JANE FOLEY<strong><br />RESEARCH DIRECTOR, FOREX.COM</strong><br /><br />HAVING rallied between March and early June on the expectation that the global economic downturn could be in the process of bottoming, the market is displaying a reluctance to extend risk. The reason is clear – economic data may have improved, but they are not yet sufficiently strong to confirm that that the global recovery is conclusively underway. <br /><br />The relief rally in stock markets and the coincident reduction of long dollar positions between March and early June was triggered by a run of better-than-expected data. Insofar as there is evidence in many countries that the downturn could be in the process of bottoming, some unwinding of safe haven positions was justified. However, since early June the market has been swallowing the fact that there can be a crucial difference between better-than-expected data and good data. The fact stands that economic statistics reflect, on the most part, very weak G10 economies. <br /><br />Without doubt fiscal and monetary stimulus in recent months has managed to stave off what could have been a far deeper crisis. While it seems likely that the worst of the financial crisis has past there are yet no guarantees that the economic recovery is firmly establishing itself. Most likely the upturn in many G-10 countries will be U-shaped but to date there is insufficient strength in economic data to dismiss the risk of a W-shaped recovery. <br /><br />The rhetoric of G10 central banks has maintained a cautious economic outlook. In general, central banks have recently acknowledged that there are signs of economic stabilisation but there is a consistent note in the statements of central banks warning that conditions are set to remain weak for some time. Far from being at a point where central banks can start to reverse some of the policy easing of recent months, the BoE, the Fed, the ECB and others likely have further work to do to ease liquidity conditions. <br /><br /><strong>LOAN AUCTION</strong><br />Last week the ECB pumped a massive €442.2bn into the Eurozone banking system via its first ever one year loan auction. The hope is the banks will increase the availability of credit within the broader economy. Despite the BoE’s asset purchasing plan (or quantitative easing, QE) the availability of credit, or lack of, is a consistent theme in the UK also. Following reports of very restrictive lending conditions facing prospective house buyers without large deposits, last week newspapers suggested that the average interest rate charged on a two-year fixed mortgage in the UK is now over 5 per cent and could rise to 6 per cent within weeks, despite the BoE holding rates at just 0.5 per cent. In line with this, BoE data released last week showed that gross mortgage lending fell further in April, the weakest flow since December 2000 while net lending to businesses showed the weakest flow since June 2000. These statistics are consistent with Governor King’s comments last week that the recovery will be a “long, hard slog”.<br /><br /><strong>FRESH ACTION</strong><br />Central banks and their battle to increase the availability of credit and underpin the economic recovery look set to remain in the headlines during the summer. The Fed took no fresh action in last week’s policy meeting though a step up in its asset buying program cannot be ruled out in August.<br /><br />Similarly is it too early to rule out an increase in the BoE’s QE program. The ECB’s action last week has detracted attention from its policy meeting this week, but the market will be closely watching for clues on how much further this program may extend. The Swiss National Bank (SNB)has thrown itself into the headlines by reportedly intervening to weaken the Swiss franc twice in a week.<br /><br />The strength of the Swiss franc is not correlated with the weak Swiss economy and with room for further rate cuts dried up (rates are at 0.25 per cent), the Swiss franc has been forced into a potential faceoff with the market on the value of its currency. Demand for Swiss francs should ease as confidence in the global economy builds, but long drawn out recession could lessen the SNB’s ability to prevent the CHF from appreciating. Euro/Swiss franc could be a lively trade in the months ahead.<br /><br />The summer months look likely to represent a period of indecision for many markets. The flurry of better than expected data through the spring is unlikely to feed through into sustainable growth for months. While the “risk trade” may prove to be a solid bet going forward, many investors may prefer to wait until the autumn before extending risk. In this environment, choppy trading may dominate summer activity in many markets.