* The dollar was mixed on Wednesday on speculation the Obama Administration prepared a plan to absorb trouble bank assets in a so-called Bad Bank. The yen fell versus other major currencies as US stocks measured by the S&P 500 index rose for a fourth day as banking stocks surged. Increased risk appetite encouraged investors to buy riskier assets. The FOMC kept the benchmark interest rate unchanged and indicated that it may buy agency and government bonds to ease credit conditions. The euro reversed earlier gains after the Fed’s announcement. European Central Bank President Jean-Claude Trichet indicated that the ECB may be on hold at next week’s meeting awaiting more conclusive economic data, which would be available at the March meeting. Sterling rose for a third day supported by renewed optimism about the financial sector. The Canadian and Australian dollars rose on the increased risk appetite and higher commodity prices.

* The EUR/GBP fell for a third day after failing to penetrate resistance at 0.90 in the beginning of the week. The collapsing UK financial sector and deteriorating economy had supported the EUR/GBP, while the recent improved banking sentiment had pressured the pair. We believe the underlining fundamentals will support the pair and the diagonal support from the strong uptrend will hold. Some European governments complained about the trade advantage the higher EUR/GBP gives to the UK. However, it will not stop the Bank of England from further cutting interest rates or even using unconventional easing tool, neither would it stop the ECB dragging its feet when it comes to rate cuts.


Financial and Economic News and Comments

US & Canada

* The Federal Open Market Committee kept its target range for the federal funds rate at 0 to 0.25%, saying economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time. The Fed said it expects a gradual recovery in economic activity will begin later this year, but the downside risks to that outlook are significant. Regarding inflation, the Fed said inflation pressures will remain subdued in coming quarters, adding that it saw some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term. The Fed said it will support the functioning of financial markets and stimulate the economy through open market operations and other measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level and will be implementing the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.

* Long bond yield rose after the Fed remained vague on the possibility of buying longer-term government securities to help the economy. Investors had pushed long yield lower in anticipation policymakers to be clearer about their intention to buy long-end Treasurys. The higher yields helped the dollar in late New York trading.

* Treasury Secretary Timothy Geithner said the Obama Administration is considering several options for its financial-rescue plan, with the goal of preserving the private banking system.


* Germany’s consumer prices declined 0.5% m/m in January, preliminary data from the Federal Statistical Office showed, after a 0.3% m/m increase in December. The consumer-price inflation rate increased at 0.9% y/y, decelerating from December’s 1.1% y/y. When calculated using a harmonized European Union method, the CPI fell a more-than-expected 0.6% m/m in January, following a 0.4% m/m increase in December. The harmonized inflation rate was at 0.9% y/y, the lowest since February 2004, decelerating from December’s 1.1% y/y. The decelerating inflation rate will likely allow the European Central Bank to cut interest rates further.

* Germany’s consumer confidence, albeit at a low level, continues to remain stable in February, with GfK AG’s consumer climate indicator holding at 2.2, following January’s upwardly revised 2.2, GfK AG reported. The propensity to buy rose sharply in January to 15.5, the first positive reading since August 2007. However, income expectations fell for the second time in a row, declining to -20.5 in January, its lowest position since March 2003, following -15.5 in December. Economic expectations slightly declined to -32.9 in January from December’s -32.4, slightly down from the record low reached at the end of 2008.


*Switzerland’s economic conditions worsened in January, with the KOF Swiss leading indicator falling to -0.87, the lowest level since records began in 1991, following December’s downwardly revised -0.45, according to Konjunkturforschungsstelle Swiss Institute for Business Cycle Research.


*Australian consumer prices fell the most in 11 years, declining 0.3% q/q in Q4 2008 after increasing 1.2% q/q in Q3, the Bureau of Statistics said. The inflation rate was at 3.7% y/y in Q4, decelerating from 5.0% y/y in Q3. The figures support an argument for further Reserve Bank of Australia interest-rate cuts.


* The Australian economy deteriorated further in November, with the Westpac Australian leading index declining 1.0% m/m following October’s downwardly revised 0.2% m/m drop, Westpac Banking Corp. reported. The leading index fell 2.2% y/y, the first negative reading since May 2001. The coincident index came in flat in November, following October’s 0.2% m/m increase.

* Japan’s Finance Ministry lowered its assessment of the regional economy for a fourth consecutive quarter amid a deepening Japanese recession. Regional economies are deteriorating all over the country, the ministry’s local-office chiefs said. The assessment capped off the longest series of downgrades since the ministry began comparing quarterly changes in 2004.

* The Reserve Bank of New Zealand slashed the cash rate 150 basis points to 3.50%, the second consecutive 1.5% cut, citing the negative economic outlooks for the global economy and New Zealand’s trading partners. The news coming from our trading partners is very negative. The global economy is now in recession and the outlook for international growth has been marked down considerably, RBNZ Governor Alan Bollard said. There remains huge uncertainty about the timing and strength of a recovery, he said, adding that going forward, rate cuts will be smaller.

FX Strategy Update