Fannie and Freddie crisis strikes one more blow to the weak USD. Who’s next?
Charis Charilaou
Chief Dealer
The deterioration of the US financial sector as is evident from the latest turmoil of the government sponsored mortgage agencies Fannie May and Freddie Mac is providing a heavy weight on the already weak USD sentiment which is expected to continue under pressure during the course of this week.
The EURO was the best performing currency during last week managing to trade higher almost against every other major currency on global concerns that the deteriorating US financial sector is posing a threat to USD’s role as a reserve currency. EURUSD has spent most of the week in a range of 1.56-1.58 as was expected but the G8’s neglect on the weak USD plus the Fed’s announcement that the emergency liquidity measures will continue to 2009 (accepting that the liquidity crunch is far from over yet) have kept the EURUSD towards the upper band of the range. On Friday a plethora of stories about Fannie Mae and Freddie Mac “being considered for government takeover” were enough to push equity markets and the USD over the edge and EURUSD traded up to 1.5940. On early Monday morning and with EURUSD trading at 1.5974, in a move resembling what has happened in March with Bear Stearns, Fannie Mae and Freddie Mac have been given borrowing access to the federal Reserve of NY, and the Treasury announced that has temporary authority to purchase equity in both agencies.
Sterling was also on the retreat against EUR, as the economic and political situation in the UK keeps worsening. The BoE did not surprise by leaving rates unchanged and traders decided to test EURGBP above 0.8000.
Geopolitics were also on the agenda during the week with Iran test firing long range missiles and reports that Israel is ready to attack Iran. The oil was on the retreat for the most of the week easing back to $135.50 from $145 but by the end of the week it rose again reaching an all-time high at $147.27/bbl.
LOOKING AHEAD
It’s going to be a quite busy week in terms of US data releases. Retail sales, PPI, CPI and manufacturing surveys will be closely watched for hints as to the state of the US economy but the most significant event will be FED chairman Bernanke’s semi-annual monetary policy testimony to congress on Tuesday and Wednesday. We expect June gains of 1.8% in the PPI on Tuesday and 0.9% in the CPI on Wednesday. Core PPI should rise by 0.3%, but core CPI should remain at 0.2%.
When Bernanke last spoke about the economic outlook in the pre-June FOMC he surprised the market voicing his concern about inflation and the weakening USD only to come some weeks later with a balanced FOMC statement and surprise the market again. We expect Bernanke in his testimony to continue to show worries about the upside risks to the inflation outlook but at the same time he should continue to feel concerned about the downside risks to growth as the financial sector, housing prices and commodity prices are still dragging the economy lower.
The highlight in Eurozone will be the inflation data on Wednesday while the German ZEW on Tuesday should show further deterioration in sentiment.
There are also a number of UK key releases. On Tuesday we have consumer prices while on Wednesday an expected deterioration in employment will put further downward pressure on GBP. Also UK inflation is expected to rise to 3.6% in June.
STRATEGY
Although we haven’t yet touched a new EURUSD high we continue to think that in the current market situation, this is only a matter of time. The two banks continue on different policy mandates and the increased inflation pressures from the commodity (especially oil) prices and plunging housing, equities and credit prices as highlighted from the events of last weeks cannot help either bank to change their policies now. The expected bailout of Fannie May and Freddie Mac is expected to add to the weakening USD sentiment and everyone in the market is starting to think who’s next? Short term support is currently situated at 1.5600 while a break of 1.6015 will see the next target at 1.6200. Although intervention risks are increasing above 1.6000, we will be following the trend and we will be watching closely the developments in equities and commodities.
The GBP data continue to point towards stagflation and we continue to think that it is difficult to see the GBP sentiment improve in the near term. EUR/GBP should continue above 0.8000 with 0.8035 the more technically important level.
Disclaimer
This research report or summary has been prepared by TFI PCL from information believed to be reliable. Such information has not been independently verified and no guarantee, representation or warranty, express or implied, is made as to its accuracy, completeness or correctness. This report is provided for information purposes only. Nothing in this report should be considered to constitute investment advice. It is not intended, and should not be considered, as an offer, invitation, solicitation or recommendation to buy or sell any of the financial instruments described herein. TFI PCL accepts no liability whatsoever for any direct or consequential loss arising from the use of this document or its contents.
