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Friday August 17, 2007 - 14:26:59 GMT
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Forex Research - FX Briefing - No risk – no fun!

FX Briefing 17 August 2007


·        Yen soars on mass exodus from carry trades

·        Money market situation fraught despite liquidity shots

·        BoJ and ECB likely to put interest rate hike plans on hold, Fed cuts discount rate


No risk – no fun!

Just to recap: at the end of June, USD-JPY climbed to over 124, and in the middle of July, EUR-JPY almost reached 169. The yen’s fate seemed sealed, with its interest rates lagging behind by 400 basis points or more. Now, a good month later, there is no more talk about interest rate differentials. Instead, the main concern is how to avert risks and safeguard liquidity. Over the past weeks, a gradual unwinding of carry trades was evident, but during the last few days, this has turned into a mass exodus. Even the “Japanese housewives”, reputed to be the most faithful carry traders with their margin accounts, are reported to have closed positions.


During the course of the week, USD-JPY fell from 118 to 113, which is still relatively harmless. EUR-JPY dropped from 162 to below 150; GBP-JPY plummeted from 239 to 224. The Australian dollar and the New Zealand dollar were even worse hit: AUD-JPY plunged from 100 to 88, NZD-JPY from 88 to below 77. Emerging market currencies such as the Brazilian real, the Turkish lira, the South African rand and the Hungarian forint, were hit just as hard.


In this environment, the dollar managed to hold its own relatively well. During the course of the week, EUR-USD fell from 1.3650 to around 1.34. The US currency benefited from dollar oriented investors reducing foreign currency risk. Presumably, US investors’ home bias played a role here, but also the liquid US markets’ function as a safe haven for investors from the wider dollar area.


The dollar also seems to be benefiting from the fact that it has now become difficult to refinance (short-term) dollar liabilities, particularly in the form of asset-backed commercial paper. Market players are therefore switching increasingly to the banking system, i.e. the money market, presumably predominantly tapping their own domestic sources. Europeans are apparently in considerable need of refinancing too; the funds are obtained in euros and then swapped into dollars. On the forex market, this results in a stronger demand for the dollar. By the way: this is how the dollar financing problem is transmitted to other currencies’ money markets.


The mass exodus from carry trades was triggered by further reports on the credit market crisis, particularly US and Australian mortgage banks’ refinancing problems. There were also reports of hedge fund losses. The fact that volatility has increased significantly in almost all financial market sectors, is likely to force investors to reduce leverage and close risk positions.


Reassuring words and liquidity shots from central banks are apparently not enough to stabilise the situation. By injecting an additional €60bn into the market, the ECB succeeded in pushing the overnight rate down to its target level. However, this trick does not work for longer maturities. For 3-month deposits, rates of almost 4.60% are being paid, despite the fact that the forward market has practically priced out the interest rate hike to 4.25% announced by the ECB. The Fed has pushed the overnight rate down to 5.0%, 25 basis points below the official target rate. Here the forward market is pricing in a rate cut to 4.50% by the end of the year. Nevertheless, the current rate for 3-month deposits is over 5.5%.


The Bank of Japan, which is holding its monetary policy committee meeting next Tuesday, is likely to put on hold the widely expected interest rate hike to 0.75%. The main reason for this is probably not so much the rather weak growth in the second quarter (0.1% quarter-on-quarter), but rather uncertainty about the outcome of the credit market crisis and the weak equity market. Also, the sharp appreciation of the yen will have a significant restrictive effect, if it is sustained.


We are also expecting the ECB to abstain from its intended rate hike in September. Judging by present circumstances, the adjustment process of risk evaluation mentioned by ECB president Jean-Claude Trichet in his press release at the beginning of August, does not seem to be going smoothly at all. The normalization of the situation on the money market, which Mr Trichet had spoken about at the beginning of the week, is still nowhere in sight.


However, the financial burden due to risk adjustment evaluation and limited financing leeway is likely to slow down the macroeconomy more than the originally intended interest rate hike would have done. Presumably, it will be difficult to securitize debts for a long time to come. Banks will be observed more closely. They will probably only manage to fill the financing gap partially, and, despite more stringent credit regulations, at additional costs to the borrower. On the macroeconomic level, we are therefore expecting economic momentum to flatten out significantly.


Stephan Rieke +49 69 718-4114

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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