by Darrell Jobman, Editor-in-Chief TraderPlanet.com
EUR/US$
The Euro pushed to highs around 1.3520 on Tuesday as rumours of an interest rate cut hit the dollar before weakening back to lows around 1.3460.
Speculation over a rate cut increased after an announced meeting between Fed Chairman Bernanke, Treasury Secretary Paulson and Senate banking committee chairman Dodd. The dollar hit a low point in early US trading at the time when a rate cut would probably be announced and then rallied as there was no announcement.
There are still very serious credit concerns which will maintain pressure for remedial action. Fed sources indicated that the central bank was ready to act on credit, but was not alarmed. After the meeting with Bernanke, Dodd stated that the Fed had promised to use all the tools available.
If measures other than a rate cut fail to stabilise conditions, then pressure for lower interest rates will increase. Futures markets have now fully discounted a 0.50% rate cut within the next four weeks compared with around 60% chance yesterday.
The interest-rate related dollar vulnerability will continue to clash with safe-haven demand. Institutional flows into US Treasuries will continue as credit remains tight which will provide important dollar protection.
The German ZEW index weakened to -6.9 in August from 10.4 the previous month. Given that the data was mostly compiled before the latest market turbulence, there will be fears over a further decline in the index next month. This downturn will maintain doubts over a September ECB interest rate increase.
Yen
The dollar failed to hold above the 115.0 level against the yen on Tuesday and weakened to lows around 114.20 in US trade. The Euro also lost support above the 155.0 level against the yen.
Precarious underlying credit conditions will ensure caution over high-yield currencies, especially with fears that further hedge-fund losses will be revealed over the next few days. The large swings in currencies will also continue to deter carry trades with volatilities double the yearly average at present. These factors combined will continue to provide important short-term yen protection.
Given the underlying stresses, only a small jolt in global markets could still trigger a rapid unwinding of carry trade positions and sharp yen gains.
The Japanese currency will tend to strengthen if there are rumours of a Japanese interest rate increase ahead of Thursday’s announcement, although an unchanged policy looks more likely.
Sterling
Sterling weakened to lows below 1.9750 against the dollar on Tuesday before a rally back above the 1.98 level. Sterling also found support weaker than 0.6810 against the Euro as confidence recovered slightly.
Sterling was unsettled during Tuesday by rumours that a UK insurer was in financial difficulties. The Bank of England’s emergency discount window was also tapped during the day which increased speculation that a major UK institution was facing difficulties rolling over credit facilities.
The high level of risk aversion will continue to undermine Sterling confidence in the short term with much greater caution over carry trades.
The CBI industrial survey is unlikely to have a major impact on Wednesday with markets focussed primarily on the financial sector. As long as the Bank of England holds firm on interest rates, Sterling should gain support, but with sharp losses if the bank hints at a rate cut.
Swiss franc
The Swiss franc continued to edge stronger against the Euro on Tuesday with highs near 1.62. The franc was unable to break through 1.20 against the dollar and retreated to 1.2065 in cautious trading.
The persistent credit concerns will continue to support the franc in the short term, especially as confidence in the Euro-zone financial sector has weakened with persistent fears over further banking-sector losses.
The Swiss trade account remained strong in July with a CHF1.57bn surplus from CHF1.65bn the previous month, although the impact will be limited with markets dominated by credit-related stresses.
Australian dollar
The Australian dollar failed to hold above 0.8050 against the dollar on Tuesday and fluctuated around the 0.80 level after finding support close to 0.7950.
The domestic indicators have remained limited with attention still focussed firmly on the global market trends and Australian dollar buying will continued to be undermined by credit-related stresses. A resumption of downward pressure on stock markets, in tandem with banking difficulties, would tend to weaken the currency sharply. There will still be some protection on yield grounds especially with markets looking for a cut in US interest rates.
