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Weekly Update

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America's currency continues to remain on the defensive this morning

Tue, Sep 23 2008, 12:50 GMT
by Union Bank of California Team

Union Bank of California

USD -- America’s currency continues to remain on the defensive this morning, as the unprecedented developments in the US financial sector last week have contributed to the grave uncertainty vis-à-vis the health of the world’s largest economy and the direction of its currency. In the ensuing aftermath of the Lehman Brothers Chapter 11 bankruptcy filing and the acquisition of Merrill Lynch & Co. by Bank of America last week, Mitsubishi UFJ Financial Group announced yesterday that it would invest upwards of 900B yen (~$8.4B) to buy a 10 to 20% stake of Morgan Stanley. Furthermore, the Fed approved the bid by both Morgan Stanley and Goldman Sachs this morning to become commercial banks, with Goldman now becoming the 4th largest bank holding company in the US. Over the weekend, Treasury Secretary Paulson announced his plan to help shore up the toxic fallout from the biggest credit crunch since the Great Depression, which would result in $700B to buy-up soured mortgage-related assets, while providing an additional $400B to guarantee money-market mutual funds. Paulson’s plan marks an unprecedented government intrusion into the financial markets and increases the US’s debt ceiling by 6.6% to a mind-boggling $11.315 trillion. Consequent to the news, the dollar began to lose its luster, dropping to multi-week lows against its major world counterparts. Though the Bush Administration’s move to stabilize the financial markets may reap short-term gains, there is growing concern amongst analysts that the “downdraft on the dollar” stemming from a huge hit to the US balance sheet will greatly eclipse any benefit in the long-term. Last week’s inflation data set proved benign (CPI: -0.1% in Aug. vs. 0.8% prior), though it was not enough to move the hand of the FOMC on 9/16 to lower interest rates, as was widely anticipated during the past week. Fed Fund futures, however, still show a 30% chance of a 25-bps rate reduction at the next FOMC meeting on 10/29. Markets will have plenty of economic data to pore over later this week as it struggles to find a firm footing for not only the greenback, but also the US financial markets as a whole.

EUR -- Europe’s single currency rose to recent highs of 1.4649 on worries that a rescue package for US financial institutions will swell the already massive budget deficit. The euro is coming-off a volatile week which saw swings below $1.41 to above $1.45 as panic gripped the markets following the bankruptcy of Lehman Brothers and bailout of insurer, AIG.
Furthermore, the announcement of Paulson’s “rescue package” is now fueling fears that the US budget deficit is unsustainable and will likely result in a weaker dollar, and a stronger EUR.

JPY -- Japan’s currency also gave away 2.6% of recent gains against the dollar, fueled mainly by the unwinding of higher risk “carry-trades”. Japanese consumers became the most pessimistic they've been in at least 26 years, making it unlikely they will spend to aid an economy weakened by slower global demand. The sentiment index dropped to 30.1 last month from 31.4 in July—the lowest since the government began compiling the figures in 1982. The economy had its sharpest contraction in seven years last quarter. Households pared spending for a fifth month in July as consumer prices rose at the fastest pace since 1997 and wages grew the least this year. Asian stocks fell the most in eight months while treasuries rose following the debt rating downgrades of AIG, Inc.

GBP -- Sterling managed to retrace 2.7% of recent losses vs. USD last week on worsening concerns over the troubled US financial markets. Last Monday saw the pound fall against the USD, as well as snap eight days of gains versus the euro. The catalyst was a government report that showed inflation had accelerated last month to more than double the BoE's target, amid consumer prices rising 4.6% from a year earlier. The UK CPI remained above the government's 3% limit for the fourth consecutive month. The pound saw continued weakness mid-last week as the BoE published its minutes from the latest MPC interest-rate meeting, and a government report revealed that jobless-benefit claims rose. However, from Wednesday through the week’s close and this morning, the USD precipitously lost ground against the sterling and the other major currencies as escalating estimates for losses in US financial institutions rose.

CAD -- The loonie looks to be receiving some drag from the US economic debacle as it joins the rest of the “dollar bloc” countries at the bottom of the G-10 performance list this morning.
However, CAD benefitted over the past week from US uncertainty, and USDCAD is now trading below the 1.0412-1.0821 range held since August. July Canadian retail sales data released this morning came in 0.1% vs. a revised 0.6% for June, as Canadian consumers are curtailing their spending.

MXN -- The peso extended last week’s late rally against the greenback this morning. The peso’s gain is related to the uncertainty surrounding the scope of the financial crisis and details of the US government’s bailout plan, which could further expand the already immense budget deficit.

CNY -- China’s currency rose to highs of 6.8234 on dollar weakness following news of the US rescue plan. The yuan gained as domestic stock prices rose 7.8% as fears of a global financial crisis subsided.

Last Week’s Currency Highs and Lows and Forecast

Published on  Tue, Sep 23 2008, 13:05 GMT