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What will happen from here on?

Few dare assume that the worst is really behind us

FINANCIAL markets have come back from the brink after last week, thanks to the Fed’s deft move to stave off a meltdown in global financial markets. But only the very brave dare believe the worst is now over.

When massive injections of short-term liquidity into shell-shocked money market systems from Japan to Europe and the US proved less than effective in stopping the deluge of nervous sell-offs in stock and currency markets, the Fed had no choice but to offer a half per cent cut in its discount rate.

In Asia, meanwhile, there were widespread reports of central banks stepping in to stop their currencies from selling off too sharply as things got from bad to worse. On the stock market side, there was also talk of covert stockmarket purchases, even before China announced (this week) that individuals on the mainland can now buy stocks direct in Hong Kong.

But before all of that, a few stock indices suffered painful relapses of 20 per cent or more from their 2007 highs, and the year’s carry-trade favourites like the Australian and New Zealand dollars likewise plunged a fifth or more against the low-yield yen in frenetic trading last Friday – before recovering this week.

The US dollar, meanwhile, received a respite from the appeal of safe-haven US Treasuries; except against the yen, the week’s biggest ‘comeback kid’ – where large carry trade positions favouring the Antipodean pair and even more exotic assets were nervously unwound.

And while we got the direction right here a week ago, all of our targets save one proved modest before the worst was over.

Here’s a sampling: Yes, in broader indexed terms, the US dollar easily breached our first overhead resistance area at 81.25 but ran out of steam at our next overhead carrier at 82.00-20. Elsewhere, however, the greenback blew past our first resistance area of S$1.53 – and even S$1.54 above that.

On the carry trade side, the yen surpassed all expectations as it exploded against the Australian dollar, New Zealand dollar, euro and British pound.

All were easily savaged below our week’s respective targets – at 95 yen, 85 yen, 160 yen and 235 yen for the pound. Before the Fed’s rescue, the Australian dollar was forced down to lows of 86 yen and S$1.18, the New Zealand dollar to 74 yen and S$1.02, the euro to 149 yen and S$2.05, and the pound to 219 yen and less than S$3.02. All have since recovered. In yen terms, for example, all four were trading at least five yen above the past week’s ugly lows yesterday.

Yet, all said and done, we are obliged to say that even as more intrepid souls return to nibble once more at the favourite currency plays of 2007 – selling the US dollar and buying high-yielders Down Under and elsewhere – there are reasons to suggest that the financial typhoons of the past week haven’t completely subsided.

True, the Long Term Capital Management (LTCM) debacle of October 1998 was followed by higher US stock prices and a stronger US dollar. However, it is seldom safe to assume that history will repeat itself, especially when the backdrop is quite different.

So here are some important factors to think about over the coming fortnight, even as trading rooms slowly return to full force at the end of the summer holidays.

If no one has really been able to unload any of their ugly sub-prime debt and unwieldy financial derivative structures in current market conditions, can we really say for sure that the worst is behind us? If we also combine the talk of weaker US growth in 2008 with growing expectations for two, if not more, cuts in the short-term US Fed funds rate, won’t the US dollar be in danger of resuming its slide?

And if the worst is indeed over, why are our friends at research firm Forecast telling us that the spread between safe-haven, three-month US Treasury bills and straight bank deposits has exploded this week to more than 2.5 per cent? We’re told it’s the widest gap between the two in more than three decades.


Source: Business Times 22 Aug 07

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