Daily Market Commentary - Fundamental Outlook

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The euro appreciated sharply vis-à-vis the U.S. dollar today as the single currency tested offers around the US$ 1.3740 level and was supported around the $1.3480 level. The common currency bounced back from yesterday's sizable losses as the markets remain highly volatile and susceptible to credit-driven dislocations. Traders are eyeing several factors. First, there is some indication that European officials may be inching closer to providing a significant financial bailout of the European banking sector. France today said it will intervene to protect French financial institutions. Second, there is still a lot of talk on trading desks about a coordinated move by global central banks to lower interest rates. Third, the Federal Reserve announced new liquidity provisions today to combat the problems in the asset-backed commercial paper market. The Fed announced the creation of a Commercial Paper Funding Facility (CPFF) to complement the Fed's existing credit facilities. Fourth, interbank lending rates remain significantly elevated. Libor rates for U.S. dollars, euro, and sterling rose across the yield spectrum from overnight funds to one year. Three-month euro Libor was fixed at an all-time high of 5.37125% and overnight U.S. dollar rates were fixed at nearly double the Fed's 2.0% federal funds target rate. Fifth, European financial institutions are experiencing significant problems. The share price of Royal Bank of Scotland was off 40% in the morning and Iceland sought an emergency loan from Russia to support its deepening financial crisis. Eurozone finance ministers met in Luxembourg to consider a response to the spreading crisis. Sixth, traders await comments from Fed Chairman Bernanke. In eurozone news, European Central Bank member Ordonez said policymakers must remain aware of inflation risks and called on central banks to "coordinate in absolutely everything." The ECB said it is increasing the size of its 28-day and 84-day U.S. dollar auctions in Q4. ECB member Bini-Smaghi said inflation pressures "are less important than in the past." Data released in Germany today saw August manufacturing orders up 3.6% m/m. Euro bids are cited around the US$ 1.3320 level.

¥/ CNY

The yen depreciated vis-à-vis the U.S. dollar today as the greenback tested offers around the ¥103.30 level and was supported around the ¥101.25 level. The pair reclaimed some of the major ground it lost yesterday as traders reacted to enhanced coordination between global central banks. As expected, Bank of Japan's Policy Board kept its benchmark overnight call rate unchanged at 0.50% and maintained its economic assessment, noting the Japanese economy is "sluggish." BoJ added it "will continue to strive to maintain market stability." BoJ Governor Shirakawa reported "downside risks for the Japanese economy are growing." The central bank announced it will conduct three additional U.S. dollar liquidity auctions in December, availing US$ 70 billion as part of the global coordinated effort to expand U.S. dollar liquidity. Finance minister Nakagawa said Japan will share its economic experiences from the 1990s with the G7 and will "contribute my making sure the Japanese economy doesn't worsen further." Prime Minister Aso called on G7 leaders who will meet later this week to "send a clear message" about stabilizing the financial markets. Data released in Japan overnight saw the August coincident indicator fall 2.8 points to 100.7. The Nikkei 225 stock index lost 3.03% to close at ¥10,155.90. U.S. dollar offers are cited around the ¥104.15 level. The euro moved higher vis-à-vis the yen as the single currency tested offers around the ¥141.05 level and was supported around the ¥136.60 level. The British pound and Swiss franc appreciated vis-à-vis the yen as the crosses tested offers around the ¥181.95 and ¥90.40 levels, respectively. The Chinese yuan appreciated vis-à-vis the U.S. dollar as the greenback closed at CNY 6.8169 in the over-the-counter market, down from CNY 6.8430. Many traders believe People's Bank of China will begin to ease monetary policy soon.

₤

The British pound moved higher vis-à-vis the U.S. dollar today as cable tested offers around the US$ 1.7655 level and was supported around the $1.7320 level. Bank of England reported it will hold two forward auctions in U.S. dollars with the Federal Reserve to provide extra liquidity during the year-end period. BoE will advise on timing and amounts in short order. Currently, the central bank is conducting US$ 70 billion in dollar liquidity auctions through its swap facility with the Fed. The U.K. government is said to be discussing an injection of capital with U.K. banks. Many traders expect Bank of England will cut its headline repo rate by 50bps on Thursday. Data released in the U.K. today saw August manufacturing production fall 0.4% m/m and 1.9% y/y. Cable bids are cited around the $1.7045 level. The euro moved higher vis-à-vis the British pound as the single currency tested offers around the ₤0.7810 level and was supported around the ₤0.7710 level.

CHF

The Swiss franc appreciated vis-à-vis the U.S. dollar today as the greenback tested bids around the CHF 1.1360 level and was capped around the CHF 1.1485 level. Swiss National Bank today announced it is expanding its provision of U.S. dollar liquidity in forward auctions in coordination with other central banks. U.S. dollar offers are cited around the CHF 1.1800 figure. The euro and British pound gained ground vis-à-vis the Swiss franc as the crosses tested offers around the CHF 1.5615 and CHF 2.0145 levels, respectively.

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