NEWS/BLOG

Brazil Keeps Booming

While European economies continue to churn and China takes a timeout, Brazil is on fire, boasting the largest growth of any major economy for the first quarter of 2010, a whopping 9%. And while Brazil still has large numbers of its citizens living in poverty, the middle class is growing by leaps and bounds, now representing 49% of the population.

The Brazilian government is involved in the economy either as partial owner of some companies or as a strict regulator. This public/private mix seems to work well.

Brazil is currently undergoing a credit revolution, but since banks here have tight government controls, the boom in credit is unlikely to give way to a bubble/crisis. Brazil’s credit growth and the burgeoning of the middle class mean that certain types of stocks are likely to do well. Some worth watching are:

Ambev (ABV) Brazil’s only bottler of Pepsi (PEP) in Brazil and of beer brands that combined have garnered 70% of the Brazilian market. This stock has Investor’s Business Daily’s highest rating in its category and is currently extended and has a 3.6% yield.

Banco Bradesco (BBD) This bank has underperformed recently but has investments in insurance and in IT.

CPL Energia (CPL) This utilities stock has just pulled back from a new high, is a “group leader” according to Investor’s Business Daily and has a 7% yield.

Gafisa (GFA) The homebuilding company is currently 30% below its 52-day high, but has begun picking up steam and is just above its 50-day moving average. With government support and the demand for more homes, it has potential.

Itau Unibanco Holding (ITUB): A premier Brazilian bank, it is currently 18% below its 52-week high.

Note: This is not a recommendation to buy any of the above investments. Do your own due diligence. 

Rogers Says Euro Won’t Last

Jim Rogers, the financial wizard who culls information by traveling the world on a motorcycle, says that Greece should simply go bankrupt and that Europe will eventually give up the Euro, though not for 15 or 20 years, and the British pound will tank in the next few years. Meanwhile, he’s playing the bounce in the euro.

Rogers sees two minor bubbles at the present, one in Chinese real estate and the other in U.S. treasuries, but he’s not making a prediction on when either will burst. He anticipates the price of gold to reach $2,000 in the next decade, as currencies lose their value. Commodities, including oil, cotton and sugar, he says, will continue going up, not reaching bubble proportions until 2019.

German Mettle?

An update from the currency exchange firm World First.

”People think we are in a mess. We are.” George Papaconstantinou, Greek Finance Minster.

I had the opportunity to sit next to an eminent economist at a reunion dinner on Saturday. The former chief Labor economic adviser now specializes in financial regulation and he certainly had some interesting comments on the current sovereign debt crisis in Greece, what it could mean going forward and why it highlights the problem of trying to use a unified monetary policy to control such disparate economies.

Interestingly, the whole crisis could be averted should Germany come out and publically guarantee the debt.  However, this is a risky strategy even though the Germans hold the largest percentage of Greek debt. The number of countries behind Greece with the potential for similar problems has been well documented and the precedent set could be rather dangerous. The cost of insuring against sovereign default soared in January and the concern that the loss in confidence in sovereign debt, especially US treasures, considered the world’s risk free asset, could have calamitous consequences for the still fragile recovery. Exaggerated fears of sovereign risk could prompt governments into premature fiscal austerity, which could push the world economy back into recession.

In spite of this, the Germans are less than willing to come out and make this statement because, as the premier global manufacturer, they are seeing the euro weaken and with it increasing the competitiveness of their goods in the market. They will have been especially keen to see the large EURUSD move over the past few weeks with many in Germany rubbing their hands with glee.

If you compare the UK to Germany, the argument for a weaker GBP becomes stronger with time and is testament to the ability of the UK to set its own monetary policy. As we have mentioned before, this allows the Central Bank to control the supply of money, availability of money and the interest rate. It has been essential in guiding the country through recession and has enabled a very close degree of control to be exerted over the economy, the lack of which some European countries have deeply missed.

The news that the UK Government still had to borrow in January, when historically incoming tax receipts sure up finances, was a stark reminder of the fragility of the recovery ahead. If the predicted exaggeration of sovereign debt risk is born out it would have catastrophic consequences on the recovery as the Government would be forced into a premature period of austerity. The need to not turn off the taps too soon versus need to sure up the debt position in the country to something resembling sustainable are the two conflicting worries that keep ministers up at night.

The complex relationships between sovereign debt and the foreign exchange market can be seen more now than ever before and with the Germans eager for a weaker euro it would be foolish for Britain to think that a stronger pound would do the economy any favors at the present time. So while both the UK and Europe would like to see a stronger pound, it might be to the detriment of the recovery. You can’t always get what you want, but if you try sometimes, well you might find you’ll get what you need.

Trade of the Week

This week’s trade of the week is a Tarn Convertible. This structure combines the ability to buy above the current market price with the ability to gain should the market move in the client’s favor.

The way a TARN works is the client has a strike rate above the current market, in this example at 1.61 on GBP/USD, and a “bucket” of figures to use, let’s say 17. If the market is trading at 1.52 then the client will get 1.61 and have to spend 9 figures from their bucket. The next month they have 8 figures to spend and this continues until the bucket reaches zero or the term of the structure comes to an end.

If the market is trading above 1.61 then the client is able to benefit up to a level of 1.66 without using any of their remaining figures in the bucket. If on the day of expiry the market is trading above 1.66, the client is obliged to buy his dollars at the strike rate of 1.61.

This trade works for both buyers and sellers of sterling and is available against other currencies (euro, yen, Aussie, Kiwi).

For more information, see World First.

See Disclaimer below.

GREECE HAD HELP FROM GOLDMAN SACHS

The debt crisis has more in common with the credit crisis in the U.S. than one might think. According to a New York Times story, February 13, Greece has sought and found help in the form of innovative financial products from none other than Goldman Sachs.

Greece needed money but its politicians, like politicians everywhere, did not want to be seen as incurring debt. Almost no rules exist as to how countries may find the money to meet their needs.

The bankers invented new financial instruments and gave them names from Greek antiquity. Aeolos, a legal entity created in 2001, helped Greece reduce the debt on its balance sheet that year. In exchange for ready cash Greece gave away future landing fees at the country’s airports. Ariadne, created in 2000, meant forfeiting the revenue from its national lottery. These appeared on the books as sales rather than loans.

There were more such deals, all effectively mortgaging the future of a country with such a proud past, and threatening European and in fact global economic stability.

The Plot Thickens in Greece

An update from the currency exchange firm World First.

The story in the markets at the moment is Greece. A country that contributes roughly 2% of the EU’s GDP could contribute to the downfall of the biggest single currency experiment since cavemen fashioned tokens from shiny rocks.

But it won’t. The Union must come first. A poll in the German paper Bild am Sonntag showed that the 53% of respondents wanted Greece thrown out of the EU and over 60% were adamant that German money should not be paid to the Greeks in the form of a bailout. Germans obviously have short memories; it was the beggar thy neighbor approach to crisis in 2008 that extended the downturn. A similar lack of foresight would likely see this Hellenic hell spiral down deeper.

Angela Merkel is a canny political operator; you have to be to become the first female Chancellor. The fact is that the German economy is exposed to the PIIGS heavily. German investment in Portuguese, Irish, Italian, Greek and Spanish debt roughly equates to 19% of German GDP ($3.65 trillion in 2008). $693.5bn; so roughly the same size as the Polish economy or half the size of Canadian GDP. Germany simply can’t afford to let Greece or any other EU members go bust. Doing so would leave a hole in their finances so monstrous that the rest of the EU would implode.

There is a split in the ruling coalition with one politician going as far to say “Solving this problem cannot be about aid for Greece. If anything, it’s about keeping any damage away from German taxpayers.”

The outlook for the euro is, as a result, weak. Hedge Funds and the speculative fraternity will look to drive the currency to its knees as rumor and uncertainty continues to swirl. The EU economy was the least well equipped to deal with the problems that the credit crunch and the winds of austerity brought to its shores.

There is a meeting going on between European finance ministers to discuss the Greek problem Change in a normal state normally moves in painfully slow increments. Greece cannot wait forever though; if no bailout is forthcoming by April then the Uk along with its European neighbors, will be entering a chapter of financial history that would truly define downturn.

Disclaimer: The above comments are the views of World First and should not be construed as advice. You should act using your own information and judgment. 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 judgment 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 authorized 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 favorable 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.

For your protection, telephone calls are usually recorded

For more information see World First. 

Trouble Ahead in European Markets

Stock markets across Europe have plunged as much as 6% amid worries that a financial crisis might be just around the corner with the result that the Euro is now at $1.37. a seven-month low against the US dollar. The dollar’s bounce hurt the prices of commodities traded globally in terms of the U.S. currency.

Like the United States, Europe has been suffering from a recession. France and Germany, the largest of the 16 countries using the euro as their currency, have taken important steps toward economic stability. Certain other countries—including Greece, Portugal, Spain and Ireland (all expat havens, by the way)—are having difficulty paying for years of debt-driven expansion. The debts are now coming due and in a worst case scenario, defaults could ensue, with a ripple effect across Europe.

In the credit markets on Thursday, February 4, the cost of insuring the debt of the countries with large budget deficits against default rose. This came on the heels of several items of grim news. One was that the European Commission had put Greece under more pressure to cut its deficit. Another was that the Portuguese government had sold only €300 million ($417 million) of treasury bills at an auction, compared with an offer of €500 million. and finally,that the Spanish government had raised its budget deficit forecasts for 2010 through 2012.

The European Central Bank is leaving the key lending rate for the 16-nation euro zone unchanged at 1%, and the Bank of England is keeping its interest rate 0.5%.for the time being, the Bank of England has halted the central bank’s 200 billion pound ($319 billion) series of bond purchases, opting to weigh the impact of so-called quantitative easing on the British economy.

The Chicago Board Options Exchange’s Volatility Index or the VIX, which measures investors’ nervousness about upcoming market swings, soared 20.9% on Thursday. The index is trackable (and tradeable) as VXX.

The Dollar Next Year: Two Angles

An update from World First.

As we move into December it is necessary to bring you our thoughts as to movements of certain currencies in the coming year. We will aim to bring you views from both sides of the argument i.e. an argument for strengthening and an argument for a certain currency’s decline. In the first of this series we will look at the prospects of the most important global currency, the US dollar.

The case for the prosecution: a weaker greenback

The US is in a terrible state at the moment with a budget deficit as a percentage of GDP larger than anything since the end of WW2, while the money that it owes in the form of US treasury debt has almost tripled in the past year and is expected to expand by around $1trn a year for the next 15 years or so. This coupled with the expansion of spending needed to fund Obama’s healthcare plan, the ‘War on Terror’ and social security for baby boomers leads us to believe that they have two options; print more debt or hike taxes and slash spending.

As a fan, interested observer of American politics and a firm believer in Josiah Bartlet I think we can safely forget the last. Obama is not going to raise taxes on “middle America” this close to the mid-term elections and would not afterward for fear of giving the Republicans the White House back after his first term. Likewise he cannot cut spending at the fear of alienating moderate democrats and liberal Republicans when he needs to so much support on ramming through his healthcare plan Superman is in trouble and will have to do what all have done before him; spend like a drunken sailor.

This will continue in 2010 and therefore we are likely to see interest rates in the US continue to remain low for a very long time.  This should lead to a weaker dollar as other countries raise rates and attract inward investment on their debt. The US is now likely to move into a time in which it is comparatively a lot poorer than it has been in the past 100 years and could see its position as the global reserve currency threatened further.

The case for the defense: a stronger dollar

Those of my profession who are looking for a stronger USD over the next year or so are focusing on the first quarter of 2010 as the time in which the starting pistol will be fired. Quantitative easing should end in the US by March. QE has had a negative effect on long-term interest rate expectations and the belief is that as soon as the Fed stop their repurchase program we will see the market price in interest rate hikes towards the latter part of 2010.

Higher US rates may serve to weaken the prospects of emerging market investments (why take the risk when the return is comparable?) and benefit from its status as a haven currency Positive correlations to this probability have been seen over the past 10-15 years.

The other thing to bear in mind is the price of this debt in yield terms. The US are due to auction off close to $2.5trn over the course of 2010 with the Fed hardly absorbing any. This leaves other investors to pick up the slack. The Fed will not risk these issuances being undersubscribed and will post attractive interest rate coupons to the debt to attract the cash. That increase in interest rate should see a surge in dollar buying and a stronger dollar as a result.

Looking at the option market we have seen an increase in the cost of protecting against dollar strength, a sign of a market preparing for an onslaught. The price has risen so much that it we are not far from the price levels that were seen in the immediate aftermath of the Lehman bankruptcy for a three month horizon. It seems that the market is sensing a strong movement in favor of the US dollar around the end of Q1; an expectation that fits in with the possible Fed curtailing.

Conclusion: We believe that 2009 has been difficult to predict, however, it may be nothing compared to 2010 for the dollar market. With cues from the options market in particular we think a hedge via an options contract is the only sensible protection measure that can be taken. We are of the opinion that dollar will weaken in 2010 as the world continues to recover and the need for haven assets lessens but would still advise a protective hedge, an example of which is below.

Next week we will turn our thoughts on the euro.

Trade of the Week

This week’s trade of the week is a risk reversal from January to June. The client sells GBP and buys USD to pay suppliers in Taiwan. They had budgeted on the next six months of invoices at a GBPUSD rate of 1.62 on our advice, but were unwilling to use forward contracts to protect themselves as they believed that the pound would rise at some point against the dollar.

The client was able to achieve a worst case rate of 1.62on their option and they benefit up to a rate of 1.80. Should the GBPUSD rate be below 1.62 on expiry they are able to buy dollars at 1.62, if it is above 1.62 and below 1.80 they buy in the spot market and if it is above 1.80 they are obligated to buy at 1.80.

This strategy required a premium of 2.7% of the notional amount (the amount hedged), and is also relevant for sellers of sterling and buyers of other currencies. As there is a potential further weakening for sterling in the future, it provides a balanced upside for this potential, while guaranteeing a tight worst case rate.

For more information, see www.WorldFirst.com.

See Disclaimer below.

China Dominates the Thanksgiving Table

An Update from World First.

The Pilgrims made seven times more graves than huts. No Americans have been more impoverished than these who, nevertheless, set aside a day of thanksgiving. ~H.U. Westermayer

American families will gather at this Thursday to celebrate Thanksgiving. It’s a time for family, a time of reflection and obviously, a time for giving thanks. The American family have not had much to celebrate over the past 12 months with consumer spending still depressed, house prices continuing to languish near the depths and a whopping health care bill still inching its way through the US Congress.

There is a division in Washington at the moment between the government’s currency talk and the government’s currency walk. The US government and Americans in general like to get behind a rallying symbol; baseball, apple pie, the star spangled banner but recently they had been beating the “strong dollar” drum.

Americans love a strong dollar. It’s a gesture of strength. The division is this: the dollar must stay strong to prevent foreign governments selling the debt that it has been chucking out for years and years. At the last calculation we believe that around 34% of US debt is held by foreign governments with the majority of that being held by the Chinese and Japanese. A significant weakening of the US dollar would see the value of these assets shrink and puts selling pressure on the debt. However a weak dollar would also cut the economy’s reliance on imports, stimulate the export market and, in a country with 10% unemployment, create valuable jobs. Ceteris paribus, you would then see consumer confidence pick up alongside consumer spending and a general improvement in the US economy.

We are still happy with our predictions that we will see dollar weakness over the course of 2009. We may not see the rate of decline that we have seen this year; dollar has weakened by 14% against sterling this year. A similar move from current levels would see GBP/USD at 1.89 in 12 months time but we doubt that the market would allow sterling to appreciate that much through a year that includes a general election.

Obama and Geithner, like Bush and Paulson before them, have a delicate balancing act to consider. It is certainly my opinion that we will not see a revaluation of the Chinese Yuan against the US dollar soon; there is very little incentive for the Chinese government to change the current dynamic.

The Americans will have to obey the golden rule: he who owns the gold, rules.

All this and more is available at www.worldfirst.com/blog.

Trade of the Week

This week’s trade is a risk reversal from January to June. The client sells GBP and buys EUR to pay suppliers in Germany. They had budgeted on the next six months of invoices at a GBPEUR rate of 1.09 on our advice, but were unwilling to use forward contracts to protect themselves as they believed that the pound would rise at some point against the euro.

The client was able to achieve a worst case rate of 1.09 on their option and they benefit up to a rate of 1.18. Should the GBPEUR rate be below 1.09 on expiry they are able to buy euros at 1.09, if it is above 1.09 and below 1.18 they buy in the spot market and if it is above 1.18 they are obligated to buy at 1.18.

This strategy required a premium of 1.4% of the notional amount (the amount hedged), and is also relevant for buyers of sterling and sellers of other currencies. As there is a potential further weakening for sterling in the future, it provides a balanced upside for this potential, while guaranteeing a tight worst case rate.

For more information, see www.WorldFirst.com. 

Weekend Update

Special Update from World First.

There is nothing worse than speaking to a depressive on Friday afternoon. Like a friend who texts on a Friday night “Only 2 days ‘til Monday!” some things we are happy to pretend to not have seen. The 500lb elephant in the room keeps trumpeting away, however, so let’s address him. We have started to see more and more analysts and commentators pointing towards a fall off in fortunes over the Christmas period; potholes and sleeping policeman in the road to recovery if you will.

These analysts expect to see such things in the coming months:

· Equity markets to begin to fall off heavily

· Dollar strength as risk averse investors jump back into US treasury bonds and bills

· GBP weakness as banks come back under pressure from balance sheet issues.

These are not the thoughts of some crackpot holed up in their bedroom and the justifications are listed below:

· US mortgage defaults have risen to a new record high. Now over 14% of all mortgages in the US are either already in foreclosure or at least one monthly payment behind.

· The number of positions betting on US dollar strength are at the highest level since this time last year.

. US consumer confidence and spending levels are still depressed with the only industries benefiting are artificially strong due to government stimulus (Cash for Clunkers, for example)

We are still very happy with a strong sterling outlook over the balance of next year but the lessons of last winter may need to be revisited. Personally I think you could do a lot worse than hedge around these levels.

For more information, see www.worldfirst.com.

Currencies in the News

An update from the currency exchange firm World First.

We had several pieces of big news last week, the headline grabbers were US unemployment jumping to 10.2%, BoE Quarterly Inflation Report and the news our friends spending the single currency had exited the recession.

The week began with concerns over the recovery in the US with unemployment posting higher than expected.  This added fuel to the argument regarding the greenback’s status as the global reserve currency and is a debate that refuses to go away. We have had further mutterings from Singaporean APEC conference that the Chinese Yuan may have to be revalued to increase its competitiveness.  It seems that the Yuan is certainly the main contender to dethrone the dollar but until the Chinese entertain floating their currency it seems the argument may be redundant.

In the wake of the poor US data we had the news that Europe had emerged from recession.  It must be said that the emergence was met with little fanfare due to a slightly disappointing GDP figure out at 0.4% against an expected 0.5%.  This happened on Friday and had little effect on GBPEUR, also leaving EURUSD flirting just below 1.50.

The news from Brussels was punctuated the day before by the BoE quarterly inflation report.  The market was looking to comments made by Merv the Swerve to place a firm hand on the tiller of the UK fiscal policy and outline a clear path forward.  In typical fashion, King’s mantra was that the Bank had decided to inject a further £25bn (bringing the total to £200bn) at the last BoE meeting, and the committee would continue to assess the situation and do what was required.  He did state that he felt that measures implemented by the Bank had worked well so far.  King was very cautious but when drawn to comment on the warnings made by Fitch that the AAA UK credit rating was “the most at risk.” He did state that although he would leave the decisions to the Credit rating agencies, he saw no reason for the UK’s rating to come under threat.  He also noted that a period of austerity was clearly required, and simply said that the pre-budget report alluded to a state of saving once the economy returned to growth.

He finally allayed many fears regarding the surprise UK GDP figure for Q3.  Governor King said that all projections are just that and stressed that the important thing was that the figure was progressing along the predicted trend.

The big news of the week will again come from the Bank with the release of the BoE minutes at 9.30 on Wednesday.  As ever, we will be looking to see if the minutes set a definitive tone for the direction of QE and the voting split may provide an insight. With the Bank notoriously tight lipped this will be particularly interesting.

Trade of the week

This week’s trade of the week is a Convertible Forward until May. For a GBP seller and a buyer of USD, this client took advantage of the uncertainty in GBPUSD in order to protect themselves against falls while being able to benefit should the market turn higher.

The client was able to achieve a worst case rate of 1.6550 on their option which allows them to benefit all the way up to a rate of 1.80. Should the rate touch 1.80 during the barrier period (one month before the expiry date) then the structure reverts to a forward at 1.6550.

This strategy requires no premium, and is also relevant for buyers of sterling and sellers of other currencies. As there is a potential further weakening for sterling in the future, it provides a balanced upside for this potential, while guaranteeing a tight WCR.

For more information, see www.worldfirst.com.

See disclaimer below.

Indecision is Final

An update from the currency exchange firm World First

The schizophrenic nature of markets was again illustrated by sterling’s contrasting performance from the beginning to end of the week. The hangover from last Friday’s shock negative GDP sent the pound into a nosedive against both euro and dollar.  This was in spite of talk that the dollar was under the cosh. The Euro, as ever, maintained its position as the pick of the trio and even touched 1.5050 against the dollar. Its position was helped by comments from Chinese officials indicating diversification away from the dollar across to the euro as the global reserve currency.

The USD benefited early on in the week when a downgrade of several US banks saw risk back on and furthermore, served as a reminder of just how volatile the currents that run beneath FX markets still are.  USD data has generally surprised to the downside during the crisis.  As with US GDP and several other key indicators this trend seems to be reversing.  This causes any more negative releases to invoke the same risk aversion trading that we experienced during the beginning of the meltdown after Lehman’s failure. The more positive USD surprises will encourage risk and assuage concerns regarding the recovery.  Consequently, we can expect a weaker USD long term.

GBP movement north against the EUR was due to the concerns regarding European competition rules on the subject of banking regulation, a similar weakening of European banking stock on the equity markets was also observed.  The pound kept pace with the greenback as the end of the week saw US data increase risk appetite.

The following week sees the busiest calendar in the FX markets for some time and subsequently a plethora of event risk. We have the FOMC meeting on Wednesday, expecting they maintain their rhetoric regarding the need for economic conditions"‘to warrant exceptionally low levels of federal funds rate for an extended period.” This will be positive for risk and USD negative.

We then follow the next day with both BoE and ECB meetings.  We can expect the ECB to hold rates steady but with Norway the first euro zone country to raise interest rates we cannot expect the single currency to be light years away from it and given the ‘hawkish’ nature of Trichet et al. hints may be given in the post-decision press conference.

Having seen the US approach to the crisis bearing fruits it highlights the market difference in approach.  The most important sentiments we hope to hear from the BoE are that of decisive and precise action; a categorical statement that either QE is finished or an exact final amount that will be allocated would bode well for the pound in the future.  With inflation figures in the UK still very low, GDP still negative, a country in recession and the previous form of the 9 voting members it seems odds on, around 70/30, for more stimulus.  However, it is impossible to predict the future so we shall just have to wait and see.

The week is not finished though; we round off with US non-farm payrolls.  As you can see the event risks are monumental so strap on your seat belts because this week is about as exciting as FX markets get.

For more information, see www.worldfirst.com.

See disclaimer below

One Year after the Lehman Collapse

An update from the currency exchange firm World First

Because of the shortened trading week, this update will offer a retrospective of the previous year. It was 12 months ago that Lehman Brothers collapsed, and the subsequent fall out caused by years of malaise within the banking system is still being felt today.

Links to the subprime mortgage market lead to the onset of the rot in 2007 when it became obvious that defaults on loans would be larger than expected. This led banks to reassess their balance sheets in an attempt to ascertain their exposure to this toxic market.  t was only at this stage that the inextricable complexity of the ownership of this debt became apparent. The debt had been packaged up into complex financial instruments that had become freely traded between banks, repackaged and traded again. Increasing default on subprime loans caused a landslide of escalating losses throughout the banking sector. Unsurprisingly, with hindsight, Lehman Brothers’ exposure to this market ended up being fatal. On 15th September 2008, Lehman Brothers one of the world’s oldest and most successful investment banks filed for Chapter 11 Bankruptcy.

Although the subprime mortgage is the most high profile factor leading to the credit crunch it is important to at least consider some of the other contributory factors that lead to a reduction in availability of credit. This then feeds forward into the consequences we have been experiencing in the currency markets.

It is undeniable that financial deregulation had its part to play in the crisis. However, the political and social debates this question raised are beyond the scope of our update. Certainly the two factors that contributed to harsher lending conditions and also caused aftershocks in the currency market are the over-leveraging and the subsequent commodity boom.  Example of the consequences of over-leveraging are Fannie Mac and Freddie May in the US and Northern Rock in the UK. The commodity price bubble saw the price of Oil rise from $50 a barrel in 2007 to $150 a barrel at the end of 2008.

The most arresting effect on currency markets was unprecedented price volatility.  Sterling for example lost approximately 18% of its value against the euro in the preceding four months.  It saw sterling approach parity with the Euro around Christmas 2008. We also saw sterling collapse against the USD by approximately 25% in a similar time frame. The cause for sterling weakness was due to its reliance on the financial sector and the importance to the strength of UK GDP. Also, once the lender of last resort, the UK taxpayer, had been called in and Government firmly involved in the UK private financial sector, all bets were off on the scale of the damage caused to our nation. USD strength was another issue as the ‘flight to quality’ cause USD to strengthen beyond all reckoning as global investors sought a safe haven for their funds.

Commodity currency prices fluctuated wildly as traders unwound their positions. This initially saw a rapid and unsustainable depreciation in the value of these crosses. However, as the Chinese economy spluttered back into life their value slowly came back.

At the one year anniversary of this financial “perfect storm” of the new millennium markets are begging for stability and starting to contemplate moving in a much more comprehensible manner. We have seen this with the USD in particular. The dissolution of the relationships between risk appetite response to positive USD fundamentals and risk aversion to negative USD fundamentals is a positive sign. With markets responding to fundamental data more succinctly we believe this will in turn lead to more stable currency markets although volatility will continue linger.

If we compare the range of GBPEUR trading in the first 4 months of the crisis to the last 4 there has been a marked calm. A return to narrower trading bands and trading on fundamentals will signal the return to stability and emergence from crisis. However, as we always forewarn, we are not out of the woods yet. If proof were needed we need look no further than to the previous month of GBP trading in which the market has reacted to negative sterling news and not traded on positive UK data.

This week we see the first meeting of the BoE since the bombshell of quantitative easing policy expansion. With the minutes of August’s meeting revealing that 3 members, including Governor King, voted to increase the policy beyond the extra £25Bn agreed we should certainly not take anything for granted.  Again, all eyes will be on Threadneedle St. on Thursday. While the storm has certainly abated, don’t expect calm seas to prevail for sometime yet.

For more information, see www.worldfirst.com.

See disclaimer below. 

Chinese Markets Cooling Off

While U.S. markets continued their rally through August, Chinese markets began plunging and on Monday, August 31, the Shanghai composite index sank 6.7%.

Volatility in Chinese stocks may be the result of the Chinese government easing its free flowing fiscal stimulus. Beijing has fought recession by pumping unprecedented sums through state banks as part of a $586 billion package. It has been highly effective, resulting in growth of 7.9% during the second quarter.

Lou Jiwei, head of China Investment Corporation, the government’s investment fund, stated last weekend that both China and the U.S. were “creating more bubbles” in their attempts to fix the global crisis. 

Bank of England Bombshell Rocks the Pound

An update from the currency exchange firm World First

The week started very well for sterling as the carryover from last week’s optimistic US GDP data, and the previous Friday’s large levels of institutional fixing set a platform that launched sterling into its highest levels of the year.  Global equities rallied, with the S&P hitting 1000 for the first time since September, and FTSE at its highest levels of 2009.  ‘Risk on’ was the cry, and sterling benefited early week, breaking into the 1.70’s for a period.  Moreover, UK Manufacturing PMI data printed at 50.8 for July, finally indicating an expansion within the sector.

Reporting season is upon us, and HSBC and Barclays began the week with exceptional figures that stoked the fires of the bull market both for UK banking equities and currency markets.  Lloyds’ figures could not have been more contrasting, and although Lloyds’ shares rose, it was a stark reminder as to the extent of the malaise in UK banking sector.  For completeness, I should mention Northern Rock results were as diabolical as expected.

The release of pleasing UK services figures on Thursday (53.4 vs. 51.8) jumped sterling up almost 1% against both USD and GBP.  But fortunes can turn in the blink of an eye.  The major event risk of the week was the Bank of England meeting, with concerns they may expand the Quantitative Easing policy to the full £150Bn they were initially set aside.  However, Mervyn King et al instead announced it would expand fiscal policy by a further £25Bn, taking the total to £175Bn, sending sterling on an immediate nosedive.  The ECB rate decision followed later, announcing they would hold rates again and not engage in any unconventional policy, highlighting the stark contrast between two Bank’s approaches.

Friday’s Non-Farm payrolls figures again signaled a sea change in the global economy.  Non Farms was expected at -340K, supported by poor ADP rising unemployment rate, yet it reported at -247K.  The USD strengthened on the back of this positive figure, the first time in some while that strong US domestic data supported the greenback.  Sterling ended the week lower at around 1.67 against the dollar, but has continued its almighty tussle with the single currency ending the week grappling in and around 1.17’s.

Events of the week to look ahead for is a flash reading for European GDP on Thursday, and FOMC minutes from the last meeting due on Wednesday. The Bank of England’s inflation report will be delivered at 10.30BST on Wednesday.  This is the major news expected in the week ahead and it will certainly sculpt sterling’s fortunes.  We anticipate Governor King to reiterate the comments made by Sushil Wadhwani, a former MPC member, who recently raised concerns that the UK may follow a similar path as Japan in the 1990’s.  Japan overcame the initial crisis but experienced a protracted 20 year period of stagnation.  King is expected to state that QE was extended in order to prevent the UK falling victim to the same debt deflation trap as Japan.

We anticipate the Bank to concede that the worst of the recession is over but they have been eternally cautious throughout the crisis, and so it is no wonder that potential recovery is being treated as equally serious and concerning as the abrupt decline itself.  Whilst all expect economic indicators to recover in the UK the spectre of Government debt will loom large in the weeks and months to come.  If the budget cannot be reined back in it could become increasing relevant to individuals living in the UK.

This week has taught us just how delicate a balance the Bank of England must strike to get us across the tightrope unscathed. Whilst we are still sterling bullish we reiterate the long stated fact that the frequency of unexpected events remains so high that it is foolish to take anything for granted.

Trade Idea of the Week

This week’s trade idea is a strategy rather than an option, and is called the “‘ratio forward.” It is a synthetic combination of two existing strategies (the participating forward and convertible forward) which are weighted 50% each. For a seller of sterling and a buyer of euro’s, this client took advantage of a strong pound, hedging themselves until the end of the year.

When combined, these strategies mean that the client was able to guarantee a worst case rate (WCR) of 1.61. If spot at expiry had never traded at or above 1.80, the client was able to benefit in 75% of the favorable movement. If 1.80 is ever touched, then half of the exposure is reverted to a forward at 1.61, and you continue to benefit in 25% of any further favorable movement.

This strategy requires no premium, and is relevant for other currency pairs. As there is a potential strengthening for sterling in the future, it provides a balanced upside for this potential, while guaranteeing a tight WCR.

For full details of this structure, please contact one of the WorldFirst options traders on 0207 801 9050.

For more information, see www.worldfirst.com.

See disclaimer below.

Never Fear, Green Shoots Are Here

An update from the currency exchange firm World First

Risky assets rallied last week as hopes of a global recovery surged, and fears of any further financial pandemonium continued to diminish. Currency and equity markets reacted to this sentiment, as risky currencies were rewarded and safe havens sold off. The pound and its risky counterparts the commodity currencies pressed further north, while the dollar, Yen and franc suffered.

What the markets are witnessing is a turnaround in sentiment from the dark days of late last year. Marie Curie once commented “nothing in life is to be feared. It is only to be understood.” As the credit crisis unfolded, Central Banks have acted calmly to understand how this crisis came about, and then move towards addressing the situation. Worldwide, a generally unified approach of slashing interest rates, supporting financial institutions and stimulating the wider economy has seen global markets start along the right path to recovery, causing global fears to wane.

The extent of the reversal can be illustrated by the VIX Index, often referred to as the ‘fear gauge” as it measures how volatile markets have been, and are expected to continue behaving. A high reading indicates pulses are still racing, while a lower reading indicates that markets are less fearful. Last week the VIX broke below a significant level of 24, the first time since the collapse of Lehman Brothers last year that it has done so. When market panic reached a climax last year, the VIX topped at levels 89.50.

The reading is not a cause for optimism itself; it merely illustrates the underlying optimism in the market which last week was pushed ahead by further positive data and earnings reports. Equity markets in the U.S. and Europe reached their highest levels of the year, advancing over 4% for the week. Predictably, the dollar fell across the board, its index falling to the lowest level in 10 months. Its low yielding partner the Yen also suffered somewhat of a selloff, losing over 1% against the pound and euro and over 2% against CAD, AUD and the NZD.

Data out from the UK was mixed over the week, helping to restrain the pounds advance. Bank of England minutes revealed a generally bullish stance for the UK economy, and retails sales figures also surprised on the upside. However, Public borrowing figures highlighted the ongoing worry of the state of the UK public finances, whilst Friday’s advanced GDP result showed the economy continued to contract by 0.8% in the Q2 of the year, far exceeding economists’ forecasts on the downside.

U.S. data revealed a stabilizing unemployment rate and housing market, both major factors in a rebounding American economy. Developments revealing that failing lender CIT would avoid bankruptcy for the moment, and corporate earnings sustaining their positive momentum drove equities higher over the week. Commodities strength in light of market developments has also helped push the dollar down.

This week reveals a drought of tier one data from Europe, with the US providing the Fed’s beige book, initial jobless claims, a PCE reading and finally an advance GDP figure. The strong correlation that equity movements and currency movements have been displaying will mean that stock markets should once again provide the main decider of the pounds fate for the week.

With risky assets rallying worldwide, and fear levels abating it is worth noting the cautious thoughts of respected investor Warren Buffet who famously states to “be fearful when others are greedy and greedy when others are fearful”

Trade of The Week

This trade of the week is relevant to a seller of sterling and a buyer of dollars. This zero premium structure enabled the client to hedge their exposure for a six month period through a ‘window convertible forward’.

The client has a worst case rate (WCR) of 1.61 and can benefit 100% of any and all upside up to a rate of 1.80 during the relevant window period. Should GBP/USD hit 1.80 at any point in the window period, the structure reverts to a forward contract at 1.61. For full details of this structure please contact one of our options traders on 0207 801 9050.

For full details of this structure, please contact one of the World First options traders on 0207 801 9050.

For more information, see www.worldfirst.com.

See disclaimer below.