The success of the Federal Governmentâ€™s rescue of the US financial
system may not be known conclusively for several weeks or even months.But the currency market reaction is already
charted.From mid-July until mid-September
the dollar gained almost 13.5% against the euro. In the past two weeks, as
Lehman filed for bankruptcy, AIG sold itself to the government and Merrill
Lynch fled to Bank of America, the dollar gave back half of that gain.
Has this latest phase of the financial crisis forced a
fundamental revision in tradersâ€™ view of the US dollar? Or did the news hit a currency
market ripe for a profit taking reversal after the dollarâ€™s recent record
setting climb.Were the events of the
past week a trigger or an earthquake or both?
The financial contagion that originated in the US housing
market is a worldwide phenomenon. It has infected equity and financial markets
around the globe. Russian, European,
Asian and British equities have suffered substantial losses. Credit markets in
Europe have experienced widening of spread premiums for securities other than
the safest grade as in the US
credits markets. For a time last week US Treasury notes were sold with zero
interest so great was the pressure in panicked capital markets for
Debt from the US markets and particularly from
the government sponsored enterprises Fannie Mae and Freddie Mac was packaged
and sold to institutions in every global financial center.The Washington Government had no choice but
to make their implicit guarantee explicit. But financial problems were hardly
limited to US institutions.
In Europe Fortis, Belgiumâ€™s
largest financial services firm, received a 11.2 billion euro infusion from the
governments of Belgium, the Netherlands and Luxembourg in return for equity
stakes in the company. The shares of Fortis fell 20% in two days
trading last week. Its price is off 71% over the past year. Officials
are reportedly seeking a buyer for all or part of the company and have not
ruled out nationalization as a last resort.
Bradford and Bingley the nationâ€™s largest
lender to landlords was seized by the UK Treasury to protect
depositors. Its shares have fallen 93% this year. This would be Britainâ€™s third
major bank forced to end its independent existence. In February Gordon Brownâ€™s
government nationalized Northern Rock Plc, and HBOS Plc sold itself to Lloyds
on September 18th.
the share price of Natixis, the fourth largest French bank,
fell 20% in Monday trading. It has lost 76% of its value over
the past year.
After much drama and election year politicking the US
Congress will pass the rescue measure this week.It will be a bill largely unchanged in its
effective provisions from the one proposed by Treasury Secretary Paulson a week
ago.Congress will pass the bill because
it dare not do anything else lest it risk blame for the ensuing recession. It will provoke voter wrath (the American
public is against the rescue) even as it attempts to absolve itself from its
very large guilt in creating the sub prime debacle and refusing to perform its
legal oversight of Fannie Mae and Freddie Mac.
As this crisis is one of confidence, the Federal rescue with
its real relief for bank balance sheets, should succeed in restoring a functioning
market, if not in returning unbounded confidence.Banks will lend to each other and the normal
round of electronic credit will gradually resume.
financial rescue will also calm the worldâ€™s financial markets and rescue the
dollar, at least for the time being. The
collapse of the American investment bank sector will prove to have been a
trigger for profit taking rather than a fundamental rethink of the European and
American relationship.The currency markets
will return to the comparison of the economic situations of Europe and the United States, with the advantage still likely
to fall with the US,
though that will require statistical proof.
The Fed has proved staunch this time by not cutting rates to
deal with a liquidity and confidence crisis.If the rescue succeeds in alleviating the financial panic and restoring
a portion of normal credit practice, Mr. Bernanke may not be tempted to cut
rates again.For the European Central Bank
(ECB) governors the story is the opposite. Inflation is retreating. The money
supply, unmentioned by the ECB recently, is now at 8.8%, not that far from the
official target of 8.0%.Despite their
rhetoric the ECB governors will be sorely tempted to cut rates soon.The dollar could benefit on both the economic
and interest rate fronts.
But in the longer analysis the addition at one stroke of so
much potential debt to the Federal balance sheet could well give pause to
foreign investors.These are the
investors the government needs to fund the US deficit.
The unthinkable has happened to Americaâ€™s financial institutions.
In the space of a little over half a year every independent investment bank has
disappeared. The financial markets have just been treated to the terrors of a collapse
of credit confidence.
The US Government is addicted to deficit financing. This is
not a scheme that can go on forever. One can justifiably ask, what else except
historic confidence supports the belief that the US government can continue its
profligate ways?If investors begin to
consider the unthinkable for US
debt, then no amount of US economic growth will suffice to support the US
Dollar. If the worldâ€™s investors begin to reconsider US credit, this current crisis
will have been like the earthquake that produces a tsunami five thousand miles
Chief Market Analyst
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Tue 17 July 2018 AA 08:30 GB- Employment A 13:15 US- Industrial Production AA 14:00 US-Powell Testimony Wed 18 July 2018 AA 08:30 GB- CPI A 12:30 US- Housing Starts/Permits AA 14:00 US-Powell Testimony Thu 19 July 2018 AA 1:30 AU- Employment AA 08:30 GB- Retail Sales A 14:30 US- EIA Crude A 12:30 US- Weekly Jobless Fri 20 Jun 2018 A 12:30 CA- CPI/Retail Sales
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