Good Afternoon,

Change is the only constant

 

Heraclitus, the ancient Greek philosopher was first accredited with the idea that change was central to the universe and attributed with the quote that “nothing endures but change”.

 

This couldn’t be truer of last week, as the Dollar took much of the limelight following debate about its status as the main reserve currency, while the US treasury announced an ambitious new plan to combat the crisis.

 

Early in the week the dollar was under pressure after Chinese authorities, worried that the Feds expansive monetary policy will devalue much of their investments in the US, called for an alternative to the US Dollar as the reserve currency. Governor of the Peoples Bank of China, Zhou Xiaochuan, suggested that having the international finance system based on a single currency has major flaws. He argued that it creates global imbalances, as countries with surpluses are left with little choice but to buy dollars, and there is also conflict of interest for the Fed, which must balance domestic and international interests when assessing monetary and fiscal policy. SDR (special drawing rights), a synthetic currency created by the IMF, was proposed as a realistic alternative to having the dollar as the default reserve currency. In response, Tim ‘loose talk’ Geithner initially stumbled, revealing that the US is “quite open” to the proposals, although later in the week reneging somewhat, stating that he thought the greenback should remain the dominant reserve currency. This gave further confidence to the status of the dollar, and saw it finish the week strongly against sterling and the euro. Perhaps change is constant, but the US dollar looks set to survive as the reserve currency for the meanwhile at least.

 

The currency debate was not the only major piece of news from the US, as Mondays announcement by the US Treasury that it would be using $1,000bn of taxpayers’ funds to remove toxic assets from banks balance sheets saw equity markets buoyed for most of the week.

 

While the plan was overwhelmingly given the thumbs up by the equity markets sending the dollar north, it did draw criticism from some, including Nobel prize winning economist Paul Krugman who labelled it “an awful mess”. The plan essentially is to create funds in which the private sector will put in a small amount of money, and in return receive large loans from the taxpayer (with an option to walkway from the deal if it loses money). With the taxpayer taking the risk, it looks like a sweet little money spinner for some private investors, however, the real difficulty may be getting banks to sell their illiquid assets at prices below where they are currently marked on their balance sheets. This would reduce their precious capital ratios, while the other alternative for the banks is to soften the blow by realising the write downs over many years, and this may be the more attractive option.

 

Commodity currencies also enjoyed a week of gains, as improved risk appetite paved the way for some buying, particularly of AUD and NZD. The Norwegian Krone reversed its strengthening trend, after the Central Bank cut interest rates, with the following comments from the Norges Bank governor Svein Gjedrem suggesting that there may be some intervention if the currency appreciated beyond fundamentals.

 

This week is stuffed full of event risk, with the ECB’s rate decision on Thursday being the pinnacle. Any hints of the ECB engaging in QE should see the Euro weaken. Nonfarm payrolls from the US are expected to show the unemployment rate at its highest level for over 25 years. The G20 meeting starts on Thursday and the outcome is bound to announce some surprises, or at least provide some entertainment for those of us in London.

 

Trade of the week

Once again the Target Accumulator Redemption Note (TARN) is an attractive option for a seller of GBP and a buyer of EUR over a 12 month period.

 

The client is given a strike rate of 1.12 with 20 big figures (euro cents) to use over the 12 months. The strike rate a TARN provides is significantly better than the current spot and forward rate of 1.075. The client is obligated to sell £100,000 at expiry per month for 12 months at the strike rate of 1.120 until either the benefit of the 20 big figures has been used, or until the end of the 12 months. E.g. if spot at expiry is 1.10 for the first month they will sell at 1.12, and have used 2 cents of the total benefit of the 20 cents (leaving 18 cents of benefit to be used over the remaining 11 months). However, if spot at expiry is above the strike rate, the client is obligated to buy at the strike rate. Once the 20 cents are exhausted, the TARN ceases to exist.

 

Please note that this cannot be considered a hedge as it doesn’t carry a worst case rate. This product is suitable for clients currently un-hedged due to the low value of sterling. Like all of our option structures, this is also available in other major currency pairings. For full details of this structure please contact one of our options traders on 0207 801 9050.

 

Enjoy the week

 

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Please feel free to contact me (rick.roache@worldfirst.com) if you have any questions or thoughts regarding these updates or if you are interested in a particular event in the calendar. If you would like to discuss your foreign exchange requirements, please contact our:

Corporate Foreign Exchange Team on 020 7801 9050 or our Private Client Currency Exchange Team on 020 7801 9080.

 

To view any past or present currency blogs please click on the following link www.worldfirst.com/blog

 

Disclaimer: The above comments are only our views and should not be construed as advice. You should act using your own information and judgement. Although information has been obtained from and is based upon multiple sources the author believes to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute the author’s own judgement as of the date of the briefing and are subject to change without notice.

Any rates given are “interbank” i.e. for amounts of £5million and thus are not indicative of rates offered by World First for smaller amounts. E&OE. Definitions of jargon/market terms can be found in our Glossary of Foreign Exchange Terms.

 

This financial promotion is issued in the United Kingdom by World First Markets Limited which is authorised and regulated by the Financial Services Authority (“FSA”) to provide advice on and execute trades in derivatives.  Please note that other activities that may be referred to in this material, such as the execution of spot foreign exchange trades, do not fall under the remit of the FSA.  World First Markets Limited’s FSA Firm Reference Number is 477561.

Investing in any of the hedging strategies contained in this material involves certain risks, for example that the exchange rate at expiry of the contract is less favourable than if you had entered into a forward contract.  Please ensure that you fully understand these risks before investing.  If you are in any doubt as to the nature of these risks, please speak with your financial adviser or an adviser at World First Markets Limited.

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