Forex report: Dollar makes strong move

IB FX View: Trichet comments spur risk aversion rally

The ECB’s omnipresent desire to avoid the pitfalls of inflation caused by excessive money growth caused its president, Jean Claude Trichet to serve up a warning earlier this morning that it must pursue an exit strategy. His words, while not exactly new, turned a mediocre equity market recovery on its head and have caused a surge in the value of the dollar at the prospect of a further amelioration of growth. The euro tumbled half a penny to $1.4808 while dollar gains are evident across the board.

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Mr. Trichet said that the ECB should gradually withdraw the emergency cash loans to the domestic banking system made during a time when a special situation demanded it. He seemed to be prescribing a clinical weaning program in order to prevent the private sector from becoming more addicted to the exceptional support provided by central banks.

Yet as that process begins in December when the one-year maturity date comes due Mr. Trichet fully admits that, “It’s too early to declare that the crisis is over.” Referring to the recently improved health of the financial system he said that a “significant volume of official support underlies these developments.”

This appears to be what is rattling markets this morning. While investors have spent the week rolling out lower-for-longer interest rate expectations, they are starting to get cold feet over the health of asset market rallies taking the line that stocks have come too far too soon and that if - only for safety’s sake - they should perhaps hold onto their dollars after all.

The earlier tone was one of strength for the Japanese yen. The Nikkei Dow closed down for its fourth straight weekly loss with exporting companies complaining about the currency’s impact on overseas earnings. Meanwhile the Bank of Japan maintained its uncomfortable position sitting on a knife-edge. It credited a near-term improvement in the economy on its low interest rate setting at 0.1%, which it agreed to maintain at its meeting today. However, it also discussed the problematic acceleration of deflationary pressures that emerged alongside strengthening growth this week.

According to the central bank the economy is suffering a mild deflationary phase due to weak corporate and domestic demand. In order to squeeze this unwanted process out of the economy, it urged the government to boost growth expectations and spending. For the government’s part it wants that Bank to buy more corporate bonds to add liquidity to the market. But as we all know, you can take a horse to water, but you can’t make it drink.

The upshot against a backdrop of weakening risk appetite in the region was for a stronger yen. It rallied sharply to the dollar to ¥88.67 before giving some back as the dollar moved from an early morning jog to a sprint. The yen is currently at ¥89.00. Meanwhile the euro dropped to ¥131.93.

The British pound slumped to its lowest reading since Nov. 4 to $1.6460 as the dollar flexed this morning. Since that time the pound rose to $1.6876 as investors bought into an extension of the asset purchase plan announced by the Bank of England. Subsequent worries over the health of the banking system and fresh warnings today for the value of home prices are cramping its style today.

The rising threat of capital controls across Asian nations whose governments reside over booming capital markets funded by cheap dollar loans is reaching a crescendo. So not only do we have an ongoing discussion over the absolute health of the global recovery, not to mention the outlook into 2010, but we also have worries that the side effects of the G7 solution is creating bubbles in asset prices across the emerging markets.

The commodity dollars are taking this combination pretty hard, especially the Australian dollar, which has also matched the reversal seen in the British pound. At 90.91 U.S. cents the Aussie is well off its November peak at 94.00 cents. Meanwhile the Canadian dollar is feeling the risk aversion sentiment too as it declines to 93.35.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com

Note: The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Interactive Brokers LLC nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. Neither IB nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

About the Author
Andrew Wilkinson

Andrew is a seasoned trader and commentator of global financial markets. He worked for several London-based banks trading cash and derivatives before moving to the U.S. to attend graduate school. Andrew re-joins Interactive Brokers following a two-year stretch at a major Wall Street broker-dealer as their Chief Economic Strategist. His coverage of stocks, options, futures, forex and bonds regularly surfaces in global media, and over the last several years Andrew has made many TV appearances on Bloomberg, BBC, CNBC and BNN and Yahoo Finance.

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