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Forex Research - FX Briefing - 21 September 2007

FX Briefing 21 September 2007


·        Euro climbs over 1.40 after Fed cuts interest rate

·        Environment not favourable at the moment for ECB to loosen monetary policy


Dollar plummets

 The dollar’s decline has gathered speed. After the Fed cut interest rates significantly last Tuesday, the US currency has lost more ground. NZD, HUF, CAD and AUD gained the most. For the first time since 1976, one US dollar cost less than a Canadian dollar. The euro broke through 1.40 and sped on to over 1.41. Thus the single European currency is venturing further and further into unchartered territory. The only time rates were higher was before the introduction of the euro – as calculated via the ECU (1.456 in September 1992), or by using the D-Mark at the official conversion rate (1.4430 in April 1995).


The yen seems to be lacking direction. After the release of Lehman Brothers’ eagerly awaited quarterly results, which markets interpreted as being predominantly favourable, the yen fell initially. It also weakened after the US rate cut decision. USD-JPY rose well over 116. During this phase, the yen followed the familiar pattern of the last few weeks: when economic risks are perceived to lessen, the yen drops; carry trades increase again. However, from Thursday on the market changed track. The classical financing currencies joined the general appreciation trend against the dollar and corrected significantly. USD-JPY fell to 114 for a short time, USD-CHF dropped by almost 2 rappen to 1.17.


This week the high-yield commodity currencies (including NZD) were the biggest winners; the forint, the Turkish lira and the Swedish krona have done well too. The performance of the euro and some of the other European currencies was middling. In contrast, the appreciation of the Asian currencies, particularly the renminbi and the yen, against the dollar was rather meagre. The pound Sterling was also relatively weak; it got caught up in the dollar’s downward movement, presumably due to the Northern Rock crisis and the unusual course of action taken by the Bank of England.


Fed to the rescue

Last Tuesday, the Fed cut the fed funds rate by 50 basis points to 4.75%. Despite a “big” interest rate step having been considered a likely option beforehand, equity and forex markets reacted quite sharply to the actual decision. Partly because there is a considerable difference between certainty and just “a good chance”, and partly because the statement indicates that further interest rate cuts are possible. In fact, markets are pricing in US interest rate cuts to 4.25% over the next six months.


Apparently, the markets had not been expecting “academic” Ben Bernanke to react so decisively to the heightening credit market crisis. Beforehand, there had been a lot of discussion about the Fed taking a more rational approach under Mr Bernanke, based primarily on modelling and data, as opposed to Alan Greenspan’s more intuitive decisions. Now it has become apparent that the result however is no different: the Fed under Bernanke also aims to contain risks, particularly those stemming from financial markets, in good time and as effectively as possible.


The Fed’s clear interest rate signal is putting more pressure on the dollar. The USD interest rate cut, though far from unexpected, has had a considerable impact on short-term rates: since the interest rate decision, 3-month money market rates have fallen by almost 40 basis points. Thus the dollar’s interest rate advantage against the euro also narrowed, for 3-month money to about 50 basis points.


The exchange rate effect is all the more pronounced because the interest rate policy rhetoric of all the other major central banks, including the ECB, is pointing sideways or even upwards. The impetus on the euro could become even stronger if the ECB hardens its stance regarding interference from French president Nicolas Sarkozy. At the last ECB press conference at the beginning of September, Jean-Claude Trichet had hinted that Mr Sarkozy’s attempts to push the central bank into a certain direction could actually have the opposite effect.


The development of consumer prices is not likely to make it easier for the ECB to give up its relatively hawkish stance. After moderate price data in the summer months, inflation is likely to increase significantly as from September, presumably to around 2.3%. The main reason for this is that last year, energy prices had fallen markedly from August right into January. As this is not the case this year, there will be higher price increases on energy products over last year. The current development of energy prices is also making itself felt. At over $79 per barrel, the price of Brent has now reached an all-time high, slightly above the peak level of August 2006. Furthermore, food prices will probably continue to rise.


The current price trends and the ECB versus Sarkozy conflict are not a favourable environment for loosening monetary policy in the eurozone. However medium-term prospects look better: the inflation rate will probably fall below 2% again during the first quarter of 2008. And the picture changes even more if the slowdown in growth is taken into account.


In our view, the bold interest rate cut in the US proves that the economic risks must be taken seriously. The US housing market crisis is far from over, and financial market disruptions still prevail. High oil prices and the appreciation of the euro against the US dollar and most Asian currencies are not improving the growth environment in Europe, quite the contrary.


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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