Fed Twist, Euro Bends, Currency Markets Broken

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The Fed moved ahead last night with its Operation Twist in a plan to stimulate consumer demand by driving long-term interest rates lower. $400bn of short term debt will be sold to finance the purchase of longer term debt; purchasing debt drives yields lower and this should therefore allow consumers to refinance mortgages at lower rates, businesses to invest in capital programs and the economy to push on from there. Or that’s what the theory says of course.

The banks and money market funds will have been happy to see the reserve rate was not cut any further but the Fed did surprise by saying that any early repayments would be reinvested back into Mortgage Backed Securities in order to stimulate further security in the weakened housing market.

Stock markets were not convinced however, especially after the Fed stated that ‘downside risks to the recovery had increased’ in the past few months and indices and other risky assets have been smashed lower in the Asian session and these losses will continue through the European open.

Fears over the US banking system were exacerbated last night by Moody’s downgrading three of the major players in the course of 25 minutes. Bank of America, Wells Fargo and Citibank all had their credit rating cut by the ratings agency after they decided that should the banking sector fall into crisis again then support from the government would be less likely. This has hit banking shares everywhere overnight and will do similar once the FTSE opens.

It is our belief that the “Twist” operation is merely a sideshow to the circus that is Europe and that the market is still looking for support in that arena before it will run higher. One thing that the further weakening of monetary policy in the US does is increase pressure on the ECB to cut rates after the two rate rises earlier on in the year. This will keep pressure on the euro in the short term.

Sterlign was one of the largest losers yesterday after the Bank of England minutes showed that the majority of the MPC are looking for further asset purchases in the future IF the inflation outlook calms down and the slump in activity is perpetuated into the 4th quarter. I don’t think there will be any doubt about that and we are happy with our predictions that the Bank of England will increase asset purchases by £50bn in November. Sterling fell to 6 month lows against the dollar in the aftermath of both central bank announcements yesterday and looks like further losses may be likely if traders resume a risk-off mentality. This will also keep GBPEUR around the 1.14/1.15 level in the short term.

Indicative Rates Sell Buy
GBPEUR 1.1418 1.1444
GBPUSD 1.5481 1.5505
EURUSD 1.3541 1.3563
GBPJPY 118.43 118.73
GBPAUD 1.5472 1.5498
GBPNZD 1.9427 1.9459
GBPCAD 1.5696 1.5725
NZDUSD 0.7955 0.7977
GBPZAR 12.62 12.67
USDZAR 8.1462 8.1865
GBPPLN 5.0484 5.1072
EURJPY 103.59 103.87

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