WISE MONEY

The dollar strengthened overnight after the Fed took steps to try and bolster the fragile US economy, saying they will maintain their holdings of securities to stop money from draining out of the financial system. In a bid to avoid a double dip recession, The US central bank said it would reinvest between $200-300m of proceeds from maturing mortgage bonds from the first $1.2 trillion QE cycle.

It left its policy rate unchanged and renewed its pledge to keep rates low for an extended period.

Following the fed announcement treasuries surged as markets anticipated a renewed round of asset purchases should the economy slow further.

Figures since the last FOMC meeting in June indicates that the pace in recovery in output, manufacturing, retail, employment and housing has slowed significantly.

However Wall Street fell heavily last night down around 2.5% as investors worried about further debt increases and slowing growth.

George Osborne has said that banks must increase lending to businesses rather than boosting bonuses and dividends now that they have weathered the worst of the credit crisis. Britain’s Treasury chief said that banks “have an economic obligation to assist” small and medium-sized businesses.

The statement comes in line with half-year figures released this week that are expected to confirm that the major institutions have returned to profit after two years of turmoil.

Lloyds Banking Group, which is 41% owned by the taxpayer, and the 84% state-owned Royal Bank of Scotland are both expected to post a profit. But Osborne questions the ability of British businesses to raise credit from the banks.

“The danger is that, particularly next year, when there is a huge amount of refinancing required, that the small and medium-sized businesses suffer from a lack of access to working capital,” he said.

Osborne continued that British banks “are in no doubt that the government wants to see reasonable access to credit on reasonable terms in the small to medium-sized business sector.”

The expected bank profits have boosted the recent Cable rally and we are now trading in the 1.58s and well on track to the key 1.60 psychological level.

Sterling weakened yesterday after the S&P said it was maintaining its negative outlook on UK’s AAA credit rating. Data released from the UK included a survey by GfK, which showed 58% of U.K. households expect economic conditions to deteriorate further, with nearly two fifths of the respondents looking to cut back on consumption.

In addition, the final Q1 GDP reading showed economic activity expanded 0.3% from the last three-months of 2009, which was largely in-line with the initial forecast.

However, the growth rate slipped 0.2% from the previous year to mark the slowest pace of contraction since the third quarter of 2008.

Comments from the BoE’s Posen that a continued UK recovery can not be guaranteed also weighed on the currency.

The euro consolidated well below two month peaks against the US Dollar as investors were cautious about the single currency ahead of Greece’s return to capital markets for the first time since late April.

This along with Moody’s cut in Portugal’s rating to A1 with a stable outlook is going to continue to weigh on the euro in the short term and doesn’t bode well ahead of the bank stress test results due next week.

The latest European administration to worry the markets is the new Fidesz Hungarian government, who suggested their predecessors had mis-led the population and markets about the financial state of the country.In order to try and prepare the population for the strict austerity measures that they will need to introduce, a newly appointed senior member of the government stated that Hungary has only “a slim chance” to avoid a “Greek situation”.

So with markets still concerned how the untried Fidesz Party are intending to marry up their populist policies with the austerity demanded by the IMF in return for its ongoing aid programme, the government’s first action was an apparent threat of default.

Given the Eurozone countries’ exposure to Hungary, it is no wonder that the Euro dropped in value. Concerted fire-fighting has limited further erosion this morning but EUR/USD has hit a new low of 1.1873 over night.

Over to the US and it was a disappointing Jobs report on Friday afternoon after figures suggested that 431,000 jobs were added to the economy in the month of May after it was widely considered to be in excess of 500k.

In addition to the top line weak data, the fact that temporary census workers accounted for 411,000 of the jobs could suggest that Uncle Sam’s recovery could be slowing.

Finally, David Cameron has spoken this morning and given a stark warning about the action needed to tackle Britain’s budget deficit and public debt. His key take outs were:

• Overall scale of deficit problem is even worse than we thought

• Potential consequences of deficit more critical than we feared

• Last government’s estimates show debt interest payments at 70 bln in 5 years

• Economic growth will not fix borrowing as much of deficit is structural

Yesterday was packed full of announcements from the eurozone, some welcome some less so.

First, Italy followed Greece, Spain and Portugal in outlining €20 billion of government savings aimed at bringing their deficit below the EU threshold by 2012.

Second, Spain announced the merger of four regional savings banks to one, in the process creating its fifth largest financial institution and, it is hoped, bringing much needed stability to the beleaguered Spanish banking system.The shotgun marriage comes hot on the heels of the Spanish Governments rescue of Caja Sur, another regional lender, after its own merger fell through at the final hurdle.

The not so welcome news is that Germany is now looking to extend the ban on short selling to all shares (this is extended from government bonds, credit default swaps and the top 10 German financial institutions).

Quite how this unilateral ban will work when it looks as though we are entering a fully blown bear market in not clear, but we do expect continued volatility in the EUR/USD and GBP/EUR pair as investors try to gain from falling markets.

Today sees the start of a new age of austerity as the Government announces £6.2 billion of immediate spending reductions, paving the way for much deeper cuts in the future.

The Liberal-Conservative coalition is hoping that these initial cuts will prepare the population for severe fiscal measures next year with reports of up to 300,000 public sector redundancies.

Despite these unpopular decisions, markets have been indicating that they want these measures in place if Sterling is to recover against the majors in the long term.

Over to the European mainland and the Euro recovered somewhat on Friday, reaching a one week high against the Greenback as buyers returned to the Euro and halted the currency’s decline. This welcome support came on the news that EU officials pledged to tighten sanctions on high-deficit member countries and said that no European country will be allowed to renege on its debts.

In the early session this morning, the Euro has given back some of these gains with traders reported to be selling into the bounce on ongoing concerns about the outlook for the Eurozone.

To add the Euro’s problems, concerns that the EU credit crisis is spreading with the announcement that the Bank of Spain is to take over the running of one of the country’s saving’s banks.

This pushed the Euro lower against the Dollar and Sterling from highs of $1.2510 and $0.8635 respectively. However the Euro remains well off last week’s four year low of $1.2146, as markets awaits further developments in terms of the sovereign risk issue.

Stock markets around the world suffered further falls yesterday as investors continued to unwind risky positions and move into calmer waters.

The problems in the Eurozone have been the driving force behind the huge market movements we have seen across the currencies over the past few days.

China has been powering the world’s economy over many years, but with Europe its largest customer, investors fear a European induced Chinese slowdown would derail any economic recovery.

Hedge funds are reported to be reversing positions to preserve capital, most notably in the Aussie dollar pairs, which have seen large swings in value over the past few days.

Disappointing economic data yesterday from the USA showing a surprise increase of 25,000 in jobless claims and poor Eurozone consumer confidence figures exacerbated the negative sentiment in the market yesterday.

Sterling fell to its lowest level in 13 months against the Dollar driven by the rush into the safe haven rather than anything Sterling based.

Retails sales showed a third straight month of increases, a positive bit of data for the UK that was shrugged off very quickly by the market. Sterling sentiment remains weak, so expect the Pound to come under further pressure as risk is taken further off the table.

Last night, the US Senate approved the financial reform bill after lengthy negotiations. The legislation, penned as a response to the Credit Crunch will, amongst other things, stop deposit taking banks from trading on their own accounts (proprietary trading) and allow the government to seize control of a failing firm that is judged to be systematically important.

We will have to wait on the fine print, but this will almost certainly have large implications for the markets because the biggest players (the banks) will be forced into restructuring. The added uncertainty of how this will work is adding to fears over the Eurozone.

Billions wiped off global markets with Greek bailout fears spreading to Portugal, Italy and Spain.

Wall Street suffered one of its worst falls in a single trading session yesterday, with mounting concerns that the sovereign debt crisis in the eurozone will not be confined to Greece.

In one of the most frenetic trading sessions in memory, the Dow Jones industrial average fell by 500 points in a matter of seconds at one point, prompting an investigation by the New York Stock Exchange.

At its worst point, the Dow fell by just under 1,000 points or more than 9 per cent— which would have represented the biggest one day fall in 17 months.

The market immediately rebounded, raising speculation that the falls had been caused by a “fat-fingered” trader who had entered an erroneous transaction, although the New York Stock Exchange was quick to point out that the fall was largely due to programme trading.

About $16 billion worth of stock changed hands during the burst — suggesting that genuine trading activity was behind the fall and rally.

Other markets also saw some spectacular lurches, with US crude oil futures for June delivery collapsing by just under 4 per cent to $76.70, its lowest level since February. Amid signs of safe-haven buying, gold prices also hit a record high.

Earlier the euro fell by more than two cents against the US dollar. Having traded at $1.2856 earlier in the session, the currency fell to as low as $1.2653 in the late afternoon, after the European Central Bank (ECB) killed hopes of early action to limit the crisis.

The financial cost to the economy of the airline chaos has intensified with Iceland’s volcanic ash cloud disruption far from over.

On top of the huge loss in revenues for airlines, other companies are suffering disruption to deliveries and supplies.

Food goods face delivery problems, with delays spreading to the drugs and hi-tech sectors if the crisis continues.

Meanwhile, more airlines have launched test flights to assess ash damage to jet engines, amid signs that some feel the threat is being overstated.

While airlines are the biggest losers, with revenues down an estimated £130m a day, other companies are starting to feel the effects of the flying ban.

They are beginning to question whether the Met Office’s computer model of the ash cloud is exaggerating its size

Although air freight represents just 0.5% of the UK’s international movement of goods, it accounts for 25% by value, and includes item like pharmaceuticals and luxury goods.

Goods air-freighted for just-in-time deliverys are especially vulnerable.

A spokesman for the British Retail Consortium said that only more exotic food produce was likely to be affected for the moment.

With the impact on businesses and travellers worsening, some people are starting to question if the air traffic authorities were too quick to shut down European air space.

The Independent newspaper’s Travel editor Simon Calder told BBC News that some airlines he has talked to are unconvinced about the extent of the safety threat.

European airlines are continuing to run test flights to assess possible damage to jet engines caused by the volcanic ash cloud. KLM, whose Saturday test went without incident, is running another eight, and Air France is also taking to the skies. Lufthansa has also run test without any problems.

British Airways ran a test flight early between Heathrow and Cardiff yesterday evening.

Meanwhile the ash cloud is spreading to the north east coast of the USA and is expected to pass over land this evening.

The Bank of International Settlements (BIS) has just published a report on the subject and it is not pretty reading for us Brits.

The U.K., they warn, will double it’s borrowings to almost 10 per cent of GDP within a decade if the Government does not do more to reduce the budget deficit. The effect of the news on the price of Sterling has been mitigated by some positive data released from the OECD (Hurray!).

They forecast that Britain will grow at a faster pace than every G7 country other than Canada, 3.1 per cent annualised, and the risk of a double dip recession has been vastly reduced. Naturally, both Labour and the Conservatives jumped on the figures as vindication of their economic policies, what it seems to suggest however, is that there is still large amount of uncertainty regarding the future path of recovery.

The ECB meets today for its monthly interest rate decision, but focus will be on the details of President Trichet’s announcement of changes to the ECB to collateral policy.

In a nutshell, this has large repercussions for Greece and its ability to post Government bonds as collateral for loans from the ECB. With the announcement yesterday that Greek banks requested further funding from the Government, Trichet needs to be spot on with the new policy announcement to avoid further falls in the Euro.

Yesterday, Eurozone GDP figures showed flat growth prompting the Euro to fall to 1.33 against the dollar and 1.14 against Sterling.