Focus Turned to Commodities Crash, Dollar Rebounded

Markets’ sentiment shifted sharply from panic dollar selling to commodity currency crashes last week. Indeed, after diving to new record low against Euro and Swissy, and as low as 95.77 against the yen, dollar rebounded strongly and closed the week higher. Fed’s smaller than expected 75bps cut in the federal fund rate played a role in dollar’s rebound. But more important, sharp reversal in commodity prices, including an 11% fall in gold prices from it’s record high of 1032/oz and more than $13 dive in Crude oil prices was more important to the dollar’s bounce. Meanwhile, even though extreme volatility is seen in the Japanese yen, following roller coaster ride in the equity markets, the Yen still managed to end higher against most major currencies except the greenback. The net result is that commodity currencies and respective yen crosses are the biggest loser last week, topping the weekly top movers chart.

The global financial markets were extremely nervous early last week, following the sale of emergency cut in discount rate from Fed by 25bps to 3.25% as well as the news of sale of Bear Sterns to JPMorgan Chase. At that point, it seemed that Fed was extremely concerned with the deepening of credit market problems and markets were betting on 100bps cut from Fed in the federal funds rates. Though, the Fed surprised most by cutting 75bps only on Tuesday. Stocks and Dollar rebounded from there and was also boosted further by better than expected quarterly results from Lehman Brothers and Goldman Sachs.

Fed’s decision to cut 75bps to 2.25% was not unanimous, with Plosser and Fisher preferring “less aggressive” actions. In the accompanying statement, Fed acknowledged that economic activity has “weakened further”, with slowing consumer spending and softening labor markets. Financial markets are still under “considerable stress”. Tight credit conditions and deepening housing contraction will likely weigh on economic growth over the “next few quarters.” But, the Fed said that the move, together with recent efforts to boost liquidity in the markets, ” should help to promote moderate growth over time and to mitigate the risks to economic activity.” But again, ” downside risks to growth remain.” Inflation is still described as elevated but members expect inflation to moderate in coming quarters. Uncertainty on the outlook increased and Fed will continue to monitor inflation developments carefully. Fed also voted unanimously to cut discount rate by 75bps to 2.5%. After all, the tone of the statement remains dovish and further easing is still expected as the statement noted Fed will “act in a timely manner as needed to promote sustainable economic growth and price stability.”

Data from US were mixed last week. Empire state manufacturing index tumbled to -22.23 in Mar but Philly Fed index recovered more than expected to -17.4 in Mar. Industrial production dropped more than expected by -0.5% in Feb. Headline PPI was tamer than expected, slowing to 6.4% yoy in Feb but core PPI climbed to 2.4% yoy. Housing starts dropped another -0.6% to 1065k. But building permits tumbled sharply by -7.8% to 16 year low of 978k annualized rate. Q4 current account deficit was slightly narrower than expected at -172.9b. TIC recorded 62.0b capital inflow in Jan.

Euro pulled back sharply after surging to new record high against the dollar. Though it’s generally mixed against other currencies only. Though, weaker than expected Service PMI, which dropped from 52.3 to 51.7 in Mar, prompted some concern of further slowing in the Eurozone economy. Manufacturing PMI was also mildly lower from 52.3 to 52.0. Q4 employment growth slowed from 1.9% yoy to 1.7% yoy.

Carry trade and stock markets continued to be a key driver in the Japan yen in an extremely volatile week. Masaaki Shirakawa was selected to fill the vacancy left by Fukui as acting BoJ governor before the government can settle on the successor to Fukui. There were also speculations flying around that BoJ would cut rates from the current 0.50% as soon as in Apr and believe Shirakawa won’t be impediment to policy easing. The main focus will be on the quarterly Tankan survey due Apr 1.

Sterling continued to be among the weaker ones against most major currencies. MPC minutes released reveal that BoE’s decision to keep rates on hold earlier this month was done by a 7-2 vote, instead of an 8-1 vote as markets expected. Blanchflower and Gieve voted for a 25bps rate cut. BoE is still facing the dilemma of rising inflation and slowing growth. However, the minutes also highlighted dissenter’s concern about delayed actions. Markets generally expect another 25bps cut in Q2 but opinions on the timing is divided. The dovish vote split raised the chance that it will happen in Apr and further worsening in the financial markets and upcoming economic data.

However, retail sales came in much better than expected by rising 1.0% mom in Feb, with yoy rate just mildly down from 5.6% to 5.5%. Employment report showed unemployment rate unchanged at 5.2% in Jan and claimant count unchanged at 2.5% in Feb. CPI climbed further from 2.2% yoy to 2.5% yoy in Feb but core CPI slowed slightly from 1.3% yoy to 1.2% yoy. After all, the timing of the next cut from BoE is still debatable.

From Canada, Feb headline CPI slowed more than expected from 2.2% to 1.8%. Meanwhile, core CPI unexpectedly climbed from 1.4% yoy to 1.5% yoy.