FX Briefing

Highlights

• US stocks fall to new lows
• SNB cuts Libor target rate to 1%
• Economic data show continued contraction

Euro - Moderately Weak

Renewed losses in equity markets and persistently weak economic data have boosted the dollar and the yen. However, considering that US equities hit new lows - the Dow Jones fell to almost 7500, and the S&P500 to about 750 - exchange rates were not affected all that much: this week, EUR-USD fell to a low of 1.2425, but recovered to around 1.26 again towards the end of the week. The European currency is thus still in its trading range of the last few weeks. USDJPY dropped below 94 temporarily, but then rose to over 95 again. Most other major currencies and emerging market currencies lost slightly more ground.

The recent weakness in equity markets was partly due to automobile shares, and in particular US car makers. The “Big Three” pleaded for a rescue package, but Congress was not very forthcoming: first it wants details of how the car industry is intending to use the public funds requested to achieve long-term stability in the sector. The matter will therefore be discussed further on 8 December, after Thanksgiving.

Macroeconomic data are gloomy, however. Industrial production rose unexpectedly sharply by 1.3% in October, but the increase is mainly due to production being resumed after the hurricane. As the September figures were revised downwards, the October level shows a decline of 1.7% for the fourth quarter. Furthermore, the New York and the Philadelphia Fed survey data indicate a sustained downward trend in the manufacturing industry. The signs of weakness are continuing in the labour market. The number of initial jobless claims rose again during the course of the month, hitting 542,000 - its highest level since 1992. Inflation is continuing to recede; the core rate excluding energy and food registered a month-on-month decline for the first time since 1982.

The minutes of the FOMC meeting at the end of October show that, despite the decision to cut interest rates by 50bp to 1.0%, at least some members of the committee are already considering more aggressive steps to fight deflationary tendencies. The growth projection for 2009 was revised down to -0.2 to 1.1% (Q4 2009 year-onyear). This suggests that the Fed is expecting real GDP to decline up until the middle of next year. Against this backdrop, further monetary policy loosening is likely at the two-day December meeting, if not earlier.

There are increasing signs that the ECB is set to make significant interest rate cuts soon too. The central bank will definitely revise its growth and inflation forecasts down markedly. Several ECB representatives, including Axel Weber, Lorenzo Bini-Smaghi and Ewald Nowotny, have explicitly pointed out that there is scope for further interest rate cuts. Expectations of a really big step of more than 50bp (which we share) have been fuelled by the Swiss National Bank's decision. It unexpectedly cut its three-month Libor target range by 100bp to 1% only. These are almost Japanese conditions; on Friday, the weekly tender was a mere 0.1%.

There are a lot of important economic data on next week's agenda. In Europe, the main focus is likely to be on the sentiment indicators, particularly the ifo business climate and the EU Commission's confidence indicators. The weak purchasing managers' indices for the manufacturing sector and also for the service sector give little grounds for optimism. It will also be interesting to see whether the labour market situation in Germany - where unemployment has been declining up to now - has reached a turning point. A sharp fall in consumer prices is expected, partly because the high energy and food price increases of November 2007 have dropped out of the calculations of the year-on-year rate, and partly because of the significant decline in energy prices at present. In Germany, the inflation rate could have fallen to 1.4%, and in the eurozone to 2.3%.

The data released in the US will also be weak for the most part: financing constraints and the bleaker economic outlook are likely to have dampened spending and willingness to spend significantly. In this environment, personal spending is likely to have fallen in October too, both in nominal and real terms. This effect will probably be noticeable in durable goods orders too.

Weak economic data are hardly likely to brighten up the mood in the markets. Amidst all the doom and gloom, however, there is little chance of further disappointment. The long Thanksgiving weekend could perhaps give a little respite. We are therefore expecting EUR-USD to continue its volatile sideways movement in the coming week.

BHF-BANK http://www.bhf-bank.com

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