FX Briefing - Downside risks to the economy prevail
Briefing 8 May 2009
Â·Drop in economic activity slows â€“ but no guarantee for recovery
Â·Stress tests for US banks show no unexpected risks
Â·ECB takes markets by surprise with its intention to buy covered bonds
risks to the economy prevail
Movements on the forex markets are still mainly determined
by market participants current take on global economic risks. Stock markets are
one important indicator of risk assessment, and there the sentiment has been positive over the past two weeks. The
rebound in stock prices has carried the Dax, for instance, close to the 5,000 threshold. This
movement was supported by better than expected economic data suggesting the beginnings of an
economic stabilization in the US, the EMU and Japan. The euro got support from the ECB: Not exactly consistent
with economic theory, but consistent with the crisis modus in financial markets,
EUR-USD benefitted from the aggressive monetary policy decisions, especially from
the plan to purchase covered bonds.
For 10 of the 19 largest US banks, the results of the â€śstress testâ€ť showed need for
additional capital to the tune of US$75bn. Treasury Secretary Tim Geithner
called the results reassuring on the whole. The outcome was more or less
expected, so market reaction was muted. Another sign that the stress tests have
not revealed any new risks is the ongoing decline in USD Libor rates and the narrowing
spreads between the Libor and the respective overnight swap rates (OIS).
Therefore the dollar â€“ currently regarded as a safe haven by
market participants â€“ fell back
against most currencies. It was mainly the emerging market
currencies which benefitted from the increase in risk appetite, such as the rand, the real, the
Turkish lira as well as the forint and the zloty. The Mexican peso more than
made up for its losses after the swine flu outbreak. The New Zealand dollar and the Australian dollar also gained significantly.
EUR-USD appreciated moderately in comparison to above 1.34.
Market participants took the ECBâ€™s actions on Thursday as
positive for the euro. Whereas the
cut in the refinancing rate to 1.00% and the introduction of
12-month refinancing operations had been widely expected, Mr Trichetâ€™s announcement that the ECB
would start purchasing covered bonds, which includes Pfandbriefe, did come
as a surprise. The exact procedure will not be decided until June, but the
programme is to have a volume of â‚¬60bn. The aim is to increase market liquidity
in this segment and thus to improve financing conditions.
The fact that the ECB Council did not rule out further
interest rate cuts was also taken as a good sign. Given comments by Bundesbank
President Axel Weber, some observers had feared that the ECB would commit
itself to the current interest rate level for a longer period, thus putting in
a floor here.
The ECBâ€™s remarkably active approach emphasizes that the
crisis is nowhere near under control despite the current â€śgreen shootsâ€ť. Admittedly anumber of economic indicators came in better than
expected in the past few weeks. US survey results such as the ISM and consumer
confidence have been moving up, housing sales seem to be stabilizing a little
and job losses have lost some momentum. In Europe and in Japan the manufacturing data has shown some bottoming out since March. This is not only reflected in the surveys of the ifo
institute and the EU Commission for instance and the Japanese Small Business Confidence Index,
but also in some â€śhardâ€ť data. In Japan and in Germany exports increased slightly in March, industrial production
in Japan rose and German production at least did not drop any
further. New orders in Germany increased.
This is a very welcome development, but there is no reason
whatsoever for euphoria. What we are seeing is a slowdown in the contraction,
not a recovery. Without such a slowdown the already catastrophic growth outlook
would become even worse. But a slower decline will not necessarily turn into a
recovery. The massive reduction in the level of economic activity is a
considerable risk. It makes a huge difference whether economic stabilization sets
in after a GDP loss of, say, 1% or after a 6% drop (compared with Q1 2008), such
as in Germany for instance. The massive underutilization of capacities
increases the downside risks to growth, mainly via the impending reduction in
employment and rising corporate insolvencies.
We thus consider setbacks likely. When fears increase again,
the dollar will benefit, even if the ECB makes use of its remaining room for
further action. All in all this speaks for an appreciation of the dollar in the
Rieke +49 69 718-4114
Grabbe / Klaus NĂ¤fken
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