Is the dollar in the doldrums?

By Julian Sudre

While the recent 50 basis points rate cut by the Federal Reserve to 4.75 per cent has undoubtedly boosted stock markets, the aggressive cut was a single whammy for the greenback and now investors are focusing on concerns over US growth and inflation. The dollar today has reached an all-time low against the euro and speculations that Saudi Arabia might revalue the riyal for the first time in 21 years has exacerbated sentiments – a move that Kuwait took in May when it dropped the long-held dollar peg.

Now, the US dollar is at parity with its Canadian counterpart for the first time since 1976. Analysts have started to wonder how far the impact of the US economy could be affected.

Sources close to the matter have said that the Fed was swapping systematic and liquidity risk for longer-term inflation risk.

Of course a lower currency typically fosters worries for inflation but its yearly continual decline that was too gradual did not trigger the Fed to consider raising interest rates instead.

On one hand, the falling dollar is good news for multinational corporations as American-made goods are more affordable in international markets but on the other hand foreign investors who contribute to finance the country’s debt will be frightened away. The result will aggravate investment in US Treasury securities and the US government will have to pay higher rates at weekly auctions to find buyers for its bills, notes and bonds. The borrowing costs for Americans could be pushed up.

US economic concerns were compounded by a six-month fall in sales of existing homes with a US home prices decline – a steepest drop in 16 years.

Those declines have given food for thought to the Federal Reserve and although it is too early days to lower the benchmark interest rate further, the question is now what will happen at the two remaining meetings this year.

Bank of England Versus FSA and Government

By Julian Sudre

Perhaps the old Victorian approach of the Bank of England after all has been extenuated by the recent bail out of the fourth biggest lender in the UK – Northern Rock. Well not just so. While we have a case of hands-on US intervention versus hands-off UK intervention, the vulture press has seemed to swoop down on Mervyn King.

As usual, someone has to take the rap; the Pavlonian response was Mr King to be blamed for as it was for the McCann’s.

While some say that the Governor of the Bank of England was stitched up by the Clunking Fist of New Labour. By doing a U-turn and injecting liquidity into Northern Rock, the latter will be perceived as nationalised and certainly will undermine Gordon Brown's credibility as he was the one who created a fully independent Bank. So Has Mr King bowed to political pressure to pump £10 bn into the financial markets?. I for one, believe that the BoE shouldn’t have provided funds but instead should have ensured that the financial system runs smoothly.

In any event, we should note that the FSE is responsible for the supervisions of the banks, hence the next in the line of fire: “please step forward Mr Callum McCarthy”.

Mr King had certainly his hands full when it came to gauge how far to extend liquidity against a wider range of collateral on the one hand and the concern of moral hazard on the other – the danger of rewarding banks that had taken a riskier approach than others. But he went on to say that the moral hazard was limited by a cap on the amount the Bank was providing to individual banks and by the penal rate of interest.

He insisted that it would have been irresponsible to have offered a full guarantee on savers’ deposits before the run on Northern Rock since that would have undermined confidence in the banking system. This is seen as yet another indication of how the Bank’s Governor has misjudged the delicate psyche of the markets.

But according to Mervyn King, Northern Rock debacle was blamed of four pieces of legislations: The Takeover Code, the Market Abuse Directive, the Insolvency regime enshrined in Enterprise Act 2002 and the Financial Services Compensation Scheme.

So after feeding Mr Kind to the Lions, in two weeks time FSA officials will appear in Parliament. And since this is the FSA which is supposed to know whether individual banks might face a liquidity squeeze and does routinely deal with asset managers, insurance groups and bankers, this time the FSA did not demonstrate any visible awareness of liquidity challenges before the summer in the banking world. Meanwhile I have come away with the feeling that the Bank's Governor has been used as a scapogoat by the dead hand of the Tresuary.
At any rate, all things being equal, if the Bank had agreed to accept mortgage collateral at its lending window ealier as Mr Darling believes, that is taking a cue from the Feds or the ECB, the damages could have been avoided. This remains to be seen because Northern Rock got itself into trouble through over-reliance on short-term funding from the capital markets.

Of course, we know by now that the FSA was more in favour of relaxing rules but it undeniably was not felt enough to make an impact across the board. Today relations between the BoE and the FSA are poisonous, no less.

Now, let's wait with bated breath if the whole issue revolving around the snap decision to inject money was a pretext from Labour to force a loosening in monetary policy.

MARKET REPORT

By Julian Sudre

The elements have been felt across money markets; European and Asian equities put in mixed performances and the yen lost ground against most major currencies – most notably the high-yielding Australian dollar. Also Canada which has been affected by the commercial paper crisis had to raise its rate in July for the first time in more than a year. The market has remained frozen mostly due from issuers’ inability in mid-August to roll over maturing issues as a result of the credit turmoil in the US sub-prime market. Hence, some of the big issuers of asset-backed paper in Canada are still unable to find buyers, forcing them to warehouse securities and in some cases, draw on bank loans.

The maxim, it never rains but it pours could not be more adequate in these circumstances with the presence of Hurricane Felix lurking about in the Gulf of Mexico. Oil prices were pushed higher amid concerns about potential damages. Meanwhile money-market lending rose to their highest level in more than eight years. The three-month interbank rate or Libor had climbed to 6.7975 per cent more than a percentage point above the 5.75 per cent base rate.

Undeniably, this has had the impact of the domino effect in financial markets with another hedge fund – Synapse Investment Management closing a £135m fund investment in asset-backed securities (ABS) owing to severe illiquidity in the market for investment.

Weather-ravaged Australia and Argentina which represent about 23 per cent of global wheat export have fallen on hard times. Wheat prices last week rose above the $8-a-bushel level for the first time ever in Chicago, soaring in August more than 20 per cent – the steepest monthly increase in more than 30 years.

Although the discount rate used by the Federal Reserve which has been dismissed by many observers as a “symbolic gesture” could actually show that it is a great indicator of the direction of monetary policy. When it changes direction, it signals a shift between expansionary and restrictive monetary policy.

Such sectors as resources, consumer staples, and utilities remain mostly insensitive to the overall economy could be used as defensive stocks when the discount rate goes up – that is the start of restrictive policy. But when the rate is cut, the idea would be to buy cyclical stocks such as consumer discretionary, financials, industrials and technology, ergo signalling easier money.

Be as it may, nevertheless, such crude strategy would have beaten the market by 3. 78 per cent a year between 1973 and 2005.

The discount rate, so far, has shown to be a remarkably powerful signal.