The London Interbank Offered Rate

The London Interbank Offered Rate (LIBOR) affects everyone in many ways. Simply put the LIBOR is a world wide guide banks use when lending to each other. Most adjustable rate mortgages (ARMs) and credit card interest rates are based on the LIBOR. The higher the rate the higher the payments on the mortgage or credit card. The British Bankers Association meets daily to compile the rate which is then released through the Reuters news agency. Unfortunately there is no way of forecasting the LIBOR beyond a year’s time. Lenders around the world monitor the LIBOR rate daily.

Record Lows Last Week

Last Friday the interbank rate for three month euro, dollar, and pound funds hit record lows. The LIBOR dropped to its lowest since the BBA introduced the Libor fixings in 1989. BBA data showed that the three month dollar LIBOR rate fell to 0.50375%. The three month spreads of LIBOR over Overnight Interbank Swap rates also narrowed. The spread is indicative of the three month premium paid over Overnight Interbank Swap rates and is widely held as an indicator of backs willingness to lend to each other. A narrow spread is seen as an indicator of more willingness to lend while a wider spread indicates reluctance to lend.

No Full Recovery Until 2010

The narrower spreads are seen as a positive development and with banks more willing to lend to each other risk sentiment is raised. Narrower spreads are good news for credit markets and have a positive effect on currency and equity markets. While the results of the current LIBOR are positive many experts believe that it will take well into 2010 for bank to bank lending to recover from the financial and credit crisis which began with the failure of Lehman Brothers in 2008.

Dollar at Two Month Low Against Majors

The US dollar is currently at a two month low against a basket of major currencies. Positive second quarter data from Intel and Goldman Sachs raised risk sentiment and raised investor sentiment about the economy and corporate earnings. A US report that showed a slowing in industrial production contraction also lifted investor’s spirits and damped demand for safe haven assets. Ian Stannard of BNP Paribas SA stated, “The recent data releases and earnings reports out of the U.S. have buoyed equity markets and seen the yen and the dollar both come under some pressure. Today’s U.S. industrial production data will be key as to whether this improvement in risk appetite continues.”

Optimism Driven Trading Emerging

US corporate earnings reports have had a major effect on currency exchange rates. The stellar second quarter performance of both Intel and Goldman Sachs exceeded the estimates of analysts. Daisuke Uno of Sumitomo Mitsui Banking Corp. said, “There is a sense that optimism-driven trading is re- emerging. The forecast-beating results from Goldman Sachs and Intel suggest the yen will weaken and stocks will advance.” Other second quarter reports are due from many of the companies in the standard and Poor’s 500 Index.

Developed Countries to Lose 30 Million Jobs

Although risk sentiment was up many forex investors and experts feel that recent signs of an economic upturn will be short lived supported only be the trillions of dollars governments around the world have poured into the global economy. The Organization for Economic Cooperation and Development said that developed countries could lose 30 million jobs during the period beginning at the end of 2007 and ending in 2010. German data showed investor pessimism and analysts believe this data shows that the German economy will not start growing until 2010. Carsten Brzeski of ING stated, “The German economy could be among the first to escape the recession. However, it is ‘if’ and not ‘when,”

Currency experts expect forex trading for the rest of the week to be volatile.

Risk Aversion Benefits Yen

The Japanese yen is at a five month high against the US dollar fueled by investor concern about US Q2 corporate earnings. Many investors believe that recovery this year will be minimal. The yen was also helped by an upgrade in Japan’s economic forecast. The dollar rose against commodity based currencies due to lower oil prices. Earlier in the year commodity based currencies such as the Aussie and New Zealand dollars had been big winners.

Geithner’s Remarks

The dollar was helped by remarks be Treasury Secretary Timothy Geithner who said that there was a good chance that the US and other major economies would see growth over the next two quarters. Trading has been thin due to summer holidays but some currency experts said that forex investors and traders are cautious despite expectations that some major firms will show signs of recovery. Lauren Rosborough of Westpac in London stated, “All the big banks, save Citi, are seen having positive earnings in the second quarter … but at the same time, the market wants to sell risk this week.”

Banks to Post Q 2 Earnings

Risk aversion has been dominant and has affected global currency exchange rates. The US dollar and the Japanese traditionally benefit from risk aversion and are seen as safe havens. Expectations of a change in the Japanese government have also contributed to risk aversion. This week several large banks will post second quarter earnings. Among these are Goldman Sachs Group, JPMorgan Chase & Co, and Citigroup Inc. James Hughes a market analyst at CMC in London stated, “This week there is heavy focus on the U.S. earnings season, and investors will want to see that any recovery for major companies is revenue-based and not cost-cutting based.”

Also due this week and sure to affect currency exchange rates are minutes of the last Federal Reserve policy meeting and a Bank of Japan meeting.

Chinese State Councillor Calls for Diversification of Global Reserve Currency System

China has renewed its push for an alternative reserve currency at the G 8 Summit taking place in Italy. Chinese State Councillor Dai Bingguo did not mention the dollar specifically but called for global diversification of the global reserve currency system. In a statement read by foreign ministry spokesman Ma Zhaoxu Dai stated, “We should have a better system for reserve currency issuance and regulation, so that we can maintain relative stability of major reserve currencies’ exchange rates and promote a diversified and rational international reserve currency system.” Dai is attending the G8 summit in place of Chinese President Hu Jintao who returned to China to deal with political instability in the Xinjiang region.

British Prime Minister Brown Skeptical

British Prime Minister Gordon Brown was skeptical saying that any discussion of alternative reserve currencies would have to wait until global markets recover from the current recession. Brown also voiced concerns that changing reserve currencies at the present time could destabilize markets and that the focus should be on recovery from the recession. Brown stated, “In this present situation as we’re trying to get out of a deep recession, I don’t want to give the impression that there is some major change about to happen around the corner that suggests that the present arrangements are destabilized.”

China Leery of Undermining the Dollar

Currency exchange rates were largely unaffected by Dai’s statements and investors focused on positive US data and signals that Germany’s Bundesbank may purchase corporate bonds. In the past China has been leery of making any moves that could undermine the dollar. 70% of China’s foreign exchange reserves are dollar denominated making the dollar a very sensitive topic for China. In the past Chinese officials have suggested that the Special Drawing Right, which is an account unit used by the International Monetary Fund, is a viable alternative to the dollar as a reserve currency.

Dollar’s Status Secure For Now

For now the dollar’s status as a global reserve currency seems secure. There was no mention of the issue in a statement from the G8 and G5 nations.

Recovery Doubts Raise Risk Aversion

Doubts about the speed of recovery from the lingering recession have dampened risk appetite as investors sell higher yielding assets and seek the safe havens of the US dollar and the yen. Both the dollar and yen gained broadly on Wednesday. The dollar was helped by comments by a Japanese official who said the leaders at the G 8 summit did not discuss the US dollar’s status as the world’s reserve currency during Wednesday’s talks on the global economy.

Investors Concerned About Chinese Political Instability

Chinese President Hu Jintao, who was to attend the conference returned home to deal with political unrest in Xinjiang region. Hu Jintao’s absence diminished speculation that any comments about reserve currencies would be added to communiqués from the G 8 summit. China has been in the forefront of nations calling for an alternative reserve currency. The political turbulence in China has some investors concerned. Boris Schlossberg of GFT Forex stated, “Part of the optimism earlier about a worldwide recovery was based on the assumption that China would be this locomotive of growth and keep the rebound going. As the political situation in China becomes problematic, it provides another reason for investors to sell any high-yielding currencies, benefiting the dollar and the yen.”

Investors Wait For Q2 Results

Investors are waiting for the second quarter corporate earnings report from the US. Poor results are expected to boost dollar and yen demand as investors seek safe haven investments. Investors will be paying particular attention to figures from financial institutions. Chris Turner of ING in London stated, “If bank earnings disappoint in any way or the S&P breaks crucial levels, traders will probably start reducing long positions in (high-risk currencies) and the dollar could be bid more.”

This week currency exchange rates will be affected by the G 8 summit taking place in Italy. The most recent communiqué from the group contained no mention of currencies.