7.1 Risk aversion still reigns in the face of US rescue and stimulus packages

Pessimism stalks the markets as flight from riskier assets saw the dollar and the yen gain against most of the other majors.

European markets opened with optimism as traders anticipated the Obama administration’s new financial rescue package and the passing of its fiscal stimulus plans, both due this week. EUR/USD followed this optimism up and the euro tested 1.3092 Monday mid-afternoon before falling back to 1.30 as the US session drew to a close. The euro came under more pressure early Tuesday on a report that Russian companies were looking to restructure $400B of their outstanding corporate debt. There is a deal of concern about the euro-zone’s vulnerability to problems in emerging Europe, and the subsequent flight from risk saw the euro test support a little below 1.2850. The euro recovered as the European session got underway on Tuesday and rose above 1.30 for the second time this week, until US Treasury Secretary Tim Geithner unveiled the new US financial rescue package to allocate $2000B for cleaning up toxic assets in the financial system and restart credit markets. Geithner’s speech was described as long on rhetoric yet short on details and US markets plunged. The euro followed optimism down to test 1.2850 once more. Wednesday saw high-ranking ECB official, Juergen Stark, noting that the central bank had room to cut interest rates in March to stimulate economic activity if necessary. Meanwhile on the other side of the pond, US lawmakers finally agreed on a compromise stimulus package to pump $789B into the spluttering US economy, meaning that the package could be passed before the end of the week. Thursday saw the euro take a dive against the background of an all-time record drop in euro-zone industrial production. There was more bad news for the euro-economies on Friday, as the zone’s GDP retracted a worse than expected 1.5%. This was the third quarterly contraction in a row, and the biggest fall since the creation of the euro in 1999. Later on Friday, the US fiscal stimulus package was finally passed and all it needs now is for President Obama to sign it on Monday. President Obama also announced that he would unveil plans to save ordinary American homeowners from losing their homes. However, the atmosphere of pessimism remained pervasive as mounting problems in the global financial system seem far from resolution. EUR/USD closed the week a little below 1.29.

Sterling fell against the greenback this week as risk aversion continued to exert downside pressure on the pound. Bank of England Governor Mervyn King said on Wednesday that the UK is in a deep recession and predicted that the economy could shrink by as much as 4% in the summer. Mr. King indicated that interest rates could be cut once again in March, whilst preparing the ground for measures to increase the money supply. UK woes deepened on Friday when the malaise affecting British banks took a turn for the worse on Friday. Lloyds banking group forecast losses of £11B for its subsidiary HBOS. The news precipitated a decline in UK banking stocks and saw the pound fall more than a cent against the US dollar.

Calendar Notes
USA: Banks will be closed in the US on Monday for Presidents Day. Monday should see President Obama signing the stimulus package. We get regional snapshots of US economic activity on Tuesday with Empire State Manufacturing and on Thursday with the Philly Fed Manufacturing Index. Wednesday sees the release of FOMC meetings, always worth reading for hints to future policy. Keep your eyes open on Thursday for the weekly US new unemployment claims. Thursday also sees the Producer Price Index (PPI), while consumer prices (CPI) are surveyed the next day. Key US housing data will be out on Wednesday with Building Permits and Housing Starts.
Euro-zone: Tuesday’s ZEW economic sentiment numbers often move the market. Friday sees a raft of PMI data, giving us some insight into economic activity across the zone.
UK: The Consumer Price Index (CPI) is out on Tuesday and Retail sales are due on Friday. Wednesday’s Monetary Policy Committee meeting minutes will shed light on the voting and discussion behind February 5^th’s 50bps cut. We will also be checking for clues to future policy.

Forecast
EUR/USD: EUR has closed below 1.30 for the third week running with any breaks above that level failing before 1.31. Should the pair see a breakdown of 1.2720, downside pressure could test support at 1.2330.
GBP/USD: Resistance should hold at 1.50. A breakdown of 1.40 could see support next at 1.3550.
USD/JPY: If the pair can break out of 92 then expect resistance at 94. We see support at 90.