Sunday October 2, 2005 - 10:25:17 GMT
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FX Briefing 30 September 2005Highlights
• Fed wants to safeguard price stability, signals continuation of interest rate hikes
• Foreigners become net sellers of Japanese securities
• ECB will increase vigilance further – interest rate hikes are coming closer
Dollar follows Fed’s interest rate policy signals
The dollar remained strong, but it did not gain much more ground. During this week EUR-USD cautiously advanced below the USD1.20 mark, only to retreat to familiar terrain. In the end, the euro dithered at just over USD1.20. The dollar strengthened a little more against the yen: USDJPY moved to over JPY113. However, the July high of 113.73 remained out of reach for now.
Again, monetary policy was the biggest driver behind the dollar strength. Fed representatives confirmed on several occasions that the economy is robust and that the negative Katrina-effect will be temporary. The various speakers underlined the higher inflation risks and the need to combat the rise of inflation expectations. The development of the March eurodollar futures contract shows that the markets have lost all hope of Katrina-induced breaks in the Fed’s tightening policy. Similar to the beginning of August, the contract has priced in fed funds rate hikes between 50 and 75 basis points.
After dropping somewhat at the beginning of the week, energy prices (especially for natural gas and gasoline) started to rise strongly again by mid-week. This is because oil production and refining activities are slow to recover after taking a double whammy from Katrina and Rita. The reasoning used to be that higher energy prices are mainly a problem for economic growth and therefore an argument for lower interest rates and against the dollar. But now that the Fed has so explicitly emphasized price stability, the view might have changed.
The latest US economic indicators have been mixed. While consumer confidence plummeted in September according to the Conference Board survey, durable goods orders perked up noticeably. Admittedly, the latter are figures for August, but they do show how robust the US economy was before the hurricanes struck. More up to date are the initial jobless claims. The September figure is a lot higher than those in the previous months, but the increase is solely due to Katrina. The jobless claims do not indicate a general deterioration in the labour market. We expect the September labour market report, due next Friday, to confirm this impression.
Japan: strong fundamentals, weak currency
What appears strange is the weakness of the Japanese currency. The current economic indicators show that Japanese growth is more and more fuelled by domestic demand. And the stock market is going from strength to strength. This month the Nikkei has risen by almost 9%; last week alone it gained 2.6%. Because of the bullish stock market and the budding discussion about ending the zero interest rate policy within the Bank of Japan, the 10-year bond yield rose by 12 points to almost 1.50%.
Given the favourable economic situation in Japan, the yen should really be strong. But in fact USD-JPY is in the upper fifth of its 2-year range. However, foreign inflows into the Japanese markets have turned around last week (up until 24 September). Apparently, foreigners have started selling equities, and above all bonds. It is possiEconomics ble that the higher, and rising US interest rate level has more of a pull in the long term than the Japanese fundamentals.
ECB: how long will words suffice?
Next Thursday the ECB Council is due to meet. The central bank now has to navigate choppy waters: due to the energy price increases, the inflation rate in the euro area has risen to 2.5% and it is unlikely to fall in the coming months, unless energy prices drop. Although the inflation rate excluding energy and fresh food, which reflects the underlying domestic price trend, is still moderate at just under 1.5%, the relatively strong deviation from the stability norm nevertheless poses a risk: one, because of the possible passing on of energy costs; two, with respect to inflation expectations.
The second warning signal for the ECB is coming from the money supply. M3 growth has accelerated to more than 8% over the past months, which is far above the central bank’s reference value. The low long-term bond yields explain this development quite well. But it is uncertain whether the excess liquidity will promptly disappear through portfolio shifts once economic growth takes hold.
In this situation, the ECB will discuss whether the time for a normalization of money market rates is drawing closer. The signs for stronger growth in the second half of the year are good at the moment, e.g. the sustained recovery of business climate in the euro area. However, the ECB will want to see the “hard indicators” confirm this trend before it takes any interest rate steps. But it will not mince its words at the upcoming meeting.
Stephan Rieke +49 69 718-4114
+49 69 718-3642
Foreign Exchange Trading
+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.
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