Global Markets Wait for European Financial Unity

Posted October 19, 2008

It’s with a lot of trepidation that people are watching currency rates right now.


The US bailout plan passed last week did not produce the market stability that was expected, but instead led to a market decline which was repeated at the close of business on 6 October 08.   The financial markets are recognizing the bailout is not a cure-all for the mortgage “meltdown” and any impact it has will take months and maybe more than a year.

But once the US passed the financial bailout package, all of the world’s eyes turned to the European nations looking for a similar display of financial unity.  They didn’t get it.  Traders are pushing for coordinated action from the European governments but they are not seeing decisive action.  The most that is happening on the European front right now is a government by government pledge to support financial institutions that are failing.

The result of all this turmoil is the dollar advanced against the euro as traders continue to seek US dollar liquidity.  The euro fell below $1.35 to the dollar which is the first time that has happened since last August 2007.   At the close of business on Monday the euro was at $1.344.  Until the 15-nation members of the euro manage to strike a coordinated deal that promises financial stability, the market is expected to decline. 

The brightest spot in the world currency markets is the Japanese yen.  The yen surged due to investors divesting their riskiest assets.  The yen rose the highest it has against the dollar due to the rapidly declining value of global stocks.  In fact, the yen saw its biggest one-day gain against the dollar in ten years and its biggest gain against the euro in nine years.  At one point the dollar dropped to 100.26 yen and the euro took a nosedive against the yen to 135.03 during trading.

The currency markets are seeing the rise in the value of the US dollar primarily because traders are buying short-term U.S. treasury bills.  T-bills are one of the safest investments that can be purchased.  The London bank Libor rates are at the highest they have been since the beginning of the year.  This is an indication of the scarcity of cash available to banks.  The result is a further tightening of credit.

So what are the currency markets waiting for now?  They are waiting for two signs that government intervention is going to stabilize the global markets.  The first sign being watched for is an indication the US $700 billion bailout plan is going to work and the slump in the US economy slowed before reaching crucial mass.  The second sign is interest rate cuts by European nations.

What European financial markets are discovering is the fact the euro cannot be as quickly impacted as the dollar.  The relatively rapid passage of the US bailout plan helped support the dollar.  The European nations are faced with the need to create a coordinated financial to stabilize the euro and instead are creating one-on-one nation plans to bail out banks and financial institutions. 

Having said this the US Dow Jones Industrial Index dropped below 10,000 by the close of business on Monday.  This is the first time that has happened in over four years.  At one point when times were good, the DJIA was expected to reach 15,000 but that goal looks very distant at this point. 

In other currency markets the ripple effect of the dollar and euro problems extended to the Australian and New Zealand also.  The Australian dollar fell to US $.6999 against the dollar which is the lowest it has seen in over four years.  The Australian government is expected to announce a large interest cut today.  The New Zealand dollar saw the same low to US $.5278 against the dollar. 

The name of the game right now is risk aversion which is why the yen is doing so well.   For example, the Japanese target lending rate is .5 percent whereas the Australian lending rate is 7%.  This is a scenario recreated around the world which is driving the value of the yen up rapidly.

Currency futures are indicating a belief that countries will cut lending rates over the next year.