World Market Update - North America

Markets Quiet for US Thanksgiving Holiday

Thu, 27 Nov 2008 19:22:22 +0100

Global Equities Hit Two Week High

Global equities are continuing their strong performance of late, hitting a two-week high as Asian and European markets rallied ahead of the US Thanksgiving holiday. Renewed trader optimism over a possible bailout for the Big 3 automakers in the US as well as yesterday's out-sized cut from the Peoples Bank of China have contributed to the positive tone for equities while yesterday's unequivocally soft US economic data, coupled with similar news from Europe today have brought down bond yields at the same time. In playing catch-up to yesterday's gains in North America, the Hang Seng in Hong Kong posted a 1.37% advance while Tokyo's Nikkei 225 delivered a gain just shy of 2% in relatively thin dealings.

European markets have largely picked up where Asian left off with the FTSEurofirst 300 index of top European shares rising 1.9%, Britain's FTSE 100 index up 1.4% and Germany's DAX climbing 1.6%. The MSCI world equity index has climbed 0.9 percent to 217.82, having earlier reached a peak of 218.46 - a level last seen on November 14.

As has been the trend of late, a positive performance for equities has been negative for the dollar as traders unload holdings of US Treasuries to move back into stock markets. The USD Index is trading 0.25% lower on the day though it has held its ground against the commodity currencies and yen with losses coming primarily against the EUR and GBP.

The Canadian dollar finds itself on the defensive this morning, selling off more than 0.5% on sagging commodity prices with oil in particular, paring its recent gains with a $1 decline driven by softening global demand. The main focus for Canada dealers however will be the government's autumn update on its fiscal position at 4pm EST. In announcing its "unprecedented fiscal stimulus" plan to boost the domestic economy just last week, traders will pour over the details of the report to analyze the possible affect of any new spending commitments, as well as the toll the price tag will take on the fiscal budget.

European Economic Figures Fail to Impress

The overall economic environment in Europe has largely failed to stabilize according to this morning's data releases, where any variations from analysts' consensus forecasts tended to be to the downside. Although Germany's unemployment rate held steady at 7.5% in November, numerous government reports accompanied the reading with a message that the labour market's resilience to this point isn't likely to persist. Euro Zone business confidence fell further than expected in November while Spanish retail sales and UK house prices came in well below expectations. In addition, two large UK retailers downgraded their outlook for domestic sales into 2009 citing significant challenges in the overall retailing environment in the coming period.

Terrorist Attack in Mumbai Send Shockwaves

Shockwaves traveled around the world overnight as the death toll from an Islamic terrorist attack in Mumbai climbed to more than 100 people, many of them westerners. In a massive co-ordinated effort, terrorists stormed multiple locations in downtown Mumbai, including several luxury hotels, a restaurant and a train station, firing automatic weapons with seemingly little discretion. More than 18 hours after the initiation of hostilities, government commandos and terrorists were still exchanging gunfire in the heart of India's capital centre.

In calls made to local TV stations, the terrorists demanded the release of all Mujahideens held in India, and called for Muslims living in the region to be left alone, specifically mentioning atrocities in the long disputed Kashmir region as part of the motivation for the attacks.

India's financial markets all closed following news of the incident.

By Mark Frey, VP Foreign Exchange Trading

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USD Picks Up Gains on Soft Data

Wed, 26 Nov 2008 18:34:52 +0100

USD Firms Despite Poor Data

The USD is mixed in early trade this morning despite durable goods orders for October plunging off a cliff with a 6.2% monthly decline against the market's consensus forecast calling for only a 2.5% drop. New orders, an important leading indicator for future manufacturing activity, also fell more than expected at 4.4%. September's headline reading was also revised lower from 0.8% to –0.2%. Clearly, consumers are beginning to feel the pinch in the US as their purchases of big-ticket items like autos, computers and household appliances slows to a crawl.

Initial jobless claims for the week of November 22nd came one day early today because of tomorrow's Thanksgiving holiday, printing a figure of 529K vs. expectations of 537K and a previous week's reading of 543K. Although first time filings for unemployment insurance did come in slightly better than expected, a number over 500K is generally considered to be recessionary. Personal income for the month of October slightly exceeded the consensus estimate while personal spending came in slightly lower than what analysts had been forecasting.

The Chicago Purchasing Manager's Index, which is a measure of the purchasing decisions of manufacturers in the city, sank more than expected in the month of November with a reading of 33.8 vs. expectations of a 38.5 figure. October had come in at 37.8. Adding to the day's sour sentiment was also news that the University of Michigan's consumer sentiment index fell further than expected to a reading of 55.3 for November against expectations of a 58.0 reading and a prior monthps number of 57.9. And finally, just in case you still had some optimism left for the day's equity session, new home sales figures for October were also released this morning with October's reading missing the consensus forecast while September was revised lower as well. It all adds up to something that sounds like a great buying opportunity – that's a glass half full outlook for you!

The Canadian data calendar is quiet today and tomorrow while the US is closed for the holiday, though we will have fresh incentives to trade on for Friday, though volumes will unquestionably be low as most US traders take a long weekend.

The USD is higher on balance today, with the Dollar Index trading 0.65% higher as the euro and Canadian dollar play the role of the biggest losers amongst the major currencies, giving back a small portion of the gains achieved yesterday in the case of both currencies. The CAD forward curve has turned completely negative yet again as US deposit rates are now higher than those of Canada across the full curve. Forward traders continue to pare back their long CAD exposures as expectations of interest rates in Canada plummet due to the coming economic slowdown while US deposit rates creep higher as the US government backstops nearly every domestic debt market with more US government debt. Should this trend continue unabated, the Loonie could find itself running out of steam in the face of a negative carry, or interest rate environment where traders pay a premium to buy CAD forward.

EU Commission Proposes 200 EUR Stimulus Package

Amid a backdrop with European Central Bank President Jean-Claude Trichet admitting that the EU will likely post negative growth throughout 2009, European Commission President José Manuel Barroso proposed an EU-wide stimulus package this morning of €200 billion to give the sagging economy a shot in the arm in an effort to better resist the impact of the ongoing financial pandemic. EU monetary affairs commissioner Joaquin Almunia added that the financial crisis was "not yet over" and that although any positive effect from stimulus package was likely to be temporary, that it was still advisable in the current climate. As part of the deal, Almunia stated that the allowable fiscal deficit levels, currently set at a maximum of 3% of GDP in the EU Growth and Stability Pact, would be waved temporarily for all nations.

News of the deal failed to inspire much confidence in the euro, as the common currency has sagged after yesterday morning's robust move higher, giving back more than a cent on the day. Similar to the story with Canada, the euro's once lofty yield premium over the USD continues to abate as US rates creep higher and the market ratchets down Euroland deposit rates in anticipation of a slightly more aggressive ECB.

News and Notes on the Day
In a sign of the times in today's credit markets, BCE announced today that it may not be able to complete the world's largest leveraged buyout being orchestrated by the Ontario Teachers Pension Plan. Shares of Canada's telecom giant plummeted 40% on the announcement to $18.90, well below the deal price of $42.75 per share as it was learned that the company would likely fail to meet a post-deal solvency test that is one of the conditions of the buyout, according to its auditor, KPMG. The deal is set to close December 11th, though that date certainly seems to be in question if not the entire deal itself.

The Peoples Bank of China surprised the market with 108 basis points of monetary accommodation overnight, nearly delivering, in one fell swoop, what the market had forecast for the months ahead with five successive cuts of 27bps being priced in. Chinese officials continue to press a pro-active agenda with respect to the coming economic slowdown, employing economic stimulus plans alongside monetary relief. Asian equity markets rallied on the news with the Hang Seng in Hong Kong closing up 3.81% on the session with Tokyo's Nikkei 225 paring its earlier losses to close down 1.33%. European traders have however failed to continue the buying spree as the major bourses of London, Frankfurt and Paris are all trading in the red at the close.

By Mark Frey, VP Foreign Exchange Trading

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US Fed Cranks Printing Presses to Full Speed

Tue, 25 Nov 2008 18:31:55 +0100

How Fast Can the Fed Print Greenbacks?

Apparently, quite fast. The US Fed must have just purchased a shiny new supersonic speed printing press to re-inflate the US economy because it has just opened the kitty to unleash a bailout bonanza of epic proportions this morning. In announcing a new program today to deal with the credit crisis and toxic securities based on the floundering US housing market, the Fed has effectively announced fresh spending commitments to the tune of $800 billion USD and yes, that is billion with a "b."

Six hundred billion of those greenbacks have been earmarked to purchase mortgage-related debt and securities, with $500B aimed at securities backed by the federally controlled mortgage insurers, Fannie Mae and Freddie Mac and the Federal Home Loan Banks. The remaining $100B aimed at the mortgage market will be targeted relief for debt issued by those government-sponsored mortgage finance entities.

Although the September nationalization of Freddie and Fannie effectively cemented the implicit governmental guarantee of the mortgage insurers debt obligations, that debt had been trading at a substantial and historically large premium over that of US government debt. In repurchasing Fannie and Freddie's notes, the government hopes to narrow the spread between its borrowing costs and that of its recently acquired mortgage finance entities. In a press release announcing the creation of this facility, it was noted that "spreads of rates on GSE debt and on GSE-guaranteed mortgages have widened appreciably of late. This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally."

The other $200B in bailout spending will be aimed at consumer debt facilities, an official recognition that the mortgage mess has now spread to consumer and credit card debt as well. Rumours of such intervention have been rampant across the market in recent weeks and the Fed has now decided that this is the time to step forward and shift its target away from only mortgage-related securities.

Market Reaction

Understandably, the US dollar is in freefall since the announcement of the Fed's new spending commitments. By specifically targeting the risk spreads being priced into mortgage-related debt, the Fed is taking a significant bite out of risk aversion, thereby weakening the foundation of the USD rally built on risk aversion and a flight to quality in US Treasuries. However, the second and perhaps more important reason for selling the dollar this morning in most traders' minds is the fact that the US government is once again committing to spend money it doesn't have, thereby driving up long-term price pressures, which will put pressure on the currency's valuation over the long haul. The Fed is making a big, big bet here in the hopes that it can once and for all stop the bleeding in global credit markets.

As a hint to the devaluing affect this action will have on the USD, the Japanese Yen is rallying alongside every other major currency. If the market was simply responding to the Fed's measures as a means by which to support global growth and the normal functioning of credit markets, one would expect the Yen to be trading with an extremely well-offered tone. The fact that even the JPY is strengthening this morning tells me that this is as much about devaluing the dollar and re-flating the economy as it is about tackling risk.

The Canadian dollar, euro, and cable are all trading more than 2 full cents higher on the day with the Aussie and Kiwi units coming up more than a cent. Again, given the Tasman currencies' sensitivity to risk, this morning's events would be expected to produce a bigger pop for the high yielders if the day's move was only about risk rather than a broad move lower for the dollar in the long-term.

As might be expected, an already positive session for equities has turned into a full-scale rally with North American equities trading close to a full percentage point higher at the open.

What Central Bank Action is Priced In?

In short, what is priced into markets as of the Monday close is a great deal more monetary accommodation (interest rate cuts) from the world's major central banks. Although expectations for the Aussies and Kiwis are certainly heightened, aggressive monetary accommodation is still expected from the Bank of England and the US Federal Reserve to a lesser extent as well. Of note: although the refinance rate of the European Central Bank is still a full 2.25% higher than that of the Fed's benchmark, market expectations are still less aggressive for Mr. Trichet than for Mr. Bernanke. In other words, the market's expectations are clearly driven as much by central bank tendencies as they are by a simple calculation of how many bullets each has left in their six-shooter.

The Fed's benchmark rate currently sits at 1.00% with their next scheduled meeting falling on December 16th. Traders are currently pricing in a 100% chance of a 75-basis point (bp) cut and a 9% chance of a 100bp cut by year-end. That being said, it is hard to think of a scenario that would lead the Fed to cut rates right down to the bone in the short-term for fear of overplaying their hand too early in the game. A more likely scenario is for the Fed to shift to a lower gear and deliver a modest, 25bp cut in mid-December.

Mark Carney at the Bank of Canada currently has interest rates on the Loonie slotted in at 2.25% with the BOC's next scheduled policy decision scheduled for December 9th. Further monetary accommodation is virtually guaranteed in Canada with markets fully pricing in another 50bp cut and a 36% chance of a 75bp cut by the end of the year. Further, more rate cuts are expected into 2009 with traders pricing in nearly a 50% chance of an additional 100bps of policy reductions, taking the BOC's rate down as far as 0.50% by the third quarter of 2009.

Jean-Claude Trichet at the European Central Bank has managed to maintain his image as a rather conservative inflation fighter in keeping rates at relatively elevated levels, at least compared to his peers. The ECB's refi rate stands at 3.25% and with its next scheduled policy meeting on the fourth of December, that image seems likely to remain in tact. Although the market is fully pricing in a further 50bp cut to the refi rate, there is only estimated to be a 54% chance of us seeing a more aggressive 75bp cut by year-end, a one-time level of monetary accommodation already delivered by nearly every other major central bank. That being said, the market is forecasting a capitulation of sorts at the head of the ECB table with the credit crisis finally breaking the Governing Council's aversion to inflation stimulus with full expectations of a further 100bps of relief coming before the end of Q2 2009.

Perhaps explaining why Cable, or GBPUSD as it is better known, has become the market's whipping boy of late is the fact that traders simply expect that the Bank of England will continue to be extremely aggressive on rates for fear of staging a full-scale economic meltdown in their home country similar to what is transpiring in the US. The BOE's current target of 3.00% is expected to come down by no less than 125bps by year-end, with further cuts to come in the New Year.

Given the fact that the Bank of Japan is effectively paying investors to borrow money in real terms, and has been for much of the past decade with inflation exceeding the official central bank interest rate, there is, in short, not much more the BoJ can do as markets price in only a 7% chance of a 25bp cut before 2009. This is perhaps the best cautionary tale that can be delivered to Ben Bernanke at the US Fed at this time; too many cuts too fast leave one with very few policy options on a go forward basis. The BoJ once thought it was being proactive in "getting ahead" of a coming economic slowdown and asset price revaluation, only to be stuck with a deflationary and stagnant economy for the better part of a generation.

That finally leaves us with the "high yielding" Aussie and Kiwi units, which I've put in quotations only because it is hard to categorize rates in the 5% range as high, at least by historic measures. The unwinding of leveraged risk has no doubt severely punished the Tasmans and the respective central banks haven't helped the currencies by cutting aggressively, often in response to the global credit calamity. That being said, the underlying economic fundamentals of the region remain comparatively firm and although struggling commodity prices are weighing on the local units, the Reserve Banks of both Australia and New Zealand aren't about to let off the gas anytime soon. The market is fully pricing in 125bps of monetary relief in both markets with a 27% and 17% chance of 150bps coming before the close of 2008 in New Zealand and Australia respectively. Going forward, markets are fully pricing in 250bps of cuts in Oz in the first half of 2009 with 225bps being handed down in NZ before the close of Q3 2009.

By Mark Frey, VP Foreign Exchange Trading

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Citi is Rescued with Sunday Afternoon Deal Sellers Finally Exhausted - Nov 24th

Mon, 24 Nov 2008 18:49:52 +0100

Citi is Saved by US Government

As sports fans in Canada sat down to watch the biggest football game of the year, government officials in the US set into motion a series of events that would lead to another giant-sized bailout of Citibank, the institution that just a few short months ago was the largest bank in the world by market capitalization. Deemed too large to fail due to its status as the "world's counterparty," Citi possesses local operations in more than 100 countries, a network that would have caused untold billions in losses at other institutions if it were allowed to fail as the dominos crashed the world over. For these reasons, nearly everyone expected some sort of a bailout over the weekend, the only question was the form it would take and whether or not another US institution such as JP Morgan or Bank of America would play the role as saviour instead of the trifecta of the US Treasury, Federal Reserve and Federal Deposit Insurance Corp (FDIC).

The terms of the deal will see a $20B cash injection by the Treasury Department, on top of the $25B delivered in the first stage of the emergency bailout fund under the same terms, with Citi issuing preferred stock in return. The second part of the plan will see the Treasury and the FDIC guaranteeing against the "possibility of unusually large losses" with what effectively takes the form of a loan guarantee on a $306B portfolio of loans funded by mortgage-backed securities. Under the loss-sharing arrangement, Citi will shoulder the first $29B in losses on the portfolio with the Treasury picking up the tab for 90% of the losses beyond that threshold, with funds partially guaranteed by the FDIC. A loan will also be extended to assist aid liquidity as the bank restructures its debt portfolios.

As a condition of the rescue, Citigroup will be forced to cut its dividend, already halved to 16 cents from 32, to a maximum of one cent per quarter. Finally, the bank has also accepted limits on executive compensation, including bonuses, the all-important selling point in terms of public opinion on the government’s bailout of financial institutions.

Importantly for the outgoing Bush Administration, the agreement calls on Citi to take steps to help distressed homeowners, forcing the bank to renegotiate the terms of mortgages for homeowners that are at risk of foreclosure in a very similar manner to the arrangement reached for Indy Mac borrowers, the failed California-based Savings and Loan.

Market Reaction to the Deal

Initial investor reaction has been positive with the deal effectively saving overall market sentiment from plunging off of a cliff. Although equity markets were mixed in Asia, stocks in Europe bounced significantly in afternoon trading as the final terms of the deal became public while North American equity futures are pointing to a positive opening as traders and dealers again begin to take on some risky plays, no longer fearing a financial apocalypse brought on by a failure at Citibank. Further aiding the mood of risk acceptance in financial markets was word this morning that shareholders of Barclays Bank Plc have voted to allow the institution to raise capital from Middle East investors instead of drawing from the UK Governments bailout fund. These two developments, as might be expected, have financial stocks rallying broadly as bonds sell off with US Treasuries losing their safe haven bid.

As word of a possible deal spread, currencies rebounded against the dollar as well, with significant gains being delivered across the board in both Asia and again in London as risk aversion abated. The EUR has rallied nearly two cents on an increasing risk appetite and the move away from US Treasuries while the JPY has of course ceded some of the gains earned last week as the market speculated on the health of Citibank.

The commodity currencies of Australia, Canada and New Zealand are also bouncing this morning, supported by not only a generally increasing risk appetite but by surging commodity prices as an extension of market sentiment. Crude oil is trading back over $51.50, up nearly $2 on the day while the broader CRB Index of commodity prices has turned positive as well.

By Mark Frey, VP Foreign Exchange Trading

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Sellers Finally Exhausted - Nov 21st

Mon, 24 Nov 2008 18:40:36 +0100

Blame It On The Pros

The markets have settled down somewhat this morning after investors in Asia put a stop to the relentless selling of stocks, commodities and currencies that has dominated market action this week. The Japanese Nikkei index managed a 2.7% gain and stocks in Europe held their ground. US stock market futures are trading higher this morning suggesting we should see a positive opening in New York. Stock markets have been absolutely hammered and have pretty much erased the last 11 years of gains as market risk premiums and return expectations normalize. Of course, the velocity of the moves over the past few months is anything but normal – stocks have fallen almost 50% in just two months, the worst market collapse since 1930/31.

Two factors account for the speed at which the markets have come unglued. The first: technology and the ability to move billions of dollars between asset classes at the press of a button. Technology also gives everyone everywhere access to the same news and information at the same time so the dynamic of the herd mentality is greatly amplified, thereby compounding market panic (and exuberance). The second: the markets have been driven by speculative trading and excessive use of leverage - what was called margin trading in the 1920's. Those leveraged positions are being unwound mercilessly as banks and other lenders call in their loans to hedge funds. At the same time fund investors are forcing asset sales to meet redemptions. So excessive leverage and speculative trading are being squeezed out of the markets without mercy and the fact that it is happening so fast, as difficult as it may be to watch, is probably a good thing, because there are now excellent bargains out there and the sooner the correction is exacted, the sooner the markets can get back to being driven by investment considerations rather than being dominated by the institutional risk takers.

Interestingly, institutions have recently accounted for more than 70% of all stock market trading as individuals have turned over investment decision making to hedge funds, mutual funds and pension funds. In the 1950's institutions accounted for less than 30% of market activity. We saw the same phenomenon in the 1920's, the late 1960's, again in the late 1990's and in this current decade – greater concentration of investment capital in the hands of “professionals” to the point where the number of mutual funds actually exceeds the number of stocks listed on the NYSE. In all cases, concentration of investment capital, and all the competitive and herd mentality dynamics associated with that, has always led to excessive market speculation and an eventual market blow-off. There's a leading indicator for you.

Finally A Day Of Reprieve

So markets are getting a reprieve today as most brokers and fund managers have probably headed out to the bars early today after the week we've just been through. After hitting 50-year lows yesterday, bond yields are up a bit today as the panic buying has subsided - for now at least. The 10-year t-bond is at 3.17% and the 2-year bond is yielding 1.05% after falling below 1.0% for the first time ever yesterday. These are indeed historic times. As a matter of fact, for the first time since 1958, the yield on the S&P 500, at 3.4%, now exceeds the 10-year t-bond yield. At these levels, one of two things is going to happen over the coming months – interest rates are going to move sharply higher, or stock prices are going to soar. Given that the US Treasury is probably going to rack up a trillion dollar budget deficit next year, I'd put my money on the interest rate scenario. That's certainly what the gold market is suggesting. Gold has taken off this morning spiking almost $30 higher.

Currencies have staged a bit of a recovery this morning and hopefully we've seen the worst of the nonsensical panic-induced selling. The Canadian dollar touched a low below 77 cents yesterday, close to the previous low on October 28th. If yesterday's low holds, we should be seeing a double bottom here and the worst is over for the Canadian dollar. Looking at the technicals, the underlying indicators that I watch, the MACD and RSI, have exhibited a negative divergence through the entire CAD rout this week. The price action has not been supported by the indicators and it is a strong sign that there is little sustainability to the US dollar spike. The Canadian dollar has recovered just over a cent this morning as has the Australian dollar. The euro and pound are both trading higher and the emerging market currencies are clawing back from significantly oversold levels.

Not sorry to see the end of this week. Have a good weekend everyone and thank you to the readers who have taken the time to provide feedback. We are happy to entertain questions and welcome constructive suggestions for improving our commentary.

By Paul Lennox, CFA, Corporate Treasurer

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Markets Remain Driven By Risk Aversion - Nov 20th

Mon, 24 Nov 2008 18:33:57 +0100

Stock Markets Continue to "Normalize"

Avoidance of any and all risks continues to dominate global financial markets. Equity markets fell sharply in North America yesterday triggering another round of global selling. Share prices fell 6.9% in Japan earlier today and stocks in Australia and Hong Kong dropped more than 4%. European markets are trading 2.5% lower at 5 ½ year lows and North American markets have opened to the downside once again. The S&P 500 index is now trading at 785 having taken out the October 850 low.

Looking at a long-term weekly chart, the S&P has now retraced 50% of its gains in the bull-run that started in 1982. A 61.8% Fibonacci retracement would take it to the 665 level. Believe it or not, but at 665, the secular bull market in stocks that started in 1982 remains intact, even though we'll have gone through a 57% correction from the market top of 1570. The point is, the run-up in stock prices from about 1995 to 2007 was a speculative aberration and stocks are just now returning to normalized levels based on historic market risk premiums and expected rates of return. So, as painful as the plummeting of stock markets is, it is certainly not the end of the world, but just a return to normalized equity valuations. At current levels, you would think we are getting close to the bottom. But with markets normalizing, don't expect to see us to return to the days of 30% average annual market gains any time soon.

Commodity prices are faring no better with oil falling to a 22-month low of $50. Gold is the rare exception in this market meltdown in that it is holding well above $735 even as the US dollar has been on a tear over the past 24 hours. Long-term bond holders are also happy as US Treasury yields continue to fall and bond prices rise. The 10-year t-bond is now yielding just 3.16%, a 5-year low. In the money markets, the US 3-month t-bill is now paying just .02% and was actually as low as .005% earlier this morning. T-bills are the safest instrument to hold, better than cash actually, and investors are saying, "just give me security against losses, I don't care about trying to make money in this environment, I want zero risk."

For risk adverse US investors, and others holding US dollars, US government t-bills are the only game in town. At the other end of the spectrum, if you are a risk taker, there is certainly money to be made. High yield (low quality) corporate bonds are now yielding about 20%. Obviously there are few takers with yields this high. It wasn’t that long ago though that "junk" bonds were trading at record low spreads over t-bonds with yields less than 6%. What a change in the propensity of investors to assume risk.

With equity and commodity markets down and investors pouring into t-bills, the US dollar is surging once again. The commodity currencies, the Australian and Canadian dollar, are being particularly battered today. The Aussie dollar is now back below 62 cents as it is down another two cents today. The Canadian dollar is no better off as it has tanked three cents this morning and is now trading at about .7750. The yen is one of the few currencies in positive territory as it does well when investors unwind yen denominated loans to avoid further losses on carry trades. The euro is holding above 1.25 this morning and the Swiss franc is holding up well after the Swiss National Bank cut interest rates a dramatic (for the Swiss) 1.0%.

Other News of Interest

The International Herald Tribune ran a story on the state of the shipping industry and it notes that rates on dry cargo have plummeted more than 90% over the past few months due to the oversupply of shipping and the slowdown in demand. This is certainly reflected in the Baltic Dry Freight Index, which has sunk to 847 today from a high of 11,800 in May.

A story in Business Week assesses the situation in Russia as the economy is being hit hard by the collapse in commodity prices. The Russian Ruble has fallen 17% since August and the stock market has tanked 75%. The Russian banking sector is in a state of chaos as they try to figure out where they stand in terms of the value of the loan assets on their books. The west may be struggling similarly, but there is even less transparency into banking, politics and business decision making in developing countries like Russia, so there is greater uncertainty and greater risk for investors. Russia has enjoyed a number of years of unprecedented wealth building, but it is now facing some very challenging times. Let's hope the economic ties Russia has developed with the rest of the world over the past 20 years continue to significantly influence Russian foreign policy.

By Paul Lennox, CFA, Corporate Treasurer

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Credit Conditions Worsen, JPY Higher, Equities Higher

Wed, 19 Nov 2008 00:40:55 +0100

So I finally get it. I never did before. I finally understand what it's like to be that kid sitting in the back of the math class struggling. You know, there was always that one kid who did his homework, came to class, was relatively smart in every other subject but just couldn't wrap his mind around the laws of mathematics. I finally understand what those kids felt like all those years ago because as I now sit at my desk and try to make sense of today's market, I simply don't get it. Perhaps it is because the impenetrable truths of which we have been writing about and trading on are breaking down. The correlations and trading signals that we've previously employed to navigate our way through this tumultuous market since last August seem to no longer be holding. I say "seem to" because two days do not make a trend, but two days can be an eternity in today's market.

So what is happening? Equities are rallying broadly, across Asia and Europe and although North American equity futures are pointing to a softer opening, there is no question that we closed on an upbeat note on Thursday. At the same time, credit conditions are worsening. Uncertainty over the future path of not only the US Treasury's TARP bailout plan but the US Federal Reserve's extraordinary liquidity injection measures is causing the all-important measure of credit market health, the LIBOR/OIS credit spread, to once again widen. After narrowing for weeks as credit market conditions improved and funds began to flow, the spread is wider by 10-basis points this morning. In addition, the one-month USD deposit spread is widening as well; trading at more than 100-basis points again this morning. Finally, the JPY, the world's proxy for currency and financial market risk is once again strengthening. That fact, taken against the widening of credit spreads is not surprising but against a backdrop of a nearly 3% equity rally in Asia and 2.5% in Europe, a Yen rally looks positively puzzling given their near perfect inverse correlation in recent months between the price action of the JPY and stocks.

Further, the US dollar has been under pressure, ceding a full big figure off of the USD Index in the past 24 hours, though the rally in commodities has been relatively muted, especially given that the CRB is up only 2 points this morning as oil struggles to find a footing at $58. Could it be that we are seeing a return to normal market conditions and that the unshakable correlations with respect to risk aversion and acceptance of the recent past will no longer hold in the coming period? Are we entering a new phase of market turmoil with either a new set of trading rules or are we simply entering a period where we'll all have to think for ourselves instead of simply following along blindly wherever these few market indicators take us? As a market participant, you learn to love patterns. You try to make sense of and find order in randomness. Therefore, a possible change in patterns presents a whole new set of risks, opportunities and challenges in terms of managing your business.

G20 World Financial Crisis Summit

The world's leaders are making their way to Washington this morning, congregating to debate future action and possibly even regulation in response to the world’s financial markets crisis. The G20 will have a powerful mandate for action in that the leaders seated around the negotiation table represent 85% of the world’s economic production and two thirds of its population. There is an unquestioned desire to work cooperatively on a solution to the coming economic slowdown but whether or not a real consensus can be achieved is yet to be determined.

British Prime Minister Gordon Brown, who has been at the forefront of the governmental response to the credit crisis with his plan to recapitalize his nations' banks (a plan that was essentially copied for all but a few key points around the world), is calling for more coordinated action to spur economic growth. Other delegates would rather focus on how best to incorporate emerging market economies into established world financial institutions such as the International Monetary Fund so as to best enhance exchange rate stability. Still others seem focused on banking regulation and the credit market contagion that has sparked the crisis.

The one sure point to make this morning is that there is a great deal of positive economic sentiment riding on the notion that this summit will produce a meaningfully positive result for the global economy. Failing a consensus on one of the above-mentioned issues, much of that positive sentiment could quickly dissipate.

North America Economic Data

US retail sales for the month of October have failed to find a floor for consumer spending as figures released this morning came in much worse than analysts' consensus market forecasts. The headline figure printed at –2.8% vs. forecasts calling for –2.1% against a prior month’s reading of –1.3%, which was revised slightly lower from –1.2%. Sales excluding autos were soft as well, though it is clear that motor vehicle sales are acting as a significant drag on consumer spending as s whole. Import prices, excluding oil, came in as expected in the US while export prices, excluding agricultural products, declined 0.3% more than expected to –1.2% in October. The market still awaits September business inventories and the preliminary reading of the University of Michigan's Consumer Sentiment Index for November, with analysts calling for a slight downturn to 57.0 from 57.6.

The economic news north of the border however has been decidedly more upbeat this morning, further underscoring the gravity defying health of the Canadian economy. New vehicle sales rebounded 2.5% in September after three successive months of declines while annualized sales jumped 2.2%. Manufacturing sales orders also edged 0.1% higher on the month on the heels of an outsized decline of 3.7% in August. The market's consensus forecast had been for a decline of 1.5% so today's report has delivered a rather surprising view of the health of Canada's manufacturing outlook.

The Canadian dollar is now consolidating the nearly 2.5 cents of gains it has achieved in the past 24 hours, with today's data perhaps affording the Loonie some additional resolve in the face of still softening oil prices. There is no question that yesterday’s $3 surge in crude oil helped fuel the CAD's rise, though it is showing surprising resilience amid a softer tone to commodity markets this morning. In addition, the extreme levels of volatility that have persisted in recent sessions seem to be abating somewhat, perhaps finally delivering a quiet North American session for USDCAD.

By Mark Frey, VP Foreign Exchange Trading

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US Treasury Changes Direction of Bailout - Nov 13th

Wed, 19 Nov 2008 00:22:47 +0100

TARP Will Not Purchase Toxic Assets

The US Treasury's Troubled Asset Repurchase Plan will not go ahead with its original plan to directly purchase toxic mortgage assets from US financial institutions. Instead, the bailout fund will likely concentrate on continuing to inject capital directly into troubled institutions via the creation of a special class of preferred stock by each firm. News that the TARP was again shifting gears was received with a mixed reaction. Many taxpayer watchdog groups heralded the move as a shift away from bailing out the big banks while openly embracing any idea that takes greater protective measures for taxpayer dollars. Market participants, however, interpreted the change as a reason to sell bank stocks as uncertainty grows as to how many institutions are going to address the impairments that have been taken to their balance sheets.

Yesterday's uncertainty over the future path of the US bailout plan and today's soft economic data have contributed to another equity route in Asia, though the news isn't quite so bleak from Europe. The Hang Seng and Nikkei 225 both traded more than 5% lower on the day while the FTSEurofirst 300 index of top European shares was down 1% with early resilience waning as mounting concerns of a prolonged global recession prompted investors to dump both financial and commodity stocks.

Traders have largely responded to the equity sell-off in a predictable fashion, dumping commodity-linked currencies while snapping up US dollars. That being said, the AUD, NZD and CAD have all held up relatively well compared to similar sessions in recent weeks. They have been at least partially supported by the Reserve Bank of Australia's reported intervention into the market with large purchases of AUD at 0.6350. Should the RBA not step in again overnight, and there is certainly no guarantee that they will, we could very well be looking at another round of lows for the dollar bloc currencies.

Recession is the Word of the Day

Contributing to the fears of a prolonged economic downturn was news that Germany has officially entered into a recession: two successive quarters of negative GDP performance with a third quarter decline of 0.5% vs. an expected contraction of 0.2%. China, with its newly minted $586B USD economic stimulus package also reported softer-than-expected annualized economic growth for Q3 at 8.2%, the lowest level of growth since 2001. The Organization for Economic Cooperation and Development (OECD) also released a report this morning forecasting that both Europe and the US will remain in a technical recession through Q3 of 2009.

As for the North American data, the US trade balance for September came in slightly better than analysts' consensus forecasts at -$56.5B vs. -$57B, against a previous reading of -$59.1B. Canada's merchandise trade surplus by contrast contracted $1.1B CAD in September to $4.5B in total, the lowest reading since January of this year. Energy and automotive products produced a drag on exports while both the volume and price of imports was higher on the month. Finally, as is the case every Thursday, US initial jobless claims were released this morning. Also, as seems to be the case every Thursday lately, first time filings for unemployment insurance benefits in the US exceeded expectations with last week's figure being revised higher as well.

Equity markets in North America are pointing to a firm opening this morning and the more robust tone in New York is limiting the dollar's gains on risk aversion. The CRB index of commodity prices is, however, trading 6.64 points lower near the open so there is risk of a decline in Toronto along with a firming USD.

Kuwait Halts Equity Trading, Announces Bailout

News came overnight that a court in Kuwait, the energy rich Gulf nation, will uphold a lower court's order to halt trading of its main exchange - an effort spearheaded by investors who have taken heavy losses with the bourse trading 31% lower on the year. Although a legal challenge has been launched opposing the closure, the commerce minister expects that trading will be halted until at least November 16th.

In response to the crisis, the Kuwaiti government has announced plans to allow its sovereign wealth fund to buy up distressed bank assets at a discount with a commitment to swap them back to the original owner in 5 years time, at the same strike price. The country's fourth largest bank, Gulf Bank, has been rescued by the central bank and it is feared that there will be more failures to come.

Other states in the region have resisted taking a similar approach, maintaining their commitment to free markets. "Bahrain depends on an open market approach so the stock exchange is available for investors to buy and sell shares without interference from relevant authorities," Sheikh Ahmed bin Mohammed al-Khalifa was quoted as saying in al-Watan newspaper. In addition, no bailout intervention is planned in the Gulf banking centre of Bahrain.

By Mark Frey, VP Foreign Exchange Trading

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USD Rallies On Anti-Risk Sentiment

Wed, 12 Nov 2008 19:09:15 +0100

Quiet Data Day But No Lack Of Incentives

The North American data calendar is bare on this day but there have been plenty of overnight developments on the global stage to provide currency traders with fresh incentives following yesterday's holiday on both sides of the border. The Japanese yen and US dollar continue to be well bid overnight as investors continue to migrate to safe haven stores of value amid the current turmoil.

The Bank of England released its inflation report this morning on the heels of its historic 150-basis point cut last week, somehow managing to surprise the market yet again with its dovish tone, driving the pound lower on the day. In addition to a downwardly revised outlook for economic growth, further rate cuts still appear to be in the cards for the BOE and the Pound is therefore likely to suffer in the medium-term, especially against the dollar given that the US Fed is running out of ammunition with which to combat the global slowdown via monetary accommodation.

The euro is also under pressure this morning following a Eurostat report showing that industrial production levels in the euro zone fell 1.6% from August to September following the previous month's 0.8% rise. Although analysts had been expecting a slightly more negative reading, the previous month's figure was also downwardly revised. On an annualized basis, industrial production in the European Union has declined twice as fast as expected with a fall of 2.4%.

US home values fell 9.7% on an annualized basis in the third quarter, the seventh consecutive quarterly decline, to a Zillow Home Value Index of $202,966, according to the third quarter Zillow Real Estate Market Reports, which encompass 163 metropolitan areas. Total price declines since the 2006 peak have come in at 12.8% nationally and 8.8% on the year while falling prices are forcing more sales at values which are less than the outstanding mortgage. In the past year, 30.2% of American homes sold have been unloaded at a loss compared to the original purchase price while 14.3% of current US homeowners are in a negative equity situation where the value of the outstanding mortgage is higher than the estimated value of the underlying property. As might be expected, poor news from the US housing market, the epicentre of the current financial turmoil, is further contributing to the risk averse tone of capital markets this morning.

The Canadian dollar has broken through the 1.21 handle late in the European trading session and now threatens to run higher in the short-term. After exercising the 1.20 figure from top to bottom repeatedly in yesterday's holiday trading conditions, the market was ripe for a break one way or the other. This morning's pro-dollar, anti-risk sentiment then was the determining factor in pushing USDCAD higher as traders continue to unwind their bets on commodity currencies with their increased sensitivity to global economic growth.

Swiss Franc Not Benefiting From Risk Aversion

LIBOR/OIS spreads continue to come in and the wheels of credit continue to turn more easily than we've seen recently. However, the continued exodus from equities, with the world's major bourses printing red results again for most of today, has seen the continuation of risk averse trading patterns in FX as well with the USD and JPY firming once again overnight, as has been the pattern of late.

Rather interestingly, the Swiss franc continues to not only sit on the sidelines of this global anti-risk, anti-carry market, but rather is being punished right alongside the very high yielding currencies that it was sold so heavily against just a short time ago. Although the JPY has rallied 9.8% and the dollar 11% since the failure of Lehman in mid-September, the swissy has traded with an offered tone, finding itself 5.5% lower over that same time. Given its traditional status as a safe haven for international capital and its low yield, one would expect the franc to at least hold its value in the present environment. In looking at a chart however, it is hard not to conclude that there is a further journey ahead for this one-way train.

Emerging Markets Continue To Show Signs Of Strain

Rumours of an imminent devaluation of the Russian ruble remain rampant in the broader market with news that the official trading band was widened by an additional 1% overnight. Russian equities have suffered a terrible fate from the systematic de-leveraging of the billionaire oligarchs and the currency has felt the pain as well. Other than Iceland, the affects of the easy money credit conditions of years past are perhaps nowhere more evident than in the natural resource rich state.

Indonesia has taken additional steps overnight to restrict the flow of capital from its borders, placing restrictions on both individuals and corporations wishing to sell more than $100K USD worth of the local rupiah. Efforts to maintain the value of the local unit are not uncommon in Indonesia but efforts aimed at restricting the flow of international trade are sure to draw the ire of trading partners during the current global economic downturn. It seems as though the overwhelming need to become inwardly focused in times of turmoil still trumps proven economic theory in the support of trade. Let's hope the rest of the world remains open for international business or the current situation will become a great deal worse.

By Mark Frey, VP Foreign Exchange Trading

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Risk Acceptance is the Theme of the Day - Nov 10th

Tue, 11 Nov 2008 19:41:14 +0100

Equity Rally Saps USD Strength

The USD came under pressure overnight as traders the world over legged into equities and higher yielding currency positions. Final details regarding the Chinese economic stimulus plan began to emerge overnight - after a few false starts in recent days - without dampening the positive buying effect on markets. A total spending commitment of $586B over the next two years was announced, aimed primarily at providing support to the domestic health care, housing, education and transportation infrastructure sectors.

Though the initial announcement occurred last week, the firm spending commitments announced today are emboldening traders to take on more risk in an environment where global growth concerns take a back seat, at least for a day. Equities have traded with a firm tone overnight with the Hang Seng rallying 3.52% in Hong Kong while the Nikkei 225 was bid 5.81% higher on the day. The buying vigour has carried over into both London and New York as equities remain well supported on the day with major exchanges around the world trading in black ink to start the week.

Shares of the insurance giant AIG are rallying this morning as well with news that the US Treasury will increase its funding of the financial behemoth to $150B USD under the Troubled Asset Repurchase Program (TARP), nearly double the original commitment announced in mid-September. Further complicating the political decision-making process in Washington is the fact that today's move with AIG comes against a backdrop of the big three US automakers still facing Congress, cap in hand, lobbying for financial assistance. The news is not all positive on the day, however, as Circuit City, the US electronics retailer, has filed for bankruptcy protection this morning. It's been hit by a perfect storm of competition, consumer spending downturn and credit worries.

Commodities and Currencies Firm

The overall risk accepting environment of the day is placing upward pressure on commodities and downward pressure on the Dollar. The kiwi unit briefly traded with a 0.60 handle this morning, driven higher partially by a surge in commodity prices but also a victory by the conservative National Party, ending 9 years of Labor rule. The Aussie Dollar threatened the 0.70 figure overnight, but is moderately ceding territory this morning as the USD retraces some of its losses.

The Canadian Loonie is on the defensive this morning despite the surge in commodities and risk appetite, though the market continues to whipsaw wildly in both directions. News that the Canadian housing sector continues to hold up well in the face of a global housing downturn has failed to inspire buying interest in the Loonie, which is as much trading on pure momentum as I've ever seen it. Market fundamentals continue to take a back seat to corporate flows and short-term momentum trading, producing wildly erratic price action on USDCAD. Liquidity also remains at a premium with tomorrow's holiday on both sides of the border ensuring the absence of many traders from their desks today, again serving to exaggerate the day's price moves.

By Mark Frey, VP Foreign Exchange Trading

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US Jobs Report Paints Gloomy Picture - Nov 7th

Tue, 11 Nov 2008 19:32:38 +0100

US Nonfarm Payrolls Decline by 240k

I've been chastised of late for being a touch too gloomy in this morning newsletter and for that I sincerely apologize. I promise that I'm not a depressed person; it's just that I have a great deal of difficulty wearing a smile all the way to the poorhouse. I suppose, in truth, I'm not actually headed to the poorhouse just yet as I've luckily divested myself of many of my equity holdings over the past 6 months, but my equities broker is definitely not getting a Christmas card this year. It's his fault that my portfolio is teetering on the brink of a 25% decline this annum and that's the story I'm sticking with.

I mention this to you all this morning because there is more bad news to share on the US employment front, though my broker is probably rubbing his hands together with sadistic glee as the value of my holdings continues to deteriorate (okay so maybe not but it makes me feel better if I vilify him). US nonfarm payrolls declined for the tenth straight month in October, shedding 240K jobs against expectations of a 200K decline. Adding salt to the wound was the fact that September's figure was also revised lower from -159K to -284K with August's figure being downgraded as well. Hourly earnings and the average workweek held steady while the unemployment rate ticked up 0.4% to 6.5%, the highest level in more than 14 years. The only bright spot of the report were public sector positions, which increased by 41K as public sector hiring is largely insensitive to the business cycle.

As might be expected, US stock index futures have significantly pared their gains though they will still likely open higher at the bell. The US Dollar on the other hand has retraced against most of the major currencies with the Dollar Index trading 0.22% lower after enjoying a positive tone throughout most of the overnight session. The market is still expecting to see pending home sales, wholesale inventories and consumer credit reports for September later on this morning. This will, of course, add further color to the outlook for the day.

Canadian Jobs Data Remains Firm

The one thing that my broker is probably disappointed with this morning is that the Canadian economy produced a net gain of 9,500 positions in the past month, against an expected decline of 10K, with an increase in full-time positions of 47,500 partially offset by losses in part-time roles of 38K. Although the unemployment rate actually ticked up to 6.2% on the month due to a surge of new entrants to the workforce, the report was on balance quite a positive assessment for the Canadian economy. Canadians are certainly not used to seeing an unemployment rate lower than that of the US given the more generous social safety net in Canada, which creates a higher rate of natural unemployment.

Further disappointing my dear broker is the fact that I'm overweight Canadian equities, something that I of course take full credit for and am, therefore, bound to outperform his other poor clients whom I'm sure were sitting on a comfortable nest egg of Lehman Bros. stock some months ago. Canadian equities, however, are still set to suffer a poor fate this morning, with the price of oil threatening to break through $60 in early trade.

Despite the pressure on oil and other commodity prices, as the outlook for global demand growth continues to weaken, the Loonie has rallied nearly 2 cents from the overnight low, primarily on the strength of the local jobs report. Volatility in USDCAD continues to be extreme, with illiquid trading conditions contributing to yesterday's near 5-cent run-up for the Greenback.

Euro Bounces Off of Overnight Lows

The Euro has bounced off of its overnight lows and is trading back up towards 1.2800 this morning on the general softness in the Dollar as well as some positive local developments. European Central Bank Governing Council member Erkki Liikanen acknowledged that the Bank is likely to deliver further cuts in the months ahead, thereby softening the disappointment of yesterday's under-sized rate cut. The market's growing sense of optimism regarding further monetary accommodation from the ECB was also bolstered by ECB President Trichet, who didn't rule out the possibility in an interview given in Frankfurt today.

On the data front, Germany's trade balance printed a figure of 15B EUR for the month of September, beating analysts' expectation of 13.5B as well as the 10.6B that was recorded in August.

By Mark Frey, VP Foreign Exchange Trading

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USD Largely Steady After Obama Victory

Thu, 06 Nov 2008 00:17:20 +0100

Markets Continue to Stabilize, but Risks Remain
Despite the fact that the global economy appears to be headed for a major recession - a notion all but confirmed by yesterday's rather weak manufacturing indicators from both Europe and the US - capital markets are continuing to stabilize if not become more buoyant. The credit freeze continues to thaw with the LIBOR to OIS spread (a figure which essentially summarizes the extent of credit risk pricing and the health of debt markets) coming in dramatically overnight once again to only 197-basis points. Only another 25-points to go before we can truly call market conditions normal, given the circumstances.
Asian equities traded with a firm tone again overnight, with the Nikkei 225 in Tokyo and the Hang Seng in Hong Kong trading up 4.46% and 3.17%, respectively. This continues what can only be described as a significant equity bounce in the region. Traders in Europe, however, have not gone on the same sort of euphoric buying spree this morning. London's FTSE, Frankfurt's DAX and Paris' CAC are all trading with an offered tone as we head into the close. European optimism was tempered this morning with a confirmation that UK industrial production is declining (-0.2% m/m and -0.1% y/y), retails sales within the Euroland remain sluggish and manufacturing activity, by way of EU and UK purchasing managers indexes, plumb new depths.

President Elect Obama has won a decisive victory in the US and the Democrats have strengthened their hold on Congress, thereby providing at least some political certainty to markets. However, North American equity futures are still pointing to a lower open - by approximately 1 percent - on news that private sector employment declined by 157K jobs in the US for the month of October by way of this morning's ADP Employment Report. In addition, although the CRB Index of commodity prices is trading higher this morning, both oil and copper are coming off their highs with some authority as traders re-evaluate the prospects for global demand growth in the coming period, thereby limiting the gains of the Dollar Bloc commodity currencies.

The BOE and ECB Set For Thursday - Currencies
The US Dollar Index has remained well bid overnight, supported in large part by weakness in the Pound Sterling and Euro as market participants tweak their expectations for tomorrow's widely anticipated interest rate announcements from the two central banks. In light of today's data, a series of major European financial houses have adjusted their expectations for the Bank of England to provide a full percent of monetary accommodation tomorrow. Expectations of the European Central Bank remain split between a 50, 75 or 100-basis point reduction.
That being said, we've seen a similar story play out positively for the local currency in Australia and New Zealand when their respective central banks delivered an outsized interest rate cut in an effort to get ahead of the coming economic slowdown. With such recent events in mind, it's hard to believe that either the Pound or Euro would be unduly punished by a larger than expected cut.
The Canadian, Australian and New Zealand Dollars have largely tracked equity markets and traders' views with respect to risk overnight. After rallying moderately amid the risk accepting, equity buying spree in Asia, London trading delivered a moderate retracement to the Dollar Bloc currencies before staging another upswing at the North American open. Meanwhile the Yen, which has traded inversely to the commodity currencies throughout much of the past few months, has firmed more than one big figure after hovering just under 100.00 vs. the Dollar throughout the Asian session. With commodities and equities on the defensive at the open, the North American session could see the secondary currencies retrace some of the day's hard fought gains.

By Mark Frey, VP Foreign Exchange Trading
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USD Sell Off Continues Unabated

Tue, 04 Nov 2008 22:01:53 +0100

Equities And Currencies Rally

The US Dollar Index is trading 1.7% off of its overnight high as it struggles to find a footing ahead of the US Presidential election. Traders at this point are not so much concerned with who will win, but whether or not the victorious candidate will garner a clear mandate from the US electorate. With current polls showing Senator Barrack Obama to have a 5 to 7 point edge heading into election day, with leads in many key swing states, those looking for a decisive victory and clear direction for the world's largest economy may not have to wait long. There is an implicit belief in equity markets that this could be a significant psychological turning point for the financial crisis, though very little if anything is going to change from a policy or regulatory front for many months to come.

Whatever the stimulus, traders were in a buying mood throughout Europe and Asia. The MSCI world equity index rose 1.2 percent while Europe's FTSEurofirst 300 index gained 2 percent on the strength of energy and financial firms. Asian stocks rose 0.3 on balance with Tokyo racking up hefty gains of 6.27% as the local market played catch-up after the holiday Monday, buoyed by resurgent exporters who have picked up big gains in the face of the Yen's 3-big figure sell off from last Friday's high.

The question that every trader seems to be mulling silently is how long is this equity bounce going to last? Although we have perhaps already seen the worst of the credit crisis (fingers crossed that emerging nations don’t begin to default on their sovereign debt), the world, by all accounts, is spiralling towards a dramatic global recession. Is it not too optimistic to think that it will all be roses from here?

As might be expected give the mood of risk acceptance today however, global currencies are rallying broadly against both the USD and JPY as investors once again take on more risk and begin to unwind their overweight holdings in US Treasuries. Market sentiment continues to become more upbeat, a notion that is underscored by the interest rate reductions now being delivered from the world's leading industrialized nations. So long as the equity rally continues and LIBOR rates continue to come down as they have again today, you can safely expect the US Dollar to come under pressure.

RBA Cuts 75, Who's Next?

The Reserve Bank of Australia surprised markets with a 75-basis point interest rate reduction last night, citing "significant weakness" in the global economy. In bringing their benchmark rate down to 5.25%, the lowest level since March 2005, the RBA has now provided two full percent of monetary accommodation since initiating its easing cycle in August. Counter intuitively, traders have reacted by buying the Aussie unit with the mindset that the RBA's rather aggressive policy stance will support the local economy in the long run, thereby providing a solid base for the currency.

Much had been made of the RBA's return to employing "two speed" monetary policy as many central banks had done in the past, where rather than tweaking interest rates by 25-basis points per meeting, as has been the current practice for the past number of years, an initial jolt higher or lower is followed by a series of smaller 25-point moves. With a cut in October of one percent and now ¾ of a percent, I don't think anyone expected the speeds to be overdrive and supersonic. The Aussie experience tells us that there is a great deal to be said for having "bullets left in the gun" so to speak. The RBA has plenty of room to be aggressive with monetary accommodation at this point because rates are coming off of relatively lofty levels as well as the fact that they didn't cut too much too soon. North American central banks have no such luxuries at their disposal. Interest rates, relatively speaking, were already at relatively low levels before the eye of the current financial storm hit and the decision to be aggressive in the early days of the crisis now means that both the US Fed and Bank of Canada have very little wiggle room on interest rates.

The Europeans and Brits however are not facing the same set of restrictions as their North American counterparts and we can therefore expect some fireworks when both the European Central Bank and Bank of England announce their latest decisions on interest rates on Thursday of this week. The market currently expects both banks to go lower by at least 50-basis points, though speculation is building that we will see larger cuts still. And, make no mistake, the market's anticipation of this aggressive line on accommodation and its affect on equity yields is what's driving the bounce in stock markets as opposed to an optimism that things are looking up in the global economy.

What's Hank Going To Do With All That Dough?

Every equity traders' favourite bailout proponent, US Treasury Secretary Hank Paulson has got some decisions to make. He's spent approximately $250B of the $700B super bailout fund and though the remainder of the taxpayers' funding was originally earmarked to purchase troubled mortgage assets from US financial institutions via a reverse auction process, there is a growing sense that we could see a second round of direct recapitalization of non-bank financial firms. Bond insurers, consumer finance entities and insurance companies are now coming into focus as potential beneficiaries of the program whereby the US Treasury takes a preferred equity stake in the companies as a direct means of providing capital to repair impaired balance sheets.

While the direct recapitalization route has been proven to have rather immediate positive affects, it also offers a great deal more comfort to taxpayers in that they have a much better idea of what value they're actually receiving for their money when compared to the reverse auction process of purchasing mortgage-backed securities. As such, there is some speculation now that the US Treasury will abandon their auction process altogether and simply purchase outright, securities from those firms that require further assistance. In any event, the incoming Administration will have plenty of options available to it come January.

Mark Frey, VP Foreign Exchange Trading

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Credit Conditions Continue to Improve

Tue, 04 Nov 2008 00:08:25 +0100

LIBOR Rates Continue to Come Down

London Inter-bank Offered Rates (LIBOR), the rates paid on USD in London's inter-bank lending market have come down again overnight, signalling that credit market conditions continue to improve. Although equities in Asia and Europe have been largely mixed, the currency market has been decidedly pro-risk, with all of the majors gaining ground on the US Dollar, including the Japanese Yen with Tokyo closed for Culture Day on Monday.

After hitting a peak of very near 5.0% on the bid, one-month USD deposit rates have declined markedly over the last two weeks and are now trading under 3.0% on both the bid and offer with only a 27-basis point market spread. Although 27-basis points is still extremely wide in normal market conditions, it is significantly narrower than the 200+ points we were seeing just a few weeks ago. Canadian one-month deposit rates are settling in just over 3%, with a slightly narrower bid offer spread. Although the higher Canadian rates should translate into positive forward points, the bid offer spread in most cases is still ensuring that one-month points on the bid remain negative while the offer has turned positive. In addition, given the fact that the US Federal Reserve's target rate is 1.0% and the Bank of Canada's 2.25%, one would normally expect a much wider divide in short-term deposit rates but there is still a significant premium being placed on Dollars due to the risk averse investing climate we find ourselves in. The LIBOR to OIS spread narrowed as well overnight on the belief that the ECB will cut rates this week to enhance market liquidity (Overnight Index Swap futures track the overnight effective Federal Funds rate, a major benchmark of the U.S. short-term interest rate market). Although the LIBOR-OIS spread is now down to just 224 basis points, it was 87 basis points before the failure of Lehman Brothers. In short, even as debt markets appear to be returning to at least a semblance of normalcy, there is still a long way to go.

Consolidation in the Banking Sector

Commerzbank, the second largest bank in Germany and a significant player on the world stage has tapped the German bank bailout fund this morning to the tune of 8.2 billion Euro. In addition, the bank announced efforts aimed at raising an additional 15 billion EUR privately after posting a quarterly loss of 285 million. Rather than being punished by investors for admitting it needs help to repair its ailing balance sheet, Commerzbank is finding its shares higher on the day, along with the rest of the German banking sector as investors anticipate that the majority of the bad news has already been divulged.

Further consolidation in the financial space has seen this morning with the announced merger of Bank Itau and Unibanco in Brazil, creating the "southern hemisphere's largest bank."

Stateside, Illinois-based Midwest Banc Holdings Inc posted a $159.7 million third-quarter loss, and announced that it had received preliminary approval to take on $85.5 million of new capital in the form of preferred stock, to be issued to the U.S. Treasury.

USDCAD Probes to the Bottom

USDCAD is testing to the bottom-side again this morning, probing through 1.1900 in the inter-bank market as investors take on more risk and commodity prices rebound moderately amid general USD weakness. In short, the market is continuing to price out the panicked wave of USD buying that began as global investors flocked to US Treasury bonds in mid-September. Some relative calm in equity and debt markets, as discussed above, is also serving to reinforce the belief that the worst may be over for not only the Loonie but currency markets in general vs. the USD.

Implied interest rate futures are currently pricing in nearly equivalent probabilities of further rate cuts from the Bank of Canada and Federal Reserve so it appears that in the short-term, it will be broad macroeconomic forces that drive the pair as opposed to short-term interest rate divergences. Although we shouldn’t be too surprised to see the move higher in CAD retrace on any negative credit market developments, it may be time to re-adjust those market orders placed to sell USD at 1.3100.

Mark Frey, VP Foreign Exchange Trading

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USD Stages Another Rally, Equities Sell Off

Fri, 31 Oct 2008 16:25:44 +0100

Smaller Than Expected BoJ Cut Inspires Selling Presure

The Bank of Japan, in a split decision, voted to cut interest rates 0.20% overnight, taking their benchmark target all the way down to 0.30%. Although there were four dissenters amongst the Board, three of them voted for a larger 0.25% cut and only one member voted to hold rates steady at 0.50%. As such, last night's move will allow the BoJ to go once more at an interval of 0.20% without actually taking nominal interest rates to zero.

Financial markets were disappointed by the slightly smaller than expected cut, and although we could certainly argue whether or not the extra 5-basis points will matter in the grand scheme of things, it does represent the effective maintenance of 10% of the BoJ’s benchmark. It's still 10% more than what participants were calling for.

Disappointment amongst traders, as we all know in today's environment, translates into risk aversion, and today is no exception. Equities immediately sold off in Tokyo on the announcement with the Nikkei 225 closing down more than 5% while the Hang Seng in Hong Kong shed 2.52% in value. The selling pressure has largely flowed into the European bourses of Paris and London, albeit on a modest scale compared to what we've seen of late, while Frankfurt is still trading in positive territory as we head towards the close. Although North American equity futures traded well into the red ahead of the open, they are experiencing a slight bounce in early trade.

Commodities are taking it on the chin this morning with the CRB index of hard asset prices trading 7.80 points lower to 263.62 as most classes of raw materials see broad declines. Gold, natural gas and live cattle prices are still being printed in black ink this morning however, as opposed to red.

US Treasuries and the Big Dollar are well bid this morning with the Greenback making gains across the board, rallying more than 2% against both the Australian and Canadian Dollars, with the Euro, Pound and Kiwi all trading more than 1% off of Thursday's closing levels. LIBOR rates continue to come in however, currently trading at 3.03%, providing a glimmer of hope to financial markets participants that credit markets are continuing to thaw even as traders largely shun risky equity assets.

Inflation in the US and Europe Heads In Opposite Directions

Euro Zone flash inflation for October printed a 3.2% figure this morning, down 0.4% from annual levels recorded just one month ago for September providing an encouraging piece of economic news for those dovish members of the European Central Bank who would prefer to be taking a more aggressive path on monetary accommodation through this crisis. Big Ben Bernanke however will not be impressed with the fact that the US Federal Reserve’s preferred measure of inflation, the personal consumption expenditures (PCE) core deflator, advanced by 0.2% (0.176%) in September, a faster pace than the 0.1% expectation, contributing to a year-over-year change of 2.4%. That being said, the Fed has clearly indicated that economic stability, full employment growth and the risks to it, are the dominant mandate in the eyes of the Federal Open Market Committee and as a result, only the most alarming spike in prices would likely alter the current rate cutting path being traversed.

Canada's gross domestic product (GDP) fell 0.3% in August as July's big contributors to GDP growth - the wholesale trade, manufacturing and energy sectors - all retreated, Statistics Canada reported Friday. Although the decline beat analysts' estimates by 0.1%, it largely reverses the gains achieved in August, thereby threatening the third quarters' collective result. Meanwhile, US consumer income and spending having taken a turn for the worst that will all but guarantee the continuation of Q3’s soft US GDP performance into Q4. In any event, the bounce being seen in equities in early trade this morning may find itself to be very short-lived given the soft overall tone of this morning's data, thereby also contributing to the strength in the USD.

Tyson Wright, Senior Position FX Trader, Custom House

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