in the Euro-area and in the U.S. managed to grow side by side since 2002, both recording an approximate 15% expansion in output.

In addition, the industrial production chart shows one very important feature. During the 2001 recession, industrial production bottomed at the same time, in three out of the four economies: in Euro-area, U.S. and Japan. This is very important to pay attention to because it likely indicates that it will most happen again whenever industrial activity finds a bottom again.

ECB Press Conference Bullet Points

2009-01-16T01:21:00.000-05:00

• The Governing Council decided to reduce the interest rate on the main refinancing operations of the Euro system by a further 50 basis points
• Since September 2008 the financial market turmoil has intensified and broadened
• Tensions have increasingly spilled over from the financial sector into the real economy
• Foreign demand for euro area exports has declined, and euro area domestic activity has contracted in the face of weaker demand prospects and tighter financing conditions
• The survey data and monthly indicators for November and December clearly point to a further weakening of economic activity around the turn of the year
• The Governing Council continues to see global economic weakness and very sluggish domestic demand persisting in the coming quarters as the impact of the financial tensions on activity continues
• Outlook for the economy remains surrounded by an exceptionally high degree of uncertainty
• Overall, risks to economic growth remain clearly on the downside
• Annual HICP inflation has declined substantially since the middle of 2008
• The significant decline in headline inflation in the second half of 2008 reflects mainly the sharp falls in global commodity prices over the past few months.
• Lower commodity prices and weakening demand confirm that inflationary pressures in the euro area are diminishing
• Headline annual inflation rates are projected to decline further in the coming months, possibly reaching very low levels at mid-year. Inflation rates are expected to increase again in the second half of the year
• Risks to price stability over the medium term are broadly balanced
• Unexpected further declines in commodity prices or a stronger than expected slowdown in the economy could put downward pressure on inflation
• The latest evidence confirms a moderating rate of monetary expansion in the euro area. Monetary trends therefore support the view that inflationary pressures and risks are diminishing.
• The broad aggregate M3 and, in particular, the components of M3 that are most closely related to the ongoing financial tensions, are stable
• The tightening of financing conditions resulting from the intensification of the financial tensions has contributed to a slowdown in the flow of monetary financial institution loans to the non-financial private sector in recent months
• The Governing Council recalls its operational decision, taken on 18 December 2008, to widen again the corridor formed by the rates on the Euro-system’s standing facilities as of 21 January 2009
• Looking forward, there is an expectation that inflation rates in the euro area will be in line with price stability
• Governing Council welcomes the European Council’s reconfirmation of its full commitment to sustainable public finances

Today’s conference press was probably the most bearish one in the ECB’s short-history. Mr. Trichet acknowledged that inflation pressures had further diminished in the last few moths, and now the Governing Council expects some very low CPI rates in the first part of the year. However, according to the bank’s assessment, this trend should reverse by the middle of 2009. In the Question and Answers session, Mr. Trichet said the Euro-area would not experience deflation, but only very low inflation rates.

The outlook for the economic activity clearly lies on the downside now. Both foreign and internal demands are very weak, affecting the Euro-area’s export market, and thus its trade balance. This trend is seen worldwide, and not only in Europe.
The most important key-points were in the Q&A session, and both were reflected in the market’s reaction. First, Mr. Trichet put a lot of empathy on the March ECB’s meeting, saying that the one in February is not so important, because of the short-time span of only 3 weeks. Shortly after, the euro started to move higher, until later, when Mr. Trichet said that the current rate of 2.00% is definitely not the limit, even though it is a very low rate. The euro started to tumble after this remark.

Also during the Q&A session, the ECB Chairman said that the transmission mechanism between the bank’s decision and the real economy throughout the 3M Libor rate, declined significantly in the near-term. In addition, Mr. Trichet has said that the ECB staff projections are going to be lowered at the March meeting, adapting to the current economic conditions.

Preparing for the ECB

2009-01-14T03:11:00.003-05:00

On Thursday, the financial markets await the ECB’s reply to the credit crunch. Currently, most estimates run for a 50 basis points rate cut, down to 2.00%.

Earlier this month, the financial markets speculated that, the ECB would vote for a hold decision. This happened after Mr. Trichet said in a public speech that the recent rate cuts would still need time to be felt in the real economy. Usually, monetary policy needs between 6-18 months until they are fully passed on to the real economy.

However, some members of the Governing Council hinted that the bank would cut in January, but it is essentially to take actions in sectors other than monetary policy, where there is more room for maneuvers, especially fiscal policy. The comments of the Governing Council over the last few months indicate that the bank is reluctant to reduce the overnight rates too low, because of the broad implications in the financial markets, particularly in the inter-banking system. This was also underlined by Mr. Trichet by saying that the Fed and the ECB face different shocks, which require different solutions.

Mr. Trichet might hint during the press conference that the ECB will wait for additional data before taking a decision. If so, the euro will certainly rise. However, if there are no clear indications what the ECB might do next, and the Governing Council puts empathy on the risk to downside, the euro will take another strong hit. Using the Bundesbank model, the ECB is committed to prepare the market for its future actions (anchor expectations), and thus it might give important hints about future monetary policy actions..

This tactic was used a number of times during Mr. Trichet press conferences. This can be seen in the strong reactions the euro had to some conferences, while at others the euro simply traded in a tight channel, as in the attached chart. This was mostly seen in the last few months, when Mr. Trichet downgraded its assessment for the Euro-area economy.

A bleeding Q4

2009-01-12T13:41:00.002-05:00

The latest estimates for the three major economies, U.S., European and U.K. points to strong contractions in the fourth quarter of 2008.

Estimates are a 1.5% contraction in each of the three economies, in nominal terms, or 0.6% annualized. This would be the strongest contraction seen in the last few decades. In addition, both Q1 and Q2 of 2009 are seen negative next year, making this recession much longer than previous ones.

The very poor GDP forecasts should not be any surprise, since almost every release is at a record low, or very near. Manufacturing and industrial production, the two big components of the real economy contracted at the fastest speed on record in the last months, according to the PMI release.

The labor markets are also in a horrible state. The unemployment rate in the U.S. is now 7.2%, but forecasts go as high as 8.5%, even with President Elect Obama’s stimulus plan. The U.K.’s labor market trails very closely, having the rate rise by almost 1% since the summer of 2008. In Europe, the jobless rate rose steadily by 0.6% in the last year, reversing a downward trend that lasted more than 2 years.

With such poor forecasts ahead, it is wise to expect risk-aversion coming back into the market from time to time. The latest case was the NFP release, when the dollar strengthened more than 300 pips against the euro, after a very poor release. However, this is good news for currency traders, because we can enjoy strong (and profitable) trends. Risk-aversion can be a very good thing, as long as you are on the right side of the trade.