FX Briefing

Highlights

• Yen soars on crisis fears
• Central banks cut interest rates in co-ordinated effort
• Governments are working on stabilisation schemes

Forex Markets In the Grip of the Credit Crisis

As the credit crisis has taken a stronger grip in the euro area - the government rescue packages for Fortis, Dexia and Hypo Real Estate indicate this - the euro has come under massive pressure. In the first week of October, EUR-USD fell by about 7% and has been moving sideways since then at around 1.36. EUR-JPY followed suit initially; the euro dropped from 155 to around 145. During the past week, however, the yen has begun to appreciate again across the board; EURJPY plummeted to 135, USD-JPY fell from 105 to 99. However, the Australian dollar was the hardest hit of the major currencies: within the last fortnight, it has lost over a quarter of its value against the yen - this was also partly due to the Reserve Bank of Australia's radical monetary policy shift - it slashed interest rates by 100bp.

Politicians in Europe are now gradually realising that the situation in the financial markets is serious and that the macroeconomic risks are increasing. The rescue operations for Fortis, Dexia and Hypo Real Estate show that, after the fatal Lehman crash, governments are resolved to prevent further bank collapses. In the last few days, most governments in the eurozone, including Germany, France, Italy and all the Benelux countries, have emphasized that they are prepared to take all necessary steps to avert bank failures. They have significantly extended existing bank deposit guarantee schemes in order to quell fears as to the safety of bank deposits.

The Fed has announced that it will start buying 3- month commercial paper directly from the issuers, i.e. banks and companies, in order to stimulate the CP market. Furthermore, the US government is considering direct capital injections into financial firms, possibly in return for preference shares. Britain has implemented a £50bn recapitalisation scheme for the seven biggest banks, which have pledged to increase their capital by £25bn initially (and possibly by a further £25bn at a later date), with government funds if necessary. The government is also planning a guarantee scheme for short and medium term debt up to a value of £250bn.

Finally, last Wednesday, the central banks in the US, the eurozone, the UK and several other countries (including China, South Korea and Taiwan) joined together in an unprecedented coordinated global effort and cut interest rates by (for the most part) 50bp. In addition to lowering the refinancing rate to 3.75%, the ECB has also made some technical changes on the steering of liquidity in the money markets, to ensure that liquidity is available at central bank rates. Further measures are probably in the pipeline.

Governments are apparently working feverishly on schemes to restore financial institutions' confidence in each other, and investors' confidence in banks in general. The G7 meeting this weekend is unlikely to come up with a comprehensive solution. However, as market participants are not counting on quick success, a positive surprise is not completely out of the question, in our view.

Economic indicators are taking a back seat at the moment. The few data released in the past week show weak economic development both in the US and in the eurozone. According to the national figures available so far, industrial production in the three biggest countries in the eurozone was better than expected in August. The August figures, particularly in Germany, were probably distorted by special factors (holiday season); all in all, however, the economic slowdown in Q3 might not have been as sharp as originally feared.

The financial market crisis will continue to influence forex market developments. If the situation eases somewhat, e.g. as a result of the G7 meeting, the euro could possibly appreciate. If, on the other hand, the crisis remains virulent, this could boost the yen. However, the fact that the Japanese yen strengthened so significantly in the last two weeks, is also partly due to a strong wave of repatriation of foreign investments. The impact of this will probably peter out.

BHF-BANK
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