Forex Market Update- May 19

Markets managed to turn on a sixpence again yesterday, recouping Friday’s losses - and more – amid a slew of more positive inputs. First off, markets took their cue from the impressive rally in Indian equities (up 17%+) after the weekend election result, triggering a full-day circuit breaker after the first 2 hours! Secondly, US home improvement retailer Lowe beat earnings forecasts and raised its full-year outlook, prompting calls that the recession may be easing and consumer spending stabilizing. Finally, the financial sector received a double bonus from an upgrade to BoA and news that the big 3 US banks were to apply to repay TARP dollars.

The shift in sentiment saw the USD retreat across the board with the exception of the JPY. Comments from Japan’s Vice Finance Minister Sugimoto put the skids under the JPY as he said he was watching markets closely, and hoped they would not have a negative effect on the economy. This was interpreted as a suggestion that Japanese officials were becoming uncomfortable with the JPY’s recent strength, and its negative impact on exporters’ earnings, and may step in to slow the JPY’s rise. While such an event is highly unlikely, similar “verbal intervention” back in January was sufficient to prompt a USDJPY rally from sub-90 levels. Add to this a short-term market that was likely heavily positioned one way, USDJPY surged along with the JPY crosses, fueled along the way by the upswing in risk appetite.

The release of the minutes of the May 5 RBA meeting came and went without much ado, partly made redundant by the release of the Monetary Policy Statement three days after the meeting. Maintaining a mildly positive tone overall, the minutes showed members thought Australian stimulus measures were supporting demand and export volumes in the March quarter were seen as better than expected. Further emphasizing the upbeat vein, the RBA forecast that the Australian economy would perform better than most in this year and next while business investment was unlikely to sink as much as in previous downturns. In general, the tone suggests the RBA will remain on hold with its interest rate policy near-term, maintaining its wait-and-see attitude with rates at record lows. On this theme, RBA Gov. Stevens mentioned in a speech before the Canadian Australian Chamber of Commerce that Australian rates were at “pretty low levels” historically, adding that the current level was expansionary for Australian households.

Japan’s Nikkei newspaper reported that the BOJ would likely consider the unusual step of allowing financial institutions to put up US T-bonds and other foreign debt instruments as collateral for open market operations (Note domestic institutions hold about JPY30 tln worth of foreign bonds). The topic would be likely debated at the upcoming BOJ two-day MPC meeting on Thursday and is seen as the BOJ pre-empting possible further turmoil in financial markets, even though markets appear to have stabilized in recent times. Indeed, 3-month LIBOR rates eased off significantly yesterday, falling 4bp to 0.785% and the LIBOR/OIS spread narrowed to 61.5bp (its tightest since mid-March 2008) and a further sign of improving liquidity.
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