Dollar lower vs euro and yen after Fed minutes

Dollar lower vs euro and yen after Fed minutes

October 9, 2007

The dollar initially jumped against its major counterparts Tuesday after the release of minutes from the U.S. Federal Reserve’s last meeting, but quickly lost ground as investors realized the minutes didn’t remove the chances of another interest rate cut.

The greenback was also undermined by comments from a key Federal Reserve official that housing and credit markets remain fragile and won’t recover for some time, implying significant risks to the Fed’s forecast for a modest improvement in the economy.

“Recent events suggest that housing will remain weak for several more quarters,” said William Poole, president of the St. Louis Federal Reserve Bank, and a voting member of the Federal Open Market Committee this year.

With the economic outlook in the wake of the financial market turmoil highly uncertain, Fed officials agreed that a half a percentage point rate cut was “the most prudent course of action,” but said only that future actions would depend on how the economy fared in coming weeks, according to a summary of the Sept. 18 meeting.

“Since Sept. 18, the housing data have deteriorated significantly and while some credit spreads have narrowed, overall credit conditions and standards have not loosened materially,” noted economist Michael Gregory of BMO Capital Markets.

“The Fed could cut again on October 31 based on these developments alone, and we judge the data flow during the next 22 days will corroborate what’s on the ground now,” Gregory said.

Lower interest rates erode returns on dollar-denominated assets and therefore weigh on the dollar.

On Sept. 18, central bankers decided to cut U.S. interest rates by an unexpectedly large half percentage point. There was no opposition to the rate cut, the minutes showed.

Fed officials were so uncertain about the outlook that they refused to provide the traditional balance of risk statement, language that indicates to the market whether the Fed believes it must focus its policy attention on higher inflation or slower growth. Such a statement in mid-September “could give the mistaken impression that the FOMC was more certain about the economic outlook that was in fact the case,” the summary said.

The dollar index, which measures the greenback against a basket of major currencies, was at 78.450, after jumping up to 78.630 after the minutes were released. It was at 78.775 in late U.S. trading Monday.
The euro spiked up to $1.4103, after dropping to $1.4072 after the minutes. It was at $1.4043 late Monday.

The dollar was buying 117.17 compared with 116.94 yen before the minutes and 117.39 yen Monday.

EU focus on China

Investors were also studying the comments that emerged from the monthly meeting of European finance ministers, which concluded Tuesday in Luxembourg.

Rather than focus on the recently weak dollar, the meeting participants chose to zero in on the Chinese yuan. Though China no longer pegs the yuan to the dollar, it still trades in ranged bands against major currencies rather than float freely according to market rates.

“First point China, second point dollar, third point yen,” said Jean-Claude Juncker, chairman of the meeting, according to news reports.
Juncker, European Central Bank President Jean-Claude Trichet and European Economic Affairs Commissioner Joaquin Almunia will visit Beijing before the end of the year.

“We note that the euro is playing its role for an orderly reduction of the imbalances,” referring to China’s huge trade surplus, the euro zone statement said.

“EU Finance ministers have gotten little indication that the U.S. is willing to change its core view on [the dollar] and have directed their discomfort with the strong [euro] at China and the lack of movement” in the dollar-yuan pair, wrote David Watt, senior currency strategist at RBC Capital Markets.


Subprime crisis far from over

October 09, 2007

The U.S. subprime housing crisis will not peak until 2009, rating agency Standard and Poor’s said on Tuesday, adding it had underestimated the extent of fraud in the industry.

S&P expected the world economy to grow 3.6 percent in 2007 and 3.5 percent in 2008, with emerging market economies driving growth. The U.S. economy would lag at 2 percent in both years, down from 2.9 percent in 2006.

Housing was the major weakness in the U.S. economy and the subprime crisis — which roiled global markets in late July and August — was far from over, although its shock value was wearing off, David Wyss, S&P’s chief economist, said in Mumbai.

“We underestimated the extent to which fraud was occurring in the industry,” he said.

“It looks, based on some surveys that had been done, the extent of frauds increased sharply in 2006.”

S&P said the U.S. Federal Reserve had estimated that subprime losses could reach $150 billion, and Wyss said that would feed through to unemployment and remain a brake on growth.

“We think in the United States the housing market is not going to bottom until winter. We think the losses in these sectors won’t really hit their peak until 2009,” Wyss said.

“We are not halfway through with this crisis yet.”

Emerging markets were far less vulnerable to credit market turmoil than during previous crises because of the capital flows attracted by high economic growth coupled with improved corporate governance standards, S&P said.

“World growth remains strong despite the weaknesses seen in the U.S. economy — especially in emerging markets because of healthy domestic demand conditions and export strength to non-U.S. markets,” it said in a report.

“The fact that the U.S. slowdown is concentrated in housing, which has relatively low import content, helps,” it said.

High commodity prices were also helping many emerging market economies, such as Latin American and African countries that are major exporters.

S&P estimated that, on a purchasing-power parity basis, the United States would contribute only 9 percent of world growth in 2007, compared with China’s 33 percent and India’s 12 percent.

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