Welcome to ECU's Market Commentary blog written by Neil MacKinnon, ECU's Chief Economist. This page will be updated from time to time to cover events impacting the global financial and currency markets.

The most recent post appears at the top – scroll down for older entries.

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27th February 2009

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President Obama's budget projections (click here for full document) reveal a prospective budget deficit that will amount to 12% of GDP, the largest in the post-WW2 period and double the previous record of 6% in 1983 under President Reagan. The President's budget projections see the deficit falling back to 3.0% of GDP in 2013. However, the total gross Federal debt more than doubles from $10 trillion in 2008 to $20 trillion by 2016 (i.e. nearly 100% of GDP). That deficit projection of 3.0% looks mighty ambitious if not very optimistic in my view.

In the UK, there is a similar deterioration in public sector finances. The last UK budget report looked for a budget deficit of 8% of GDP but it is likely that it will exceed 10% of GDP this year. The chief executive of the Audit Commission notes that some economists think the deficit could reach 15% of GDP, more than double the figure reached in 1976 when the Labour government had to go to the IMF for a bail-out. He thinks that UK public debt is hitting "Armageddon" levels with the UK ratio of public sector debt (including the debts of nationalised and part-nationalised banks) exceeding Italian and Japanese equivalents and this will inevitably require tax increases and public spending cuts (click here for an article in The Times).

As far as bond markets are concerned, rising debt issuance and soaring budget deficits warn of trouble ahead and a likely bear market in bonds i.e. higher bond yields. It is worth noting that academic empirical research of the impact of rising budget deficits on longer-term interest rates shows that higher budget deficits generally raise long-term rates by a fairly minor amount. Why? Higher budget deficits normally reflect recessions (lower tax revenue and higher public spending) and recessions are normally associated with a loss of pricing power and therefore lower inflation. In these circumstances, bond yields normally decline. In the current situation of virtual economic depression and balance sheet deflation, bond yields can fall in my view despite rising debt issuance. For example, the US 5-year and 7-year debt auctions this week have been well received with good bid-cover ratios and healthy demand for US Treasuries from foreign central banks. For bond markets to enter a bear market requires evidence of higher inflation which can only happen once the velocity of money increases and nominal GDP expands. That is someway off in my view.

In the meantime, the economic newsflow continues to be dreadful. The latest data in the last 24 hours has seen US durable goods orders drop 5.2%, worsening US jobs claims (pointing to yet another horrible jobs number next Friday) and US new home sales collapsing 10.2% in the month of January alone. In Japan, industrial production also dropped 10% in the same month and is 30% down on a year ago. The Japanese economy is collapsing and they now have a trade deficit rather than the surplus they have been used to for a long time. The Chinese stockmarket has dropped 13% just in the last two weeks and Hong Kong exports are at their lowest since 1958.

The nominal appreciation in the yen in recent years has resulted in a (necessary) real depreciation of asset prices and a decline in per capita GDP (‘the standard of living’). Usually countries that have banking and financial crises end up with a real depreciation of the currency. For the US, a currency depreciation is inevitable in the long term. Indeed, any nominal APPRECIATION in the short term which is the result of capital repatriation etc. has to require a REAL depreciation in the medium to longer term but this will only intensify the depression/deflation scenario. The answer is to step up quantitative easing with the aim of restoring pricing power. The Bank of Japan has been slow to expand its balance sheet to the same degree that the Fed and Bank of England has but I believe they will have to and this will ultimately produce a bear market in the yen.

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26th February 2009

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All eyes on Mervyn King, the Bank of England (BoE) Governor as he testifies before the Treasury Committee this morning. He is expected to clarify proposals for the BoE to start its programme of quantitative easing. This would entail buying a wide range of government and corporate securities with the aim of increasing money supply growth and credit creation. Some analysts estimate that this could entail a minimum purchase of about £85 billion of gilt-edged securities. Of course, it is not just the BoE that is implementing quantitative easing as all the major central banks are now adopting similar monetary policies to deal with the global financial and economic crisis. A cut in UK interest rates at next week's MPC meeting is on the cards. In the meantime, the Chancellor is offering guarantees worth £600 billion against ‘toxic’ assets for RBS and Lloyds. In return, the banks will provide extra loans worth £40 billion. This has helped equity prices this morning but I am not convinced it breaks the spiral of further bank losses and the need for more capital. Balance sheet restructuring is likely to remain in place for some time especially as the UK economy is still deteriorating. Sterling, in the near term, has been trading defensively against the major currencies. BoE MPC members still haven't changed their tune on the currency but a weak currency policy does little to attract foreign investors into buying UK Inc or the huge amount of gilt-edged securities that the Debt Management Office has to sell this year. A change of policy on the pound would be helpful....Mervyn take note please!

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25th February 2009

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The latest GDP data for the UK economy released this morning reported a 1.5% drop in the fourth quarter, the most since 1980. The only ‘bright spot’ was a 1.5% gain in public spending but consumer spending fell 0.7% and exports slumped 5.5%. There are few signs of recovery and I think we are talking a mini-depression as far as the economy is concerned. Unemployment is likely to continue rising for a while yet and all this points to the Bank of England having to cut interest rates again at their scheduled policy meeting a week tomorrow.

With the key FX fundamentals of the UK economy (housing, financials) still under pressure, a reduction in UK interest rates is unlikely to sponsor a durable appreciation in sterling (click here to see the Bloomberg chart illustrating the relationship between the 2-year gilt yield and the sterling trade-weighted exchange rate). Therefore, in the interim, any rallies in sterling are largely driven by technical and positioning factors and intra-day traders continue to dominate activity in the FX market generally. 

Elsewhere, the S&P index is trying to rally off its 2002 lows (click here for a detailed chart) in response to the President's stimulus package, but there is the nagging suspicion that investors will be disappointed and new lows in the S&P index can't be ruled out. Fed Chairman Bernanke's Congressional testimony yesterday was fairly bleak and his forecast of economic recovery is contingent on a stabilisation of the financial markets (click here for more details). US consumer confidence is now also at a record low in the latest data reported yesterday (click here for more on this).

Elsewhere, more bad news for the eurozone. The cost of bankruptcy protection on German sovereign debt has reached an all-time high. The state governments of Hamburg and Schleswig-Holstein agreed on a EUR3 billion cash rescue yesterday for Landesbank HSH Nordbank, the world's top source of finance for shipping (click here for an article in The Telegraph).

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24th February 2009

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Stockmarkets are at their lowest in ten years and sentiment remains fragile. In spite of (or because of?) the endless initiatives and directives of the US and UK authorities, investors remain nervous. The US and UK banking sectors are probably insolvent and full nationalisation is the likely end-game. So more bad news ahead, I think, and I would not be surprised to see further losses in the equity markets (e.g., the S&P index falling to the 600 level – click here to see the Bloomberg chart). For a comparison with previous equity bear markets, there are interesting charts on the dshort website (click here).

As far as the major economies are concerned, the outlook remains gloomy. The powerful forces of deleveraging and balance-sheet deflation point to a prolonged period of economic weakness, suggesting the worst is yet to come. Comparisons with Japan's ‘lost decade’ in the 1990s are not far-fetched. Zero interest rates failed to spark a recovery and debtors either went bust or just worked to pay down their loans. Much the same dynamic process can be expected to apply in the US and UK economies where collapses in the housing and financial sector painfully interact with a fatally wounded banking sector and deteriorating government budget deficits. For a good summary of how this recession compares, read Jeffrey Frankel's contribution on the lessons of the 1930s (click here for the article).

As far as the FX market is concerned, the US dollar trade-weighted exchange rate is running into important technical resistance (click here for the Bloomberg chart). Near term, there is scope for a pullback in the dollar. Likewise, the euro crosses are edging higher despite worsening fundamentals in the eurozone area. Perhaps any euro ‘strength’ at this juncture might simply be due to repatriation...we shall see.

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Neil Mackinnon is away today. Today's blog entry has been written by Mike Hughes, ECU's Head of Risk Management

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23rd February 2009

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Gold stole the show on Friday with a US$25 leap in the spot price taking it to just below the psychological $1000 mark. Whilst it failed at its first attempt to penetrate this level - finishing the day close to US$992 - there seems little reason, or indeed little appetite to explore lower levels, and as the editor of the "Boom, doom and gloom" articles, one M. Faber commented, what happens after we break US$1000? The answer is simple: US$1001, US$1002 and US$1003!

In the FX markets, euro and sterling started the day under pressure again as first Asia and then early London tried to push through the 1.2500 and 1.4100 support levels respectively. But, with so many short-term traders crowding the position, and with no new momentum appearing, euro and sterling soon both recovered, and duly squeezed out all of the early sellers.

Over the weekend there has been plenty of global news and rumours to digest. First and foremost was a rumour out late Friday that contrary to an article being circulated during the day that Citigroup & Bank of America were unlikely to last more than 60 days, the Fed were about to announce a further cash injection into Citigroup through the purchase of up to 40% of their shares. This has helped to put a bottom on euro and sterling for the time being, and indeed today, risk is back in fashion. The next important levels to watch out for are 1.3100 and 1.5000 respectively.

The Japanese yen also rejected important levels of resistance on Friday around 94.75 against the US Dollar. However, having seen a significant pullback to 92.50-70, the market has bought the pair back up above 94.00 this morning, with EURJPY looking particularly well bid, now above the 120.00 & 121.00 resistance levels. Failing pullbacks, it looks like 124 and above is the next stopping point.

What can be said about FX markets of late is that there has been a lot of "noise", rumours and counter rumours. Short-term players putting risk on, and taking it back off again very quickly when follow through is not forthcoming. However, what we are not seeing yet is what can be classed as medium-term, or even long-term investors, changing their investment outlooks or entering markets in anything other than a small and tentative fashion. Markets therefore are being driven by short-term stops, ie, the euro goes up because of a plethora of intraday short euro

positions, and goes down when they have been squeezed out and feel they are missing the next big move lower.

We therefore remain vigilant to moves which may be something other than intraday, and anything which may suggest to us that sterling in particular

has bottomed. However, whilst almost all of our short-term indicators suggest that we remain relatively rangebound, we prefer to stay on the sidelines.

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Neil Mackinnon is away this week. Today's blog entry has been written by Mike Hughes, ECU's Head of Risk Management

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20th February 2009

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Yesterday morning's test and rejection of important support levels at 1.2550 in EURUSD and 1.4150 in GBPUSD saw a whole raft of short-term players turn tail and cover their positions. As has been typical of recent months, lack of real liquidity (natural bids/offers, banks willing to warehouse risk etc.) exacerbated these moves and managed to squeeze some of the longer-term investors back onto the sidelines. Interestingly however, neither pair made any serious attempt on the 1.3000 or the 1.4500 areas of resistance.

Meanwhile, USDJPY continued its recent path higher, eventually taking out the 93.75 resistance level, and indeed this morning it is sitting above 94.00 as we await London's next move. There has been a very crowded long yen position in the market for some time now, and what we have seen of late is some reduction in these positions. We still see very few long-term players wanting to open new short of yen trades, and indeed with the Japanese year end just a month away, we would not be surprised to see some yen repatriation at these levels.

If ‘Risk on’ categorised the morning's trading (GBPJPY eventually recorded a high of 136.35), then the afternoon and overnight sessions saw a return to ‘Risk off’. First to dissappoint the morning traders was the Philadelphia Fed numbers, released at 10.00am New York time. At -41.3, they were even worse than the expected -25.0. This in turn took all the steam out of what had been a tentatively positive start to the Dow and S&P. Asia quickly off-loaded risk by selling GBPUSD and EUR as the Nikkei 225 and Hang Seng Index shed 1.87% and 2.5% respectively.

And so the debate for us continues as to whether or not sterling is bottoming, or indeed has already bottomed. On current evidence it is hard to conclusively argue one way or the other. Whilst one can say that most, if not all of sterling's bad news is probably now factored in, and indeed we may be further ahead of the curve than some of our trading partners (sterling is indeed being rewarded aginist the euro for just such reasons), it will remain a difficult decision to make whilst global stock markets struggle to rally. Find the bottom in stocks and you may well have found the bottom for sterling....

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Neil Mackinnon is away this week. Today's blog entry has been written by Philip Manduca, ECU's Head of Investment

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19th February 2009

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It seemed to be a quiet day in financial markets to casual observers, but screen addicts noted the failure of gold to mount any form of correction to recent strength, closing higher on the day near to $985. Elsewhere, some US bank stocks fell again to near to their 52 week lows as equities generally could not correct their sharp falls of the last few days/weeks/months.

The Japanese yen continued to weaken modestly amidst signs that the global credit and economic crises are worsening. We believe that this moderate weakness has more to do with speculation that the Bank of Japan will weaken the yen via intervention to mitigate the economic crash that is occurring in Japan. We do not expect intervention yet. We believe that it is almost inconceivable that the major currency governments would sanction the Japanese embarking on unilateral competitive currency devaluation whilst simultaneously exhorting the Chinese to strengthen their currency. In addition, historical movements in the yen have less to do with domestic Japanese economic conditions and far more to do with investment flows into and out of Japan.

It is tempting to believe that risk-averse currencies (the yen and Swiss franc) now offer a huge corrective selling opportunity, particularly against sterling. We just can’t find sufficient evidence to support this thesis at this time, although the possibility requires constant monitoring and, in the medium term, there could be a clear ‘value’ trade here. FX markets have settled into a form of price equilibrium prior to the next bout of volatility. We believe that more volatility is coming very soon.

Elsewhere, the fall in equities continues to pressure the pensions and savings markets. How many pension plan holders do you know who just can’t decide whether to liquidate their remaining equity holdings or to hold on until a ‘rally’ occurs? Our experience suggests that equities will not truly bottom until investor capitulation occurs, and makes us believe that new lows are imminent in most stock markets. As we suggested earlier this week, one major casualty will be the emerging markets and this could unleash another round of US dollar repatriation and thus strengthening in the next few weeks.

Gold rising, equities falling, debt issuance ballooning to solve a exploding debt problem, savers being punished with zero interest rates for being economic anti-heroes because of their lack of spending – it makes for a harsh economic winter ahead. However, even in the Depression of the 1930s, huge equity rallies were witnessed as hope and greed re-surfaced from time to time. With zero interest rates (almost) and unemployment not at tragic levels (yet), an equity rally in a type of Indian summer could be soon upon us, whilst we feel just enough confidence in our leaders to save all of us, regardless of whether it is justified. It’s about the need to believe.

GBP bulls should be able to position from better levels than currently, but it may well prove to be a sizeable opportunity to procure a ‘value’ position between now and the beginning of April. First up, however, could be new lows in the equity markets. When? The media will scream out to the public, creating near panic. We expect the noise to mark the timing of this next major equity market low. Hold on tight.

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Neil Mackinnon is away this week. Today's blog entry has been written by Philip Manduca, ECU's Head of Investment

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18th February 2009

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With both equities breaking lower and gold pushing higher as forecast in this blog yesterday, the FX market behaved in a confused manner. The euro moved a little lower on fears that the looming emerging market debt crisis – particularly in Central and Eastern Europe – would inflict major damage to European banks. Sterling strengthened even though financial sector stocks fell significantly. Indeed, against the safe haven Japanese yen, sterling was slightly stronger on the day. It was odd. We think the most likely reason continues to be UK banks repatriating their overseas loans back to the UK requiring temporary sterling purchases.

Yesterday evening, Bank of England (BoE) policymaker Tim Besley stated that sterling weakness mitigates the prevailing deflationary pressures. We feel that it is going to be difficult for sterling to strengthen whilst the BoE continues to favour further weakness in its currency, and is forewarning that quantitative easing (a currency negative) is imminent if not upon us. The BoE must stop talking the currency down – in a mega-fiscal deficit environment it is the surest way to provoke a debt and currency collapse.

All other currencies have their problems too. Japan’s economy is probably in a depression. Europe is being severely challenged by both the dysfunctional fiscal structure within the eurozone, and by its enormous lending to the emerging market sector (Holland, for example, is chronically exposed). Switzerland is ready to depreciate its currency and suffers from a heavy GDP reliance on its own financial sector; and the US is in a fiscal deficit explosion of its own.

At present we still feel that the US dollar has a little more mileage to strengthen due to a global investor flight to ‘quality’ as equities move to test or make new lows. The dollar argument is supported by data confirming that overseas investors increased their purchases of US debt in December 2008, the latest month to be monitored. We expect sterling to drift lower against the dollar in the next few days.

But mark 2nd April in your diary. It is the date G20 meet in London and, just for once, we expect real co-ordinated policy measures to be put forward. This will combine with a series of improvements in the economic data releases over previous desperate statistics (not difficult and possibly not very meaningful), yet will allow hope to overcome fear, greed to ally with need, and equity markets to commence a rebound from probably new low levels prior to the end of March. This may well translate in the FX markets with a period of sterling strength. That is the good news.

The bad news is that by year end, hope could have given way to despair if a vicious cycle of corporate bankruptcies and declining wealth and permanent unemployment combine to create a sustaining and deep economic winter in most western nations. The probability of this bleak climate change is too slowly dawning on a populace weaned for so long on leverage, debt and excessive consumption. Yesterday has gone. We are going to have to re-invent our economic selves, as Western nations cannot compete with the labour markets of Asia and Africa. With the paper prosperity stripped away, we must ask: what “wealth” have we truly generated in the last decade or so to justify this generation’s huge increase in lifestyles compared to the conditions existing in the previous post-war generation?

The forthcoming economic winter brings into question the competency of the current government’s plan to re-generate the UK by making the country a manufacturing economy once again. What can Europe or the US produce in scale that most other emerging nations cannot also produce equally well, but at a much cheaper price? Answer this question and, just possibly, winter can turn into summer once again.

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Neil Mackinnon is away this week. Today's blog entry has been written by Philip Manduca, ECU's Head of Investment

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17th February 2009

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After a quiet US President’s day holiday in FX markets, volatility has returned immediately. The euro has broken lower versus the US dollar, whilst gold has moved above the $950 level. I believe that levels of fear and despair in the abilities of the US to IMMEDIATELY solve the world’s financial problems are increasing, and combine with insufficient fiscal support from most other G7 countries, as they appear to be relying on the US to bail out the world. This will not suffice. Worse, it would eventually lead to a debasement of the US dollar, the world’s reserve currency.

We are not quite at this point yet. First, we appear to be headed for another emerging market crisis as inward investment has shrivelled and de-leveraging and repatriation of money back to the US, Europe and Japan increases. I feel that this will temporarily increase the value of the US dollar AND the value of gold, which are normally negatively correlated. This is an important moment to get one’s timing right in markets as the medium-term picture will witness different FX movements than those that are likely to occur in the next few weeks.

Consequently, as equities now weaken again amidst increasing consumer and investor gloom, regardless of the fact that within a couple of months this author believes that economic data will have commenced a counter trend bounce, so we have to expect sterling to weaken too, particularly against the US dollar. We will be following this currency and equity market weakness very closely as the media trumpets that the world is coming to an end with equities capitulating to lower levels.

We believe that the G20 meeting in London will be a landmark event when a more co-ordinated approach amongst the major nations to the economic crisis will become apparent and the more positive investor emotions of hope, need and greed re-surface. All is not yet lost, at least not for the time being.

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Neil Mackinnon is away this week. Today's blog entry has been written by Mike Hughes, ECU's Head of Risk Management

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16th February 2009

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The G7 statement released from Rome was broadly in line with expectations, with the main focus again on fiscal and monetary stimulus. For those who had hoped for some clarity on recent FX moves, whether specific reference to the Yen or indirect reference to Sterling by highlighting the risks of competitive devaluation, there were few crumbs of comfort. Indeed, there was only the regular reminder that "excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability". As usual, the G7 "will continue to monitor exchange markets closely, and cooperate as appropriate". In terms of major FX market implications, the statement offered little that could be classed as notable or exceptional, something which may well have been designed to dampen some of the recent market volatility.

The Chinese currency was the only one singled out by the G7 for mention, but this too was in the most uncontroversial of fashions. "We welcome China's fiscal measures and continuedcommitment to move to a more flexible exchange rate, which should lead to continued appreciation of the Renminbi in effective terms and help promote morebalanced growth in China and in the world economy".

All in all there was no new information to be gleaned for the FX markets, and so we would expect a continuation of short-term volatility as at first stocks, then currencies rise and fall on risk appetite and aversion.

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16th February 2009

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I am away this week on school half-term holiday and so I will take a break from blogging until next Monday (23rd February).

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13th February 2009

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I came across a very interesting interview in Barron's from Ray Dalio at Bridgewater Associates. It is worth reading because I think it is a realistic assessment of what's going on in the financial system. His conclusions are bearish though he says buying equities later this year can /might prove profitable. Click here for the interview.

For the weekend, and to keep for future reference, there is an excellent study from Giles Keating and Stefano Natella at Credit Suisse called "Global Investment Returns Yearbook 2009". It looks at more than 100 years of data on financial market returns covering 17 markets that represent 90% of stockmarket value. The study finds that the real equity return is some 3-6% on average over the last 109 years and equities were the best performing class everywhere. The US was the best performer in terms of real equity and bond returns. However, many of the best performing equity markets over the last 109 years tended to be resource-rich and, quite often, New World countries. Click here for the study.

Otherwise it is the G7/G8 Finance ministers meeting in Rome today and tomorrow. The FX market is not expecting anything substantive here as the state of the global economy will likely be top of the agenda. However, it gives an opportunity for the US authorities to state their position on the dollar and especially their attitude to the Chinese currency.

Professor Ron McKinnon (no relation) at Stanford University claims that the Americans should agree to stability in the dollar/yuan rate in exchange for greater Chinese fiscal expansion. Click here to read more.

European Finance Ministers may give the UK Chancellor a tough time on the pound according to a story in The Daily Telegraph despite the recovery in the pound from its lows (click here for the article).

And finally, in today's Economist, is America's banking crisis worse than Japan's during the 1990's? It looks like it, says the Economist (click here to read more).

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12th February 2009

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Shock, horror. Mervyn King, the Bank of England (BoE) Governor, said yesterday that "the United Kingdom is in deep recession". The Bank expects the UK economy to shrink by 3% this year. If you exclude post-war adjustment years, then this is the worst UK recession since the Great Depression. In the Bank's Inflation Report published six months ago, the Bank did not mention the possibility of recession once. In yesterday's Inflation Report it was mentioned 39 times (click here for an article in The Telegraph). Mr King said yesterday, "I'm not paid to forecast the future. It is pointless to to pretend you can forecast the future precisely."

I think this statement is astonishing. No one expects precise forecasts but I think it is his job – along with the vast army of economists employed by the Bank and the government – to at least understand what might be going on in the economy and draw some sort of conclusion. Did anyone not think that the huge build-up in UK household debt, the bubble-type increase in UK house prices and the fact that UK banks had the largest loan-deposit ratios of all the European banks (plus huge dependency on short-term funding) was not an accident waiting to happen? If not, Mervyn King should hand his PhD back. Understandably, the FX market was less than impressed and sterling's recent rally is now starting to turn round (as I thought it would) and looking at my technical charts, there is still scope in the near term (i.e. next few days) for sterling to lose ground against the major currencies. Zero interest rates are on the cards now for the UK (soon) and the BoE is now following the Fed and is starting to implement ‘quantitative easing’. The latest UK unemployment figures report 1.97 million people out of work and I think the unemployment situation will get worse.

President Obama's stimulus package and Mr Geithner's bank rescue package have not been well received in the equity market. There doesn't seem to be much stimulus (see the Congressional Budget Office assessment of the impact on the US economy here) with the plan bringing about only a 1% average decline in the unemployment rate over the next three years. Mr Geithner's ‘plan about a Plan’ has been criticised for lacking detail but I suspect Wall Street's negative reaction was simply down to the absence of a bumper no-strings attached bail-out. I reckon the US and UK banking systems are virtually insolvent and I think the end-game will be nationalisation. Clause 4 no longer looks stupid, comrade.

Against this background, gold continues to rise and stands at US$944 as I write. My colleague, Philip Manduca (ECU’s Head of Investment), thinks the gold price will breach US$1000 en route to US$2000. Currency debasement and an investor preference for hard assets over paper assets are the rationale (click here for a nice chart and history of the gold price from 1954-2009). Since the beginning of this year, the gold price and the trade-weighted dollar have moved up in tandem. Normally, the gold price goes up when the dollar goes down (the hard asset/paper asset trade) but it looks as though in the current environment there is both a demand for the leading reserve currency and the leading hard asset. Weighing on the euro (the ‘anti-dollar’) are reports that the toxic debts of European banks may pose a systemic risk to the European banks (click here to see an article in The Telegraph). While this sounds bearish for the euro, I would caution that repatriation and demand for liquidity flows might temporarily prop up the euro but it's not exactly bullish for the euro in the longer term.

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11th February 2009

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As I intimated in my blog yesterday, there was likely to be market disappointment with the US stimulus measures and bank rescue package. So it proved with bond yields lower on fresh risk aversion and the S&P index closing lower with a 5% loss on the session. Read Martin Wolf in the FT today "Why Obama's new Tarp will fail to rescue the banks".

Equity markets look fragile this morning and in the FX market we have seen sterling lose some ground on the major cross rates with the US dollar looking a little soft. As risk aversion goes up, the yen goes up and, ahead of the G7 meeting on Friday, $/yen is back below 90. My guess is that the Bank of Japan/Ministry of Finance will ‘smooth’ volatility in $/yen. I'm not sure the G7 meeting is going to come up with anything that surprises the FX market.

As far as the euro is concerned, there was some focus in the FT this morning that the ECB is closer to a zero rate policy than the market thinks (click here to read more). I certainly hope so.

The FT (in the company section – click here) carries a reasonably upbeat article on the pound. However, as I pointed out earlier this week, the technical charts point to some short-term corrective price action in the major sterling crosses though I do not think you will see new lows in the pound.

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10th February 2009

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So says Ed Balls (the Secretary of State for Children, Schools and Families), Gordon Brown's closest ally. He could well be right. All eyes then on the Obama stimulus plan and Geithner bank bail-out plan to save our bacon. Unfortunately, it's not clear at this stage that the plans will live up to expectations. For a good analysis of what the stimulus bill is about, click here. The US banking sector is probably insolvent and plans that fail to recognise this could end up looking ‘half baked’. In the UK, bank chiefs appear this morning in front of the Treasury Committee. The UK Government has been pretty weak in dealing with the banks. Perhaps what the Government should have done is to immediately step in and sack the boards and freeze pay and bonuses. It is a public scandal that taxpayers’ money has been used to pay ‘bonuses’. Bonuses for what? So any notion that the Treasury Committee will be a ‘show trial’ is some distance from the point. Stalin would have known how to deal with the bankers.

While we are on a Russian theme, the latest news overnight was a story that Russian regional banks are looking to renegotiate loans worth US$400billion. Admittedly, details are sketchy on all of this but there may be trouble ahead here despite the best efforts of the Putin Government to avoid a repeat of 1998. The sovereign credit default swap for Russia stands at a whoppoing 700bps. Russia has defaulted before (1998) and a maxi-devaluation of the rouble looks quite likely to me. This isn't good news for emerging marketsgenerally as western investors have bad memories of the 1998 crisis.

In the eurozone, the economic news continues to get worse. Data released this morning reported French industrial production was down 1.8% in December after a 2.8% decline in the previous month. Industrial production is now falling at its fastest rate since the inception of the eurozone in 1999. The ECB needs to act in cutting interest rates soon.

In the UK there was mixed economic news overnight with BRC retail sales up but with RICS house prices at their worst in 30 years. I am in the camp that believes the UK economy is still struggling. The unemployment situation looks bleak. As a result, I think that recovery is some way off. Hopefully, we will see ‘green shoots’ in 2010. As far as sterling is concerned, I do think it has bottomed BUT the recent rally looks a little overdone and there is a risk of correction in the sterling crosses over the near term. This might then give better entry levels before the next leg in any sterling recovery.

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9th February 2009

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Last week's interest rate moves were as predicted, but the US jobs report on Friday was poor, not that any one was looking for any improvement in the US jobs market. 3.6 million jobs have been lost in the US in the last 13 months and the current jobs downturn could end up being the worst since the Great Depression (click here for more information). Interestingly, the S&P index ended up 2.7% on the day on the basis that bad economic news would concentrate the minds of US policymakers/Congress and hasten the arrival of a large fiscal stimulus. The risk is, of course, that the markets end up being disappointed. There is already Congressional wrangling and the ‘bad bank’ proposal could end up being compromised (click here to read Professor Krugman’s article in the NY Times). The bottom line is that both the fiscal stimulus and banking clean-up measures may end up being a let down. In this scenario, the S&P index gives up its recent gains. There is key Congressional testimony from Messrs Bernanke and Geithner tomorrow which will be closely monitored.

Otherwise, looking at the FX market this morning, it looks short term that sterling could give back the recent rallies against the dollar, Swiss franc and yen. The dollar looks a short-term sell against the yen and Swiss franc and maybe the euro too (short-term trend line support at around 1.2600). It could be an interesting week.

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6th February 2009

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The Bank of England, as expected, cut interest rates by half a percentage point to 1.00%. Whether they decide to cut again is open to debate but one thing is for sure in my opinion and that is that very low interest rates are with us for sometime to come. I believe 2009 will be a write-off for the UK and global economy. Deleveraging, restructuring and higher unemployment will be the key themes. As far as the European Central Bank (ECB) is concerned, their decision to keep interest rates unchanged yesterday at 2.0% beggars belief and I said as such when I was covering the ECB's interest rate announcement on CNBC yesterday lunchtime. This was a day in which the latest data release for the German economy reported a slump of 6.9% in factory orders for the month of December. This was on top of a 5.3% decline in November. There are myriad other economic indicators, not just for Germany, but for the rest of the eurozone which highlight the very serious possibility that ECB inaction is dragging the eurozone into deflation and depression. You would have thought they might have read their history books.

The main focus for the financial markets today is the release of the US jobs report. This is one of the closely watched economic releases of the month and often sets the tone for investor sentiment and price direction for the equity, fixed income and currency markets in the weeks ahead. The market consensus looks for a drop in non-farm employment of 540k following a decline of 524k in December. The US unemployment rate is expected to rise to 7.5%. An eventual rise to 10.0% would not be a surprise in my view. Other auxiliary labour market indicators like the Monster Employment Index (down 13 points in January), the ADP private employment numbers (down 522k) and planned layoffs at US firms at their highest monthly level in seven years would suggest that the underlying picture is poor. The equity market wants to think otherwise at the moment and is trading on ‘hope’ ahead of the Obama stimulus package and ‘bad bank’ plan. A crucial juncture for markets I think (equities and FX) and we will see whether risk appetite is back on a durable basis.

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5th February 2009

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The Bank of England is expected to cut interest rates again today though the ECB is expected to keep interest rates unchanged. UK interest rates at 1.00% with 'quantitative easing' is likely to be in place for some time, given that the UK economy is unlikely to recover any time soon. In the financial markets there are some optimists though who believe that the global economy might be getting better not worse. For example, US Treasury bill yields have increased from zero to 0.25%, the US 2-year Treasury bill yield is close to breaking above 1.00%, suggesting that investors are using excess cash piles to put risk back on the table. A sharp recovery in the Baltic Dry index (a proxy for Chinese raw material demand), together with sharp increases in gold and copper have been key features of this week's price action. Does this mean China is starting to stockpile again as part of a massive infrastructure plan? Maybe, though I think it doesn't mean that a global recovery is just around the corner. Any recovery in China will likely be domestic-focused rather than export-focused, but it does mean that there is scope for commodities (base metals etc.) to go up in the medium term.

As far as equity markets are concerned, there is clearly a lot of 'hope' that the US Administration will come up with a sizeable package (US$900bn?) but there is increasing wrangling in Congress which might dissipate in terms of its market impact going forward. So the markets are at an interesting juncture in the battle between bears and bulls. The reaction to tomorrow's US jobs report is important I think. If equities react positively tomorrow then sentiment will be bolstered and this means in terms of FX risk appetite that you buy sterling (as a proxy for global risk), sell yen and swiss franc...and sell the US dollar. We shall see.

The ECB is not expected to cut interest rates today with the next cut pencilled in for next month. The ECB continues to lag behind other major central banks in terms of easing monetary policy. The eurozone economy is in bad shape and looks as though the situation is getting worse. It is difficult to get bullish about the euro which is now testing technical support on the charts at 1.2600-1.2780. If these levels break down, a move to at least the low 1.20s is then imminent. Any recoveries in the euro will be shallow I think (repatriation and liquidity demand notwithstanding) and provide opportunities to sell the euro again.

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4th February 2009

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At yesterday's annual FX conference at Goldman Sachs in London, their economists and strategists again made positive noises in favour of sterling. It is entirely possible that yesterday afternoon's minor rally in the sterling/dollar exchange rate was on the back of FX investors taking heed of Goldman's advice. Admittedly, the rally was not huge and there may be plenty of investors and traders who are not entirely convinced of the arguments. But as I have said on my blog previously, the market mood with regard to sterling had become extremely ‘one-way’ and bearish. Jim Roger's famous comments the other week ‘sell sterling now’ might actually have marked the low as such extreme comments usually do. Yesterday's announcement by the Bank of England (BoE) that it will accept government-guaranteed yen denominated debt as collateral is also perhaps recognition of UK banks exposure to sizeable FX liabilities which I have commented on before.

But for many in the FX market, it is all about the US dollar which in turn is all about equity markets. If you are an equity market bear then you have got to believe the dollar goes up as risk aversion increases. You also buy the yen and Swiss franc in this scenario. If, on the other hand, you are an equity market bull then an increase in risk appetite is to the dollar's disadvantage. Of course, it may not turn out to be this simple. Funding pressures in the money markets and FX swap arrangements complicate short-term FX flows but it is these short-term flows which dictate price action in the FX market rather than economic fundamentals.

Tomorrow sees the BoE make its latest decision on interest rates. The market expects a 50bps cut. The Bank has already moved towards ‘quantitative easing’. In contrast, the ECB is still dragging its feet and the market is not expecting a rate cut until March. The economic situation in the eurozone is getting worse and European banks stand over-exposed to emerging market debt. If for any reason, the euro should go up against the US dollar in the near term (and technically there is scope for a minor recovery in the euro) then I think you should treat any rally in the euro with care. It certainly won't be down to economic fundamentals and will more likely be a function of those short-term liquidity flows.

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3rd February 2009

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No, cabin fever has not set in despite being snowed in at home. But I have taken the opportunity to extend my usual reading list. First, I recommend a new report from the Milken Institute which contains some great charts and tables relating to the US housing market as well as the financial crisis. In particular, there is a fascinating chart of US house prices since 1890 which shows how far house prices went off track during the recent ‘bubble’. There are also good summary tables detailing recent policy initiatives from the US authorities in dealing with the financial crisis. Click here for the report.

Second, my former colleague from way back at Merrill Lynch, David Rosenberg, has put together an interesting compendium of charts and analysis on the US economy. He thinks the economy is already in a depression. When I worked at Merrill pre-dotcom bubble, there was a massive banner in the reception area of the London office which said ‘Be Bullish!’ Those were the days. Click here for the report.

Third, I came across a selection of charts detailing what happened in the US economy during the 1930s Depression. Mr Bernanke, the current Fed chairman, is an expert on the history of that period. In the 1930s, the Fed contracted the money supply and the banking system nearly fell apart. This time around, the Fed acted quickly by providing liquidity as well as other measures designed to resolve the impairment of the money market and credit markets. There are some indications from movements in credit and money market spreads that the Fed's measures are gradually working. Click here to see more.

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2nd February 2009

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