The global economy, allied with central bank measures to alleviate the downturn, was the dominant market focus over the week. Volatility increased sharply as the dollar weakened sharply before securing a strong recovery from lows against European currencies.
The US economic data maintained a very weak tone as consumer prices fell sharply by 1.7% in November after a 1.2% fall previously. Core prices were unchanged following a 0.1% decline for October to give a 2.0% annual increase. Housing starts weakened to an annual rate of 0.63mn for November from a revised 0.77mn previously while building permits fell to 0.62mn with both series at 50-year lows.
The Philadelphia Fed index remained extremely weak with a reading of -32.9, although this was an improvement from the -40.0 previously which suggested that the rate of deterioration may be slowing, Initial jobless clams fell to 554,000 in the latest week from 575,000 previously with continuing claims at another 25-year high.
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The main attention was on the Federal Reserve FOMC meeting and the Fed sanctioned a further aggressive easing of policy. The Fed Funds rate was cut to a target range of 0.00 – 0.25% from the previous 1.0%, the lowest rate ever recorded. In the statement, the FOMC stated that the economy had weakened further with a deterioration in labour markets while financial markets remain quite strained. It also stated that inflationary pressures had diminished appreciably.
As well as the rate cut, the Fed pledged to continue large-scale purchases of agency debt and mortgage-backed bonds. The FOMC is also evaluating the potential benefits of purchasing long-term Treasury Securities. The move to near-zero rates and shift towards quantative easing will continue to curb yields. US yields continued to decline with the 10-year yield at a record low. There were suggestions that a second fiscal stimulus from the next Administration could be at worth least US$675bn.
The German IFO index weakened to 82.6 from 85.8 which was a record low since the index was created in 1982. Although IFO officials suggested that interest rates should be cut by a further 0.50%, they did not signal that conditions had deteriorated further.
The ECB did not announce any change to the main financing rate on Thursday, but they did adjust the rate corridor. The deposit rate was cut by 0.50% to 1.0% while the lending rate was increased to 3.0%. The move suggest that the ECB is looking to discourage deposit inflows and this pushed the currency sharply weaker.
ECB Chairman Trichet stated that there was a limit to how far interest rates can be cut. Bundesbank head Weber stated that the ECB had some scope to lower interest rates and that a decline to below the 2.0% level was possible briefly, although he also warned that rates would need to be increased rapidly once economic conditions improved. Officials did not indicate alarm over the Euro’s rise.
The dollar initially came under heavy selling pressure and dipped to lows beyond 1.47 against the Euro before a sharp correction back towards 1.40. There was an even sharper move against the Swiss franc with the dollar weakening to lows below the 1.05 level before rallying to 1.10. The US currency dipped to two-month lows on a trade-weighted index before a recovery.
The Australian and Canadian dollars secured a net advance over the week as the US currency lost ground, but weaker commodity prices were an important barrier to gains for these two currencies with Australian selling above 0.70 against the US currency.
The Japanese data remained weak with the Tankan business confidence survey weakening sharply to -24 in the latest quarter from -3 previously while capital spending estimates were also lowered. There were further profit warnings from the industrial sector, especially the car sector, as confidence weakened.
Bank Governor Shirakawa also stated that the bank needed to lower its outlook on the economy with conditions severe following the Tankan survey. Following the monetary meeting, the central bank cut interest rates to 0.10% from 0.30% by a 7-1 margin while there were additional measures to boost credit supply.
The Finance Ministry also indicated alarm over the further yen strengthening and there were warnings over intervention, although no confirmation of any yen selling.
The Japanese currency strengthened against the dollar with fresh 13-year highs near 87.10 before correcting weaker while it lost ground against the Euro as intervention fears curbed yen buying.
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The UK labour-market data remained very weak with a further 75,700 increase in jobless claims for November after a revised 51,800 increase the previous month, the fastest rate of increase since 1991. The December CBI retail sales index was a record low of -55 from -46 the previous month. The official retail sales data was better than expected with a 0.3% increase compared with expectations of a 0.6% decline, although the data quality is questionable, especially with heavy price discounting.
The government budget position continued to deteriorate with a record GBP16.0bn borrowing requirement for November pushing the cumulative figure to GBP56.1bn.
Consumer inflation fell to 4.1% from 4.5%, but markets had expected a larger decline while the core rate increased slightly to 2.0% from 1.9%. In its inflation letter to the Chancellor, Bank of England Governor stated that inflation would fall back to the 2.0% target in the first half of 2009 while it could dip to below 1.0% over the second half. The comments reinforced market expectations of further cuts, especially with Chief Economist Bean’s comments that rates could be cut to zero.
Sterling remained under heavy pressure with a succession of record lows against the Euro with a weak point beyond the 0.95 level before a slight correction. The UK currency resisted heavy losses against the dollar, but hit heavy selling above 1.55 with a move back to the 1.50 region.
