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Forex outlook:
Summer doldrums quickly disappeared as capital markets scrambled wildly to cope with the liquidity crisis unleashed by the BNP Paribas announcement that it’s was suspending redemptions in its asset backed funds. This was the third such move by a major financial player over the past few weeks, and while in the short term it may have been a prudent course of action for preservation of assets in the fund – the long term implications for capital markets of such arbitrary changes in policy could be disastrous. As one market participant noted in mid-week, “There is huge pressure on money rates due to an apparent sense of mistrust. Following BNP Paribas' statement, very few institutions appear willing to lend. If you kill off the inter-bank market and the asset- backed commercial paper market has effectively collapsed, then we look to be heading for a serious liquidity crunch.'” Indeed if investors lose confidence in their ability to redeem their capital, they will simply refuse to provide it and that could have a chilling effect on all risk taking operations.
As we noted on before, “Ironically enough, this doomsday scenario would likely benefit the US dollar – the epicenter of the sub-prime mess - as the greenback would become bid on safe haven flows. Tonight’s price action is a good example of this dynamic at work, as the buck strengthened across the board following the BNP news.”
While last week the markets priced in with near certainty the possibility of a rate hike to 4.25% from the ECB after Jean Claude Trichet used the keyword “vigilance”, this week such certitude no longer exists. After the BNP turmoil on Thursday, the ECB was forced to inject more than 130 Billion dollars into the system as European credit markets came to a grinding halt. Therefore, it is not unreasonable to speculate that the central bank may decide to hold off tightening monetary conditions given the very precarious nature of money markets in the 13 member region.
The safe haven theme may persist next week, especially if the markets continue to experience volatility, but eventually real economic issues will begin to weigh on the greenback. Unlike this week, next week’s calendar is chuck full of data and most estimates look for declines in everything from housing to consumer confidence. One possible boost for dollar bulls could come from the Retail Sales number on Monday. With expectations of a consumer slowdown so prevalent in the markets, any upside surprises in the July data would suggest that the US consumer remains relatively healthy despite the collapse in housing. If that remains the case, talk of a soft landing rather than a hard crash could improve market expectations of US growth going forward. In Europe next week the economic calendar offers little support to euro bulls. German GDP is expected to print lower dropping to 2.8% from 3.1% in Q1. This by the way will be the first time since the summer of 2006 that US GDP growth will exceed that of EZ biggest economic actor and while the overwhelming majority of analysts believe this to be a one off event, it bears watching. If against all market expectations EZ growth dips below US growth in H2 of 2007 the primary source of euros strength may be gone.
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