Carry Trades Plunge as Volatility and Risk Aversion Rises (page 2 of 2)

In contrast to the central bank's fears of rising inflationary pressures, German producer prices dropped 0.1 percent last month. This was not much of a surprise since wholesale prices dropped for the first time since October 2006. ECB members are growing less hawkish which reduces the risk of an interest rate hike from the ECB in the first quarter. We believe that the massive drop in European equities and the continual problems in the subprime and financial sectors will force the central bank to remain on hold over the next few months and possibility even for the remainder of the year. ECB members are already growing less dovish. Last week, Mersch switched his bias from hawkish to dovish and today, Wellink warned that the Eurozone economy is likely to slow more than the central bank initially expected. Once again, we expect the ECB to be all talk and no action.

Bank of Canada Expected to Cut Interest Rates

Carry trade liquidation, weaker economic data and softer commodity prices drove the Australian, New Zealand and Canadian dollars lower today. Wholesale sales growth slowed in the month of November which suggests that retail sales numbers for Canada, which are due for release tomorrow could be soft as well. The Bank of Canada will also be making an interest rate decision. They are expected to lower rates by 25bp tomorrow to 4.00 percent, putting Canadian rates below US rates temporarily. The Canadian economy has really taken a turn for the worst with growth in all sectors of the economy slowing. In Australia, inflationary pressures appear to be easing with producer prices rising only 0.6 percent last month. Although central bank Governor Stevens still believes that inflation will remain uncomfortably high in the near term, the drop in producer prices allows him to postpone any plans to raise interest rates. This flexibility comes in handy in the current environment when a rate hike would only exacerbate the losses in the Australian dollar and Australian stocks.

British Pound Falls to 9 Month Low

The British pound remains weak as mixed economic data gives the Bank of England no reason to postpone lowering interest rates next month. Public finances and money supply grew more than expected last month but mortgage approvals continued to drop. The housing market remains one of the most vulnerable aspects of the UK economy and if housing goes, so will consumer spending.