ProgressiveFX.co.uk

The week closed with risky assts; GBP, EUR, AUD inparticular rebounding in a fairly unconvincing manner from recent lows after several days of predominately downside volatility as concerns intensified over the state of the global economy, weak commodity prices and fears of the viability of the US and UK banking sector in the absence of further Government support.

In the UK, the Labour Government is under increasing pressure to more effectively tackle the collapse in banking sector confidence and investors have sold off banking stocks aggressively with BARC and RBS particularly hard hit with Barclays suffering on rumours the management have not been sufficiently prudent in the marking down of assets and bad debt provision.

The weakest Britsh QoQ GDP data, 1.5% lower, since the early 80's further encouraged investors to short Sterling with the main beneficiary over the week being the Yen which reached new multi-year highs against GBP as investors sold higher risk currencies in pursuit of relative safety.

The Euro-zone also remained under focus with appalling economic fundamentals in Spain, Ireland and Greece dragging the single currency lower despite a relatively stronger scenario in the regions largest economy Germany .

Looking forward we are likely to see further volatility in EUR, GBP and AUD as bullish investors try to catch currencies at stretched RSI's hoping for a bounce whilst pessimists continue to short riskier currencies in anticipation of continued weakening economic data.

Recent days have seen a return to deep pessimism that even an historic Obama inauguration could not lift. UK bank shares have collapsed further with RBS now down from around 650p to 13p in just 2 years. Without UK government intervention is it quite possible the bank along with HBOS may have disintegrated on a lack of liquidity and enormous bad debt exposure. GBP has fallen to new multi-year lows against the Dollar as speculators shorted the UK currency unsure of the liability the UK Government has acquired by committing to endlessly support fundamentally flawed entities.

Equities have also fallen back though not as far as October / November 2008 lows, but another couple of bad sessions could further undermine fragile confidence and we could as yet see new lows.

On a more positive note even the dithering ECB have started to acknowledge the deepening economic problems and have more proactively reduced rates, though they are still behind the curve relative to the Fed and BoE.

Globally, with unemployment worsening, corporate profits slumping and renewed fears over the viability of the banking sector we are more likely to see further strength in the JPY and even the USD, which despite the US $12 trillion deficit, continues to attract risk averse capital due to its position as the worlds leading reserve currency.

Looking forward hedge funds closures will persist, more smaller US banks will fail, RBS and the Lloyds Group may well move closer to full nationalisation and the financial community will quite possibly never be the same again.

The pound made a nervous start to the week, Rightmove House Price Index came out better than expected at -2.3% m/m versus the prior reading of -2.9%. While the number were initially supportive for sterling house prices are still expected to fall which capped any benefit the numbers provided. Cable trade was dictated by the crosses with EUR/USD creating markets trends for the pound. President Bush failed to provide markets with a clear decision on the bail out of US car makers on Monday and linked with weaker industrial production pushed the dollar to 2 month lows. Oil prices rose to above $50 per barrel on speculation that OPEC would announce further production cuts and added to the pressure on the US Dollar. However, the main focus of the week was certainly the FOMC meeting and UK CPI data. The Fed surprised markets by cutting interest rates by 75 basis points and added to this confirmation to the markets that interest rate would be kept within a 0 to 0.25% range. These levels in rates gives the Fed fewer tools at their disposal to stimulate the US economy and places ever greater pressure on the US government to deliver fiscal stimuli.

In contrast to the Fed, ECB President Trichet stated that the central bank would not cut interest rates forever, strongly hinting that they may keep interest rates on hold at their next meeting in January. German CPI data mid week further support the euro coming out in line with expectation and while the data maintained the euro’s trend higher traders were focused on the Bank of England minutes due later in the day. The minutes were considered to be quite dovish, revealing the MPC unanimously voted for a 100 basis point rate cut and discussions of a even larger cut. The pound hit a new record low breaking the 1.05 level versus the euro before retracing as the dollar recovered late week on the confirmation of a bail out for the US car makers and profit taking took place.

Next Week:

Sterling is more than 3% lower against the dollar and over 2% lower against the euro. This reflects market reaction to the yesterday?s Bank of England Quarterly Inflation Report, and subsequent press conference. Much of the data for the Report was compiled before the MPC decision to reduce base rate by 1.5%. Consequently there was considerable focus on the Bank of England press conference. The Governor stated that current financial market conditions were ?unprecedented?. He laid emphasis on the rapid turn of events in September and October, citing three key factors behind the decision to reduce base rate by 1.5% on November 6th. These factors were: (1) very negative UK survey data (2) the exceptionally sharp fall in commodity prices (3) the collapse of Lehman and associated financial market events. The emphasis of the MPC is clearly on risks to growth. Short term, there is likely to be further downturn in sterling, which in the long run will place UK industry in a competitive position once the global economy recovers momentum.

Period rates have fallen significantly in response to the Quarterly Inflation Report and subsequent press conference comments. Forward markets virtually discount a fall in UK base rate to a low point of 2% by the spring of next year. The Governor placed emphasis on the 2% inflation target, emphasising that CPI would have fallen to 1% within the next 2 years had there not been a substantial reduction in base rate. The Governor indicated that further interest rate action would be taken if required. The current UK central bank forecast for growth is negative short term followed by a significant upturn in late 2009. If the economic climate continues to deteriorate, a fall in base rate to 1% is feasible. Our current view is that signs of recovery in the housing market will be apparent in the spring of next year and that base rate will reach a trough of 2%. The biggest risk to growth is the rise in unemployment. In September, the unemployment rate rose by 0.1% to 5.8%. It may well reach 7% by the spring of next year. Yesterday, 3 month LIBOR fixed at 4.3100%.

Equity markets remain in negative mode despite the prospect of further interest rate cuts and the probability that the global downturn will be far less pronounced than in the past. The impact of the credit crunch remains the key driving force, given the financial pressures facing some of the largest corporations, notably General Motors.

Brent crude (1 month forward) has fallen to $51/ barrel, on the negative prospects for European growth following the UK Inflation Report and a sharp downturn in German economic growth.

Market focus this week has been squarely on the European Central Bank and the Bank of England MPC meetings, both of whom had their monetary policy meeting this week, and the U.S presidential Elections. The U.S made history on Wednesday as Barack Obama becoming the new President elect. Equity markets reacted favourably to the election results which placed the dollar under pressure early in the week. The BoE shocked markets by cutting interest rates by 150 basis points, bring the central bank?s lending rate to 3%. Market speculation had been for between 50 and 100 basis point cut but the unprecedented move caught most traders completely off guard. Reaction to the rate cut was very mixed as the size of the cut sparked fears anew that the extent of the credit turmoil and recession is possibly  far worse than analyst may have initially thought. Global equity markets suffered heavy losses as investors once more fled risky positions to favour the dollar. The BoE statement to support the interest rate decision on Thursday indicated the MPC felt that the UK economy would suffer a severe contraction in the short term, the housing market would continue to deteriorate and consumer budgets are likely to be squeezed even further.

The ECB also delivered a rate cut this week, cutting by 50 basis points, in line with market forecasts. The announcement came shortly after the BoE decision and disappointed many traders who had begun to price in the possibility of a larger cut. ECB President Trichet was able to calm markets during the follow up press conference. He left the door open for future rate cuts and made it clear that the ECB will take appropriate action to ensure economic stability is achieved and maintained.

The dollar made some late week gains on the back of Thursday?s equity market slump but volatility for the US dollar was not only driven by stock markets but also by weaker economic data that quickly saw the buck give up most of its gains. Employment data this week came out much worse than market expectation. U.S ADP data showed employers shedding 157,000 jobs in October. The ADP report was followed at the end of the week by the U.S Non Farm Payrolls, the report painted an even bleaker picture of the US economy showing 240,000 job were lost in October, market participants had expected a loss of only 200,000. The unemployment rate in the U.S increased to 6.5% from the previous months 6.1%. The data called into question whether the U.S economy was actually recovering as well as was first thought.

After a week where inflation, recession and interest rate outlooks have dominated the markets, traders will keep a close eye on the weeks inflation data. The BoE rate cut has confirmed a complete shift in focus for the MPC who have in the past been primarily focused on price stability. Analysts will want to see whether inflation data will support the central banks statements that lower energy and food prices will eventually bring inflation to within the bank?s inflation target range.

Sterling is significantly lower against the dollar and over 1% higher against the euro. This reflects movements in the dollar/euro rate following better than expected US growth data. Gross domestic product fell by an annualised 0.3% in the third quarter. The impact of the weak US domestic economy was partially balanced by a 6% increase in exports. There is a limited volume of key economic data today. The major releases from a UK perspective are the Chartered Institute of Purchasing and Supply Managers surveys which are good leading indicators of trends in the UK economy. The surveys are expected to provide evidence that the contraction in the UK economy will continue throughout the winter months. We expect clear evidence of economic recovery to be apparent in early spring as the full impact of monetary policy easing works through the economy.

The pound has virtually collapsed against the majors shedding over 14% of its value against the U.S Dollar and 6.5% against the EUR this week.

The pounds woes began when markets opened to lower than expected Housing and business confidence figures. Rightmove House Prices index posted a year-on-year drop in prices to -4.9% from -3.3%, while a business confidence survey showed confidence had plunged to new lows in the wake of the economic downturn. The minutes from the last Bank of England MPC meeting revealed a unanimous 9-0 vote to cut interest rates by 50 basis points.

Central bankers were the main market movers, however. Fed chairman Bernanke was the first, testifying before the House budget committee the chairman warned that the U.S economy would be weak for some time still and that a recovery would depend greatly on the health on the financial sector. Dollar support came from Bernanke?s backing of a second fiscal stimulus package, which he had rejected previously, calling the action appropriate considering the risk of a protracted economic slowdown.

BoE Mervyn King, speaking in Leeds, commented on the health of the UK economy and sparked overnight losses on 6% versus the dollar. King stated that the UK economy would enter a recession in 2009 and that he had significant concerns over rising unemployment and a falling housing market.

While markets were digesting these revelations and various economic indicators, traders began pricing the possibility of a further 50 basis point cut in interest rates and the MPC?s next rate setting meeting.

The week ended with the release of UK GDP  q/q results, GDP fell q/q to -0.5% versus a market forecast of -0.2%. The numbers confirmed wide spread concerns that the UK was possibly already in a recession and backed up the BoE Governors assessment of the UK economy earlier in the week.

Oil prices have dropped steadily over the week reaching a low of 62.65 before OPEC announced production cuts and allowed prices to recover some of their losses.

In the present economic climate confidence has taken center stage in driving market movements. The unilateral decision to cut global interest rates by 50 basis points and a move, spearheaded by Gordon Brown, that has seen governments taking an equity stake in financial institutions has done little to quell fears within the markets.  Equity markets posted some of the biggest losses in 21 years with the FTSE falling 7.2% and shedding over £125billion of its value. Similar drops on Wall Street and in Europe has created a great deal of turmoil in currency markets.

Economic fundamentals while having little impact on currency movements, have not in essence altered the economic outlook for the broader economy. UK CPI broke the BoE?s forecasted 5% peak coming out at 5.2% y/y while unemployment worsened to 5.7% from the previous months release of 5.5%. Average hourly earnings showed little sign of a reduction in wage price inflation, coming out in line with expectation. On the whole the UK economy is still suffering from high inflation and slowing growth which has in recent days sparked talk of recession.

Fears over recession and a worsening of the credit crisis has done little for the pound, particularly against the USD. Sterling touched a 2 and a half year low versus the US dollar and remained within ranges against the euro aided somewhat by the euro?s losses against the dollar.

But not all currencies have suffered in these unpredictable markets, falling equity markets and a drop in the price of oil have aided dollar gains across the board. Crude Oil reached a low of $68.74 per barrel this week, while the Dow Jones Industrial Index fell to below 9000.   Economic data for the U.S remained mixed with only the drop in CPI inflation to 4.9% y/y from 5.4%, being noteworthy

Next Week:

With the recent surprise 50 basis point interest rates cuts by the BoE, ECB and Fed, the day before the official BoE rate decision was expected, will have traders very interested to see what the minutes from the last MPC meeting will deliver. Most analysts expect the MPC to continue to voice concerns over inflation, but their main interest will be to see if there is any comment regarding the previous days rate cut, a decision which probably went unopposed by the members given the present market climate. UK Retails Sales and GDP will garner some attention as talk of recession increases in the markets.

At the brink of systematic meltdown or the buying opportunity of a lifetime? That is the question investors are faced with during these chaotic times and in the absence of an internationally co-ordinated, immediate and comprehensive sponsored solution, the clever money, if there is still such a thing, would lean towards to the former depressing scenario. But the team at ProgressiveFX, whilst not wishing to embrace rose-tinted spectacles believe that a confidence building solution is imminent and the floor of the equity market, and therefore the peak of risk rejection is within our grasp.

We suggest the sharp mid-session fall in the Dow this past Friday to 8,000 may well be the crisis floor. Alternatively, if the G7, IMF and world leaders delay the publication of the international rescue plan, and the devil is in the detail, we may see new low's early this week but we predict the corner will be imminently turned.

We are not suggesting that the fundamental problems will be fixed in the short term but market's have shunned risky assets with a selling frenzy not seen for 75 years. There are still many companies in good financial health with great prospects that are trading at discounts to fair value that are positively insane. The recent destruction of wealth and extreme price volatility of risky assets has created incredible trading opportunities in FX and equity indices that will persist for years to come. Of course, some businesses will fail. Unfortunately some countries may even fail, but the investment scenario is crystal clear. Leading up to US open each day the question is do you buy or sell risk today? Anticipating the correct answer to this question will provide generous potential returns for investors. In our opinion the best instrument to buy risk is long Dow, The best sell-risk play is long JPY (probably at the expense of the EUR). Our advice is to follow risk appetite closely with US Dow futures as good an indicator as any. Use medium gearing and tight trailing stop losses (15bps) and you could well make more in the next 12 months than you lost over the past year. Maybe.