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Forex Blog - Dollar Consolidates as Traders Wonder if TARP Equals TRAP

Dollar Consolidates as Traders Wonder if TARP Equals TRAP Last Updated 9/24/2008 5:57:41 PM EST (GMT +5)

TODAY’S BIGGEST PERCENTAGE MOVERS

USD/CHF ( +60 pips or +0.55%)

EUR/NZD ( -91 pips or -0.45%)

EUR/AUD ( -96 pips or -0.42%)

THE STORIES IN THE CURRENCY MARKET

  • USD: CONSOLIDATES AS TRADERS WONDER IF TRAP = TARP
  • EUR: COULD THE EURO REPLACE THE DOLLAR IN TIME OF CRISIS
  • GBP: UK ECONOMY MAY BE IN A RECESSION
  • JPY: CURRENCY VOLATILITIES REMAIN HIGH, BE CAREFUL WITH CARRY TRADES
  • CAD: NEARING A TOP?
  • AUD: GOLD PRICES DROP $10
  • NZD: SURPRISING IMPROVEMENT IN CARRY TRADES

EXPECTATIONS FOR UPCOMING FED MEETINGS

 

** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THE PROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE

US DOLLAR CONSOLIDATES AS TRADERS WONDER IF TARP = TRAP

For the second day in a row, Federal Reserve Chairman Ben Bernanke and US Treasury Secretary Paulson pleaded to the power players of Washington to pass their request for $700 Billion to implement their Troubled Asset Relief Program (TARP). However if we move the letters around a bit, TARP becomes TRAP and that is exactly how many investment managers, economists, politicians and average Americans view the plan. They are afraid that this is a trap for US taxpayers because they may be paying for a bailout that benefits the private and not public sector. Bernanke argues that a failure of the private sector would have “grave” consequences for the public sector, which is true and Paulson has finally agreed to accept limits on executive pay under the bailout plan. Yet, today’s price action in US stocks and the US dollar suggest that some investors are holding out the hope that Paulson’s TARP does not become the trap that keeps Americans still paying for bailout many years to come.

LIBOR Rates Jump, TED Spread Widens

Other investors on the other hand are more skeptical. Three month LIBOR rates jumped 26 basis points to 3.47 percent, which is the highest level since January. The TED spread, which measures the difference between the interest rates of the 3 month LIBOR and the 3 month Treasury bill hit an intraday high of 311 basis points. Not only is this only the second time in 2 decades that the TED spread has gone above 300bp, but the premium is far above its pre-credit crunch levels of 20 to 30 basis points. The greater the TED spread, the greater the degree of risk aversion and the fear of default in the market. Therefore the jump in the LIBOR and the widening of the TED spread suggests that investors are still hoarding their cash and they are skeptical of whether the government’s efforts will actually restore stability in the financial markets and improve risk appetite.

Paulson’s Plan Could be a Lose-Lose for the US Dollar

Paulson’s plan is ultimately a lose-lose situation for the US dollar. If it is approved, it would cause a destruction of the US balance sheet by increasing the nation’s debt ceiling by 6.6 percent to $11.315 trillion. If it is not approved or if Paulson and Bernanke only get a trimmed down version of the plan, they would have to go back to the drawing board to come up with other solutions to unclog the mess. If we end up being between rescue plans, the uncertainty would weigh on the US dollar. Therefore I still believe that the US dollar could fall another 5 percent over the next few months.

Home Sales, Durable Goods and President Bush

Existing home sales dropped by 2.2 percent last month while mortgage applications plunged by 10.6 percent, the largest decline since July. The ongoing turmoil in the financial markets has made it increasingly difficult for even people with money to buy a home to secure loans. House prices continue to fall with the median price declining 9.5 percent from last August, causing more homeowners to pull their houses off market. The inventory of unsold homes dropped 7 percent, which was the largest decline since December 2006. In times of strong growth, a reduction of inventory may be good because it could suggest that demand is strong, but in times of weak growth, it suggests instead that homeowners are giving up on selling their homes now. Durable goods, jobless claims and new home sales are due for release Thursday morning. We continue to expect economic data to confirm that the US economy is weakening. President Bush will also be giving a nationally televised address on the financial crisis on tonight. Although we do not expect any groundbreaking announcements, his comments could nonetheless be somewhat market moving for the US dollar.

IS THE EURO REPLACING THE US DOLLAR IN THIS TIME OF CRISIS?

German business confidence dropped to the lowest level in more than 3 years, yet the Euro managed to hold onto most of its gains against the US dollar. For traders, this price action may be befuddling because in many ways, the Eurozone faces the same degree of slowdown risk as the US. However the strength of the EUR/USD does not reflect the market’s sentiment towards Euros, but instead its distaste for US dollars. Central banks could be considering reserve diversification out of US dollars and into Euros, but we do not believe that the Euro is replacing the dollar in this time of crisis. Both regions are plagued with their own problems and it may just be a matter of time before the Eurozone’s problems become a bigger story. Instead, we continue to believe that Gold is the currency of choice. If the problems exacerbate, the flight to quality should be into gold and out of US dollars. Meanwhile the latest rise in oil prices should give the European Central Bank another reason to keep interest rates on hold. Oil prices continue to drive the price action of the EUR/USD. The currency ended the US trading session near its lows as oil slid from a high of $109.50 to $105.15 a barrel.

BRITISH POUND: UK ECONOMY MAY BE IN A RECESSION

The British pound slipped against the Euro and US dollar despite an improvement in the CBI Distributive Trades survey. Although the data indicates that consumer spending declined for another month, the pace of deceleration has slowed. It is important to point out that UK consumers have been surprising resilient. The CBI has been forecasting negative consumer spending since April, but retail sales actually increased 3 out of past 5 months. However it remains to be seen whether the strength in the British pound can last. Earlier this week, outgoing MPC member Gieve was wishy washy about his comments, giving us little color on the Bank of England’s monetary policy bias. This evening, MPC member Sentance was relatively grim when he said that the UK economy “may be in a recession.” However he also said that the central bank should not overreact to the volatile markets and that they should be pragmatic on curbing the jump in consumer prices. In other words, Sentance acknowledged the problems with growth but suggests that this may not be enough to convince the BoE to cut interest rates.

CURRENCY VOLATILITY REMAIN HIGH, BE CAREFUL WITH CARRY TRADES

Despite the minor weakness in US stocks today, most of the Japanese Yen crosses ended the US trading session slightly higher. For some traders, this may be encouraging, but we continue to warn our readers against any big positions in carry trades. The sharp rally in LIBOR rates and the widening of the TED spread confirms that risk aversion still dominate the markets. Volatilities in currency also remain high. For example, the 1 month at the money implied volatility of the EUR/USD is at 14 percent. At the beginning of the year, the volatility was around 8 percent. The 1 month volatility of USD/JPY is 16.3 percent, which is sharply higher than the 10 percent volatility that we saw in the beginning of the year. Although some may argue that the high level of volatility foreshadows a fall in volatility, we think that the greater takeaway is that currency traders are still nervous and therefore carry trades should underperform. Picking a top in volatility can sometimes be as frustrating as picking a top in the EUR/USD.

CANADIAN, AUSTRALIA, NEW ZEALAND HOLD STEADY DESPITE DROP IN OIL AND GOLD PRICES

The Canadian, Australian and New Zealand dollars held steady despite the drop in oil and gold prices. Economic data was mixed with Australian skilled vacancies falling 3.5 percent and New Zealand consumer confidence jumping from 81.7 to 104.8. The improved sentiment was largely due to the rate cuts by the Reserve Bank of New Zealand and the recent drop in commodity prices. The recent rally in the Australian, New Zealand and Canadian dollars has been impressive, but based upon the latest price action, they could be nearing a short term top. There are no major economic releases from the 3 commodity producing countries for the next 24 hours. Therefore the price action of the CAD, AUD and NZD should be determined by the move in oil and gold prices or the market’s sentiment towards US dollars.

GBP/USD: CURRENCY PAIR IN PLAY OVER THE NEXT 24 HOURS

The only major releases over the next 24 hours are from the US. Durable goods and jobless claims are due for release at 8:30am ET or 12:30 GMT while new home sales will be released at 10:00am ET or 14:00 GMT. The EUR/USD should continue to be a big focus, but since we have written about the EUR/USD for 2 days in a row, we are shifting our focus to the GBP/USD. As trading will be dictated by the dollar both the GBP/USD and EUR/USD should behave in similar manners.

The GBP/USD has staged a very impressive rally over the past few weeks and it is now trading within our “Buy Zone” which is established using Bollinger Bands. In these situations, we would be looking for opportunity to buy on dips, but before that opportunity arises, we may see the GBP/USD fall below 1.8350. The currency pair is currently testing the 38.2 percent Fibonacci retracement of the 2.0157 to 1.7447 bear wave. If the currency continues to fall, support would not come in until 1.8308, the first standard deviation Bollinger Band and Monday’s low.

 

 

About The Author

Lien has extensive knowledge within the interbank market, particularly in trading spot FX and options. She has written for numerous publications, is frequently quoted on financial media outlets, and is the author of several books, including Millionaire Traders. Read more >>

DISCLAIMER: This forum and the information provided here should not be relied on as a substitute for extensive independent research before making your investment decisions. Global Forex Trading is merely providing this column for your general information. The views of the author are not necessarily those of Global Forex Trading, its owners, officers, agents or employees. In addition, any projections or views of the market provided by the author may not prove to be accurate. Global Forex Trading and Kathy Lien will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained in this column. Global Forex Trading and Kathy Lien do not render investment, legal, accounting, tax, or other professional advice. If investment, legal, tax, or other expert assistance is required, the services of a competent professional should be sought.




 

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