Given that they have essentially reached the terminus of their monetary policy options, all three Central Banks are exploring further options aimed at pumping money into their respective economies. The Fed has already “announced a program to buy $100 billion in the direct obligations of housing related government sponsored enterprises (GSEs) — Fannie Mae, Freddie Mac and the Federal Home Loan banks — and $500 billion in mortgage-based securities backed by Fannie Mae, Freddie Mac and Ginnie Mae.” As I wrote in a related article, “this was quickly followed by repurchase programs, lending facilities, investments in money market funds, and option agreements, all of which were designed to supplement its ‘traditional open market operations and securities lending to primary dealers.’ The Fed’s efforts also worked to ease the liquidity shortage in credit markets abroad by entering into swap agreements with several foreign Central Banks suffering from acute Dollar shortages.”
In conjunction with the rate cut, the Bank of the UK, meanwhile, will pump £150bn directly into UK credit markets through liquidity support, buying public and private debt, and asset purchases. “The main purpose of quantitative easing is not to send the money supply into orbit but to stop it from crashing…the broad money held by households has risen at a worryingly slow rate over the past year, and holdings by private non-financial firms have actually been dropping.” In contrast to the monetary programs of the UK and US, the ECB has thus far refrained from the kind of liquidity support that would necessitate printing new money. Instead, “the central bank will continue offering euro-zone banks unlimited loans at the central bank’s policy rate until at least the end of this year.”
The interest rate cuts were announced simultaneously with a spate of macroeconomic data, which collectively paint a bleak picture. Eurozone growth is projected at -2.7% for 2009 and 0% for 2010. The current unemployment rate at 8.2% and climbing. The thorn in the side of the EU is represented by eastern Europe, where growth is falling at an alarming pace, dragging the EU down with it. While EU member states have pledged to intervene if one of their own falls into bankruptcy, it’s unlikely that they would intervene similarly if a non-EU member state went bust. The UK economy is similarly desperate, having contracted at an annualized rate of 5.8% in the most recent quarter. The wild cards are the real estate and financial sectors, the fortunes of which are increasingly intertwined.
So what do the forex markets have to say about all this? Economists have used the dual phenomena of risk aversion and deflation to explain the interminable weakness in the the Pound and Euro. Everyone is surely familiar with the notion of the US as “safe haven” during periods of global financial instability. The deflation hypothesis, meanwhile, suggests that the ECB (and to a lesser extent, the Bank of UK), fell behind the curve when easing liquidity. The ECB, especially has harped on inflation as a reason for cutting rates more quickly. Given that investors are now more concerned with capital preservation than price inflation, it follows that they would prefer to invest where Central Banks were more vigilant about deflation (i.e. the US).
Personally, I think that the continued declines in both currencies, in spite of steep interest rate cuts, indicates that the deflation hypothesis is bunk, and investors remain fixated on risk aversion. By no coincidence, the temporary rebound in US stocks that took place in January was also accompanied by a bump in the Euro. (See chart below).
I think this mindset is reasonable, but only in the short-term. Given the current economic environment, I don’t think investors (and currency traders) can be faulted for ignoring the possibility that quantitative easing and liquidity programs will have to be funded with the printing of new money, which would be inherently inflationary. Many comparisons are being made with Japan, whose ill-fated quantitative-easing program succeeded only in inflating a bond-market bubble and vastly increasing Japanese public debt. According to one columnist, “it’s hard to argue that quantitative easing ended deflation; high oil prices did that. Meanwhile, the economy cured on its own most of the structural problems such as excess capacity and too much debt associated with the deflationary environment.”
In short, with a medium and long-term investing horizon in mind, I think the ECB’s approach to dealing with the credit crisis is more conducive to monetary stability. Thus, when investors grow weary of the idea of US as safe haven, they will no doubt focus instead on fundamentals. At which point, the ECB will likely be rewarded for fulfilling its anti-inflation mandate, in the form of a stronger Euro.
Key Overnight Developments
• Asian Stock Drop Ignored by US Dollar as Markets Look to NFP
• British Pound Rises, Euro Confined to Familiar Ranges
Overnight trading saw the Euro keep to the consolidation range established in the US session, oscillating below the 1.26 mark. The British Pound advanced higher, adding 0.4% on the US Dollar. For complete analysis of all the major currency pairs, please see the latest weekly technical outlook report.
Asia Session Highlights
Risk trends faded into the background in the overnight session as forex traders looked ahead to tomorrow’s Non Farm Payrolls release. The cues from stock exchanges were decidedly negative: shares traded lower across Asian exchanges following a 4% drop on Wall St. Financials led the selloff after it was revealed that the US administration’s mortgage rescue plan would effectively be confined to loans owned by Fannie Mae and Freddie Mac, leaving banks like Wells Fargo (which owns 16% of the mortgage market) in the cold. Downward pressure was compounded as Moody’s downgraded JPMorgan, the heretofore beacon of financial stability, while the chairman of the FDIC said its deposit insurance fund may become insolvent by the end of this year. Interestingly, the flight from risky assets failed to boost the US Dollar (the current safe haven du jour) as the markets braced for the US economy to shed -650k jobs in February.
Euro Session: What to Expect
Switzerland’s inflation is set to come to a standstill with the Consumer Price Index expected to print at 0.0% in the year to February. The growth outlook remains decidedly bleak, with a survey of economists conducted by Bloomberg calling for GDP to contract at an increasing pace through the third quarter of 2009, meaning inflation could well turn negative in the near to medium term. This poses a serious threat to consumption and investment because if individuals and businesses expect prices to fall in the future they will perpetually delay spending to get the best possible deal, putting the brakes on economic growth altogether. Indeed, Swiss National Bank Vice-Chairman Philipp Hildebrand has even suggested forex market intervention to check the deflation threat.
In the UK, the Producer Price Index is set to add a meager 0.1% through February to bring the annual pace of wholesale inflation to an 18-month low at 3.1%. The metric foreshadows further downside in consumer prices, the headline inflation gauge, as firms pass on lower manufacturing costs through cheaper finished products. On balance, the metric is unlikely to have much of an immediate impact on British Pound price action after the Bank of England suggested it was done cutting interest rates after the last reduction to a record-low 0.50%. The policy statement accompanying the rate decision warned of the potential dangers of taking borrowing costs too low and signaled that Mervyn King and company would now embark on a policy of quantitative easing.
The implications of the central bank’s new policy could spell trouble for the British Pound. Manually expanding the money supply may prove profoundly inflationary as the eventual recovery materializes, eroding the currency’s value if lending rates do not rise fast enough to drain excess liquidity. Policymakers’ recognition of a rebound tends to lag behind its actual beginning, threatening to put the BOE behind the curve. On balance, this suggests the risks are to the downside in the long term sterling outlook.
Written by Ilya Spivak, Currency Analyst
Article Source - US Dollar Ignores Asian Stock Drop as Forex Traders Brace for NFP (Euro Open)
What is Forex?
The foreign exchange market (Currency, Forex, or FX) is where currency trading takes place. It is where banks and other official institutions facilitate the buying and selling of foreign currencies. Forex transactions typically involve one party purchasing a quantity of one currency in exchange for paying a quantity of another. The foreign exchange market that we see today started evolving during the 1970s when world over countries gradually switched to floating exchange rate from their erstwhile exchange rate regime, which remained fixed as per the Bretton Woods system till 1971.
Today, the Forex market is one of the largest and most liquid financial markets in the world, and includes trading between large banks, central banks, currency speculators, corporations, governments, and other institutions. The average daily volume in the global foreign exchange and related markets is continuously growing. Traditional daily turnover was reported to be over US$3.2 trillion in April 2007 by the Bank for International Settlements. Since then, the market has continued to grow. According to Euromoney's annual Forex Poll, volumes grew a further 41% between 2007 and 2008.
Forex used to be a closed market because only the “big boys” because you needed between 10 and 50 million $ to open an account. But today, with the development of internet, online Forex brokers have the possibility to offer their services to “little” traders. All you need to start is a computer, fast internet connection and information which you can find on this page also.
This enormous market is like the dangerous sea where you can meet lots of sharks and dangerous waters but at the same time it is the only one where two weeks of trading can hypothetically bring you $1,000,000 out of $1,000 of initial investment.
This is certainly hypothetically because a lot of newbie traders deal with their trades as gambling, that surely bring them to having nothing in the end. You should always keep the phrase "be careful!" in your mind. This market would give you its profit possibilities only if you learn the basic things hard and make lots of demo trading.
The statistics is that as much as 95% of traders come to losing their money at Forex, 5% have profit and less than 1% of traders make large fortune at Forex. You shouldn't produce, sell or advertise anything trading at Forex. Your assets are your knowledge, experience and a small amount of cash.
This market is a platform for banks, transnational corporations and individual traders to change the currencies they possess into other ones. This is the spot Forex market. At this market you can trade with up to 1:400 leverage which means that you'll get $400 on your account for each dollar invested. So, you can trade with the $400,000 sum having invested $1,000 onto your account.
Why to trade on Forex?
1. There is no commission fee for trading at Forex.
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3. Forex is open 24-hours a day.
4. Nobody can influence the market for a longer period.
5. High liquidity.
6. Free demo accounts, analysis and charts.
7. Small accounts that allow everyone to try out his luck.
Hope this has answered a lot of questions you were asking yourself about Forex and that you can now start trading. Also make sure that you check out other articles on this blog which can help you earn your fortune.
Good luck to everyone!