A Forex View From Afar

Confidence Crisis, Still no relief

The U.S. markets do not want to show any signs of relief, even after global central banks’ coordinated action to cut by 50 basis points on their overnight interest rates.

At the time of the announcement European equity markets rose from trading at -7%, moving to somewhere slightly above the break-even line initially. However, the joy was short lived and the major European indexes closed back into the negative territory, recording an average 5% declines. U.S. futures had a similar pattern of trading, they rose from -3% to the break-even level, however, soon went back into the negative territory. Heading towards the close the S&P 500 is positive by 1%. Today the VIX index, also know as the “fear index” rose to an all-time record of 59.00 points. At the beginning of September, the index was just above the 20 point benchmark, while in normal market conditions, the VIX trades somewhere around 10 to 15 points.

In the money markets, dollar Libor surged to a new intra-day high. Dollar Libor rose 144 basis points, to 5.38%, showing that banks are still charging huge premiums for unsecured loans. In normal market conditions the Libor is set just a few basis points above the Fed Funds Rate. It should be noted that the LIBOR rate was fixed before the central bank’s statement was made public.
All this put together shows that markets are still not ready to buy risk. In the currency market, the Japanese Yen, which strengthens in times of uncertainty, broke under the 100.00 yardstick on the Usd/Jpy pair. This is the second time in 2008 that the yen has broken this level, which had previously held since 1995.

The unprecedented action taken today clearly shows that the central banks are willing to fight the crisis of confidence, and now it is a possibility that these actions will inspire sufficient credibility that the markets can slowly find a bottom in the following days. If this happens, treasuries will be shorted for riskier assets, in a flight to “quality”, but first the VIX must head lower as Libor rates move lower and approach the fair value, which is far below the current read.

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