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Forex Blog - Dollar Rallies as Agreement is Reached on Bailout Plan

Dollar Rallies as Agreement is Reached on Bailout Plan Last Updated 9/25/2008 5:39:25 PM EST (GMT +5)

TODAY’S BIGGEST PERCENTAGE MOVERS

CAD/JPY ( +74 pips or +0.72%)

GBP/CHF ( -140 pips or -0.68%)

AUD/JPY ( +55 pips or +0.64%)

THE STORIES IN THE CURRENCY MARKET

  • USD: RALLIES AS AGREEMENT IS REACHED ON BAILOUT PLAN
  • EUR: WHAT’S IN STORE
  • GBP: FALLS FOR THE THIRD STRAIGHT DAY
  • JPY: JAPANESE BANKS ON BUYING SPREE
  • CAD: OIL PRICES RISE TO $107 A BARREL
  • AUD: WEAKER ECONOMIC DATA FAILS TO HURT THE AUD
  • NZD: IS NEW ZEALAND IN A RECESSION?

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

DOLLAR RALLIES AS AGREEMENT IS REACHED ON BAILOUT PLAN

The currency market never responds favorably to uncertainty and when a plan is in place and there is hope, relief is expected. This is exactly what we saw in the stock market and the US dollar today, as they both rallied on the announcement of a tentative agreement to Paulson’s $700B Troubled Asset Relief Program (TRAP). Gold prices also fell by more than $6 an ounce while Treasury prices eased, confirming there is big sigh of relief that the wheels are in motion. In order to get the deal done, the Treasury actually had to compromise significantly. According to the tentative deal, they can only access the funds in installments and they agreed to limits on executive pay. Furthermore, the last $350B could be blocked by Congress if they were not satisfied with Paulson’s efforts. At this point, it is reasonable to expect that a full announcement would be made no later than the beginning of next week. In fact, a plan could come as early as Friday. Congress goes on recess at the end of next week, which is why a plan needed to be approved now, especially since Obama and McCain have been called to Washington to meet with President Bush for a negotiating session and a photo-op.

Hungry for Treasuries

Despite the rally in the US stock market and the dollar, there is still plenty of evidence that Main Street and Wall Street investors are erring on the side of caution. For example, the 3 month LIBOR rate and the TED spread that we have been talking about for the past few days continued to rise. Yesterday, LIBOR was at 3.47 percent and today it increased another 29 basis points to 3.76 percent. The TED spread continues to hang near 300bp while the spread between LIBOR and Overnight Index Swaps (OIS) neared its historic highs. Lending between banks has been frozen and so far, the Treasury’s plan has not thawed the credit markets. On the retail level, the US Mint announced that they have stopped selling the 24-karat gold American Buffalo coin because demand is exceeding supply. When the average American starts to question the value of their paper money, we know that the US financial markets are in serious trouble.

Economic Data at Depression Levels?

It certainly doesn’t help that the latest economic reports have hit depression like levels. That of course is a bit of an exaggeration, but still the turmoil that we have seen in recent months can only be matched by the Great Depression. New home sales fell below the 500k make or break mark for the first time in 17 years. The last time we saw new home sales at these levels was during Bush Senior’s Administration. As we mentioned yesterday, even if prospective homeowners have the money for a down payment, they are having a very difficult time securing mortgages. The 30 year mortgage rate increased to 6.03 percent from 5.78 percent last week. Jobless claims also climbed to 493k, the highest since 2001. We expect September non-farm payrolls to be very ugly and to add salt to the wound, durable goods orders dropped 4.5 percent last month, suggesting that third quarter GDP will be particularly weak. Although the economic reports have failed to put a dent into the US dollar, the euphoria in the markets could be short lived since the stock and currency markets have been very fickle. In fact, the dollar’s strength was only limited to the Japanese Yen, British pound, Swiss Franc and Canadian dollar. The Euro, Australian and New Zealand dollars actually strengthened against the greenback. The final figures for second quarter GDP and consumer confidence for the month of September are due for release on Friday. In the meantime, we still believe that the long term impact of the Paulson’s plan is dollar negative. As indicated by the Fed interest rate expectations table above, the market is pricing in an 82 percent chance of a 25bp rate cut in October.

WHAT IS IN STORE FOR THE EUR/USD?

The tentative bailout plan has failed to phase the EUR/USD. The currency pair rallied at the beginning of the US trading session but gave back most of its gains throughout the remainder of the trading day. Although we are bearish the US dollar against the Japanese Yen, we continue to believe the EUR/USD will be range-trading for the remainder of the year. Weak economic data in the Eurozone has led many people to ask if the Euro can hold onto its gains. To answer this question, it is important to realize that it is the systemic risk in the US financial markets that is driving the Euro higher and the US dollar lower. German and French banks have undoubtedly been affected by the US financial crisis, but so far, no German banks have failed. Their leverage ratios are not as high and as a result, they are better equipped to whether the storm. Furthermore, oil prices continue to rise which will encourage the European Central Bank to keep interest rates on hold. To many people’s surprise, we even saw consumer confidence improve in October. The Eurozone economy has its weaknesses but for the time being, the greater risk still lies in the US financial system.

BRITISH POUND FALLS FOR THE THIRD DAY

For the third consecutive trading day, the British pound weakened against the US dollar. Given that there was no economic data released and nothing is expected on Friday, the currency pair traded entirely off of the market’s appetite for US dollars. Like her other counterparts at the Bank of England, Kate Barker was worried about the implications of the credit squeeze but said that it was too early for the central bank to take their focus off of inflation. With oil prices trading at $107 a barrel, she has a good reason to be more concerned. Crude prices have been very volatile and rather than cutting interest rates prematurely, the BoE and ECB have been smart to be skeptical about the prior sell-off in oil prices because it didn’t last. In yesterday’s Daily Currency Focus, the GBP/USD was our “Currency in Play.” Interestingly enough, we said that there could be a potential move to 1.8308, which happened to be today’s low.

JAPANESE BANKS ON BUYING SPREE

USD/JPY continue to be move in lockstep with equity prices. With the exception of GBP/JPY, all of the other Japanese Yen crosses gained strength today. However the strength could be fleeting if stock prices failed to extend their gains. We continue to believe that this is a difficult market for carry traders. As evidenced by the rise in LIBOR rates and the TED spread, risk aversion still dominates. The only good thing that can help the Japanese Yen crosses is the buying spree by Japanese banks. They have a reputation of being far less leveraged than their Western counterparts and it is finally paying off. Japan’s largest bank, Mitsubishi UFJ spent $8.4 billion US dollars to buy a stake in Morgan Stanley while Nomura, Japan’s largest broker bought the Asian, European and Middle Eastern divisions of Lehman Brothers for a bargain price of $230 million US dollars.

IS NEW ZEALAND IN A RECESSION?

Easing risk aversion has driven the Canadian, Australian and New Zealand dollars higher against the greenback despite weak economic data. Australian leading indicators were flat in the month of July while new home sales continued to fall. New Zealand’s current account to GDP ratio dropped from -7.9 percent to -8.4 percent, which is indicative of a deteriorating trade position. New Zealand GDP is due for release this evening. Consumer confidence improved while retail sales were strong in the second quarter which should help to boost growth, but the deterioration in trade will be a big drag. The market is looking negative quarterly GDP growth. If this materializes, New Zealand would have seen 2 consecutive quarters of negative GDP, which is the definition of a technical recession. This would also add pressure on the Reserve Bank of New Zealand to cut interest rates again this year.

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

The second quarter GDP report for New Zealand is scheduled for release at 6:45pm ET or 22:45 GMT. The market is looking for GDP growth to fall by 0.5 percent and given the offsetting factors of stronger retail sales and weaker trade, the data is a tough call.

Technically, the NZD/USD is in the “range trading zone,” which we determine using Bollinger Bands. There is very significant resistance around the 0.6900 level. Not only has it been the daily high for the past 5 trading days, but it is also capped by the 23.6% Fibonacci retracement of April to September sell-off and the first standard deviation Bollinger Band. If the currency pair manages to break above that level, there is no major resistance until 0.70. If on the other hand, it breaks today’s low of 0.6798, we could see a move down to 0.67 cents.

 

 

 

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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