More Volatility with a Busy Calendar and Subprime Credit Fears

Much volatility was experienced in the forex markets last week as all attention were turned to the turbulence in credit markets. News that BNP Paribas suspended redemption from three funds that are exposed to US subprime markets triggered concern that investors would seek redemptions from other funds, which could in term dry up the markets. LIBOR rates spiked higher in the middle of the week and that in turn, triggered injection of cash from central banks around the world, including Fed, ECB, BoJ, BoC and RBA. But the fear in the makets continued, with stocks stumbling and carry trade unwinding massively. The markets only stabilized on Friday after the Fed added another $38b and pledged more fund will be injected "as necessary" to calm the markets. Looking ahead, news about the credit markets and subprime problem will continue to take the center stage. Economic calendar is jam-packed this week, which could trigger further volatility in the markets. But impact from data could be temporary as they continue to play a secondary role in moving the markets.

Higher yield currencies were most hit by massive carry trade unwinding last week, in particular Aussie and Kiwi, which also weakened sharply against dollar. The greenback benefited such carry trade unwinding and indeed rose against other majors and even closed higher against the yen on late Friday recovery.

FOMC rate decision was the main event from US last week. Fed kept rates unchanged at 5.25% as widely expected. Tightening bias was, to some's surprise, maintained in the accompanying statement as "the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected," even though downside risks to growth have increased. Regarding inflation, Fed members still think that the sustainable moderation in inflation pressure is not "convincingly demonstrated" yet. Regarding growth, Fed still expects "the economy seems likely to continue to expand at a moderate pace over the coming quarters", but added that it will be "supported by solid growth in employment and incomes and a robust global economy."After all, the statement ruled out the possibility of a Sep cut and didn't hint on any rate cut this year yet. However, the Fed seems left the door for moving to a more neutral stance. The upcoming employment and incomes data will become evenly more closely watched and market moving and that could be trigger for bias shift.

Another major events of last week was the BoE quarterly inflation report which confirmed market's expectation that one more rate hike is needed to bring CPI inflation back to 2% target in 09. Sterling was also boosted temporarily by hawkish comments from BoE Governor King who said that the starting point of UK economic growth is stronger than the latest ONS numbers and that inflation expectations have not fallen back yet. Housing market also remains strong.

RBA raised Australian interest rates to a decade-high of 6.5% to curb persistent core inflationary pressures as widely expected. However, reaction to the news was muted as this was already widely expected. Also, markets are speculating that RBA will be on hold at 6.5% for the remainder of the year. Kiwi and CAD was boosted temporarily by lower than expected unemployment rate but just like others, both were pressured again as carry trade unwinding returned to be the focus.