YB Currency Update – Friday 18th September

The Dollar dropped to a fresh one-year low on a trade weighted basis yesterday as buoyant equity and commodity prices boosted investor confidence, sacrificing the Dollar to purchase riskier, higher yielding assets alsewhere. This has been a continuing theme over the past couple of weeks, and without expanding on the exact cause-effect relationship, the dollar has been at the heart of the recent movements in the financial markets. The sell-off in the Dollar and the rally in equities is a sign that investors are becoming more optimistic about growth prospects, and that this expectation is not baseless. The weakness of the dollar will boost foreign earnings for US corporations,  boost demand for US goods, and encourage benign investors to snap US assets at bargain prices. Fed chairman Ben Bernanke has already thrown his weight behind the recovery story and the latest string of economic reports support the rosier outlook for the economy. With ultra-low interest rates (US 3month LIBOR rates are now lower than those of Japan), the dollar is now subject to huge selling pressure every time risk appetite picks up, and this will continue until the Fed shows signs of abandoning its quasi-zero-interest rate-policy, which doesn’t appear to be on the immediate horizon.

Amongst all the talk of greenback pain, it is tellling that Sterling is one of the only currencies that has still weakened compared to the Dollar. With the negativity from Mervin Kings speech providing the theme for the week, the Pound took a further hit overnight amongst renewed pessimism over the UK’s financial instiutions. The announcement that Lloyds Banking Group will have to participate in the British Government’s Asset Protection Scheme is a reminder of the weakened state of the banking sector as well as the fiscal pressures burdening the government. Lloyds signed up to the scheme in March, giving it the option of ringfencing up to £260 billion of toxic assets (mostly related to its acquisition of HBOS). Lloyds were discussing “possible changes to the commercial terms on which Lloyds might enter into the Government Asset Protection Scheme, including the possibility of reducing the amount of assets covered by the scheme” – they have since been told by the FSA that this is not possible. In the last 24 hours GBP/EUR has dropped around a cent to 1.1130, while Cable dropped nearly 2 cents to 1.6340.

Today has seen worse than expected M4 money supply figures and public sector net borrowing figures which have furthered this decline for Sterling, though we may see a correction of many of the trends seen this week as the markets take profit in time for the weekend.