Agent Market Commentary - Summary of October 2008

GBP/EUR

GBP/EUR moved a step closer to joining the ranks of the volatile currency pairs as it covered the entire previous 7 month’s trading range in just one week.

Last events again impacted the Dollar more than most currencies but GBP/EUR endured its fair share of volatility covering a range of more than 4 cents from below 1.25 to almost 1.29.

• The month had started badly for Sterling as the UK’s mortgage lending for August fell to just £143 million from £3 billion in July and £9 billion a year ago. The stamp duty saga was mainly responsible but huge falls in the manufacturing and service sector surveys confirmed that Q3 is heading for negative growth. The demise of Bradford & Bingley highlighted the UK’s link to the world financial crisis but the escalation of banking failures into the European arena last week more than balanced the books for GBP/EUR. Indeed the German and Belgian bank failures, along with a similar collapse in EU-wide manufacturing activity and a rise in unemployment, appeared to finally convince the ECB that there was actually something to worry about.

This reversed the previous hard-line stance on inflation and money markets immediately priced in a possible cut next month, sending the Euro tumbling against all major currencies, including Sterling.

• At the beginning of the month, the cascade of European institutions succumbing to the credit crunch saw the Euro fall against Sterling, taking GBP/EUR close to 1.30 for the first time since March this year. But as Sterling slid against the Dollar, EUR/USD fared relatively well, leaving GBP/EUR to give up all of those gains and more.
• The UK Government action to announce a £500 billion package, to crank start the LIBOR market and re-capitalise the UK banking sector, was well received by the markets, but initially failed to either restore confidence in the stock markets or help the jammed inter-bank lending. The UK then joined in the co-ordinated 0.50% rate cut, but still Sterling and UK stocks were buffeted by the storm in the global markets. London’s pre-eminence as a global financial centre counted against Sterling as Dollar based funds in the City were forced to liquidate non-Dollar assets, including those in Sterling, sending the Pound sharply lower. The heavy contribution that the City makes towards UK growth also helped to turn sentiment against the UK currency and finally the massive unwinding of carry trades, one of which is GBP/JPY, made a significant impact.

Despite an alarming jump in the UK unemployment rate to 5.7%, GBP continues to remain well supported against its Eurozone counterpart.

• GBP also got the wind behind its sails with the Brown/Darling plan to tackle the banking crisis gaining international recognition.
• Helped by this politics of proactivity to tackle the crisis, investors are looking to GBP with a little more confidence, after GBP was stunned 12 months ago after the Northern Rock debacle.
• After testing the recent high close, GBP/EUR appeared to be floating in relatively calm waters, compared to the unprecedented volatility seen in virtually every other currency pair in recent weeks.
• However, the speech by Bank of England Governor King started to brew a storm for the Pound when he admitted that recession was likely and that Sterling may have further to fall.
   

Gordon Brown then confirmed what we all really knew about the likelihood of a prolonged downturn and this official pronouncement from these 2 key figures, sent GBP/EUR sharply lower to 1.25.

• Having attempted, quite rightly, to maintain morale on the economy in recent months, both of them no doubt compelled to face up to reality and begin the job of resuscitation in the face of overwhelming evidence in the past month and, not least the impending release of the key Q3 GDP figure (of which they would have had prior notice).
• The worse than expected outcome of a 0.5% decline laid down the first step towards the definition of an official recession and GBP/EUR slumped to a new all time low at 1.2205.

Central bank rates:
UK (MPC) 4.50%
EU (ECB) 3.75%

High & Low of the month:
High: 1.2994 (20/10/08)
Low: 1.2178 (24/10/08)

Difference of cost on a €200k property:
Low: £164,230.58
High: £153,917.20 euros
 

A difference of £10,313.38
 

GBP/USD

One year’s of Volatility in a Week!

The month started with a bang as the US bail-out package failed to get through the lower House of Congress, sending the stock markets into another record breaking tail-spin. Meanwhile banks both sides of the Atlantic continued to collapse with US bank Wachovia, rescued by Citibank (later to be replaced by Wells Fargo), Bradford & Bingley and Belgium’s Fortis effectively nationalised and further carnage in Germany and Iceland, all on the same day.
 

• The popular up-rising against the bailout package was gradually subdued by the pragmatic voice of the Senate, as it became clear that a lack of credit on Main Street was a more serious issue than how to punish Wall Street and the lower House eventually followed suit late on Friday. No doubt the escalation of global banking failures, a collapse in the US manufacturing survey and the largest monthly fall in employment since 2003, concentrating enough minds on the big picture.
• Despite the focus remaining on the US problems, the US Dollar continued to strengthen as global investors sought the safe-haven of US Treasury Bills and Bonds, sending yields tumbling. GBP/USD slipped throughout the week to trade below 1.76 again, a fall of 11 cents in a week.
• Some of this fall could be attributed to the Bradford & Bingley news and an alarming fall in August mortgage lending to a mere £143 million, compared to £3 billion the previous month and £9 billion just a year ago. Whilst the Government dithering over stamp duty was no doubt the prime suspect here, this is no comfort to any other business dependent upon house sales in the UK. The monthly service and manufacturing surveys also dropped precipitously, virtually confirming that Q3 is already doomed to show a negative GDP.

We saw ever more radical, comprehensive and co-ordinated rescue plans emerge from around the world in response to the spiralling financial crisis but the turmoil continued maintaining unprecedented levels of volatility in the stock, commodity and currency markets.

• In the UK, Brown and Darling unveiled a £500 billion rescue package designed to recapitalise the ailing banks and get the LIBOR market working again. The package was widely acclaimed for its size and content but bank shares continued to be sold and the 3 month LIBOR rate refused to fall indicating no pick up in activity. The globally co-ordinated 0.50% interest rate cut again offered hope of some respite but the markets remained firmly in panic mode. The key features of the last week’s meltdown were panic selling of equities and any other long-term investments such as the currency carry trade. Some of this capitulation can be traced to the forced unwinding of Lehman’s investments and the knock on impact on hedge funds and other investment funds who are both running out of liquidity and desperate to sell assets themselves ahead of the rest of the market. The extreme conditions have resulted in some of the thinnest markets traders have ever experienced, leading to widening spreads and massive swings in prices minute to minute. This is being felt in the currency markets every bit as much as in the stock markets.
   

The story here is a combination of Dollar strength and Sterling weakness. Firstly the Dollar continues to strengthen as US Dollar based funds (including US, Far East and Middle East) capitulate out of non-Dollar assets and buy the Dollars back for the fund. In previous weeks, this had been a flight into the safe haven of US Treasury Bonds but it appears that only cash will do now. London’s pre-eminence as a global financial centre means that many of the non-Dollar assets are in Sterling, creating some of its current weakness. The importance of the City to the UK economy also militates against Sterling when currency speculators look into future growth prospects.

• Also counting against the Pound was the implosion of the Icelandic banking sector which revealed a huge community of UK savers who had been chasing the higher yields on offer.

No sooner had they been offered a reassuring guarantee by the UK Government, than it became clear that many Local Authorities and Charities had also placed their funds in Icelandic banks, and this time the UK Government declined to immediately cover these deposits.

• Finally, the panic out of currency carry trades saw the Yen strengthen and the Australian and New Zealand Dollars depreciate at a record pace. Sterling has also been used as the ‘higher yielder’ in this investment, hence GBP/JPY crashed over 20 Yen to 7 year lows, adding to Sterling’s overall weakness.
• We have not seen this type of move in GBP/USD since Sterling’s ignominious fall out of the ERM in 1992 and whilst that was a Sterling-specific event, and the current conditions are a global phenomenon, we can draw some lessons from that experience.
• The first is that such illiquid and volatile markets may not respect the traditional support and resistance levels in the short-term. We felt that the 1.70 – 1.74 area which had proved to be both the cap (resistance) in the post ERM years until 2003 and strong support on the dip in 2005/06, would come into play again during this time, but the ferocity of the past week’s move has punched a crater in that expected platform. Whether this proves to be another trap-door for GBP/USD remains to be seen but we note that, as in all markets, although these are far from normal conditions, this previous pivot point for GBP/USD, 1.70, is perceived as such an important level; it may yet prove to have some validity.
• However, the piercing of this level last week cannot be ignored as a signal and we stress that as risk managers, first and foremost, we must urge extreme caution for our Dollar buyers.
• The G7 meeting although not producing any fresh initiatives, demonstrated unity amongst the major economic nations and appears to have calmed the markets to a degree this morning. The EU meeting in Paris also made the right noises and a package similar to the UK version looks likely to emerge.
• The UK package has been bolstered again with 2 major UK banks effectively nationalised.
  Tier 1 capital has been increased, bank heads have stepped down and bonuses and dividends suspended, as part of the Brown/Darling scheme, again to general acclaim. Details are still being released but so far the 2 bank’s shares are down, the other banks are up and the FTSE is up strongly.

GBP/USD has fallen 45 cents in the 3 months since the start of August (from 1.98 to 1.53). This compares to a similar fall in the 2 months (October/November) following Sterling’s fall out of the ERM in 1992.

• The range this year has been 51 cents (2.04 to 1.53) compared to an average annual range of 22 cents in the past 8 years.
• This month we saw a range of 22 cents, equivalent to a whole year’s average volatility!

 Why?

• As we explained, despite the siren headlines in the newspapers, the bulk of this move has been down to massive rise in the Dollar rather than exclusive Sterling weakness.
• The huge falls in stock markets and commodity prices around the world are testimony to the panic selling of assets by Hedge Funds, Insurance, Pension and US Mutual Funds around the globe as investors seek to redeem their investments before they lose further value. The Hedge Funds, in particular, having leveraged up their investments are having their lines of credit withdrawn by the banks and finding that their sales into illiquid markets are driving prices lower at an alarming rate.
• It’s estimated that up to 75% of the Hedge Funds are Dollar based, either directly or due to their base currency being linked to the Greenback. This includes funds originating from China and the Gulf oil states. Thus when non-Dollar assets are sold, the Dollars must be re-purchased, leading to the current enormous demand.
• The crumbling of asset prices and currencies in countries such as Brazil, South Korea, Hungary,
  Poland and South Africa, confirming this rush for the exit for Dollar based investors.
• The decline in GBP/USD has been given extra zip in the past week as both Mervyn King and Gordon Brown dared to utter the ‘R’ word. With the Q3 GDP about to be released their role as optimistic cheer leaders for the economy inevitably had to give way to reality and pragmatism in the face of much clearer evidence of the impending slow-down. On cue, the GDP figure revealed a worse than expected -0.5% decline for the quarter, setting the scene for an official recession to be confirmed at the end of this quarter.

Outlook

• We highlighted the break of 1.70 is significant because of its role as the pivot for the past 15 years trading in GBP/USD, since the ERM exit. In normal circumstances we would have expected at least a significant reaction around this level but such is the lack of liquidity and the excess of volatility in all markets, that ‘hot knife through butter’ became the most appropriate description.
• The subsequent fall almost satisfied our target, of 1.50 or below, within 2 days, with the subsequent bounce to 1.58 merely fuelling the mood of volatility rather than suggesting that the move was over.
• With no floor yet in evidence in stocks or commodities and the assets and currencies of emerging nations continuing to crash (Hungary, Ukraine and Belarus being the latest in joining Iceland by seeking funds from the IMF to bail out their beleaguered economies), we must conclude there is a strong possibility that both the volatility and the Dollar strength will continue. Allowing for the fact that the lack of liquidity is exaggerating every move in the currency markets, we might expect a 1.40-1.70 range in coming weeks (days!), before there is any chance of the dust settling and global risk appetite returning.
• What is left when this financial tsunami finally recedes will have to be assessed at the time.
   

Central bank rates:
UK (MPC): 4.50%
US (FED): 1.00%
EU (ECB): 3.75%

High & Low of the month:
High: 1.7872 (01/10/08)
Low:  1.5252 (24/10/08)

Difference of cost on a $200k property:
Low: £131,125.19
High: £111,903.76
 

A difference of £19,221.43

EUR/USD

As the voice of the people put paid to an easy passage for the giant $700 billion US rescue package, the financial markets continued to reel. US bank Wachovia, recently touted as a “rescuer” was rescued itself by Citibank, the latter curiously replaced by Wells Fargo later in the week. With the contagion spreading across the pond again, Belgian bank Fortis, followed the UK’s Bradford & Bingley into nationalization and Germany’s second biggest commercial mortgage lender flew the white flag.

Stock markets gyrated at each twist and turn of the political situation in the US and the financial institution calamities but the major currency impact all week was for Dollar strength as investors sought the safe haven of US Treasuries.

On the data front, both the US and the EU saw large falls in their respective manufacturing surveys, but the rise in “lost jobs” in the US was probably the more alarming development. In the face of stricken money markets and the excalating financial crisis this appears to have given way to a refreshing note of pragmatism and the money markets immediately shortened the odds.

Having broken the long term up-trend the Euro rather than Sterling could have led the slide lower against the Dollar over the days but EUR/USD confined itself to sliding.

• GBP/USD panic and complete capitulation from hedge funds, investment funds, banks etc., some of which has been sparked by the forced liquidation of assets owned by the failed Lehmans Bank, led to sustained selling in stocks, financial derivatives and certain currency pairs. It appears that the Dollar is benefiting from both a flight to safety, previously marked by the rising price of US Treasury Bonds, and a liquidation of non-Dollar assets held by Dollar denominated funds. The latter would include funds based in the Far East and Middle East where the local currency is pegged or related to the Dollar.
• There has also been a massive unwinding of the currency carry trades producing a rapidly strengthening Yen at the expense of high yielding currencies such as the Australian and New Zealand Dollar. This headlong rush into the Yen also impacts more liquid Yen cross pairs such as EUR/JPY which has seen a 25 Yen drop in the past weeks.
• In terms of Government and Central Bank response, the EU and ECB could have been said to be falling behind the curve after the US bail-out and a well received UK initiative. However, the ECB joined in the co-ordinated 0.50% rate cut and it appears a scheme similar to the UK’s will emerge from yesterday’s Paris meeting of the EU.
• Accepting that we are dealing with a once in a lifetime situation (how quickly it has escalated from a once in a generation scenario), the break of the long term up-trend channel leads us to believe that EUR/USD may have further to slide before it can stage another correction.
• Further out, again bearing in mind the markets are all moving in a fast-forward fashion, the Dollar denominated funds will be searching again for value and diversification, reversing some of the forced Dollar purchases of recent weeks. But in the meantime we urge extreme caution and encourage you all to stick to strong risk management principles to avoid the worst excesses that Having broken the long term up-trend and strong support around 1.36 a couple of weeks ago, EUR/USD has managed to nestle itself within a tight trading pattern (1.33-1.38) buffeted by the equity market storms.
• We saw weakness in the US economy with falling retail sales, industrial production posting its biggest drop in 34 years and further signs of a deteriorating manufacturing sector with the
  Philly fed survey crashing to -37.5 in October.
• On top of this consumer confidence fell sharply and the housing market saw further evidence of deterioration with housing starts falling by 6.3% to a 17 year low and building permits falling 8.3% to a 27 year low.
• However while the global economy crumbles under the pressure of the credit crunch, the US dollar continues to strengthen aided by its safe haven status and also helped by positive flows in US dollars by the hedge fund industry having to battle with redemptions.
• There is little confidence that the Eurozone will remain unscathed from the credit crunch and perhaps remains a step behind the US in terms of taking steps to tackle the issues.
• However with EUR/USD having already dropped significantly from its heady days above 1.60, it looks as though this currency pair has found its buffer of support between 1.30-1.35.
• With focus on the US economy and the elections just around the corner, the US dollar seems to have strengthened enough for now and arguably looks vulnerable to a sell-off back to levels above 1.40.

As we have explained in the GBP/USD report above, a massive flight out of global assets by global Dollar based funds has led to an unprecedented strengthening of the Dollar as investors scramble to return to cash.

• Whilst many of these funds are based in the US and in London, yet more are based in the Far East and Middle East where their currencies are effectively tied to the Dollar.
• Hedge Funds, in particular, are forced sellers of assets as the funding for their massively leveraged positions is withdrawn or reduced by the under-pressure banking sector.
• The result has been huge falls in the stock and commodity markets across the globe, a collapse in several emerging market currencies and a huge demand for US Dollars.
• The result for EUR/USD has been a 35 cent fall from 1.60 to a 2 year low of 1.25 in the past 4 months. This compares to an average annual range for EUR/USD of around 20 cents.
• We therefore caution that until the stock and commodity markets show signs of calming, we should expect continuing volatility in the currencies and a continuation of the current vicious trends. Using ‘expect the unexpected’ as our guide, sound risk management should take all precedence over short-term forecasts.

Central bank rates:
UK (MPC): 4.50%
US (FED): 1.00%
EU (ECB): 3.75%

High & Low of the month:
High: 1.41739 (01/10/08)
Low:  1.23277 (28/10/08)

Difference of cost on a $200k property:
Low: €162,236.27
High: €141,104.42
 

So a difference of €21,131.85

GBP/AUD

We saw GBP/AUD jump higher in the beginning of October as investors dumped higher-yielding currencies and riskier assets - spooked by fears of a global economic slowdown and pessimism about weather the US governments bailout plan would really unfreeze the financial sector; GBP/AUD rocketed a remarkable 42 cents to a 5 year high.

The Australian dollar began to stabilize after the Reserve Bank of Australia stunned investors with its biggest interest rate cut in 16 years; a dramatic attempt to insulate banks, households and firms from a meltdown in the global financial markets. The central bank cut its benchmark rate by a full 1.0% to 6.0% following its monthly policy meeting, a reduction twice the size expected and the biggest rate cut since May 1992. The currencies losses were further shown as commodities from oil to base metals all lost ground.  on

In response, the Australian government announced a AUD10Bn stimulus package to cushion the economy away from the credit crunch, just days after Canberra offered guarantees on the country’s AUD600-700Bn in bank deposits – however, it was unable to hang onto gains, again due to concerns the global slowdown would hurt the demand for their natural resources.

Central bank rates:
UK
Current rate: 4.50%
Last change & date of change: -50bps  08/10/08
Next Meeting:  06-Nov-08

AU
Current rate: 6.00%
Last change & date of change: -100bps 07/10/08
Next Meeting:  04-Dec-08

High & Low of the month:
High: 2.7066
Low: 2.2229

Difference of cost on a $200k property:
£16,079

GBP/NZD

The National Bank of New Zealand’s monthly business outlook survey showed its sentiment rose to a net 1.6% of people expecting the economy to improve over the next 12 months – boosted by lower petrol prices, interest rates and pending tax cuts. These figures came in sharp contrast to the -20.5 who expected it to worsen in the August survey and marking the first time overall confidence has been positive since May 02.

We then saw the NZD collapse in value as global investors rushed to exit the carry trade, along with every other ‘risky’ investment such as stocks and commodities. GBP/NZD then saw the effects as investors with a ‘seesaw’ risk appetite drove demand for the high yielding NZD. This turmoil over the troubled markets overshadowed figures showing a modest rise in August retail sales, however the consumer spending remained low – backing views that the Central Bank will cut interest rates further,

NZD was then pushed higher towards the end of the month as investor focus returned to the looming global recession and stock market weakness – prompting increased ‘risk aversion’ and a sell off of the NZD. This erased the previous gains after New Zealand’s Central Bank slashed interest rates by a record 1.0% on Thursday and said further cuts were in the pipeline as the global financial threatens. The move followed a round of rate cuts by Central Banks around the world earlier in the month and brings the official rate to 6.50%, the lowest since January 2005.

Central bank rates:
UK
Current rate: 4.50%
Last change & date of change: -50bps  08/10/08
Next Meeting:  06-Nov-08

NZ
Current rate: 6.50%
Last change & date of change: -100bps 23/10/08
Next Meeting:  04-Dec-08

High & Low of the month:
High: 3.0103
Low: 2.6213

Difference of cost on a $200k property:
£9,860
 

GBP/CAD

The beginning of the month pointed to a much stronger than expected start to the third quarter; the economy grew 0.7% in July and this was primarily due to a surge in crude oil and natural gas production - This was more than three times market forecasts of 0.2%.

The Canadian dollar then weakened aggressively against the Pound as investors bet the Bank of Canada would cut interest rates further to spur economic growth in response to expectations of weaker US growth. Furthermore, the decreasing demand for oil and commodities also impacted the CAD. Along with other leading banks the BoC cut its key lending rate in an attempt to increase confidence and get credit flowing again; the rate cut came ahead of the interest announcement later in the month.

With concerns that the global economy is teetering on the verge of a recession (which would ultimately have an effect on the price of oil) GBP/CAD surged to an 11 month high as a slide in the price of oils and metals dragged the commodity – linked currency lower across the board. The attention focused on this and interest rates which meant the news of the re-election of a minority conservative government had little or no impact on the currency.

The decision to cut interest rates at the end of the month by a further 0.25% to 2.25% created some sever volatility, despite GBP/CAD finishing marginally lower at the end of the month. The BoC added that it would likely have to east further to combat the effects of the global credit crisis “In line with the new outlook, some further monetary stimulus will likely to be required to achieve the 2.0% inflation target over the medium term”.

Central bank rates:
UK
Current rate: 4.50%
Last change & date of change: -50bps  08/10/08
Next Meeting:  06-Nov-08

Canada
Current rate: 2.25%
Last change & date of change: -25bps 21/10/08
Next Meeting:  09-Dec-08

High & Low of the month:
High: 2.0728
Low: 1.8716

Difference of cost on a $200k property:
10,372
 

This article was provided by HiFX.com

Like this? Then share with your friends and colleagues!