Market will now shift focus to Washington as Barack Obama will be sworn in as the 44th President of the US on January 20. Will a new President save the US economy and restore banking stability? Although many plans are in the pipeline and will be launched as soon as Obama takes office, including a new round of fiscal stimulus, in the form of tax cuts and government spending, and financial stimulus, perhaps in the form of a bad bank to take over bad assets of banks, it will take time for these measures to take effect. In the mean time, bank and corporate earnings will continue to disappoint and economic conditions will deteriorate. Despite government efforts, the US unemployment rate could surge past 9%, from 7.2% at present. All these will bode badly for riskier assets and provide more room for the US dollar to score further gains against other majors in the first quarter of this year.

Interest Rates

The race to zero rates is still on. After the Fed cut rates to a range of zero to 0.25% and the Bank of Japan to 0.1%, other central banks are not far behind. The Bank of England and the European Central Bank reduced rates by 50bps in the past two weeks as their economies fell into deeper recession. Rates in the UK stand at 1.5% and that in the euro zone at 2%. Both central banks signaled that more rate cuts could be expected if the downturn accelerates. The decline in inflation as a result of falling oil and commodity prices also give monetary authorities more leeway for further policy easing.

With US rates near zero, the Fed is resorting to unconventional monetary policy to revive lending. It is using its balance sheet to purchase commercial paper and mortgage backed securities. Starting in February, the Fed will provide three-year term loans to investors against consumer and small business loans. If credit conditions do not improve, the Fed might consider purchasing longer term securities as a means to push down longer term interest rates.

As a matter of fact, the Fed’s action has already helped ease stress in money markets, as evidenced by a narrowing spread, from over 450 bps in October 2008 to around 100 bps in mid-January 2009, between interbank interest rates and Treasury Bill rates. Mortgage rates have also come down after its announced plan of purchasing mortgage backed securities in government sponsored enterprises. The average rate on a 30-year fixed mortgage dropped below 5% in mid-January 2009, from about 6.5% in the last week of October, 2008.

The Fed is determined to revive growth and there is no limit to how far it Fed could expand its balance sheet. But the Fed’s action will of course has long term consequences, including escalating money supply growth and inflation, if not handled carefully and promptly.

    US treasury yields have again approached 4.5%, some 75 basis points below the cash rate, and at this level bond yields are attractive. For bonds to rally further requires a recession, but we believe the risk of an outright recession is very low. Though we expect global growth to moderate this year, we think it is likely to be mild as we do not expect significant problems in the global economy from either the US housing slow down or industrial activity. Whilst in the short term bond prices could remain strong as investors seek safety, we see this as an opportunity to adjust exposure for the medium term as we remain cautious on fixed income.
     Over the month, the yen was supported by better than forecast Japanese Gross Domestic Product, which boosted confidence in the economy. However, despite raising interest rates to 0.5%, the Bank of Japan’s comments that the outlook was for gradual future rises saw the Japanese currency give up some of its earlier gains. Over the month the yen was stronger against the dollar and the US currency also fell against the Euro which was supported by market expectations of an interest rate rise from the European Central Bank in March.
    Against the Euro and Sterling, we expect the US dollar to be range bound. But the Yen can continue to strengthen against the US Dollar as the Japanese economy is likely to be hold up in 2007. The low interest rates in Japan have prompted heavy selling of the Yen over the past year and its recent rebound indicates that investors are aggressively buying the currency back. Over the coming months, we will see high volatility in the currency markets. Asian currencies are fundamentally undervalued and we favour Asian currencies against the US Dollar

He also estimated that foreign investment had exceeded 90 billion U.S. dollars, up about 20 percent.

China has been hammered by the global financial crisis, which has cut exports and foreign investment as the world economy went into a downturn.

The economy grew 9 percent in the third quarter, the slowest pace in five years, as the global crisis sapped demand for Chinese goods and domestic industrial production waned in response to weak demand and rising raw material costs.

Foreign direct investment was 86.4 billion U.S. dollars in the first 11 months, up 26.3 percent year-on-year. The increase was lower than the average of 35 percent for the first 10 months.

The actual use of foreign investment slipped 36.5 percent year-on-year to 5.32 billion U.S. dollars in November.

Cai Qiusheng, an official with the State Administration of Foreign Exchange, was quoted by Tuesday’s Shanghai Securities Journal as saying that foreign exchange reserves were below their peak at 1.9 trillion U.S. dollars as of the end of September.

From January to November, foreign trade was 2.38 trillion U.S. dollars, jumping 20.9 percent year-on-year. However, November’s total trade stood at 189.89 billion U.S. dollars, down 9 percent year-on-year.

Chen told a national conference on commerce on Tuesday that the ministry would take steps to maintain stable export growth next year.

The measures will include expanding financial and fiscal support for exports, such as more credit support to exporters, and making more efforts to explore emerging markets in south and central Asia, the Middle East, South America and Eastern Europe, while consolidating China’s food hold in traditional markets.

The ministry would also strive to improve the structure of export products next year by promoting domestic brand-name products, large machinery and equipment and agricultural products. It would also emphasize labor-intensive products and support small firms’ technological innovation.

The ministry pledged to boost service trade, including software, culture and traditional Chinese medicine. It also vowed to expand imports, especially of equipment with up-to-date technologies as well as key spare parts, through policies including tariff cuts.

Ding Lei, general manager of GM’s flagship venture in China, said although GM is shedding brands and closing plants to boost liquidity in the US market, business in Latin America and Asia remains healthy.

“There won’t be changes in GM’s investment in China,” said Ding from Shanghai General Motors Co Ltd, “The Chinese market will be the top priority for future development.”

Overseas car makers are still investing in emerging markets like China to help offset slackening demand in traditional markets in Europe, the US and Japan.

Although the stocks slump and a slowing economy in China is also hitting demand for vehicles, the 11-percent sales increase for the first 10 months remains one of the world’s fastest.

Ding expects the car maker will be able to get through the tough times with government support as the US car industry, with annual sales of 15 million units, plays a crucial role in the US economy.

In China, GM is also facing challenges with declining market share and sluggish sales despite new models like the Buick Excelle and the Chevrolet Aveo compact car.

Shanghai GM Monday launched a revamped Buick Regal mid-class sedan in Shenzhen, as part of its efforts to upgrade products to win back Chinese customers who have been buying more cars from Volkswagen and Toyota.

Next year, the Chevrolet Cruze mid-class sedan will also begin domestic sales ahead of another 10 new models for the Asia-Pacific region by 2010, according to Ding.

The car maker is also boosting the production capacity of its plant in Shenyang to 150,000 units every year.

Ding believes China’s car sales will not post a year-on-year decline for the coming year because a 4-trillion-yuan (US$586 billion) investment being offered by the government will help rebuild market confidence and will boost domestic consumption.