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FX Briefing

FX Briefing 22 September 2006

Highlights
• Philly Fed fuels US growth concerns
• Forint drops on political shock in Hungary
• Commodity price decline has so far not impressed forex markets much
• Falling inflation rates make ECB action less urgent

Weak commodities, strong dollar?

After the G7 meeting, EUR-USD continued moving sideways around 1.27. After it had become clear that the finance ministers and central bank governors would not be able to agree on a common line on exchange rate policy, and certainly not on a weakening of the dollar, the forex markets lacked inspiration. They were not even fazed much by the flood of hawkish comments coming from ECB representatives in Singapore. The yen firmed slightly, partly as a result of the BoJ basically confirming its rate hike policy, and partly in connection with the political tension in Thailand, where the controversial prime minister Thaksin Shinawatra was ousted in a military coup.

However, towards the end of the week, after the release of the Philadelphia Fed index, concern about US growth mounted again: the Philly Fed index plummeted in September. For the first time in over three years respondents predicted a (slight) decline in economic activity. Because of the risk of the manufacturing industry now weakening too, the markets revised their interest rate expectations quite considerably downwards – especially as the Open Market Committee backed away a little further from its rate rise option in its statement on Tuesday. As a result of all these factors, the forex market livened up after all at the end of the week: EUR-USD rose over 1.28 and USD-JPY dropped below 116.50.

There is an exceptional situation in Hungary at the moment: during the course of the week, the forint fell more than 2% against the euro after some very disturbing comments made by prime minister Ferenc Gyurcsany about his government policy and the necessity for reforms had been made public, triggering violent protests, which are still going on. These developments are highlighting the dire state of Hungary’s budget and current accounts and the possibility of EMU entry being delayed. It was only last summer that Hungary postponed the originally planned date (2010). On 10 October, the Ecofin will discuss the new convergence plan, which specifies stringent measures being enforced, for example in health care.

Commodity prices under pressure
One of the most striking developments over the last few weeks is the strong decline of commodity prices. Since mid-July, crude oil has fallen by 19% and gold and copper by 11% respectively. The CRB Index, which comprises agricultural commodities as well as energy products, precious and industrial metals, dropped by a total of about 15% over the same period.

In the first half of this year we had a close correlation between exchange rates and commodity prices. The higher commodities prices went, the more the US dollar weakened against other currencies. Although the euro is not exactly a “commodity currency”, commodities and the euro moved in tandem (cf. graph). The picture is similar for the classic commodity currencies. They in particular have suffered losses in September, because of lower export earnings. The South African rand lost more than 6 % against the dollar, the Brazilian real and the Norwegian krona almost 3 %. Other currencies, such as the Mexican peso and the Australian dollar lost less ground.

But so far the forex market reactions to the slide in commodity prices have been limited. Most observers seem to be taking this as a temporary price correction but see an intact long-term upward trend for commodities because of the expected increases in demand from emerging markets. One argument which supports this assumption with respect to oil, for instance, is that the spread between the front contract and the contracts further down the line has widened significantly.

But one should be cautious here; collective optimism for commodities is not justified. In its latest World Economic Outlook, the IMF, for instance, comes to the conclusion that the prices for metals are likely to come down in the medium term. This holds especially true if growth forecasts are adjusted down, which then also implies higher uncertainty as to the development of commodity currencies.

ECB interest rate hikes: No rush
Given the numerous important indicators from Europe to be published next week, the forex market is likely to focus on the European side. As already mentioned in last week’s FX Briefing, we expect the German and then the European price data on Friday to show that inflation has slowed dramatically. At the same time we expect business climate and industrial confidence (ifo, Eurostat) to have weakened a little further in September. And then the ECB too might start questioning the urgency of its interest rate hikes – at least once the interest rate step planned for October is over and done with.

Stephan Rieke +49 69 718-4114
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.
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All rights reserved. Please mention source when quoting from it.


 

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