The US$ continues to benefit against the euro and sterling from risk aversion, while losing against the yen as “carry trades” continue to unwind. More reporting overnight showed higher writedowns from subprime mortgages, helping to underpin anxiety in the market. Barclays announced an initial loss of $2.7 billion overnight, significantly less than the rumors that pervaded the market of a $21 billion loss. This brings the total of current losses from large banks to over $45 billion. Today, the consumer price index for October will be released at 8:30 a.m. This number is expected to show an annualized increase in October of 3.5%, up from 2.8% in September. Excluding food and energy, the number is expected to rise to 2.2%, up from 2.1% the previous month. Elevated readings of inflation should be expected moving forward as the interest rate cuts take hold in the market. In addition, the falling value of the US$ adds to inflation, causing import prices to rise proportionally. Producer prices, released yesterday, showed that inflation increased significantly over the previous month, though not as high as economists had forecasted. Higher inflation should benefit the US$ in the near term as expectations for further interest rate cuts diminish.
The euro was slightly lower against the US$ overnight. Risk aversion in the market continues to help the greenback, causing both technical and fundamental indicators to point to a relief rally for the US$. Such rallies have been infrequent since June and have been correlated to spikes in risk aversion. The yield advantage that the US$ has over the euro has withered away, with expectations that the 50 basis point interest rate advantage will disappear over the next year. For this reason, a possible rally in the US$ is likely to be shallow, perhaps 2.5%, considering the continued negative sentiment toward the currency.
The yen was higher overnight as its correlation with movements in equity markets continues to sit at around 80%. Though the reported loss by Barclays comes in below market rumors, the news of additional subprime writedowns was not welcomed. In additional news overnight, Bank of Japan Governor Fukui issued comments stating that it is more difficult now to determine changes needed in interest rates. The market has already discounted the BOJ’s ability to raise interest rates this year. Instead the focus should point more towards an increase at the end of the first quarter next year. This timetable is likely to be supportive of carry trades over the coming months, suggesting the yen could weaken if investor sentiment improves.
Sterling was lower again overnight after trading violently yesterday. The Bank of England’s quarterly inflation report, which included in its calculations an interest rate cut in the early part of 2008, continues to weigh on the pair. Between this news, unwinding of the carry trade, and a slight move into US$’s as a safe haven, sterling has lost over 3.3% during the past week. This weakness is likely to continue in the near term as sterling’s support wanes. Should economic fundamentals, which have been supportive of the pound, also begin to change, sterling could again fall significantly in a short period of time.
