Two interventions and a downgrade


For investors worried about deepening risk aversion as markets opened last Monday, the worst wall street bloodbath since ’08, interventions by Swiss and Japanese authorities and the unprecedented S&P downgrade of US rating betrayed sobering market dismissal of US and European efforts to contain their debt and deficit problems.
The Swiss central was the first to act, on Wednesday, declaring the franc “massively overvalued” as markets remained unimpressed by the eurozone debt relief package as well as the last-minute scramble in Washington to avoid default. But even the unexpected SNB interest rate cut failed to deter the safe haven rush and trading remained choppy. USDCHF traded at around 0.778 after the announcement (a third of the level one year ago), and dropped again to near-historic lows at 0.767 by the end of the week. Its exchange rate with the euro, 1.11 now as opposed to 1.38 around the same time last year, is also indicative of lack of market confidence in European leaders.
The Japanese came in with greater force the next day, Thursday, selling yen and buying dollars to drive down the value of the Japanese currency. The BoJ also announced further expanding its program to purchase government and corporate bonds. The move succeeded in pushing USDJPY from 76.9 Thursday morning to above 80. It closed the week at 78.3 before dropping to 76.25 earlier in the week. The new trading week begins with after effects of last week’s biggest bombshell – S&P’s unprecedented downgrade of US rating to AA-plus – as the market begins to price in eventual rise in borrowing costs for the American government, corporates and consumers, in addition to questioning the dollar’s reserve-currency status. While Moody’s and Fitch have maintained America’s AAA rating, Friday night’s post-trading S&P downgrade casts serious doubts on both Republicans’ and Democrats’ ability to govern effectively through the ongoing crisis. The market will be unforgiving of the outcome reached after both parties sought to draw political mileage from a potential catastrophe. Increasing uncertainty means the risk-off environment will deepen. But with the franc and yen poised to discourage further inflows even as all developed economies suffer, more weakening risks triggering currency wars that will further deteriorate investor sentiment. Both Swiss and Japanese governments, being trade dependant, will not allow their economic well being to be compromised by weakening fundamentals in Europe and America. So, even risk aversion will likely incorporate fresh dynamics as Europe struggles to contain contagion and America inches perilously close to double-dip recession.
Trading Perspective
Next week surely would not be for the weak hearted, expect lots of volatility with major whipsaws. USD across the board is expected to take some pounding due the rating downgrade, which has in some way put a question mark on dollars reserve status. Although Euro doesn’t look good either but markets are expected to ignore it till Thursday when ECB monthly report comes out. Whereas, GBP looks on relatively stable ground and would likely gain against the dollar, further momentum could also be derived from Industrial production numbers due on Tuesday and BoE’s inflation report on Wednesday. CHF would undoubtedly be the star of the show next week with risk factors tipping in its favor.JPY remains tricky however, on one hand it remains attractive switching option from dollar, but another BoJ intervention might contain its advance.