by Darrell Jobman, Editor-in-Chief

There was further extreme tensions in the global financial markets over the week as fears over the deteriorating economic trends and the banking sector continued to escalate amid scenes of near panic in many markets.

The Japanese currency strengthened rapidly as market fears intensified and there was evidence of a massive unwinding of carry trades. The yen tested levels below 100 against the dollar and also strengthened to highs beyond 135 against the Euro. The Swiss currency also gained strong support over the week with a peak beyond 1.51 against the Euro.

The Australian and Canadian currencies were subjected to extreme selling pressure on the week with the Australian dollar declining to lows near 0.65 against the US currency which was a four-year low for the currency while the Canadian dollar dipped very sharply to 1.17 from near 1.03 in late September.

At the end of last week, the House of Representatives approved the Troubled Asset Rescue Plan following its rejection the previous week. Despite the approval, Wall Street remained under heavy selling pressure and dipped to five-year lows with the Dow Jones index weakening sharply to below the 9,000 level on Thursday.

There was a sharp deterioration in emerging-market sentiment with the Brazilian and Mexican currencies, for example, falling very sharply. There were also huge stresses surrounding the Icelandic economy and the dollar continued to gain defensive support as funds were forced to unwind positions in emerging markets and commodities.

The global central banks continued to battle against extremely tight credit markets over the week. Despite further liquidity injections and the financial-rescue plan, market stresses remained intense with spreads still at extremely elevated levels. Fears over the global economy, allied with structural dollar demand on a liquidity shortage, continued to benefit the US currency and it retained a firm tone. The dollar pushed to a 14-month high against on a trade-weighted basis while it pushed to near 1.35 against the Euro.

The Federal Reserve also cut interest rates in a co-ordinated move with a cut to 1.50% from 2.00%. The central bank also stated that it would move to buy Commercial Paper in the markets while there was some speculation that the Treasury would take direct stakes in the banking sector, but sentiment remained extremely fragile.

Federal Reserve Chairman Bernanke was generally downbeat in his assessment of the US economy and at the end of last week there was a reported decline of 159,000 in September employment, the steepest decline of 2008 and the ninth successive decline.

US Dollar Index
VantagePoint Intermarket Analysis Software

There was little in the way of major economic data over the week with initial jobless claims falling to 478,000 in the latest week from 498,000 the previous week.

There was a decline in monthly consumer credit for the first time in over 10 years which maintained fears over the outlook for consumer spending.

Early in the week, there was confusion over the German stance over bank deposit protection and fears that the European authorities would not be able to make a concerted approach unsettled confidence in European markets. There were no major developments from the ECOFIN meeting of European officials.

As part of the co-ordinated central bank moves, the ECB cut interest rates by 0.50% to 3.75% from 4.25%. The central bank cited additional risks to the growth outlook and a reduction in inflation pressures for the move to cut rates.

The UK currency initially held firm against the Euro, but then weakened sharply later in the week with a retreat to around 0.7960. The UK currency remained firmly on the defensive against the dollar and dipped to lows below 1.70 the weakest for five years.

The banking sector remained a key focus and the government announced a major rescue plan as fears over the sector increased. There was GBP50bn support package for the banks with the government taking a stake in the banks while there were wider guarantees with the total potential support for the bank at GBP500bn.

The Bank of England moved the schedule interest-rate setting meeting 24 hours earlier and joined in with the co-ordinated interest rate cuts with a reduction of 0.50% in the repo rate to 4.50% from 5.00%. The bank cited increasing fears over growth and a reduction in inflation pressures, although it still expected inflation to increase over the next 2-3 months. Markets moved to price in an accelerated pace of rate cuts.