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Friday August 31, 2007 - 18:48:25 GMT
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Forex Research - FX Briefing - Between fear and hope

FX Briefing 31 August 2007



·        Still desperately seeking liquidity

·        Consumer confidence and business expectations are deteriorating

·        ECB unlikely to raise interest rates

·        Hoping for help from Bush and Bernanke before the Labor Day weekend


Between fear and hope

The credit crisis continues to dominate the forex markets. The tight money market liquidity situation shows how bad things still are. Despite an ample supply of central bank money, there is still a scarcity premium reflected in money market rates. The 3-month money market rate has been 60 to 70 basis points above the ECB refi rate for about two weeks. Banks are hoarding liquidity, partly as a purely precautionary measure, partly to be prepared if credit lines are drawn on. The Fed’s latest data shows that the volume of commercial paper in circulation has dropped by $233bn or 10.5% since the beginning of the month, the biggest reductions being in Asset- Backed CP (–15.5%) and CP of foreign finance institutions (–25.7%).


Equity markets have stabilized after the Fed’s discount rate cut. Some market participants believe that credit markets are going to relax and that the current market weakness creates a buying opportunity. But confidence is shaky and volatility is very high. Exchange rate movements are correspondingly high too, especially in the yen, which continues to act as a gauge for risk appetite. In the first half of the week, USD-JPY fell from about 116.50 to 114.0. In the second half of the week, quotes returned more or less to where they were to start with. For EUR-JPY, the difference between this week’s high and low was more than 3%, for the AUD-JPY over 5%, and for NZD-JPY almost 8%. There were no major swings, however, in EUR-USD. Towards the end of the week the euro is roughly at the same level as last week – slightly above 1.3650. It has, in fact, been trading in a range between 1.3560 and 1.37.


Currently the markets are awaiting information from President Bush about the planned relief measures for subprime borrowers, as well as Ben Bernanke’s speech in Jackson Hole. In anticipation of these speeches, shortly before the long Labor Day weekend in the US, equity markets have gone up and EUR-USD has risen.


Economic data – orders and production in particular – are indicating that the development in the manufacturing sector has been mostly solid in the third quarter, both in the US and in the euro area. But the survey indicators do show that sentiment has deteriorated and that people are more pessimistic about the future. In the US, consumer confidence has deteriorated significantly; and in Europe it has weakened too. The regional surveys in the US manufacturing industry have been mixed in August: The New York Fed index remained at the high levels of the previous months, while the Philadelphia Fed index again dropped significantly. Germany’s ZEW fell noticeably, and weak business expectations dragged the ifo business climate down further.


It is too early for the available data to show much evidence of fallout from the credit crisis. But what we do have is consistent with the view that the credit market crisis is starting to spill over into the real economy towards the end of the third quarter. But we will have to wait for September and October figures to get a conclusive picture.


Next Thursday the ECB Council will be meeting for the first time since the beginning of the crisis. We do not expect it to raise the refi rate. Inflation risks are not acute - euro area inflation is currently 1.8%. It is likely to rise to somewhat above 2% in the coming months because energy prices had plummeted in autumn 2006 so that last year’s base is relatively low. But at the beginning of 2008 this effect is likely to run out. We assume that the new ECB staff projections for 2008, which will be announced on Thursday, will not be significantly changed (2.0%).


The risks associated with raising interest rates now weigh a lot heavier. As the third quarter draws to a close, the direct financial burdens resulting from the credit market crisis will become clearer in the coming weeks. We are afraid that more bad news is in store. As long as uncertainty is widely spread, an interest rate hike can only do damage. The available economic data gives little guidance to monetary policy. But growth risks have increased significantly because financing costs are higher and credit is less easily available. If this hits the real economy, inflation risks would moderate.


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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