Friday October 12, 2007 - 15:08:15 GMT
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FX Briefing - EUR-USD range-bound for the time being
FX Briefing 12 October 2007
Â· Revival of carry trades, yen weaker against most currencies
Â· Eurogroup steps up criticism of Chinese FX policy
Â· FOMC minutes give no indication of concrete interest rate cut plans in October
EUR-USD range-bound for the time being
In view of the fresh highs on US equity markets, risk appetite seems to be increasing again in the forex markets. The yen and the Swiss franc were the weakest of the â€śmajorâ€ť currencies this week, which suggests a revival of carry trades; the winners, apart from the Swedish krona, were the eastern European currencies zloty, koruna and forint. The New Zealand dollar climbed against the US currency to its highest level since the end of July. The rand went up significantly too. Other currencies such as the Australian and Canadian dollars only rose slightly after last weekâ€™s gains, but remained firm.
During the course of the week, EUR-USD was quite volatile. At the beginning of the week, it dropped to around 1.40. It is difficult to pinpoint the exact reason for this: some market participants put it down to the more upbeat US labour market data, which make all-too aggressive rate cuts by the Fed less likely. Others hold comments made by the European finance ministers (Eurogroup and Ecofin) responsible. But their positions on currencies, which have been finalized ahead of the G7 meeting, did not go much further than previous statements; apparently France did not manage to get its way. EU ministersâ€™ strong call on China to let the renminbi appreciate could however have been a concession to France. The dollarâ€™s recovery at the start of the week could however also have been fuelled by fears that the correction on the US equity market, which had begun last Friday after a fresh high shortly before the end of trading, could continue the following week. The fact that Monday was a public holiday in the US and Japan did not help to dispel these fears either.
But from Tuesday afternoon on, there was significant profit-taking. Equity markets developed favourably and EUR-USD began to gather steam again. Positive economic data from Germany â€“ industrial production increased significantly in August by 1.7% month-on-month â€“ and the prospect of the FOMC minutes of the meeting at the end of September being on the dovish side, helped to boost the euro.
The FOMC minutes did indeed dampen rate cut hopes somewhat: the main aim of the interest rate step had been to offset possible adverse effects of tighter financing conditions on the economy. The Fed emphasized however, that the macroeconomic consequences are very uncertain. Although the Fed professes to be basically willing to take further steps, the minutes give no indication of a definite intention to continue cutting interest rates in the near future. Markets are now pricing in odds of less than 50% for a Fed rate cut on 31 October.
The more cautious assessment of rate cut prospects did not deter the record rally on equity markets, nor did the first, somewhat mixed, quarterly results on Wall Street. DJ Industrials, S&P 500 and the Nasdaq all hit fresh record highs on Thursday, before market players got vertigo and the weekâ€™s gains were pared back.
Equities continued to influence the forex market. EUR-USD rose to a peak of 1.4240, fairly near to the high of 1 October (1.4282). EUR-JPY climbed to 167.63, thus also within reach of the last high of 168.95 on 13 July. However, after the recent equity market correction, EUR-USD slipped back to below 1.42 again, EUR-JPY to around 166.50. Thus gains remained modest this week. Whereas the movements of EUR-USD and EUR-JPY are closely correlated, USD-JPY remained remarkably firm all week, trading for the most part between 117 and 117.50.
Because of their close connection to the equity market, it is difficult to estimate how currencies will develop. US data to be released next week are expected to be on the weaker side. The New York and Philadelphia Fed regional surveys will probably indicate a slowdown in the manufacturing sector at the beginning of the fourth quarter; industrial production is not likely to have increased in September. As far as housing market indicators are concerned, the news will most probably be negative. This could burden the dollar via interest rate expectations.
However, the World Bank and IMF annual meeting is commencing in Washington; the meeting of G7 finance ministers and central bankers takes place on Friday. There are unlikely to be any concrete monetary policy decisions, but general caution with regard to political verbal intervention could make market participants more wary. Political pressure is likely to be focussed mainly on the Asians, particularly China and Japan. And, as suggested by recent comments made by US President Bush and Treasury Secretary Henry Paulsen, the Americans will support the strong dollar. All in all, we are expecting EUR-USD to remain within the present trading range in the next few days.
Stephan Rieke +49 69 718-4114
+49 69 718-3642
Foreign Exchange Trading
+49 69 718-2695
Matthias Grabbe / Klaus NĂ¤fken
+49 69 718-2688
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