By Darrell Jobman, Editor-in-Chief,

Markets attempted to stabilise early in the week, but stresses increased substantially later in the week given the severe dislocations following the credit crisis. There were severe tensions and extreme volatility in the currency markets over the second half of the week.

There was a significant easing in money-market rates during the week as the unlimited central bank injections of liquidity had an effect. The easing of these pressures was offset by sharply increased fears over global economic conditions.

There were further major emerging market stresses with notable tensions in Argentina as the government acted to nationalise pension funds while regional equity markets also fell sharply and severe stresses spread to other major emerging markets. These pressures were very important in providing underlying dollar support over the week as positions were reduced or forced to be closed on massive stop losses.

Risk appetite remained low and the exodus from high-yield and commodity positions was also important in bolstering the dollar with fear at very high levels as metals prices fell sharply and oil prices fell to a 20-month low near US$60 per barrel.

There was little in the way of US major data releases over the week with initial jobless clams rising to 478,000 in the latest week from 463,000 previously. House prices recorded a further decline for August while foreclosures increased by over 70% in the year to the third quarter although there was a small quarterly decline.

Fed Chairman Bernanke maintained a downbeat view of the economy with a warning that there had been a serious slowdown with particular concerns over a sharp downturn in auto sales. Markets continued to price in further interest rate cuts next week.

The Euro-zone PMI data recorded a monthly decline for October which reinforced pessimism over the region. The comments from ECB officials retained the more dovish slant seen over the past week. Gonzalez-Palermo, for example, stated that there was scope to lower interest rates without undermining inflation control and this appeared a strong signal that rates would be cut again in November.

The Euro-zone current account remained in deficit for August at EUR8.4bn with net investment outflows. There will be further fears over capital outflows and sentiment will remain weak, but there may be scope for longer-term buying to emerge.

US Dollar Index
Source: VantagePoint Intermarket Analysis Software

The dollar retained a very strong tone over the week with gains to a 2-year high against the Euro beyond the 1.26 level and it also pushed stronger on a trade-weighted basis as there were strong advances against many emerging-market currencies.

As risk aversion spiked higher, there were huge gains for the Japanese currency. The yen pushed to a high near 91 against the dollar which was a 13-year low for the dollar while the Euro suffered massive losses to a four-year low below the 116 level.

There was increased speculation that the Bank of Japan could move to sanction a cut in interest rates to counter the slowdown and there was also further speculation over a second fiscal stimulus. There was also some speculation that the Finance Ministry could intervene to stabilise markets given the surge in volatility.

The commodity currencies remained under very heavy selling pressure as prices continued to decline sharply. The Australian dollar dipped to lows below the 0.62 level against the US currency during the week while the Canadian currency weakened to lows beyond 1.28.

Bank of England Governor King issued a downbeat assessment with a warning that it was likely that the economy was entering a recession with a difficult few months ahead. King also stated that there was the risk that Sterling would fall further and faster than expected previously which triggered another wave of negative sentiment towards the currency. The Governor also stated that the bank had room to act on rates.

There was little relief from the economic data over the week. The CBI industrial survey recorded a decline in the orders component to a five-year low while the overall quarterly survey was at a 30-year low. Retail sales fell 0.4% in September with the annual increase at a three-year low of 1.8%, although there will be some relief that the decline was not even sharper.

The GDP data recorded a 0.5% decline for the third quarter, the first decline for over 15 years and steeper than market expectations of a 0.2% decline.
Sterling came under heavy pressure as confidence in the economy and currency continued to deteriorate. The UK currency weakened against the Euro and also dipped very rapidly to a five-year low against the dollar with a trough below the 1.55 level.