It is unlikely that the Fed will let us down tomorrow, however, their statement will need examination. A Fed Funds rate of 4 ¼% is priced in for year end and probably 4 ¾% later. For the dollar to gain further support the market will need to anticipate additional rate hikes. The Dallas Fed chief (Fisher) commented that the inflation rate is towards the “upper end of the Fed’s tolerance range” and that the Fed needs to be “especially vigilant”, which could provide that support if increased tightening is expected. These comments were later endorsed by other Fed leaders, including Janet Yellen (SF Fed) commenting that at 3.75%, she believed the rate was at the lower end of her estimate of neutral policy.

Most recently the long-term dollar negatives have been pushed to the side and the dollar has gained support from rising rates. Support for the dollar could fade, however, if the market starts to believe that the ECB is looking to tighten. While the ECB kept their rate unchanged at 2% (for the 28th consecutive month), comments from bank president Trichet show they are concerned about inflation and will keep a “strong vigilance”, and that energy prices have contributed to the risk of a slow down. Core inflation numbers in some Euro-zone countries (such as France & Ireland) could push up the overall number, suggesting more hawkish comments from ECB board members.

The dollar gained additional support from the ‘TIC’ data – which shows capital inflows into the US dollar. The August number was $91.3bn (higher than the $87.5bn reported in July) and easily covers the current account deficit. Institute of Supply Management (ISM) survey of manufacturing activity was unexpectedly robust at 59.4 (up from 53.6 in August) – an indication of the reconstruction spending? This was also followed up by the Fed’s Beige Book also showing signs of fairly solid economic activity.

The EU has recently updated their growth forecast (again) suggesting a slowing down of GDP for 2005 to 1.2% from 1.6%. Following the political wrangling after the election, Germany is to get its first female Chancellor (and the first from the former east) as Mr Schroeder takes a step back, although last minute senior resignation(s) are hindering the final government composition. Depending on how the ‘Grand Coalition’ works investors are hoping for a more reforming government - this is uncertain at the moment and perhaps reflected in the muted ZEW survey of economic expectations, which showed a small increase in October over September, below what the market was anticipating and showing a fragile improvement. Inflation for October was higher than expected at +2.6%, with energy prices being blamed and explains many of the ECB comments. The IFO survey was higher than expected at 98.7 (a 5 yr high) – there seems to be more confidence from the larger exporting companies.

Bank of England kept their rate unchanged at 4.5% (later reported that the vote was 9-0). There remains a dichotomy for the MPC of a weak consumer with very weak high street sales, a low savings rate, house prices off the top all suggesting more cuts, while manufacturers input prices are increasing, also CPI has been picking up. Later in the month the BoE governor (Mervyn King) was quite ‘hawkish’ pointing to the increase in energy prices increasing inflation. The CPI figure for September increased slightly to 2.5% from 2.4%, with Core CPI remaining at 1.7% - overall not as bad as expected, but clearly the MPC remains concerned. Retail Sales in the UK fell again in September, -0.8% over the previous September, following a -1% in August. Unfortunately Producer Prices are showing that manufacturers are passing on increased prices, contributing to higher consumer prices. This is having a damaging effect to the economy and Sterling.

The Bank of Japan’s Tankan survey of business confidence was not as strong as expected (which hurt the Yen), with the trade surplus narrowing, although the BoJ is trying to foster the growth – Japanese bonds still look poor value.

We are now entering the last few months Alan Greenspan’s tenure (ending 31 January 2006) and we expect Mr Greenspan to want to say that he has ‘done his duty’ and (especially with other comments) expect the Fed Funds rate to continue to rise. With the appointment of Ben Bernanke to succeed Alan Greenspan and assuming he will want to earn his ‘spurs’, suggests that the Fed will look to tighten beyond Greenspan. As we enter the last two months of the year, risk appetites seem to be falling with managers being more cautious, while the Volatility Index (VIX) has picked from last month. Canadian rates were raised again in October, as expected by 25bp, to 3% and are likely to continue to follow US rate moves.

New Zealand inflation breached the central bank’s 1-3% band, rising to 3.4% and the central bank raised their rate to 7% (the highest in the industrialised world). Turkey, after 40 odd years of hope has gained agreement to join the European Union (at some point in the future). Although, the ultimate date of accession will be a few years away and will be the source of many an EU argument over that time.

South Africa surprised the market by reducing exchange controls. The initial worry was for capital to leave, which some will, but overall this is a positive step for the country and showed the government’s confidence in the financial system.

Oil prices are certainly easing with supply and demand more evenly balanced. While the price is now around $60 p/b. The futures price suggests it can go lower, however, with an expected very cold northern hemisphere winter you will have to be brave to go short early. Is it me or does there seem to be more ‘natural’ disasters than usual these days? (and increased fear of ones overdue).

Currency summary

• Undervalued:Canadian Dollar, Norwegian Kr, Swiss Franc
• Neutral: Australian Dollar, Euro €, Japanese Yen, Danish Kr, Sterling (£), Swedish Krona, New Zealand Dollar, US Dollar
• Overvalued:
• Attractive smaller currencies: SA Rand, Korean Won, Mexican Peso.

Evergreen International Advisors, London, 1 Nov 2005.