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Forex Analysis

Libor Starts To Move Lower. The freeze thaws.

Written by A Forex View From Afar on Friday, October 31, 2008

Following the global rate cuts and the impressive measures taken to ensure liquidity in the financial markets, the Libor rates are starting to show signs of relief.

The 3-month dollar Libor, or the rate at which banks borrow money from other banks with a maturity of three months, declined for a full 14 days, to 3.19%. The overnight dollar Libor rate, used to fund overnight activity, dropped to 0.79% a record low as the market expects more rate cuts to follow shortly.

Action taken by the ECB, looking for a similar outcome, driving the inter-banking rates lower, the central bank has pumped over a $1 trillion into open market operations. The euro 3-month Libor rate also declined yesterday for the 14th consecutive day, down to 4.83%.

However, even though short-term rates are at very low levels due to the huge liquidity central banks provide, banks still do not lend on longer maturities. The spread between the shorter-term and the longer-term loans is still very large, despite recent declines. The 3-month dollar Libor is 220 points above the Fed’s rate, compared with just a few dozen points in normal market conditions.

The question now is how low and how quickly will the rates fall. Central banks are now walking at the “extreme end” of monetary policy. Central banks operate by influencing short-term rates, and hoping (it is really hoping) to move the longer maturity rates; very similar to a whip. However, as banks are reluctant to loan to each other, a central bank has practically no control over the “end” of the whip, thus, the high spread between the shorter-term (which are at record lows) and the longer interest rates.

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Expecting A Hold, But Secretly Wanting A Cut To 0.25%

Written by A Forex View From Afar on Friday, October 31, 2008

After the Federal Reserve cut interest rates by 50 basis points yesterday, markets have shifted their focus to the Bank of Japan, which is expected to hold firm the overnight lending rate, but there is rising speculation they will cut 25 basis points.

Speculation is increasing for a cut although just one week ago the chances for such a movement were minimal. If the bank does cut, as is speculated, the overnight rate will fall to 25 basis points, and remain the lowest among the developed countries.

The rate cut might see more support from the government rather than from the central bank. The Japanese economy may face a prolonged slowdown, as exports slide due to international tensions and the stronger yen. In the past, BoJ Governor, Masaaki Shirakawa, declared that the current rates are dangerously low.

However, if the central bank does not cut, the Japanese Yen may continue to strengthen. Looking at how the markets have reacted to risk lately, in the case of a hold decision from the bank, it would not be out of the question for the yen to test the 94.00 and 90.00 areas again.

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Foreseeing A Currency Crisis

Written by A Forex View From Afar on Thursday, October 30, 2008

It was mentioned earlier that a number of currency crisis’ may emerge in the future as the world continues to head toward a recession and funding (money) becomes scarce.

Emerging economies have the most exposure to a currency crisis, because they usually have a high balance of payment deficit (with most of the debt attributed to the governments’ entities). If the country also has a pegged currency exchange, it can become a sitting duck.

The reason is that the debt must be supported by inflows of cash. If economic conditions and outlook deteriorates (as is happening these days for most of the world), inflows will slow down, and even switch to outflows. This puts double pressure on the currency, first that the government is near bankruptcy (can’t issue any more debt) and then the currency is set to depreciate due to money exiting the country.

This is where the rating agencies usually come into play, and cut the country’s debt rating. To make things worse, typically the same trade desks who issue a negative outlook for the country are the ones who initiate the currency attack, and force the country to drop the peg, or depreciate the currency at a very fast pace.

The country does not have too many options available, so it will be forced to adopt a flexible exchange rate. As the currency depreciates, the foreign debt will increase, making matters worse. These types of attacks are very well documented, such a case being the 1997 Asian Crisis and then a few years later the Argentinean crisis.

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Looking to Central Banks for Intervention

Written by A Forex View From Afar on Tuesday, October 28, 2008

The Bank of Japan will very likely intervene and sell the Japanese Yen, in order to give a helping hand to Japanese exporters.

The Japanese Yen strengthened this month about 15% against the dollar and 29% against the Euro, as the currency is being bought to cover the short positions from carry trades.

European authorities declared that the Bank of Japan should do the intervention alone, with no help coming from the ECB. The reason behind this decision may very well be that both the ECB and European politicians are more than happy with the low value of the single currency, after more than a year of being criticized for a strong currency.

Sources have also said that other central banks have intervened in the foreign exchange market lately. The RBA stopped the Australian Dollar depreciating during the last few days, after it fell almost 30% from its peak reach in July. Others also pointed to the Swiss National Bank for supporting the Swiss currency lately, in an effort to reduce the intra-day volatility. Central banks from emerging countries have also supported their currency lately against speculative attacks.

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Consequences of the Lehman Bankruptcy

Written by A Forex View From Afar on Tuesday, October 28, 2008

Since Lehman was declared bankrupt, it seems the financial world has gone completely mad. In the past few weeks the LIBOR rates have set new records, now the Fed funds rate is following.

However, what exactly is the “Fed funds rate”? The fund rate is the inter-banking rate at which U.S. primary dealers lend to each other to meet the minimum reserve requirements. In order for a bank to operate, it needs to build up a minimum reserve at the Federal Reserve. Due to diverse operations (lending, deposits) the minimum required figure changes from one day to the next. As such, banks that do not meet the minimum requirements borrow from those who have excess reserves.

When the Fed sets the interest rate, it actually sets the target for the Fed funds rate. It should be noted, that the Fed only targets a specific rate, but the real (effective) rate, fluctuates on a daily basis around the targeted rate.

Here is where the Fed’s problems come in. It looks like lately, especially after the Lehman collapse, that the Fed has lost control over the effective rate. A simple look over the attached chart can see the high volatility occurring in the Fed funds market. The yellow line shows the effective rate, while the straight line denotes the target rate. Notice how after the Lehman collapse, from the middle of September, the effective rate has gone haywire.

This is very important because it actually shows the loss of control over the Fed Funds, which through others, is the rate at which the central bank controls the whole economy and the business cycle. Losing the ability to control monetary policy, the central bank has practically tied its own hands.

With the effective rate staying at 0.95% (compared with the targeted rate of 1.5%) it looks like the Fed will only have to sign the paper on Wednesday, because the inter-banking market has already priced in a 50 basis point rate cut. The “cut joy” will be seen only in the stock market and for a limited amount of time.

Fed Funds Rate after Lehman

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Nikkei: The Road To 1982 And Back

Written by A Forex View From Afar on Monday, October 27, 2008

The Japanese Nikkei tumbled 486 points overnight, falling to 7,162.90. So far this year, the Nikkei has fallen, in the face of the credit crunch, a little more than 50%.

The same level, 7,160 points, was last touched by the Japanese market back in 1982, when one of the biggest bubbles known to modern financial world was developing. The bubble continued until 1989, where it peaked at 40,000 points, more than 5.5 times today’s value.

In order to heal its wounds, the Nikkei retraced for 13 years, until 2003 when it fell to 8,400 points. At its peak, back in 1989, the earnings per share was standing at 70.00 compared with today’s 8.6..

On the macroeconomic scale, since the 1990’s, the Japanese economy has fought deflation and a fast ageing population. Due to the low inflation environment, the BoJ interest rates are already at a low level, 0.50%, leaving the central bank’s hands tied in the face of the global slowdown.

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Fundies and Trading
There is a constant question from some traders as to why anybody would ever need to consider the ‘F’ word when trading. Fundamentals: what is so damaging at looking at both Technical charts and having a Fundamental filter to gauge how many Lots to put on? Why is it that accepting that Technicals give us price points to trade, but Fundamentals determine the direction that we travel is so difficult for some traders to accept? Without a Fundamental Filter very few pure Technical traders would have seen this Dollar move coming today.

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