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Forex: FX Briefing 16 September 2005

FX Briefing 16 September 2005
*Japan is beginning to move away from its ultra-loose monetary policy
* “Division of labour” between monetary and fiscal policy after Hurricane Katrina
* Election result in Germany completely open

Dollar overcomes uncertainty

The US dollar has this week continued to recover from its setback after Hurricane Katrina. EURUSD fell by almost 1.5 cents to about USD1.2250. USD-JPY however remained just under JPY111. After Koizumi’s surprisingly overwhelming victory, the yen only rose at the beginning of the week. The relative weakness of the yen was rather unexpected as, after the strong upwards revision of GDP data for the second quarter, more and more observers now think that Japan is close to saying goodbye to its ultra-loose monetary policy.

Speculation has also been fuelled by statements from the central bank. The Bank of Japan’s deputy governor, Kazumasa Iwata, indicated that current policy was to continue in order to combat deflation expectations. At the same time however, he hinted that an end of this policy was imminent. This does not yet seem to have had much impact on the markets. The Japanese bond market only reacted temporarily with a yield increase.

At the moment the forex markets are more concerned about the longer-term effects of Hurricane Katrina on oil prices, the US economy and on the global economy as a whole. Three weeks after the hurricane wrought destruction on the Gulf coast, it looks as though the majority of the oil rigs and refineries will be able to be repaired quite quickly. However, the plants which were more seriously damaged will be out of action for a relatively long period. Thus about 5 per cent of the total US oil production and refining capacities are not likely to be repaired before the beginning of next year. The US will therefore be increasingly dependent on imports in the coming months.

US gasoline prices have fallen from their peak of around $3.10 to below $2.90 per gallon. However, in view of the limited capacities, oil and in particular gasoline prices are likely to remain high. The direct and indirect consequences of Katrina are now evident in economic data. Consumer confidence (assessed by the ABC comfort poll) plummeted in the week after Katrina. Also initial jobless claims rose considerably by about 70,000. In the coming months, statistics are likely to be very distorted, making it difficult to judge the present momentum of the US economy. Therefore, the FOMC meeting next Tuesday will be extremely significant. Central bank representatives’ statements up to now seem to indicate that the Fed regards the macroeconomic effects as temporary. Market players are therefore starting to anticipate again that the central bank interest rates will be raised by a further 25 bp. It will be extremely interesting to see whether the Fed changes its wording in the statement and thus indicates an interest rate pause.

One argument against this is that the financial aid of $62bn promised to the flood victims in the coming months will act as a considerable fiscal stimulus to the US economy. Moreover, in an address to the nation, President Bush announced the biggest rebuilding programme that the world had ever seen. Republicans in Congress estimate that the package could reach a volume of $200bn. In the light of this, the Fed will find it difficult to move away from its current policy. Given that these funds are unlikely to be used sensibly in all cases, Richard Fisher, president of the Federal Reserve Bank of Dallas, pointed out in his last speech that the Fed would be ill-advised to monetarize any fiscal profligacy.

All in all it looks as though the political response to Katrina will be two-pronged: fiscal policy will concentrate on the regional consequences, while monetary policy is likely to address Katrina’s macroeconomic effects. These include possible growth losses due to the rise in energy prices, as well as inflationary risks. We think that the growth-dampening effects will be temporary and moreover be cushioned by the Bush Administration’s expansive fiscal policy. The Fed will therefore focus on the higher inflationary pressure. Its main task will be to curb the recent increase in inflation expectations by hiking interest rates. In our opinion, the Fed will have to go further here than would have been necessary had the hurricane not struck.

In the short-term, the election results in Germany will also influence EUR-USD. The fact that the outcome is completely open again helped the US currency to gain ground over the past few days. If the conservative CDU/CSU and the liberal FDP do gain a solid majority, the euro could be off to a good start next week.

Uwe Angenendt 069 718-3648
Economics Department
+49 69 718-3642
[email protected]
Foreign Exchange Trading
[email protected]
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.
© 2005 BHF-BANK Aktiengesellschaft
All rights reserved. Please mention source when quoting from it.


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