WISE MONEY

The deteriorating situation in Japan continues to drive market conditions and the markets are extremely volatile. Investors continue to ponder the various pieces of news on the nuclear situation in Japan.

Therefore, risk aversion remains highly on the agenda and the usual cocktail of safe haven assets such as US Treasuries, German bunds and the CHF are the main benefactors.

On the other hand, risk assets including global equity markets and risk currencies have been subject to increasing pressure.

Pre-earthquake risk aversion was already on the agenda amidst renewed eurozone peripheral bond tensions however the consequences of the earthquake has seen our risk gauge rise to its highest level since the end of August last year.

Any fall in risk aversion will now be based on the nuclear situation coming under control but until then the general “risk off” market tone will continue.

In the same way currency and equity instability will also remain relatively high.

Overnight the US Dollar/JP Yen exchange rates hit a low of 76.25 during an unstable session but Japanese powers that be noted that rumours of Japanese life and non life insurance companies returning funds back to Japan are “groundless”.

USD/JPY pushed higher from its lows yet there looks to be no sign of interference even though there may have been Bank of Japan rate check, which reduced some fears about looming intervention.

There is a high risk of FX intervention providing USD/JPY remains below the 80.00 level.

In other news yesterday the Organisation for Economic Co-operation and Development (OECD) stated that Chancellor George Osborne must continue with his budget cuts and reform strategy despite a slow down in economic growth.

The OECD maintained that the cuts “will bring long term gain” even though growth forecasts have been reduced to 1.5% from 1.7%.

With the crisis in Japan continuing to dominate, the currency and money markets remain in limbo. A further explosion from reactor 3 at the Fukushima plant has lead to fears of a meltdown and this has caused the Nikkei to fall a further 11% on top of yesterday’s 6% loss.

This is spilling over to Europe and the US with equities expected to take a bashing.

The Yen has held firm during the disaster as the BoJ continues to pump billions in to support their economy. The total cost of the tsunami has rocketed with estimates ranging from $60-100 billion.

Closer to home, the European governments remain divided over how to boost the rescue funds for debt strapped countries, taking the gloss of the weekend pledge to step up the fight against the fiscal crisis.

Finance ministers from the 17 euro countries failed to decide how to bring the emergency aid fund up to its full €440 billion from around €250 billion currently.

Europe faces an end of month deadline to work out the fine print after political leaders vowed on 12th March to reinforce the rescue fund and enable it to buy bonds directly from debt swamped governments.

Any delay in arranging this could lead to more doubts about the Eurozones capability to handle its sovereign debt crisis.

The Pound has suffered slightly in the wake of the tsunami as investors have cut positions in riskier currencies looking for safer places like the USD and Swiss Franc.

Sterling had a strong start to year, but has faltered recently as the upward momentum of an imminent rate hike has subsided.

Estimates now range from May to July for a first rate rise from the BoE, but this will be dependent on the GDP number released in the meantime.

The consequences of the devastating earthquake and Tsunami in Japan will be the main driver for the money markets this week over-riding the continuing tensions in the Middle East. News screens over the weekend have shown the devastation throughout the country with the full impact of the earthquake yet to be seen.

Obviously, apart from the terrible human cost, the economic price will be brutal for the next few months until reconstruction efforts boost growth.

So far early estimates suggests around a 1% negative impact on Gross Domestic Product this year.

The Japanese government is likely to declare a further spending package over coming weeks to support relief efforts however this will no doubt place further strain on Japan’s uncertain debt situation at a time when concerns about the country’s fiscal state were already soaring.

So far the negative JPY effect of the natural disaster made way to strength in expectation of possible repatriation flows by Japanese life insurance companies and other institutions as they cash in on assets abroad to pay for insurance payments in Japan.

The JPY trend will likely continue to be upwards but trading could be choppy in the short-term.

Traders holding significant long USD/JPY positions will probably ease these positions over next few weeks following the earthquake to fulfil JPY requirements.

However, this may be meet by some foreign selling of Japanese assets specially given as foreigners have boosted Japanese asset purchases over recent weeks.

As a result, it’s not a formality to see JPY strength.

That said if the JPY has a strong rally and flirts to drop well below the key psychologically level of 80 the spectre of intervention will be likely.

The Bank of England kept interest rates and the QE program unchanged yesterday, immediately after the announcement the Pound began to sell off sharply against both the Dollar and Euro and this trend continued throughout the afternoon and into early trading this morning. The key level for the GBPUSD pair will be around 1.60, with UK producer prices due out at 9.30 and US advance retail sales out this afternoon, if we see a move through the figure on the back of positive US figures then there may be room for further declines in Sterling next week.

The market seems to be crying out for the MPC to jack up interest rates but expectations of future rates look unlikely to be met by the Bank in the face of impending spending cuts by the Government, and that may hurt Sterling, especially against the Euro if as expected the ECB raise rates at their next meeting.

Some market watchers now think the BoE will keep rates on hold until the end of 2011.

Making it two in two weeks, Japan suffered a huge earthquake overnight with the 8.9 magnitude quake causing widespread devastation and triggered several Tsunamis with warnings of further to follow.

The Yen mirrored the New Zealand Dollar in plummeting against its major trading partners but has regained some ground in early trading in London.

We will have to wait for some days until the total damage can be assessed, what is clear is that Japanese authorities are not in the same position as their pacific neighbours in being able to lower interest rates temporarily to ease the pain of recovery.

On Friday, the US dollar fell towards an eight month low against the Euro on further speculation that Federal Reserve policy makers will shortly signal their willingness to buy more government debt to support economic growth. The Dollar also touched a 15 year low versus the Japanese Yen ahead of tomorrow’s release of the Fed’s September 21st policy meeting minutes.

The moves on Friday were primarily driven by the release of the US payrolls report for September. Both the headline print and the private payrolls component disappointed expectations.

US employers cut payrolls by 95,000 workers in September after a revised 57,000 decrease in August. Average expectations had been for a 5,000 drop.

Markets are now expecting the FOMC will formally announce renewed balance sheet expansion on November 3rd- aka QE2.

The weekend’s G7/IMF/World Bank meetings ended without any specific agreement on FX matters, despite Eurodollar trading close to 1.40.

However, the issue will likely resurface at the G20 meeting of finance ministers and central bankers which begins on October 22nd.

Overnight was a relatively quiet Asian session with Japan on holiday.

This calmness is likely to continue throughout the day with US markets also closed due to the Columbus Day holiday.

20 years ago today marked Britain’s first day as a full member of the ill fated European Exchange Rate Mechanism (ERM), aimed at reducing exchange rate variability and furthering monetary stability in Europe. The ERM was a first step on the road to a single European currency which we currently know as the Euro.

But as we all remember, the experiment did not end well.

Speculators including George Soros famously made a killing betting against the Pound and the downward pressure on Sterling first prompted interest rate hikes and finally Britain to formally pull out of the system.

The lesson the Bank of England learned that day was that no longer could a Central Bank hold back the tide (or should that be Tsunami) of the market.

Although we now live in a world of floating rather than fixed exchange rates, informal Dollar pegs by many developing nations are still used to manage exchange rates.

The sharp Dollar sell off over the past month leaves these nations in somewhat of a pickle. To maintain international competitiveness they must buy Dollars and sell their own currency to maintain the desired rate of exchange, but the whole market seems poised to short Dollars as soon as the Federal Reserve announces a resumption of quantitative easing.

Direct intervention may work in the short term (as witnessed by the spike in USDJPY after the intervention by the Japanese) but it is a futile and expensive policy if the market thinks otherwise.

The Dollar Yen pair is approaching levels once again when the Japanese may be forced to intervene and may do so over the weekend before European and American markets open, for maximum effect.

Both the ECB and BOE kept rates on hold yesterday at 0.5% with no changes to asset purchase schemes.

This morning the Bank of Japan cut its key overnight call rate to a range of 0% to 0.1%.They also announced further easing of monetary policy with an extra 5 Trillion Yen set aside to buy Japanese government bonds and other assets.

The move took the markets somewhat by surprise, it shows the resolve of the Japanese to use every policy tool in their handbook to keep the Yen at competitive levels for domestic exporters.

The Yen weakened slightly on the news and traded towards the 84 level in the USDJPY pair, but has started to strengthen once again at the start of the European session.

Also overnight, the Reserve Bank of Australia keep interest rates on hold at 4.5%, the RBA was widely expected to raise rates by 25 basis points (0.25%), but in a statement released after the meeting, continued uncertainty in financial markets and subdued credit growth were given as the main reasons for keeping rates steady.

The statement was not unduly hawkish, but further rate rises remain very likely, and given the fact that the US & UK interest rates show no sign of rises in the near future, continuing Aussie strength will almost certainly be a reoccurring theme in the FX markets.

Better than forecast PMI figures this morning has given Sterling a welcome lift versus the Dollar, but do not read too much into the data.

The figure was the weakest since June ’09 and is likely to be speculators temporarily driving Sterling higher rather than a positive shift in underlying economic conditions. The fact remains that a second round of QE is becoming increasingly probable, with the first member of the MPC to publicly say so, Adam Posen, doing so last week.

With the first glimpses of governmental spending cuts revealed at the conservative party conference this week, it seems to be a wait and see strategy by the BOE rather than a pre-emptive strike. The above target inflation rate is probably the reason why this is the case the bank may also be waiting for Americas lead in starting the printing presses once again.

The European victory in the Ryder Cup was about as good as it got for the Irish as markets continued to heap on misery.

Moody’s, the rating agency, said it is placing the Irish credit rating on review (typical!) the week after Ireland announced the full scale of the bail out of troubled bank Anglo Irish.

European policy makers have also been in China discussing the Yuan’s value against the Euro and will press China to let the RMB appreciate against the single currency. What effect this will have on actual Chinese FX policy long term is uncertain but in the near term, it will be negligible.

Today marks the start of a busy week in the wise money markets. A large amount of important data releases are scheduled for release this week and several prominent central bankers are due to speak.

This is set against the backdrop of further intervention by Japanese authorities, aimed at curbing Yen strength and further grumblings by the US of China’s refusal to let the Yuan appreciate to fair levels against the Dollar.

The Greenback is yet to recover from last week’s FED meeting and continues to struggle across the board, this afternoon the Chicago Fed National Activity Index will probably show a further slowdown in economic activity so expect the Euro and Sterling to cling stubbornly onto the gains from last week until tomorrow.

Later in the week US GDP is announced, with forecasts of a slight increase from 1.6 to 1.8 per cent. The Fed & markets will be following the figures intently, as disappointing figures may mark the start of the “exceptional measures” the Fed mentioned in the last meeting.

UK GDP figures are released on Tuesday; again the number is very important to the future path of Sterling, with positive growth vital in the face of the steep government spending cuts just over the horizon.

The fear among some economists is the announced cuts reduce growth below the levels needed to service existing debt payments and we enter into a death spiral of further cuts and further reductions in growth, leading to further cuts.

The UK housing market also showed further signs of slowing, all Britain’s regions showed monthly price declines in the Hometrack Housing Survey.

The big question economists are asking is how long the recent Euro strength / Dollar weakness will last?The price action topped at 1.3438 yesterday despite weaker Eurozone data in the form of Eurozone PMI. The rate held above 1.3335 which, coincidentally was the exact level we were at in August before the Euro decided to move south and dip to 1.2600.

Today is a quiet day in terms of data and the current level could make the German IFO release this morning very interesting.

Once again, the potential difficulty is the future expectation component and if, as seems likely, the position for the German economy remains ominous, coupled with the concerns over Eurozone sovereign debt issuance requirements, the present value of the Euro may demonstrate a little over reaction.

However, numbers in line should see Euro/$ have another quick sniff at 1.3400.

The Far East session was again destroyed by holidays but what promised to be a ordinary trading period was enlivened by a swift leap in USD/YEN from 84.50 to 85.30 in the matter of half an hour. State intervention perhaps?

No comment was the official response (which would be surprising if the BoJ had been involved ie why try and push the rate and then deny it?) and so the market spent the next couple of hours allowing the cross to ease back to the 84.60 level.

Commodities remain strong, with Gold the headliner.

This continues to wend its way higher but other less high profile assets are also making waves.

Silver is now at a 30-year high, again with further to go, and the entire commodity scenario argues for continued gains in the Aussie and Canadian currencies.

Wise Money wishes you a good weekend!

The Federal Reserve meeting yesterday evening did not throw up any surprises, but the Fed signalled a more sluggish outlook for the US economy and reiterated its willingness to take additional measures to boost the economy. There was no mention of concrete action as yet, which given the fact that we are rapidly approaching US mid-term elections, is sensible but the change in tone from “wait and see” to “we stand ready to act” was enough to reverse all of the Dollars recent gains in a broad sell off of the Greenback overnight.

Over the next few days we will see if the market is correctly pricing another bout of QE in the near term or if this move will be shrugged off quickly since central bank threats of action has been spectacularly unsuccessful over the past few months.

The Dollar sell off also brings the Japanese FX intervention back into focus, as the USD JPY pair moves back towards levels where intervention initially occurred.

Prime Minister Kan has been quoted as saying the intervention in the FX markets in not yet over, so the fear is fast becoming a beggar-thy-neighbour competitive devaluation as central banks scramble to keep exchange rates low in the hope of stimulating the faltering economic recovery.

The only problem is that not everyone can do it at the same time, and we can expect emerging markets and the commodity producing nations (since it will be these currencies that will strengthen as others devalue) to be none to happy about the prospect of significantly reduced competitiveness in world markets.

The Euro is benefiting from the USD weakness, although the Irish and Spanish bond auctions were broadly successful (the only issue was the high interest rate the market extracted for buying the Irish debt) it is Dollar weakness that is the main driver and we have moved past 1.33 in the EURUSD pair and under the 1.18 level in GBPEUR.