Mounting optimism that the US economy would outperform the rest of the developed world pushed the dollar to multi-month highs against leading currencies this week as the oil price resumed its downward path, providing support for equity markets.
On the foreign exchanges, the dollar enjoyed its best one-day advance against the euro for eight years as the single currency fell briefly below the $1.50 level. The dollar also hit a 21-month high against sterling and a seven-month peak against the yen.
The trigger for the greenback’s rally – and a sharp rise in European government bonds – came from comments by Jean-Claude Trichet, the president of the European Central Bank, following Thursday’s decision to leave eurozone interest rates unchanged.
The yield on the two-year German bond hit its lowest since May 20.
Mr Trichet acknowledged that economic growth in the region was weakening – in effect taking further ECB rate rises off the table and underscoring the bleak message provided by a series of weak data releases, most notably from Germany. His remarks compounded increasingly gloomy outlooks in the UK and Japan.
“Over the past quarter, sentiment on growth prospects in the eurozone, Japan and the UK has deteriorated incredibly rapidly and most now accept that recession has already begun in all these three regions,” said Albert Edwards, global strategist at Société Générale.
Ulrich Leuchtmann, a currency strategist at Commerzbank, said the market now believed once again that the US economy would be able to leave the financial crisis behind very quickly.
“Not only US monetary policy, but also fiscal policy has been very quick in its reaction to the subprime crisis and its impact on the real economy. “The rest of the world reacts comparatively slowly,” he said. “That’s something markets were reminded of by Mr Trichet’s statement.”
But Mr Edwards took a more pessimistic view.
“The next big market surprise will be a similar dislocation in growth optimism for the US. In spite of many commentators now agreeing that a mild recession probably started towards the end of last year, few expect a deep recession will unfold over the next year,” he said. “They will be equally stunned by a collapse next year in emerging market economic growth.”
The Federal Reserve also left interest rates unchanged after its Open Market Committee met this week. However, in contrast to its eurozone counterpart, the US central bank’s accompanying statement was little changed from its previous meeting and had little impact.
The futures market moved to lower the odds of US rate rises this year and Treasury bonds held steady over the week. The yield on the 10-year note was at 3.95 per cent on Friday, up 1 basis point on the week. Successful auctions of long-dated paper also helped the mood in the Treasury market.
Meanwhile, the Bank of England and the Reserve Bank of Australia held rates steady this week – although the latter signalled that borrowing costs would be cut in the months to come, possibly as early as September.
The Australian dollar subsequently slid to a six-month low against the US dollar.
Meanwhile, oil led a broad commodities decline amid the dollar’s strong rally and growing concerns that demand would slow as growth contracted.
Nymex September West Texas Intermediate dipped below $115 a barrel on Friday to a three-month low, taking it more than 20 per cent below the record high struck in July.
Gold fell to a three-month low and base metals prices also retreated.
Serge Laureau, a strategist at Saxo Bank, said oil’s recent decline was a corrective market response following an overshoot last month.
“Markets are finally noticing the falling demand from the OECD countries and at the same time new supply from exporters, mainly from Saudi Arabia.
“Also we believe that China and other Asian countries will not stay immune and sooner than expected [will] show signs of slowing economies.”
The drop in oil prices helped keep alive a bullish mood among equity investors. By the close on Friday in New York, the S&P 500 was up 2.9 per cent over the week, while the pan-European FTSE Eurofirst 300 index rose 3 per cent.
In Tokyo, the Nikkei 225 Average edged 0.6 per cent higher.
But it was a gloomier picture for emerging market equities. In Moscow, the RTS index sank more than 11 per cent as tensions between Russia and Georgia escalated.
Chinese stocks, meanwhile, ended at a 19-month low as the Olympic Games got under way, although Indian shares notched up a fifth successive weekly gain – their best run this year, in spite of growing worries about inflation.
The MSCI EM index touched its lowest level since August 2007.
