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USD: Political decisions in the limelight now

Fri, Oct 3 2008, 09:01 GMT
by Erste Bank Bond Research Team

Erste Bank der oesterreichischen Sparkassen AG

Swiss franc: Safe haven

Yen continues firm

US dollar

The financial market crisis remains the dominant theme for now. The rescue package proposed by Treasury Secretary Paulson with a volume of USD 700bn had been euphorically welcomed just two weeks ago. However, when the discussions on the bailout in Congress become drawn out, sentiment on markets dimmed. The temporary low was reached yesterday when the House of Representatives rejected the rescue package. This came as a shock to markets, since representatives of the two parties had previously already reached an agreement on the bill.

The USD responded to the turbulence of the past weeks by firming slightly vs. the euro, because the news from the monetary union was anything but pleasing. Weak economic data and rescue missions also for European banks exerted pressure on the common currency. However, we do not view this movement as sustainable, because neither will any good news come from the US – not to mention the low US interest rates. In the coming weeks (and after) the movements of the USD will be determined primarily by political decisions. Because the rejection of the rescue plan is not final yet. Should it be still be passed, then the details will be critical for how it might impact the USD. However, if no agreement is reached, this would mean a standstill until year-end. After the elections on 4 November, the new Congress will be constituted only as of the beginning of next year. In this case, we expect the USD to decline. At present though, the situation can change daily and we advise against any type of positioning in US dollars for now.

Swiss franc

Even though the KOF (Center of Economic Research at ETH Zürich) revised its growth forecasts sharply downwards (from 1.8% to 0.3% for 2009), the extent of prevailing insecurity on financial markets is so high that the franc climbed back to its highs of two weeks ago. The current failure of the bailout package for the American banks has certainly contributed to this development, and overall, the fast pace of events is causing the firming of the Swiss franc – which we had expected – to come about sooner than originally assumed. Another massive gain of the exchange rate is not in sight right now, but considering the current insecurity we believe it appropriate to exercise extreme caution, and continue to assess the risk to our forecasts as exceptionally high.

Japanese Yen

There are rumours that the yen is being traded as the new safe haven currency. This means that the yen would firm significantly in the case of turmoil on financial markets. Such movements have been observed in the past, but these were attributed mainly to the closing out of carry trades. As the yen has gained a lot of ground in the course of the current crisis, it seems possible that it will respond more sensitively to insecurity in the future, and it could rise again briefly versus the USD.
Another factor could be the new preferential position of Japanese banks that hardly reported any write-offs and this has put them in a position to buy ailing US and European investment banks (but they have also suffered losses in this context).
On the other hand, even though the outlook for the Japanese economy is gloomy, we believe that over the medium term, the currently extremely volatile exchange rate will be driven mainly by the events on the financial markets, and these are hard to predict at present.

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Published on  Fri, Oct 3 2008, 09:04 GMT