Investors are increasingly concerned at the lack of response from central bankers and governments as confidence across markets deepens. Fed Chief Bernanke yesterday met with President Obama this week to discuss the alarming situation at a time when panic was growing fuelled by ill-founded rumors of a French sovereign downgrade and a collapse in one of the nation's leading banks. The obvious challenge facing the two is simply how to address the problem with arguably fewer tools than three years ago. The worry that few economists have addressed is that the proverbial can that is being kicked down the road is now larger, heavier and nosier. What started off as a bursting of the real-estate bubble and all its ancillary components was dealt with by a relaxation of monetary policy and a series of asset purchases designed to spur confidence across borrowers and employers. The result is that monetary policy has long been retired and the landscape has become blotted by bloated budget deficits that are missing the key growth ingredient that can heal them. We're left revealing an ailing financial system that was veiled by what's proved to be temporary fix. Sliding benchmark indices are no longer flashing oversold simply because the shock to confidence in the face of government and central bank impotence is morphing into a real economic downturn. If that's the case, equity prices have far lower to aim at before confidence can return.

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U.S. Dollar - In the short space of two weeks investors have been treated to a set of perverse price actions as events have unfolded. The biggest is probably the impact of S&P's sovereign downgrade to the United States in an event that most would have expected to see a run on both the dollar and government bonds. The event actually crystallized rationale thoughts leading to the conclusion that the economy was set to stall and delivered a decidedly lower yield curve. So now that the economy is arguably in greater need of further quantitative easing, the Fed finds its work already done with a seismic ratcheting lower for the yield curve. Logically the dollar has followed suit. If there is to be no QE3 then dealers are more bullish on the dollar. At the same time the demand for safe havens once again includes the dollar as equity prices spiral lower. The dollar is on the verge of becoming the latest event feeding in to the loop as its rise simply speaks to elevating pressures on the financial system. Today its index added 0.4% to 75.04 and is honing in on the highest level in two weeks at 75.38. In a sign of a slowdown in global growth over the summer, the U.S. trade deficit unexpectedly widened even as a cheaper dollar in June failed to spur a slump in demand for American-made goods abroad. The deficit widened to $53.1 billion from $50.8 billion and had been expected to narrow as falling oil costs delivered a smaller import bill. Initial claims data was steady at 398,000 with fresh claims falling by just 4,000 through last weekend.

Euro - The euro slumped to its weakest in four days as policy tensions played out in the stock market where an early rally suddenly fizzled as French banking shares once again came under scrutiny. The euro recently reached its session low at $1.4103. There was also modestly good news for inflation with German wholesale prices in July repeating a 0.6% dip in the previous month with the year-on-year pace easing to 8.2%. Still, investors have savagely pared expectations of monetary tightening with the yield curve flipping over and pricing out any intention the ECB might have in raising rates in this era of elevated concern for growth. The euro pared losses after news emerged that French President Sarkozy and German Chancellor Merkel would meet next week to discuss governance of the Eurozone and other international affairs.

British pound - The pound is falling on rising concerns for growth amid the most stringent austerity measures in 65 years. Lawmakers were dragged back to parliament during their summer break after the worst rioting for 30 years broke out on British streets. Austerity measures are in part being blamed with Chancellor Osbourne apparently under growing pressure to repeal some measures in light of the riots and after the Bank of England this week made reference to the "headwinds increasing daily" facing the economy. The central bank relaxed its predictions for growth to what still looks like an ambitious 2% pace in the "new economy" where it also admitted monetary policy could only have a "limited impact." The pound trudged to a session low at $1.6121 and is coming under pressure to breach $1.6000 as the dollar strengthens.

Aussie dollar - The Aussie had to digest a weak employment report overnight and made a faint effort to embrace a stable display for regional equities. The government reading disappointed expectations of a 10,000 job gain during July with a net gain of just 100 positions. The resulting rise to 5.1% in the overall rate of unemployment was the first in nine months and strongly suggested that not only was external demand slower, but that exporters were suffering at the hands of a strong exchange rate. The Aussie touched $1.0118 U.S. cents although recently traded in New York at $1.0254.  

Japanese yen -Demand for the dollar overnight saw the yen dip to ¥77.13, while an opening pop on Wall Street has helped take recent pressure off the yen. Machine orders in June jumped by more than expected to stand 7.7% higher than the previous months and 17.9% higher than a year ago. The yen also weakened against the euro recently trading at ¥109.20 having earlier jumped to as high as ¥108.15.

Canadian dollar - The Canadian unit is choppy and has traded both softer and firmer against the dollar on Wednesday. Earlier weakness saw the so-called loonie come within one-third of a cent of parity for the second time this week. The local dollar recently firmed to $1.0063 cents.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com       

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