Overall strategy:
Markets will continue to focus heavily on financial-market conditions amid still very serious underlying stresses. It will be difficult to secure a sustained improvement in risk appetite even with the US rescue agency plans. The dollar will continue to gain defensive support from a reduction in net capital inflows into emerging markets. Nevertheless, overall fundamental weaknesses suggests limited scope for gains, especially with greater pressure on the Federal Reserve to maintain a very loose monetary policy.
Key events for the forthcoming week
Date |
Time (GMT) |
Data release/event |
Wednesday September 24th |
08.00 |
Germany IFO index |
Wednesday September 24th |
14.00 |
US Federal Reserve Chairman Bernanke testimony |
Dollar:
The severe financial-market stresses will tend to remain dominant for now. The US currency will gain some support on defensive grounds with a repatriation of investment flows. The Federal Reserve will have to maintain a loose monetary policy to help provide protection which will reinforce the lack of yield support. There will be renewed doubts over US economic trends which will also tend to undermine sentiment. From a medium-term perspective, the US fiscal position is also liable to deteriorate which will pose important dollar risks. Hopes for a resolution to the financial crisis should offer some short-term dollar backing.
Conditions and developments within the US and global financial sector continued to dominate market sentiment with intense volatility. The dollar weakened in the middle of the week, although it recovered strongly from its worst levels and gained ground on Friday as market fears eased with gains through 1.42 against the Euro.
Investment bank Lehman Brothers was forced into bankruptcy after it failed to secure a private-sector deal and the government refused to provide support. In contrast insurance group AIG was given a US$80bn bridging loan from the Federal Reserve to stave off collapse. In return the Fed took an 80% stake in the company.
The US currency secured some defensive support as there was a flight to Treasury bonds with yields falling to extremely low levels. There was also evidence of a flow of funds out of emerging-market currencies which supported the US currency.
There were serious tensions within the money markets as banks remained very reluctant to sanction inter-bank lending. Global central banks injected near US$200bn of liquidity into money markets in an attempt to stabilise conditions.
Following the series of bailouts, there were greater fears over the US fiscal situation and there were some warnings that the US sovereign credit rating could be in jeopardy in the medium term. Immediate confidence rebounded on Friday as US authorities met to debate plans for an agency which would buy illiquid holdings from the banks.
The US Federal Reserve held interest rates at 2.0% following the latest policy meeting. The statement was generally balanced with unease over inflation offset by a statement that the economy appeared to have deteriorated over the past few weeks.
The economic data tended to be of secondary importance given the focus on financial markets, although there were important releases. There was a further decline in housing starts to the lowest level for over 17 years while building permits also weakened further over the month.
The industrial data was mixed with the New York manufacturing index falling back to below zero according to the September survey, although the Philadelphia Fed index recovered. There was also a 1.1% decline in industrial production for August, undermined in part by a sharp decline in utility output. Initial jobless claims also increase to 455,000 in the latest week from 440,000 previously.
Consumer prices fell by 0.1% in August while there was a core increase of 0.2% to give a 2.5% annual rate. The latest capital account data was weaker with net long-term inflows of US$6.1bn for July while there were net outflows of overall capital.