Dear ATCA Colleagues

[Please note that the views presented by individual contributors are not necessarily representative of the views of ATCA, which is neutral. ATCA conducts collective Socratic dialogue on global opportunities and threats.]

News that Standard & Poor's may cut the ratings of 612 residential mortgage-backed securities backed by US sub-prime loans (worth an estimated USD 12 billion) began the US dollar's further decline against both sterling and euro 36 hours ago. Fears that other ratings agencies could follow suit made the British pound (GBP) hit a new 26-year high against the dollar, rising to USD 2.0322 -- its highest level since June 1981. The euro (EUR) climbed further into record territory yesterday -- within sight of the USD 1.38 mark -- amid concerns about the health of the US economy fuelled by discouraging growth forecasts from key retailers and home builders as well as the currency markets focus on the possible collapse of the US subprime lending market. Traders said they sold dollars on concerns that problems in the US housing market could slow American economic growth.

The Federal Reserve Chairman, Ben Bernanke, said Americans have "...less erratic expectations..." for inflation. Interest rates have not been raised because "...although inflation expectations seem much better anchored today than they were a few decades ago, they appear to remain imperfectly anchored." A possible interpretation could be, "Yes, I'd like to raise rates to fight inflation and protect the dollar...but we are concerned about the subprime mess." Investors realise that the greenback may get no further support from the Fed in 2007.

China's trade surplus has hit a new record in June -- USD 26.9 billion -- half of it coming from the land of the dollar. This number was 87% higher than a year ago and considerably higher than experts had predicted. The contagion of the US dollar decline is spreading to softer currencies. For example, the Indian rupee (INR) has ended at a fresh nine-year high of 40.37 against the US currency. The rupee continued to draw support from consistent and heavy foreign investment flow, which in turn, attracted traders to build positions in the local currency. Traders anticipated some dollar demand from public sector banks at the behest of the central bank but dollar buying was not forthcoming despite global oil prices hovering around USD 72 per barrel. The Reserve Bank of India (RBI), which seemed interested in holding the rupee at 40.50 level for the past one month, failed to get the opportunity to intervene in exchange market in view of a substantial portfolio inflows in the last six to seven days. In cross-currency trades, the rupee was marginally up against sterling but eased against the euro and the Japanese yen.

European Central Bank (ECB) executive board member Juergen Stark said the euro's rapid strengthening was no cause for alarm. Stark said the euro's value showed the European economy's strength, indicating he was comfortable with its appreciation to a record against the dollar. European officials are split on how best to deal with the euro's appreciation. French President Nicolas Sarkozy says the European Central Bank (ECB) needs to curb the rally because it is hurting exporters, and Portugal's central bank said yesterday it was concerned that global imbalances could push the euro's exchange rate higher, further hurting the competitiveness of Europe's economy. But German Finance Minister Peer Steinbrueck, whose economy has been fuelled by export growth said he was "not worried" about the currency's strength.

Interest rate differentials are also playing a key role in both sterling and euro appreciation as investors move away from the dollar and into currencies where interest rates are rising. Investors are encouraged to buy pounds by speculation that the British central bank (Bank of England) may raise interest rates further, which would boost the return on some investments in that currency. With sterling firmly amongst the top three yielding G10 currencies, it is becoming an increasingly attractive target for the carry trade. We could be at the beginning of a vicious circle: an increase in the money supply -- caused by investors buying sterling against the yen, for example -- is of concern to the Bank of England (BoE) because it can contribute to inflation, but to control inflation, the BoE raises rates -- making sterling even more attractive to the carry traders. Globalisation is not a new phenomenon, but its impact on local markets is growing and could complicate the BoE's efforts to control inflation in the UK.

We are at one of those moments in financial markets when the reality may not have changed much but perceptions have clearly shifted. The shift is about risk: the assessment of risk, the willingness to accept it and the premium to charge for it. The decline of the US currency may be a symptom of something deeper: the loss of confidence in the US debt markets over higher-risk bonds. There is nothing fundamentally wrong with high-risk, as long as those risks are understood and allowed for in the yield. Higher risk equals higher reward. But when the premium has been squeezed down and/or the purchasers don't understand where the risks lie, there is the danger of sudden disruptive movements in the markets. Something disruptive is happening now, though the gravity of the shift and the consequences are far from clear.

[ENDS]

We look forward to your further thoughts, observations and views. Thank you.

Best wishes


For and on behalf of DK Matai
Chairman, Asymmetric Threats Contingency Alliance (ATCA)
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ATCA: The Asymmetric Threats Contingency Alliance is a philanthropic expert initiative founded in 2001 to resolve complex global challenges through collective Socratic dialogue and joint executive action to build a wisdom based global economy. Adhering to the doctrine of non-violence, ATCA addresses asymmetric threats and social opportunities arising from climate chaos and the environment; radical poverty and microfinance; geo-politics and energy; organised crime & extremism; advanced technologies -- bio, info, nano, robo & AI; demographic skews and resource shortages; pandemics; financial systems and systemic risk; as well as transhumanism and ethics. Present membership of ATCA is by invitation only and has over 5,000 distinguished members from over 100 countries: including several from the House of Lords, House of Commons, EU Parliament, US Congress & Senate, G10's Senior Government officials and over 1,500 CEOs from financial institutions, scientific corporates and voluntary organisations as well as over 750 Professors from academic centres of excellence worldwide.

The views presented by individual contributors are not necessarily representative of the views of ATCA, which is neutral. Please do not forward or use the material circulated without permission and full attribution.
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Intelligence Unit | The Philanthropia, ATCA, mi2g.net

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