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Friday October 22, 2010 - 15:37:22 GMT
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FX Briefing - Dollar remains under pressure.

FX Briefing 22 October 2010


Chinese central bank raises lending and deposit rates

Eurozone leading indicators, ifo business climate improve again in October


Dollar remains under pressure.


The forex market remains volatile. According to the CFTC report, speculative investors in US futures markets are continuing to bet against the dollar. Net long positions have reached high levels– on EUR, JPY, CHF, AUD and NZD. If all market players are on the same side, the movement tends to lose momentum. At the same time, the risk of a reversal increases, as very short-term investors are quick to react to headwinds.


Such a correction occurred at the beginning of this week. EUR-USD slipped as low as 1.37 for a time, and USD-JPY rose to almost 82. This was partly prompted by an interview with ECB president Jean-Claude Trichet, in which he opposed Bundesbank president Axel Weber’s relatively aggressive stance, and partly by a drop in the US stock market which triggered a wider retreat from risk positions.


The dollar’s strength was only short-lived, however. On Wednesday, there was a turnaround;

EUR-USD headed back to 1.40, USD-JPY is slightly over 81. The prospect of the Fed embarking on a fresh round of quantitative easing is still weighing on the greenback. After Fed Chairman Ben Bernanke had spoken out in favour of this, several of his colleagues followed suit.


The most concrete suggestion so far has come from James Bullard, president of the St Louis

Federal Reserve, who is in favour of the central bank buying $100bn worth of Treasuries prior to the FOMC meeting in December: furthermore, the Open Market Committee should give guidance on whether a further $100bn of assets is likely to be purchased in the period following the meeting. A decision for the period up to 27 January would then be taken in December and guidance given on the period from the end of January to the middle of March – and so on. In view of these deliberations, US bond market yields are stuck at low levels, particularly in the short maturity segment. Yields on 2-year Treasuries are a mere 0.35%, which is fuelling the search for alternative investment options, particularly abroad or in foreign currencies.


As the majority of emerging market central banks are currently more concerned about stemming capital inflows and preventing their currencies from appreciating, the Chinese central bank’s interest rate rise on Wednesday caused quite a stir initially. After leaving interest rates unchanged for almost three years, the PBoC raised the reference rate for one-year loans and one-year deposits by 25 basis points to 5.56 and 2.50% respectively. In the first instance, this fuelled haven demand for the dollar, and commodity prices fell for the most part. Market participants’ main worry seemed to be that the interest rate step could have been a sort of emergency braking measure ahead of the release of inflation and other key economic data.


But the Chinese economic data published on Thursday give no reason to assume that Chinese monetary policy is planning to slam on the brakes. Growth slowed down slightly in the third quarter to 9.6%. The increase in consumer prices accelerated somewhat again in September, but at 3.6% year-on-year (after 3.5% in August) is hardly cause for alarm. The interest rate decision was probably aimed primarily at keeping growing risks due to too much liquidity, loose lending and asset price bubbles under control.


The PBoC’s interest rate hikes underline once more that the US central bank (and also, apparently, the Bank of England) is moving in the opposite direction to the rest of the world. In the eurozone, interest rates continued to rise – partly because of the tighter liquidity supply in the money market, and partly because of the improvement in the economic outlook. The 3M Euribor has now breached 1% again, 2-year Bund yields are around 1% (and thus 65 basis points higher than their Treasury counterparts). Yields on 10-year Bunds are almost 2.50%; thus the interest rate advantage enjoyed by the US up to now at the long end of the curve has virtually flattened out.


The October survey indicators for Germany and the eurozone were surprisingly upbeat. When growth fears escalated in the US a few months ago, forecasters immediately warned that growth could collapse in the euro area. However, the laws of gravity do not seem to apply here. The upswing seems to be continuing into the fourth quarter, which is particularly encouraging. The leading indicators actually show an additional upward trend in October: the purchasing managers’ index for the manufacturing sector in the eurozone rose by 0.4 to 54.1; the business confidence survey in France improved significantly in spite of the strikes, particularly the outlook for the production sector. And the ifo business climate index climbed a further 0.8 to 107.6 – with not only the assessment of the current situation improving, but also, rather surprisingly, that of the future situation too.


We are therefore expecting the ECB to continue to work towards normalising monetary policy. This includes reverting to variable-rate tenders for refinancing operations – probably at the beginning of 2011; government bond purchases could be formally discontinued. The next step –from about the middle of 2011 – would then be “conventional” again.


Stephan Rieke +49 69 718-4114




Economics Department

+49 69 718-3642

[email protected]

Foreign Exchange Trading

[email protected]

Matthias Klein

+49 69 718-2175

Matthias Grabbe / Klaus Näfken

+49 69 718-2146 / -2683


This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHFBANK 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.


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