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Friday October 17, 2008 - 13:35:14 GMT
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FX Briefing - Rescue packages only boost euro temporarily

FX Briefing 17 October 2008

Highlights

·        Stabilisation packages reduce worries over financial markets

·        Focus now on global recession fears

·        EMU has more leeway to cut interest rates than USA

 

Rescue packages only boost euro temporarily

EUR-USD began the week on a firmer footing, peaking at 1.377 on Tuesday – about 3 cents higher than at the end of the previous week. On Sunday, leaders of the eurozone countries agreed in principle on a stabilisation plan for the financial system, and on Monday, Germany and France unveiled the national details. Thanks to these rescue packages and additional measures taken by the central banks to provide liquidity, there now seems to be less likelihood of individual institutions collapsing and thus endangering the financial system as a whole.

 

Equity markets in particular heaved a sigh of relief, clawing back most of the previous week’s

losses by Tuesday. However, towards the middle of the week the euphoria faded and share prices plummeted again because government rescue schemes cannot stop the global economic downswing. Therefore, an impending global recession has now become the prime concern. During the latter half of the week, EUR-USD dropped below 1.34 at times. The euro has not been lower since June 2007, before the subprime crisis broke out.

 

Governments all over the world are offering guarantees and providing capital in an attempt to

restore the banks’ confidence in each other. In Germany, the financial market stabilisation fund

will play a pivotal role: this fund will have the power to extend guarantees for new loans and

deposits totalling up to €400bn in return for a fee. Furthermore, it will be able to inject between €70bn and €80bn into financial institutions, either as fresh capital or by purchasing troubled assets. A revision of accounting rules is being considered in order to reduce the necessity of write-downs; due to the lack of liquidity in the markets, the present asset prices are distorted.

 

In the US, the government rescue package is no longer focused on buying up troubled assets, but rather, as in Europe, on providing guarantees and capital in return for preference shares, which, according to the Fed, will be regarded as tier 1 capital. The nine biggest banks are intending to accept the capital injections in return for partial nationalisation.

 

Additionally, central banks have announced further liquidity measures. The ECB, for example, will also accept lower-rated collateral up to a BBB– rating in its refinancing operations. Moreover, up until March 2009, all refinancing transactions will be in the form of fixed rate tenders where all bids will be covered. With effect from 20 October, the Bank of England is introducing a new discount window facility enabling banks to borrow gilts against lower-rated collateral.

 

The money market rates fell in reaction to the rescue measures. The 3-month Euribor declined by 20 basis points to around 5%. But confidence has not yet really been restored in interbank trading. In the eurozone, banks are still preferring to deposit surplus funds at the ECB: in the middle of the week, the deposit facility was being used for a record amount of €210bn.

 

US Federal Reserve chairman Ben Bernanke has expressed confidence that the measures taken by central banks and governments will stabilise the financial markets. However, he pointed out that the economic downswing in the US had started long before the financial crisis escalated, and that the crisis itself could delay recovery. The further weakening of economic activity described in the Beige Book is clearly reflected in the September retail sales and industrial production figures, which had fallen more sharply than expected; the same applies to the first regional purchasing manager indices for October.

 

Mr Bernanke is expecting weak US growth and declining commodity prices to restore price stability. Instead of inflation worries, the Fed is now focusing on recession and financial market risks only. Thus markets are pricing in Fed funds rate cuts, regardless of the unscheduled internationally co-ordinated 50 basis point interest rate cut on 8 October. Rates are expected to be cut to at least 1.25% at the end of October. However, the president of the San Francisco Fed, though skeptical about the economy, expressed reservations on further interest rate cuts.

 

Interest rate speculation is not weighing on the dollar, as there is much more leeway to lower interest rates in the eurozone, where rates are still much higher. We are expecting the ECB to take advantage of this, because the economic risks identified beforehand have now materialised and the risk of inflation is diminishing.

 

Next week there are only a few US indicators on the agenda. Leading indicators and existing home sales could have stabilised somewhat in September after their sharp declines. In contrast, October sentiment indicators in the eurozone will be pointing downwards again. Partly for this reason, risk aversion is unlikely to wane in the markets, and thus the euro is unlikely to strengthen against the dollar.

 

Peter Meister +49 69 718-2600

Economics Department

+49 69 718-3642

volkswirtschaft@bhf-bank.com

Foreign Exchange Trading

devisenhandel@bhf-bank.com

Jörg Isselmann

+49 69 718-2695

Matthias Grabbe / Klaus Näfken

+49 69 718-2688

 

This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHF-BANK Group") solely for the information of its clients. The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities. This publication must not be distributed in the United States.

© 2007 BHF-BANK Aktiengesellschaft

All rights reserved. Please mention source when quoting from it.

 

 

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