The credit crunch turned another corner last week, sweeping up Central and Eastern European countries, as fears were raised about the ability of some states to finance their current account deficits. Credit has dried up in the region that is heavily reliant on capital inflows from the West and economic conditions continue to deteriorate. Many of the Eastern European countries are heavily export reliant economies struggling to cope with slackening world demand and the bubble bursting in commodity and property markets. Major cracks started to appear late last year, and in October 2008 Hungary and Ukraine were the recipients of an IMF bailout.

Last week saw ratings agency Moody’s warning about possible downgrades for European banks with exposure to the region. This sent to the Euro to three month lows against the dollar and to more comfortable levels against sterling.

European banks have the lion’s share of the exposure to this region, with over 90% of the foreign lending in the region, a total amount of liabilities estimated to be over $1500bn. A large proportion of mortgages in the region are denominated in foreign currencies such as the Swiss franc, and the recent and precipitous depreciation of the home countries’ currencies have meant that those countries consumers are now faced with even larger mortgage repayments. Parent banks with subsidiaries in Europe are also faced with shrinking assets due to the currency depreciation of their subsidiaries which have assets denominated in local currencies.  They must now make a decision on whether to spend their precious capital to shore up subsidiaries balance sheets, or cut and run.

Germany suggested it would defend any member state that could not meet its debt obligations late in the week, causing the Euro to regains some composure. Questions have been raised over the validity of this, as it is currently not possible for EU member countries to bail out other EU contemporaries.

The US had troubles of its own, as worries were raised that it would follow the UK down the path of bank nationalisation. This led equity markets down severely across the board to near the bear market lows seen in November, and saw the dollar to strengthen. Gold also soared to 7 month highs on as investors sought a haven from the turmoil. Strangely the Yen managed to weaken over the week as investors lost confidence in the currency following GDP figures which showed the nation’s economy shrinking at an annualised rate of 12.7%, the worst since rate of contraction since the oil shock of the 70’s.

BoE minutes were released from the last rate decision, the main news being that there was a unanimous decision to initiate quantitative easing. The ‘Banking Act’ also came into effect on the weekend in an attempt to address the issue of confidence in the banking sector. The government can now conduct in private any discussions with lenders that require extra capital, as it aims to stabilise the sector and avoid a repeat of the Northern Rock run on the bank.

Looking ahead for the week, we will be watching closely the development of the US banking sector and the news that the government may be taking a 40% share in Citigroup. A positive reaction to this will increase risk appetite in the market place which in turn will put sterling in a healthy position. Manufacturing data will also be important from the US, as will new and existing home sales. Consumer confidence and spending surveys in the UK are also due, with bleak results anticipated.

Trade of the week

This week’s trade of the week is a Premium Paid Risk Reversal on GBP/EUR. This Premium Paid Risk Reversal gave the client a worst case rate of 1.14 and a best case rate of 1.25 for an upfront premium of 3.5% of the total contract amount. If, on expiry, GBP/EUR is below 1.14 the client will receive 1.14, if it is between 1.14 and 1.25 the client will buy at spot, and if above 1.25 the client has an obligation to buy at this level. For full details of this structure please contact one of our options traders on 0207 801 9050.

Enjoy the week

———————-

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.

There are a number of charges that we will levy if you enter into a hedging strategy.  The nature of these charges depends upon the specific strategy, but may include an up front premium .  We recommend that you read carefully the details of these charges which are set out alongside the description of each strategy.