He emphasized growth being contingent on various anti-recession policies being successful. Specifically, he highlighted four policies recently announced by the Treasury and the Fed: (1) the new capital assistance program; (2) the public-private investment fund; (3) the expanded TALF program and (4) home foreclosure relief. He noted that "Together, over time these initiatives should further stabilize our financial institutions and markets, improving confidence and helping to restore the flow of credit needed to promote economic recovery." Over time, yes, but such measures although necessary, will drag out the recession/depression for an undetermined period.

We expect the dollar to gradually find its way back to recent highs as investors tread cautiously and await further policy steps. While Bernanke played down the prospect of bank nationalization the markets will likely remain fearful on this front. Meanwhile, radical plans are in the making in other markets, ranging from ongoing talk of an intra-Eurozone bailout to quantitative easing by non-G3 central banks. The lack of alternatives to the dollar in the current environment is becoming increasingly conspicuous. We hedge our view of either a risk rally or a debasing of the US dollar with a 6-month call option on the AUD. Which currency is the least worst, for now it is AUD and we have to consider USD strength on further prospects of risk aversion.

For those hoping equities will undertake a sustainable rally and form a “V” bottom, I believe it to be highly unlikely. Over the past ten years hundreds of small (100M – 1B+) were created in regions around the world. These funds took on excessive leverage by means to detailed for this commentary. The leverage, much in the form of carry trade and other, enabled them to prop up equity prices on exchanges around the world. With the current washout and restructuring of the financial systems and lack of credit, these funds have all but dried up, as well as disappeared. What does this mean for FX? Further repatriation to USD over the long term. JPY is subject also to strengthen on risk aversion (selling of equities), but with the strong JPY, is a deeper stake in the horribly weak economic arm of Japan. Equities will not see new highs for at least a decade.

ECB President Trichet warned yesterday that the currency union's financial system is under severe strain and hampering economic recovery. By his normal standards these comments were quite bearish but the market is already looking beyond the possibility of more rate cuts and looking at the possibility of an intra-Eurozone bailout. The ECB has been tight-lipped on this issue and national governments are so far unclear. However, it is obvious that contingency plans are currently being drawn in the event of a serious crisis arising from any Eurozone nation. So far the focus has been on national banking systems' exposure to asset impairments on loans made to developing Europe, but we also note that several other Eurozone nations are facing serious deficits and increasing fissures within the Eurozone. The ECB's Nowotny cited the enormity of the current economic slump but mentioned that quantitative easing is not currently an issue as the official rate is still positive and has room to move. In recent data, the German Ifo indicators were slightly below expectations across all sectors. Business climate Ifo was 82.6 (cons 83.0, prior 83.0), current assessment Ifo was 84.3 (cons 84.9, prior 86.8) and expectations Ifo was 80.9 (cons 81.1, prior 79.4).It was positive to see an increase in the expectations figure despite the decline in the headline number. While the slight drop in the headline Ifo number does not contradict economist's overall view that lead indicators are close to their bottom, it does not tell us anything about where they might move from here. Even if they are at a bottom, there are other economic issues to contend with that have resulted from the current crisis environment. The upcoming figures could remain in contractionary territory for some time and we still think hopes of some stabilisation in Eurozone sentiment are premature at the current juncture.

Japan's trade balance for January was released this morning and showed a deficit slightly narrower than expected at Y356bn versus consensus of Y494 bn. Japan exports for January fell by 45.7% y/y, in line with expectations of -45.6% y/y, but nonetheless was still a record y/y decline. Japan's new finance minister Kaoru Yosano said yesterday that the government should study measures to support share markets as they were having a big impact on the economy. Direct intervention to support equity markets has not been mulled by any G10 government so far as it does little to address the underlying issues currently plaguing the global economy, such as the solvency of banks and the lack of credit. Yosano's comments also differ from prior BoJ plans to purchase equity stakes directly held by banks which form a part of the banking sector's capital base. These measures would have a more meaningful impact as it removes a significant source of pressure on capital adequacy and may encourage banks to reengage borrowers. Other asset purchases schemes launched by governments are purely credit easing in nature and not designed to help shareholders curb losses. We doubt that any such plan will find traction and Japan's deteriorating fiscal position means there are not much resources at the government's disposal to finance such a scheme. The BoJ minutes from the January meeting warned of tight financial conditions and one member warned against excessive credit easing. The yen is continuing to lose traction as a safe-haven based on current price action and may face further pressure up ahead.

Australia's wage cost index for Q4 is due out this morning and the market expects a rise of 0.9% q/q, unchanged from the previous quarter. Of greater interest however will be the capex survey for Q4 due out on Thursday. UBS Economists expect it show declines of 5% in the quarter, led by a 10% drop in equipment. The survey will also include the first snapshot of investment intentions for 2009/2010 and hence will provide a valuable insight to the outlook for the Australian economy. No doubt investment intentions will be revised sharply lower. Finally, private sector credit for January is due on Friday and the market expects a 0.2% m/m increase following a 0.3% contraction in December. While Australia's economy is likely to slow significantly, we do not think the RBA will need to engage in quantitative easing. As such, given the aggressive monetary policy actions of major central banks to date, we are long a 6 month AUD call option expressed against a basket of G3 currencies. AUD is the flavor of the week. So if you take the strongest and the weakest, but AUDJPY on dips.

Notably, JPY has weakened in an environment of global equity sell offs and new lows for US indices. This divergence is suggestive that JPY and equity indices relationship is separating and possibly the market has deleveraged more than 80%. We are still well away from the end of this story.

Chris Lori

Ref: UBS, Bloomberg

Tags: FED