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Friday June 22, 2007 - 18:24:20 GMT
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Forex Market News - FX Briefing 22 June 2007 - Carry trades push yen down to record lows

FX Briefing 22 June 2007
• Speculation on interest rate hikes boosts carry trades
• First hedge fund victim of subprime mortgage problems
• Next ECB interest rate rise not before October

Carry trades push yen down to record lows
The prospect of further tightening in the high yield currencies plus fading hopes of the funding currencies raising interest rates are continuing to boost carry trades. At the end of the week in quiet trading, the yen remained steadfastly at its new record low. USD-JPY, currently at 124, fell near to its 4½-year low of 124.14, and EUR-JPY hit a new record low of 166.47. EUR-USD also only moved in a narrow trading range around 1.34.

It was not the central banks of the main currencies, but the minutes of the Bank of England’s monetary policy meeting that were the main cause for these movements. At the meeting at the beginning of June, only a very slim majority of 5 to 4 had voted to keep interest rates unchanged at 5.5%. As the result was so tight and because central bank chief Mervyn King had voted in favour of raising interest rates, market participants are now assuming that there will be a rate hike to 5.75% as early as July. Previously, markets had been expecting this to happen in August. Although cable benefited from this, it remained below 2.00 against the dollar.

Sweden’s central bank raised interest rates by 0.25 basis points and announced that there would be two further hikes before the end of the year. Subsequently, the Swedish krona appreciated by
over 1.5% against the euro. This fuelled speculation of other important central banks doing likewise.

This week the markets have been focussing more on potential credit risks again. Market participants have got used to central banks warning about underestimating the risks; however, now, commercial banks are starting to issue similar warnings as well. For instance, the Chairman of UBS has pointed out that the growing volume of risky loans could harm the reputation of the banking sector and possibly generate a flood of legal action, even if the risks are widely spread amongst investors. These remarks coincided with problems in two US hedge funds: as a result of the subprime mortgage sector crisis, they have got into a precarious situation. A $3bn rescue package is being considered. This would be on a similar scale to the LTCM fund rescue package in 1998.

Thus market participants’ attention reverted again to the problems in the US housing market. Data released this week did not indicate any improvement either: house owners, particularly those with a low credit rating, are still suffering from rising mortgage rates and falling residential property prices. After three consecutive increases, housing starts dropped again significantly;
building permits, which had declined sharply the previous month, only recovered slightly.

However, apart from the housing market, the US economy is looking very robust at the moment. The first purchasing manager indices for June show that growth has accelerated substantially in the second quarter. GDP growth rates for Q2 are being estimated at 3 to 4%, after 0.6% in Q1; even private consumption, which was weak initially, has increased significantly recently. The bond markets seem to have more or less priced this in with the last interest rate hike, which raised 10-year yields from 4.6% to over 5.3% temporarily. Thus expectations for the second half of 2007 are likely to be crucial: in view of high gasoline prices, rising interest rate levels and falling property prices, there has been a significant drop in US consumer confidence recently, which suggests that the strong growth momentum in the second quarter might not persist.

Unlike in the US, growth momentum in the eurozone seems rather to be declining somewhat in the second quarter. After weak production data from several EMU countries, partly due to public holidays, other economic indicators have turned out weaker too. For instance, consumer confidence in Italy has dropped noticeably, and in April and May, consumer spending fell in France. Sentiment indicators in Germany are pointing downwards for the first time: both the ZEW economic sentiment and the ifo business climate index turned out weaker than expected in June. Up to now, the data are indicating that growth will only be moderate in the second quarter.

The ECB’s last monetary policy meeting before the summer break is taking place at the beginning of July. There is not expected to be any change in interest rates or in the statement. At the moment, the market is counting on the central bank raising the refi rate to 4.25% in September, after the summer break. However, we are not expecting an interest rate hike before October at the earliest, because the ECB Council will first prepare markets for this step verbally. And if growth turns out weaker in the second quarter, the ECB will have no reason to hurry either.

Uwe Angenendt +49 69 718-3648
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.
© 2007 BHF-BANK Aktiengesellschaft
All rights reserved. Please mention source when quoting from it.


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