Worldwide selloff worsens as Eurozone teeters on the edge of recession

Tom Tong26/Sep/2011Currency Updates

Risk assets worldwide took another tumble last week. Worries have spread from Eurozone woes, and now investors are increasingly pricing in a worldwide synchronized slowdown. The continued outpour of negative macroeconomic surprises, combined with the absence of decisive policy actions, has brought about a new phase in the selloff. Risk assets are now being sold indiscriminately, without much regard to the underlying fundamentals. Hence, we are seeing assets as disparate as emerging market currencies, on the one hand, and precious metals, on the other, all tumbling together against the US dollar, which is finally being buoyed by the general flight-to-safety and rallied massively, up nearly 2.5% in trade-weighted terms. While rumours are swirling about the possibility that the European sovereign bailout facility will be upped to the neighbourhood of 2 trillion Euros and using it to recapitalize European banks, investors have been disappointed too many times by piecemeal, half-hearted responses to the European crisis and only deeds will reverse the bearish trend in risk assets.

GBP

The minutes of the September MPC meeting, released last week, fully vindicated our view that another round of QE is coming sooner rather than later, and quite probably at the next meeting. They stated that “most” members agreed that “it was increasingly probable that further asset purchases…would become warranted at some point.” The minutes also made it quite clear that most of the discussion in the MPC revolves around other ways the Bank of England can stimulate the economy. Investors increasingly regard GBP as a proxy for Euro woes, and Sterling once again traded as a low-beta version of the common currency, dropping over 2% against the greenback but eking out a small gain against the Euro.

EUR

The minutes of the September MPC meeting, released last week, fully vindicated our view that another round of QE is coming sooner rather than later, and quite probably at the next meeting. They stated that “most” members agreed that “it was increasingly probable that further asset purchases…would become warranted at some point.” The minutes also made it quite clear that most of the discussion in the MPC revolves around other ways the Bank of England can stimulate the economy. Investors increasingly regard GBP as a proxy for Euro woes, and Sterling once again traded as a low-beta version of the common currency, dropping over 2% against the greenback but eking out a small gain against the Euro.

USD

The main news of the week was the more aggressive than expected “Operation Twist” by the Federal Reserve. As the FOMC is increasingly concerned about the stalling US economy, it is groping about for new ways to provide monetary stimulus to the economy. With interest rates at zero and a much enlarged balance sheet, it has decided to replace short term bonds with long term ones in order to put further downward pressure on long-term interest rates. The aggressive response, as well as the FOMC’s very explicit fears for the economy reflected in the statement spooked risk assets and brought about a sustained “risk off” trade for the rest of the week. Significantly, the US dollar rallied sharply in spite of the aggressive easing of monetary policy. It appears that the correlations of the 2008 panic are coming into force, and investors are beginning to react to bad news by buying dollars –a very significant change in psychology.

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Written by Tom Tong

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