World Bank downgrade snaps the recent risk driven rallies.

Yesterday the World Bank predicted that the global economy will contract 2.9% this year compared to their previous forecast of a 1.7% decline. This caused a seismic shift in the markets as the wave of risk driven rallies crashed and petered out as concerns that recent "green shoots" will not be sustainable. The effects in the markets were significant; equities were driven lower- the S&P down 3%, Nikkei down 2.8% and the Dow falling over 2%. Oil and Commodities tumbled as investors jumped into safer harbours; Oil fell 4%, Copper over 5% and Gold hit its lowest level since mid-May. In the currencies the moves were very apparent…we saw the AUD unwind significantly against the USD and the CAD also offloaded recent gains retreating to over 1.15 against the USD. So the big losers were the commodity driven currencies and the main gainers being the "safe haven" currencies namely the USD and Japanese Yen. So did the market get ahead of itself? It is hardly surprising that we have hit a barrier in the drive for recovery; it would be naïve to think that we would see a "V" shaped global recovery and in fact that we could even predict a recovery in such uncertain and unchartered conditions. The mood was not helped by the fears of banking issues in the Eurozone and concerns over German debt…look out for the ECB’s first auction of one-year funding tomorrow…as the auction is open to foreign banks along with European banks this could lead to funds moving out of euros into other currencies.

The USD was also boosted as a safe have port by comments from Moody’s that the triple-A rating is safe; risks to the rating would arise if the government is unable to bring a downward trajectory on debt and if the US dollar is challenged as the main reserve currency.

Data today from Europe confirmed that June PMI which measures activity in the manufacturing and services sector came in weaker than expected, however the euro is up this morning against the USD and the GBP as stress tests on Greek banks were positive. In the UK mortgage approvals came in better than expected, however net lending was down. Sterling is under pressure against the Euro and the USD following the dip in market confidence.

report by Phil McHugh

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Mixed reports from the Eurozone

Looking at the markets this morning the euro has started on the back foot. The reason for the fall in the euro is due to banking fears again creeping into the scene. The European Central Bank has warned that the region may face another €283 billion of losses by the end of next year and it seems that the skeletons are still appearing for Europe's banking sector. Further writedowns are likely to appear in most major economies, however the scale of the losses in the Eurozone is likely to weigh on the euro going forward. An article in the Wall Street Journal also highlighted the plight facing the German economy stating that "weaker tax revenue, soaring welfare bills and new spending for bank bailouts and fiscal-stimulus measures could increase germany's debt by more than €100bn next year". Further write downs and ballooning debt will certainly undermine the euro, especially given the conservative stance so far taken by the ECB. The German Ifo business climate survey released already shows an improvement in June to 85.9 from 84.2 in May, the business expectation index also rose to 85.90 in June from 84.30 in May. This is good news for Germany but has not helped the euro gain as the market takes that data with a heavy pinch of salt given the weaker sentiment shrouding the euro-zone and Germany as mentioned earlier.

In the UK, Rightmove has reported a 0.4% month on month fall in house prices which has bucked the trend of recent improvements in housing sector data. The Bank Of England also identified weakening of lending in its last survey for April. Sterling so far has not been dented in the weaker data, it seems that the market does not expect back to back improvements in house prices at this point.

Looking at the week ahead the main focus is on the Fed rate decision on Wednesday evening. The Fed are not expected to move on interest rates although their response to QE measures already introduced and possible further measures could surprise the markets.

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Mixed data leads to range trading

The currency markets settled into range trading yesterday as mixed market data continued to cloud the outlook for global economies. Sterling dipped sharply following unexpectedly weak retail sales data which reinforced recent words of caution from the Bank Of England and Mr Darling. The pound managed to claw back most of the losses in later trading and this bodes well for the technical strength of the pound which could see it form a base for a move towards 1.20 against the euro and 1.65 on the USD.

Focusing on data yesterday from the US, weekly jobless claims rose modestly to 608,000 and there was a decrease in continuing claims; this indicates that the pace of lay-offs has fallen and added optimism to the markets as employers look to retain staff with the view of an expected rise in business activity going forward. In addition, the Philly Fed survey on the manufacturing sector showed a rise to -2.2 in June from -22.60 in May, although still in contraction the data is much healthier than expected. This helped to calm jitters and lift activity in riskier assets, the AUD posted gains against the YEN, USD and GBP and the Kiwi dollar also gained.

In other news, German producer prices came in as expected and EU leaders stated that further budget stimulus was not warranted at the present time. Leaders also backed the reform of financial supervision following news from the UK and the US on this topic; the EU will plan a creation of pan-European standard-setting and risk monitoring bodies in 2010. EU leaders are expected today to back a plan for a quick disbursement of the next installment of aid to Latvia. The Euro is looking stronger against the USD but remains under pressure against sterling.

Figures from yesterday showed that Britain's public finances fell with net borrowing rising to nearly £20 billion. Also a report from the Bank Of England showed that lending to British businesses fell by £5.4 billion in April- not a good indicator for easing credit conditions. Sterling was not dented on the news but growing debt and tight credit conditions going forward will weigh on the pound.

The Swiss National Bank (SNB) said that it would continue to act to prevent the appreciation of the Swiss Franc against the euro- the SNB intervened on March 12 and again through the Bank for International Settlements on May 15th. The Swiss Franc was a major gainer during the global slowdown and the SNB are proactively trying to maintain a leash on the strength of the Franc.

report by Phil McHugh

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Surprise drop in UK retail sales

Following yesterdays’ cautious assessment from the Bank Of England, sterling dipped after a good run. The dip in sterling yesterday was not hugely significant (1% against the euro and 0.8% against the USD) but it does dampen recent expectations of targeting 1.20 on the EURO and 1.70 against the USD. Data just released in the form of UK retail sales was much worse than expected falling 0.6% month on month against a forecast of a 0.4% rise…this brings the fall in retail sales to -1.6% on a year on year basis! The fall in retail sales is a big surprise and bucks the trend of recent gains on retail sales in April and May…the fall has been attributed to poor sales of clothing, footwear and sales by department stores. It is worth noting that online retail sales posted the slowest growth rate in the surveys nine year history dropping 3.5% from April’s level- this identifies that both on the street and on-line sales are suffering as the economic slowdown maintains its hold with consumers. Sterling dipped sharply on the news against across the markets dropping a full cent against the US dollar and 0.6% against the euro.

David Blanchflower (former MPC member) warned that we have yet to realize how painful economically the next few years will be, Blanchflower’s opinion is well regarded as he was one of the few voices warning of the full economic impact of the sub-prime fall out before the reality of it kicked in. Mervyn King, in a speech at Mansion House emphasized the need for a clear plan to reduce deficits in the next parliament; this will be key for the future performance of sterling and the USD as concerns are mounting on the spiralling debt levels - lack of a clear plan to reduce this debt will lead to weakness in the USD and the pound.

On to regulation…Alistair Darling in his speech called for banks to focus on long term wealth creation and not short term profits, noting that the process of learning has to start in the boardroom- this is fine rhetoric but can it be assured? Mervyn King wants the Bank Of England to have more say in financial regulation contrasting to Darling’s view that the current system is adequate. Similarly in the US Barack Obama in between swatting flies has come up with some new proposals to try to safeguard the US economy from a repeat of recent issues. The theme of the proposals was to increase power and accountability for the Federal Reserve and to get banks to raise additional capital going forward. Whilst the regulatory discussion are not having a direct bearing on the markets- it is critical that this dealt with along with spiraling debt in order to increase confidence in the UK and US economies moving forward.

Looking at the USD we did see some weakness in trading yesterday as lower inflation data essentially underlined the necessity to maintain interest rates at low levels for some time to come. In other news a report in Australia showed that the Reserve Bank of Australia sold over 1 billion AUD in May to try to suppress the strength of the currency- this just shows the demand for the AUD as a higher yielding commodity currency in the last month.

report by Phil McHugh

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Sterling continues to gain

June 3, 2009

We continue on the bull-run for sterling as PMI data emphasises a rise to 51.7 in May from 48.7 in April, over the 50 level identifies that the sentiment is positive for the UK activity. Sterling rallied on the news this morning and tested new yearly highs against the US dollar and the euro. The improvement in PMI levels was mirrored in the eurozone as composite PMI, a gauge of private sector activity rose to 44.0 from 41.1 in April. This data lends further weight to shouts of a recovery to commence by the end of this year for the UK and an indication that the worst is behind the eurozone. More positives came in the form of UK consumer confidence data released by the Nationwide Building society which strengthened in May as more optimism is foreseen in the next 6 months in the economy and the jobs market.

Tomorrow we will get the announcements from the Bank Of England and ECB on interest rates. It is not anticipated that we will see any movement from the UK on interest rates and it is unlikely that we will see additional measures for QE – although that was the thought process last month too! For the ECB Trichet said 'We expect to engage in a programme of around 60 billion euros that targets an important segment of the private securities market which has been particularly affected by financial market turbulence'. This in theory should weaken the euro and help sterling gain further, however given that lots of good news has already permeated sterling we could be in line for some profit taking….watch this space!

Later we have testimony from Ben Bernanke on current economic conditions and the federal budget. It will be interesting to see if attention is turned to the recent fall in the US dollar and the long term factors that are driving this weakness- in particular the fiscal health and 10 year budget projections amid ever increasing debt levels.

Report by Phil McHugh | www.currenciesdirect.com