Global FX

• Currencies are being driven by risk appetite. Better economic reports from Europe, Asia and the US raised hope that the deepest economic slump in decades might be stabilizing. Investors were also relieved that results of the stress tests on US banks contained no surprises and became more willing to take on riskier assets. None of the 19 banks examined faces insolvency; but 10, including Bank of America, Wells Fargo, Citigroup, etc., need to raise capital by a total of USD74.6 billion. These 10 banks will have until June 8 to develop a plan to raise the required capital and until November 9 to implement it.
  
  
• With risk appetite returning, global stocks surged to multi-month highs. In fact, many major stock indices, including the Nasdaq, FTSE 100, and Hang Seng Index, are higher than their start of the year levels. The higher yielding currencies, considered to be riskier, also returned to favour. The Australian dollar gained about 8.6% against the dollar and nearly 19% versus the Japanese yen since the start of the year. The New Zealand dollar, the British pound and the Canadian dollar also strengthened versus the greenback by a margin of 4% to 6% during the same period. In contrast, the Japanese yen was the worst performer. It has lost about 8.6% against the dollar as flight to safety demand waned.
  
  
• Looking ahead, trading is likely to be dictated by risk sentiment in the near term. As more less-negative economic data could be released, the dollar could come under more selling pressure. Technical traders also say that the greenback could head lower as the dollar index, measuring the value of the greenback against a basket of major currencies, has recently dropped below its 200-day moving average for the first time since August 2008.

Interest Rates

With interest rates in major economies approaching zero, the race to zero is almost over, and central banks are now increasingly resorting to non-conventional monetary policy tools in an attempt to revive the growth engine.

Even the European Central Bank decided to undertake a limited scale of bond purchase. The Bank announced after its policy meeting on May 7 that it would cut its benchmark interest rate by a quarter point to a record low of 1% and buy EUR60 billion of covered bonds. While the size of the bond purchase was smaller than the asset purchase plans previously announced by the US Fed and the Bank of England, it represented a shift in the ECB’s monetary policy stance. It was the bank’s first purchase of bonds and could be taken as the first step on a path of quantitative easing.

Meanwhile, the Bank of England kept its key rate unchanged at 0.5% at its May 7 meeting but decided to expand its programme of asset purchases from an initial GBP75 billion to GBP125 billion as the initial impact of its easing moves seemed to be fading. Government bond yields in both the US and UK have rebounded from their low levels in recent weeks as investors became increasingly concerned that central banks’ quantitative easing programmes would ultimately spark inflation.

The Fed also decided at its latest policy meeting to keep the fed funds target rate at a range of zero to 0.25% for the third straight meeting and repeated its intention to keep the target rate low for an extended period. However, it refrained from increasing the purchases of Treasuries and mortgage securities for now. While Fed officials said that the pace of contraction in the US economy seemed to be slowing, they did not expect a strong recovery anytime soon.

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