Bernanke and Co. wipe $10 trillion off equity values this month. Is there more to follow?

Investor’s mini euphoria is over. What ever advances we saw this week looks like to be given back. Cbanks (including Japan) globally slashing borrowing costs has done little to stem the sea of red that appear on all bourses. Traders and investors are happy buying USD$ and JPY, risk aversion and fears of a deeper recession dominates all. Expect next weeks ECB rate decision and NFP to be an eye opener.

The US$ is stronger in the O/N trading session. Currently it is higher against 14 of the 16 most actively traded currencies, in another ‘volatile’ trading range.

FX Heatmap October 31st, 2008

Yesterday US data has pushed the economy towards a recession. Real GDP contracted by -0.3% in 3rd Q, it will be the first consumer led recession in 7-years. Analysts have tabled three more quarters of decline. Even with Bernanke slashing funds by 50bp, the data indicates that additional monetary and fiscal stimulus is required (Yellen looks for rates closer to Zero). A disappointment to all who believe that borrowing costs will hold steady at 1% for the medium term. Despite the headline print being better than anticipated (-0.3% vs. -0.5%), the consumer numbers remain the drag. Personal consumption accounted for the majority of the decline, falling -3.1%, as durable goods contracted by -14.1%. Non-durable goods dropped by -6.4% as disposable income fell -3.7%. As expected, government consumption and some export growth helped support economic activity. Government spending jumped +5.8% for the quarter (strongest growth in 5-years). Digging deeper one notices that inventories fell, but at a slower pace than the previous quarter. It is worth mentioning that the first snapshot on a given quarter’s GDP is prone to substantial revision. So, expect next quarter’s news to change markedly when the next set of data rolls around.

Surprisingly, in a split decision (4-4, overriding vote by Governor Shirakawa) the BOJ cut its benchmark interest rate to +0.3% to help ‘stave off a prolonged recession’. The argument for no change had been that rates were already low, normal economic tools are ineffective in manipulating monetary policy when borrowing costs are so low. JPY continues to be well sough after as investors become more risk averse as they dispose of higher yielding assets.

Initial jobless claims remained unchanged at +479k last week, which lowered the 4-week moving average down by 6k to +476k. However, continuing claims remain elevated, down just -12k to 3715k, which is consistent for a six figure NFP print. Initial estimates h ave a figure south of -250k. Analysts are also forecasting a +0.2% rise in the unemployment rate to 6.3% next week.

Aside, Tokyo traders are warning that $90b’s worth of ‘complex foreign exchange products’, mainly sold to Japanese households and institutions, are on the brink of ‘collapsing’. The market expects some sort of rescue package from the issuers (Japanese, European and American investment banks). Analysts foresee the rescue process to involve extensive hedging measures that will potentially throw global currency markets into ‘deeper turmoil’. The complex products ‘power reverse dual currency notes’ (PRDC-the name even sounds volatile), offered higher yields than regular savings a/c. They created exposure to FX, FI and domestic inflation and have formed a small part of the JPY ‘carry trade’.

The US$ currently is higher against the EUR -1.70%, GBP -1.40%, CHF -0.96% and lower against the JPY +1.85%. The commodity currencies are weaker this morning, CAD -2.94% and AUD -3.62%. Interest rate differentials, global equities and commodities had propelled the loonie close to its biggest weekly gain in 4-decades. Yesterday’s data south of the border stating that the US economy contracted less than anticipated was a temporary bonus for the currency. 75% of all her exports head south and 50% of all exports are commodity based. Renewed optimism in unfreezing credit markets had global equities paring some of this month’s horrendous losses and by default lent support for the riskier assets. Most of yesterday’s gains have been pared in the O/N session. The magnitude of the loonie move caught most traders by surprise as many investors were caught in off side positions. Higher equity valuations across the globe are attracting better tolerance for risk, and there is a ray of optimism that global equities may be bottoming out. This can only bode well for the loonie in the short term. Too far, too fast was definitely a concern, traders continue to see better levels to own the currency despite the strength of the one directional play. In the O/N session, investors were happy to dispose of higher yielding currencies; the fear of a deeper recession has once again provided a stronger bid for the USD. Expect the currency to trade in a tighter range until ECB and BOE announcements next week. Now that the Fed eased 50bp, it’s anticipated that the BOC will need to extend interest-rate cuts (2.25%) in the face of slowing economic growth. Last week Governor Carney reduced overnight borrowing costs by 25bp (2.25%), less than the market had anticipated, but added that it will probably need to act again (Dec. 9th) to fend off the effects of a credit crisis and global recession. Futures are pricing in a 50bp cut in Dec., thus pushing borrowing costs below the 2% level. Look for better levels to own the currency.

In recessionary times higher yielding commodity assets suffer and the AUD$ is no exception. Slashing interest rates by Cbanks has so far not being capable of propping up the equity markets (Australia’s inflation rate may limit the RBA to cut borrowing costs as deeply as previously expected next week). This month alone, $10 trillion of market value has been wiped away. The AUD$ will probably set the biggest monthly decline in 25-years as concerns that the global economy will slip into recession has persuaded investors to dump the countries higher yielding assets (0.6617).

Crude is lower O/N ($63.36 down -260c). After its 8% rise on Wednesday, oil has pared its advances on concerns that the biggest economic decline from the world’s largest consumer of the black-stuff will curb fuel demand even further. Advances this week had relied on signs that global credit markets are beginning to work coupled with Cbanks slashing rates to boost future demand. The commodity continues to trade close to its 17-month low print achieved at the beginning of the week. Fundamental data combined with the recent greenback strength has investors selling oil contracts on rallies. Expect investors to concentrate on ‘demand destruction’ after yesterday’s GDP numbers. The threat of global equities advancing and OPEC potentially wanting to meet again before Dec. has only been able to provide temporary support. OPEC this week indicated that they may call a new meeting if prices fail to react to the -1.5m barrel-a-day output cut it announced last week. The cut in production is to start tomorrow. Thus, growth fears continue to outweigh any cut in production. OPEC still produces over 40% of the world’s oil, but there are doubts that they can cut much more, the members also need cash, just like most economies do. So do not be surprised to see some members ‘not’ adhere to future cut quotas. The EIA report yesterday showed that US inventories of crude oil and distillate fuel rose last week. Crude oil stocks climbed +493k barrels to +311.9m barrels w/w vs. a +1.55m barrel gain. Distillate inventories rose +2.33m barrels to 126.6m barrels vs. an increase of +1.05m barrels. While gas stockpiles dropped -1.51m barrels to +195m, (1st decline in 5-weeks). Overall a bullish report as inventories rose less than anticipated. But, sluggish demand continues to be the catalyst for rising inventories. Gold fell the most in a week as the greenback climbed vs. the EUR on signs that reductions in borrowing costs in Europe will lag behind the US. It’s time for the Trichet to step up to the plate.

The Nikkei closed 8,576 down -452. The DAX index in Europe was at 4,801 down -67; the FTSE (UK) currently is 4,221 down -70. The early call for the open of key US indices is lower. The 10-year Treasury yields backed up 8bp yesterday (3.93%) and eased 5bp in the O/N session (3.88%) as investors sold equities and sought sanctuary in the FI asset class. Traders cheapened up the US yield curve ahead of the 5-year US debt auction and it had remained cheap amid concerns that the Fed’s efforts to unfreeze credit markets will result in an unprecedented amount of US debt being issued. It’s Friday and the end of the month and year end for some, some moves do not make sense as traders balance thir books.

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Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell