Banking Problems, Tight Credit and Demand for the Dollar Should Weaken the Euro

The EUR USD closed sharply lower this week because of a combination of a flight to quality break and a possible interest rate cut by the European Central Bank.  The market started the week steady but was quickly met by selling pressure as signs developed indicating that European Banks were on the brink of collapse.  This news triggered a flight to quality rally into the Dollar.  Early in the week the Dutch bailed out Fortis, the French helped Dexia and the Bank of England took over mortgage giant Bradford and Bingley. 

After these transactions the credit markets tightened further as commercial and central banks began to accumulate U.S. Dollars.  The accumulation turned into outright hoarding as the banks refused to lend out money.  The week ended with a virtual standstill in the credit market leading to speculation of more trouble next week.

On Thursday morning the final blow was dealt to the Euro when ECB President Trichet made mention of the fact that the ECB policymakers had considered cutting rates.  Rates were left at 4.25% this month, but further comments about the weakening Euro Zone economy led to selling pressure on speculation the ECB would cut rates in either November or December.  The market finished the week on a new low for the year and is expected to feel downside pressure on the opening Sunday night.

The GBP USD dropped sharply lower for the week but held on to the low for the year at 1.7442.  This market felt incredible selling pressure early in the week because the Bank of England was forced to bailout mortgage house giant Bradford and Bingley.  This led to further speculation that other U.K. financial institutions would also fail.  Late in the week it began to become more apparent that the Bank of England would have to cut interest rates at its October 9 meeting because the worsening housing markets were dragging the U.K. economy into a recession.  Although the Bank of England is offering emergency relief where needed, U.K. financial institutions are expected to feel pressure next week. Look for more selling pressure as the market anticipates the October 9 rate cut.

The USD JPY traded mostly lower last week as the risk for appetite was diminished by the huge sell-off in equities.  Early in the week the Yen rallied when the stock market fell after the House voted down the banking rescue plan.  Late on Friday, the stock market fell to new lows for the week even after the House voted to support the plan.  Closing on the low indicates the strong probability of a lower opening on Sunday night.  This should put more downside pressure on the USD JPY as traders will seek the safety of the Yen as they dump more risky higher-yielding assets.

The USD CHF posted a slight gain for the week as traders focused on the weakening Swiss economy.  Early in the week a report out of Switzerland confirmed that the Swiss manufacturing sector was contracting.  This led to speculative buying in the USD CHF.  Late in the week the market focused a little on the carry trade as it became apparent the U.S. stock market would close on its low for the week.  If the market focuses on the carry trade next week then look for the USD CHF to break if the stock market trades sharply lower.  A steady to better stock market may send buyers back into the Dollar and out of the Swiss Franc.

The USD CAD showed strength all week as the credit crisis caused heavy commodity selling.  Weaker gold and crude oil weighed heavily on the Canadian Dollar as demand for commodities was expected to be down because of a looming global recession.  With a recession in the U.S. likely, financial market traders in Canada began to give indications the Bank of Canada would cut interest rates at its next meeting on October 21.  Traders are expecting the recession in the U.S. to spread to their trading partner in the north.  They expect the Bank of Canada to make a preemptive strike before the Canadian economy actually begins to weaken.  Tight credit and a weaker commodity market should continue to provide support for the U.S. Dollar over the Canadian.

The AUD USD made a new low for the year this week as traders dumped higher yielding assets.  Traders are shunning risk at this time in search of safety and protection.  Furthermore, weaker gold and crude oil also weighed on this market.  Traders are expecting a global recession to hit Australia hard and financial traders are already indicating the possibility of an interest rate cut before the end of the year.

The NZD USD was under pressure all weak because of the weakening global economy.  Traders feel the commodity driven economy of New Zealand will feel pressure as economies around the world slow down. The New Zealand financial markets are anticipating another interest rate cut by the end of the year.  Falling commodity and stock prices should continue to put downside pressure on this pair.