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Gloomy equity markets support dollar

Mon, Sep 7 2009, 07:35 GMT
by BHF-Bank Economics Department

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Highlights

• ECB Council: Too early for exit discussions; no premium on 1-year tender

• After DPJ election victory, markets test lower USD/JPY limit, low intervention risk

• Gloomy equity markets support dollar

Caution and Prudence

Trading in EUR-USD still lacks direction. Towards the end of the week, the euro was around 1.4280, only slightly below the previous week’s level. The mood in equity markets was predominantly subdued. After the substantial losses incurred by the Chinese market at the beginning of the week, the markets remained on the defensive. From a macroeconomic perspective, the data from the eurozone remained favourable for the most part, but had little impact. The same also applies to the US, with one or two minor exceptions. However, the ADP employment indicator was slightly disappointing, which clouded the outlook for the labour market report on Friday.

The ECB Governing Council, which held its monthly meeting on Thursday, did little to brighten up the mood. The key words at the press conference were “caution” and “prudence”. The Council did acknowledge that there were some signs of recovery; the growth projections were also revised slightly upwards. At the same time, however, the ECB sees a “very bumpy road ahead”, and warns against premature discussions about ending unconventional measures. The ECB’s decision to offer the one-year tender at the end of September at the refinancing rate of 1%, without charging a premium, can be seen as a signal.

Japan has entered a new political era. At last Sunday’s elections, the Democratic Party of Japan (DPJ) won 308 of the 480 seats in the lower house. The LDP lost two thirds of its seats. On 16 September, the DPJ leader, Yukio Hatoyama, is to be elected prime minister.

In this environment, USD-JPY dropped from almost 94 to 93. The US currency fell briefly to 92, close to its low of the beginning of July. This was probably partly connected with the political change. The DPJ is focusing its economic policy on strengthening domestic demand; the Democratic Party is reputed to be less sensitive in exchange rate matters than the LDP, which is closely affiliated with the export industry.
Against this background, without the threat of intervention, the markets appear to be testing the waters somewhat. In addition, the safe-haven yen is benefiting from the jittery equity markets.

G20 in the run-up to the summit

With the end of the holiday season, the international political merry-go-round is getting into full swing again. The meeting of the G20 finance ministers is taking place in London this weekend. In the next few weeks, further meetings of various groups are being held in preparation of the G20 world financial summit in Pittsburgh on 24 and 25 September.

In a common position paper, heads of state from Germany, France and the UK are demanding an improvement in the functioning of the financial markets, in order to avoid a repetition of the present crisis. One key issue in Pittsburgh will be to further design a “regulatory framework for the financial sector, that puts it at the service of the real economy.”

In addition to the much-discussed topic of regulating compensation and benefits, there will be discussions on modifying capital requirements in order to prevent speculative transactions which put stability at risk. In this connection, taxing financial transactions has even been mentioned.
Such measures would certainly affect the forex markets too.

A further topic for discussion will be how to limit the moral hazard of systemically relevant financial institutions, particularly with regard to supervising, and possibly winding up, such institutions. Apparently, the possibility of splitting up large institutions is also being considered, so that, to quote ECB Council member Jürgen Stark, a bank “too big to fail” could simply mean “too big to exist”.

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Published on  Mon, Sep 7 2009, 10:19 GMT

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