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• British Pound Falls to a Record Low
• Breakout Expected in the Euro

Big Week Ahead for the US Dollar

After a quiet start to the week, volatility has returned to the currency market. The moves that we have seen over the past 2 trading days are just a taste of what we expect for the week to come. With consumer spending, inflation, manufacturing and housing market data on the calendar, the EUR/USD is prime for a breakout. The US dollar has already weakened significantly today as trouble on Wall Street spills over to the corporate sector. For the first time in 5 years, General Electric reported a quarterly drop in profit. Their Financial Division was hit the hardest as the Bear Stearns debacle forced GE to write down its assets at very low values, resulting in a 42% increase in loss provisions. Frontier Airlines also became the fourth airline to file for bankruptcy this month. The 3 others were Aloha, ATA and Skybus. Although Frontier credited their bankruptcy to “an unexpected attempt by its principal credit card processor to substantially increase a holdback of customer receipts,” rising fuel prices have contributed substantially to the failure of these 4 airlines. This proves that those economists who say core prices is the only thing that matters are wrong because prices including food and energy is crippling the global economy. The weakness of the dollar was exacerbated by the sharp drop in consumer confidence. According to the University of Michigan, consumers have not been this pessimistic in 26 years. The problems in the US labor and housing markets combined with rising prices are becoming too much for the average American to handle. On Monday, we will see whether the rise in prices will offset the contraction in consumer spending. We believe that 3 months of net job losses will make it difficult for most Americans to be liberal with their spending. Retailers around the nation have been closing shops, Kimberly-Clark Corp has increased prices on everything from Huggies diapers to Cottonelle bath tissue and even Las Vegas casinos are reporting a decrease in gaming revenues. With this in mind, we continue to expect further dollar weakness, particularly against the Japanese Yen.

British Pound Falls to a Record Low -

The British pound dropped to a record low against the Euro as problems continue to plague the UK mortgage sector. Last month, I indicated that the British pound could fall below 2.0 if disaster hits UK mortgage lenders. Since then, the pound has traded lower and even though there has been no blowup, nearly every major UK mortgage lender has either increased their interest rates on mortgages or withdrawn from the mortgage market completely. Despite the Bank of England’s 25bp rate cut yesterday, UK mortgage lenders have not relaxed. In fact, Abbey National, the last remaining lender to offer 100 percent mortgages has pulled their products off the market. The Bank of Ireland has also completely withdrawn their mortgage products for eight days while they reassess the value of their home loans. Existing lenders are expected to continue to hike borrowing costs, making it even more difficult for the UK housing market to recover. Next to the US dollar, the British pound is the currency that we are most bearish. However, next week could bring some respite with inflation and employment reports due for release. Even though the economy is deteriorating, the employment components of the PMI reports suggest that the labor market could actually rebound.

Breakout Expected in the Euro -

The Euro is consolidating within 100 pips of its high against the US dollar. For traders that like technicals, there is a clear ascending triangle forming in the EUR/USD which indicates that the currency pair is prime for a breakout. Wholesale prices in Germany were stronger than expected, confirming the ECB’s fears about inflationary pressures. In the week ahead, US data dominates the calendar with only the German IFO report, Eurozone consumer prices and producer prices due for release.

Australian, New Zealand and Canadian Dollars Drop in Rising Risk Aversion -

Rising risk aversion and the 250 point drop in the Dow has driven the Australian, New Zealand and Canadian dollars lower against the greenback. New Zealand reported their REINZ house prices, which hit a 7 year low, as record high interest rates start to take a toll on the overall economy. Next week’s retail sales figures are also anticipated to drop, as personal savings grow. In contrast, New Zealand’s consumer prices and food prices should report cheery figures, as dairy prices remain high. With economic slowdown creeping into the picture, RBNZ officials show no remorse, as wage pressures continue to boost inflationary pressures. On the other hand, Australia did not have any releases, but yesterday’s unemployment report indicated that the once resilient economy is starting to weaken. Next week’s depressed home loan and investment lending releases will prove to investors that the housing sector is already in a slump. On the Canadian front, new housing prices grew at a slower pace than anticipated, as the housing market starts to mimic the US housing market. Next week’s CPI releases indicate that inflation is slowly approaching the 2% safety zone, but it should not be a concern for officials.

Yen Crosses Rally Ahead of G7 -

After a week of relatively consistent losses, the Japanese Yen had an unexpected gain today on the unwinding of carry trades. If this trend should continue over the few trading sessions, there is potential for the Yen to end up near its support level of 95. With no economic news released\, investors look forward to next week, with the G7 meeting and BoJ minutes due for release this weekend. This should set the tone for Monday’s trading session, along with providing investors vital information about the issues that are of main concern for officials.

DailyFX

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The G7 Statement from the meeting of Finance Ministers and Central Bankers were released on Friday and judging from the language, the attendees are worried about growth, the problems in the financial markets AND the fluctuations in currencies.

When the currency markets reopen on Sunday night, they may take this to mean that the concern of the G could compel COORDINATED ACTION!

The Finance Ministers and Central Bankers are pretty serious about tackling the problems plaguing the global economy and I wonder if they are planning a BIG announcement. When was the last time that the G7 invited 10 major banks to Washington to discuss ways to avert a financial crisis?

G7 Meetings Matter:

There are TWO new sentences in the paragraph referencing exchange rate fluctuations

APRIL STATEMENT:

“We reaffirm our shared interest in a strong and stable international financial system. Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability. We continue to monitor exchange markets closely, and cooperate as appropriate. We welcome China’s decision to increase the flexibility of its currency, but in view of its rising current account surplus and domestic inflation, we encourage accelerated appreciation of its
effective exchange rate.”

FEBRUARY STATEMENT:

“We reaffirm that exchange rates should reflect economic fundamentals. Excess volatility and disorderly movements in exchange rates are undesirable for economic growth. We continue to monitor exchange markets closely, and cooperate as appropriate. We welcome China’s decision to increase the flexibility of its currency, but in view of its rising current account surplus and domestic inflation, we encourage accelerated appreciation of its effective exchange rate.”

Here are some highlights from the statement:

*‘URGENT ACTION’ NEEDED ON OFF-BALANCE-SHEET ACCOUNTING
*CITIES CONCERNS ABOUT CURRENCY MOVES ON ECONOMIC STABILITY
*NATIONS ‘COMMITED’ TO TAKING ACTION AS APPROPRIATE
*CENTRAL BANK LIQUIDITY EFFORTS ARE ‘HELPING’
*NOTES ‘SHARP FLUCTUATIONS’ IN CURRENCIES SINCE FEBRUARY
*URGES BANKS TO RAISE CAPITAL AS NECESSARY
*URGES BANKS TO ‘FULLY AND PROMPTLY’ DISCLOSE RISK EXPLOSURE
*SETS 100-DAY PLAN TO STRENGHTEN FINANCIAL MARKETS
*GLOBAL FINANCIAL TURMOIL ‘REMAINS ENTRENCHED’
*U.S. HOUSING, OIL PRICES POSE THREATS TO GROWTH
*ECONOMIC OUTLOOK ‘WEAKENED,’ CITES ‘DOWNSIDE’ RISKS
*WILL CONTINUE TO MONITOR EXCHANGE RATES AS APPROPRIATE
*ENCOURAGES CHINA TO ACCELERATE APPRECIATION OF YUAN
*WELCOMES CHINA’S DECISION TO INCREASE YUAN FELXIBILITY
*SAYS WORLD ECONOMY FACING ‘DIFFICULT PERIOD’

Full G7 Statement:Statement of G-7 Finance Ministers and Central Bank Governors

Washington, DC – We met today amid ongoing challenges to the world economy and international financial system.

The global economy continues to face a difficult period. We remain positive about the long-term resilience of our economies, but near-term global economic prospects have weakened. While economic conditions differ in our countries, downside risks to the outlook persist in view of the ongoing weakness in U.S. residential housing markets, stressed global financial market conditions, the international impact of high oil and commodity prices, and consequent inflation pressures. The performance of emerging markets has been a bright spot, but these countries as well are not immune from global forces.

The turmoil in global financial markets remains challenging and more protracted than we had anticipated. In the context of a weaker economic outlook, financial markets confront the interrelated issues of: re-pricing of risk and significant de-leveraging; managing counterparty risks; accommodating balance sheet adjustments; raising capital; improving the liquidity and functioning of key markets. We welcome efforts by many financial institutions to improve disclosure of exposures to structured products and related risks, and raise significant new capital.

We reaffirmed our strong commitment to continue working closely together to restore sustained growth, maintain price stability, and ensure the smooth and orderly functioning of our financial systems. We welcome the coordination by major central banks to address liquidity pressures in funding markets and recognize the importance of their coordinated actions to address disruptions in global financial markets. In particular, the recent steps taken by some central banks to expand access to central bank lending facilities and expand the range of collateral that they will accept is providing liquidity to financial institutions and helping to support improved market functioning. In addition, we welcome other measures that have been taken including monetary and fiscal policy that aim to give support to underlying economic activity and ensure price stability. Each of us remains committed to taking action, individually and collectively as appropriate, consistent with our respective domestic circumstances.

We reaffirm our shared interest in a strong and stable international financial system. Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability. We continue to monitor exchange markets closely, and cooperate as appropriate. We welcome China’s decision to increase the flexibility of its currency, but in view of its rising current account surplus and domestic inflation, we encourage accelerated appreciation of its effective exchange rate.

Last fall we tasked the Financial Stability Forum (FSF) for a report identifying the underlying causes and weaknesses in the international financial system that contributed to the financial market turmoil. We thank Mario Draghi, the chairman of the Financial Stability Forum, and FSF members, for the report that sets out detailed recommendations to enhance market and institutional resilience. We, the G-7, strongly endorse the report and commit to implementing its recommendations. Rapid implementation of the FSF report will not only enhance the resilience of the global financial system for the longer term but should help to support confidence and improve the functioning of the markets.

The FSF report presents a specific and substantive set of recommendations across five major areas. We have identified the following recommendations among the immediate priorities for implementation within the next 100 days:

* Firms should fully and promptly disclose their risk exposures, write–downs, and fair value estimates for complex and illiquid instruments. We strongly encourage financial institutions to make robust risk disclosures in their upcoming mid-year reporting consistent with leading disclosure practices as set out in the FSF’s report.
* The International Accounting Standards Board (IASB) and other relevant standard setters should initiate urgent action to improve the accounting and disclosure standards for off-balance sheet entities and enhance its guidance on fair value accounting, particularly on valuing financial instruments in periods of stress.
* Firms should strengthen their risk management practices, supported by supervisors’ oversight, including rigorous stress testing. Firms also should strengthen their capital positions as needed.
* By July 2008, the Basel Committee should issue revised liquidity risk management guidelines and IOSCO should revise its code of conduct fundamentals for credit rating agencies.

We endorse the following FSF proposals for implementation by end-2008:

* Strengthening prudential oversight of capital, liquidity, and risk management: The Basel II capital framework needs timely implementation. The Basel Committee should raise capital requirements for complex structured credit instruments and off-balance sheet vehicles, require additional stress testing, and enhance their monitoring.
* Enhancing transparency and valuation: The Basel Committee should issue further guidance to enhance the supervisory assessment of banks’ valuation processes to strengthen disclosures for off-balance sheet entities, securitization exposures, and liquidity commitments.
* Changing the role and uses of credit ratings: Investors need to improve their due diligence in the use of ratings. Credit rating agencies should take effective action (consistent with IOSCO’s revised code of conduct) to address the potential for conflicts of interest in their activities, clearly differentiate the ratings for structured products, improve their disclosure of rating methodologies, and assess the quality of information provided by originators, arrangers, and issuers of structured products.
* Strengthening the authorities’ responsiveness to risk: Supervisors and central banks should further strengthen cooperation and exchange of information, including the assessment of financial stability risks. It is important that an “international college of supervisors” be established for each of the largest global financial institutions. Market authorities also should act cooperatively and swiftly to investigate and penalize fraud, market abuse, and manipulation.
* Implementing robust arrangements for dealing with stress in the financial system: Central banks should be able to supply liquidity effectively during financial system stress, and authorities should review and where necessary strengthen their arrangements for dealing with weak and failing banks, domestically and cross-border.

We ask the FSF and its working group to monitor actively the implementation of the report’s recommendations. It is important that member bodies of the FSF, including the Basel Committee, IOSCO, the IASB, and the Joint Forum, accelerate their timetables of work to conclude their efforts by end-2008 and that the recommendations of the FSF be fully and effectively implemented. We look forward to an update at the Osaka meeting in June and a comprehensive follow-up report by the FSF at our meeting in the fall. We welcome the strengthened cooperation between the FSF and IMF, which should enhance the early warning capabilities of key risks to financial stability.

We also welcome efforts by private-sector participants to develop proposals to contribute to a better functioning of the financial system.

The current financial market turmoil also has raised broad policy issues about the appropriate regulatory frameworks of our financial sectors. We have reaffirmed the importance of reviewing regulatory frameworks to consider whether changes are necessary to ensure that our financial systems are as efficient and stable as possible in the future.

We reaffirm the important role for the IMF in securing global financial stability. In this light we endorse the significant progress on IMF reform:

* We welcome the agreement on quota and voice reform in the IMF as an important step to recognize the greater global weight of dynamic economies, many of which are emerging markets, and increasing the voice of low income countries.
* We reiterate the importance we place on the IMF’s new framework for surveillance, including for exchange rates, and urge its firm and even-handed implementation.
* We welcome progress toward putting the IMF’s finances on a more sustainable footing, including a $100 million annual reduction in administrative expenses. Ongoing budget discipline will be required. We support new sources of income, including an endowment financed by a limited sale of IMF gold.

Taken together, these important reforms will boost the IMF’s legitimacy, effectiveness, and credibility.

Upholding open trade and investment regimes is critical to realizing global prosperity and fighting protectionism. We highlight the urgent need for a successful conclusion to the Doha Development Round. We also commend the OECD work on open investment and the IMF’s commitment to deliver a set of best practices for Sovereign Wealth Funds by the IMF Annual Meetings in October. The policy principles put forward by Abu Dhabi, Singapore, and the United States should be helpful inputs into these processes.

By Kathy Lien, Chief Strategist of DailyFX.com