[B]The dollar will be generally vulnerable in the short term following Bernanke’s comments. The extent of selling pressure on the US currency will be determined to an important extent by whether the increased fears are confined to the US or whether there are greater fears over the global economy as well. Overall, the dollar should be able to resist heavy selling pressure as there is liable to be increased unease over the Euro-zone trends. Sterling should be close to a near-term bottom even with very weak confidence. [/B]
[B]EUR[/B]
The comments from Fed Chairman Bernanke will reinforce expectations of an aggressive interest rate cut at the end of January and this will reinforce the dollar’s lack of yield support. There will also be further fears over a US recession which will damage confidence, especially with further unease over the financial sector. Despite a tough ECB stance, there will be increased concerns over the Euro-zone economy and this will curb Euro demand at current elevated levels. Fears over the global economy will also trigger some important defensive US currency demand. The dollar will remain vulnerable in the short term, but should be able to avoid heavy selling pressure form current levels with short-term support close to 1.4810 against the Euro.
The dollar was unable to sustain gains below 1.4650 against the Euro on Thursday and weakened sharply after contrasting remarks from Federal Reserve and ECB officials. The dollar dropped to lows beyond 1.48 and remained weak on Friday.
As expected, the ECB left interest rates on hold at 4.00% following the latest council meeting. In a statement following the decision, ECB president Trichet stated that inflation pressures remained strong and that the bank would act pre-emptively on inflation. The central bank head stated that there had been a discussion of a rate hike at the meeting, although Trichet also warned that there were downward risks to the growth outlook.
The tough rhetoric is aimed primarily at domestic policymakers, especially as the ECB’s key concern is to prevent secondary inflationary effects from rising wage settlements. Nevertheless, the tough stance will provide important near-term Euro support.
In contrast, US Federal Reserve Chairman Bernanke, stated that further interest rate cuts may be required while the central bank was ready to take substantive action if required. The comments will reinforce market expectations that the Fed will sanction a 0.50% rate cut in late January and this will tend to undermine the dollar in the short term. Some caution is required as there are a wide range of views within the Fed and there could be strong opposition to a 0.50% cut. Hoenig, for example, was more cautious over the need for further rate cuts, although he will not be a voting member in January.
The latest US jobless claims data recorded a drop to 322,000 in the latest week from 340,000 previously. The data will offer some degree of reassurance over the labour market, but recession and financial-sector fears will persist.
[B]GBP[/B]
Confidence in the UK economy will remain weak in the short term with strong expectations that the Bank of England will cut interest rates in February. There will also be the risk that capital flows will deteriorate further in the very short term, especially if credit fears increase. The latest industrial data will not offer any Sterling support. Nevertheless, there should be scope for at least a limited corrective recovery after recent sharp losses as selling pressure has been very heavy. Overall, there is the potential for Sterling support close to 1.95 against the dollar in choppy trading while the Euro offers poor value at current levels given the pressure for a correction
Sterling found support close to 1.9550 against the dollar on Thursday, but was unable to regain the 1.9660 level. The UK currency also weakened to fresh all-time lows beyond 0.7520 against the Euro. Sterling was subjected to renewed selling pressure on Friday with the trade-weighted index at the lowest level since 2003 as global risk aversion increased.
The Bank of England left interest rates at 5.50% on Thursday. There was no statement with the decision and the breakdown of the vote will not be known until the minutes are released in two week’s time. Sterling rallied briefly following the decision before being subjected to renewed losses. Although interest rates were held this month, there are strong expectations that the bank will cut interest rates in February. Markets are also expecting a series of rate cuts during 2008 which will undermine Sterling.
There was a 0.1% drop in industrial production for November with manufacturing output also dropping by 0.1%. The data will reinforce negative sentiment towards the UK economy and currency, although the impact should be limited.
[B]JPY[/B]
The downbeat comments from Bank of Japan officials will tend to undermine confidence in the yen and will certainly reinforce the lack of yield support. Levels of risk aversion will also remain very important for the Japanese currency. There will be conflicting pressures with fears over risk and credit conditions offset by hopes that aggressive action by the Federal Reserve will trigger a recovery in asset prices. In this environment, volatilities are liable to remain generally high. Overall, the dollar should find further support below the 109 level against the yen with short-term gains capped near 110.0.
The dollar failed to hold above the 110.0 level against the Japanese currency on Thursday and weakened back to 109.30 in US trading, although the moves were constrained in comparison to European currencies. Wall Street was able to secure net gains after Bernanke’s comments which curbed yen buying, although trading conditions were highly uncertain.
Confidence in Japan was undermined on Friday by cautious remarks from Bank of Japan Governor Fukui who stated that the pace of growth was slowing and there was some renewed speculation that the central bank could consider a cut in interest rates, especially as bank lending has slowed.
The yen was still able to secure net gains against the US currency as credit-related fears increased. There was speculation that Merrill Lynch would report bigger than expected losses while the Nikkei index also weakened to a 19-month low. The dollar weakened to below 109.0 in early Europe as credit fears increased.
[B]CHF[/B]
The near-term Swiss currency moves will tend to remain dominated by degrees of risk aversion and franc demand is likely to remain strong in the short term. There will, however, be expectations of aggressive Fed action to support the economy which should provide a boost for global asset prices and curb aggressive franc buying. In this context, the Swiss currency looks to offer little value at current levels with dollar support below the 1.10 level. The Euro should find near-term support close to current levels against the franc.
The Swiss franc retained a strong tone on Thursday and strengthened to test highs beyond 1.63 against the Euro. The franc also strengthened to test highs near 1.10 against the US dollar and retained strength in European trading on Friday.
There was sustained demand for the Swiss currency during the day with investors generally cautious over global risk conditions. The currency retreated from its best levels as Wall Street rallied, but the overall performance was still robust. The franc secured renewed buying support on Friday as risk tolerances remained lower with the franc again testing levels around 1.10 as fear increased.