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Forex Research - Dow Rallies 936 Points, Currencies Rebound: Gearing Up For a US Announcement

Dow Rallies 936 Points, Currencies Rebound: Gearing Up For a US Announcement Last Updated 10/13/2008 5:18:30 PM EST (GMT +5)

TODAY’S BIGGEST PERCENTAGE MOVERS

 

AUD/JPY ( +625 pips or 9.65%)

AUD/USD ( +528 pips or 8.31%)

EUR/AUD ( -1356 pips or -6.52%)

THE STORIES IN THE CURRENCY MARKET

  • USD: DOW RALLIES 936 POINTS, CURRENCIES REBOUND: GEARING UP FOR A US ANNOUNCEMENT
  • EUR: EUROPEAN LEADERS AGREE ON INDIVIDUAL SOLUTIONS
  • GBP: BRITISH POUND SOARS AS UK INJECTS $64B INTO BANKS
  • JPY: RALLY IN DOW LEADS TO CARRY TRADE RECOVERY
  • CAD: FINALLY REBOUNDS AFTER FALLING 17% IN TWO WEEKS
  • AUD: GUARANTEES BANK DEPOSITS
  • NZD: RETAIL SALES STRONGER THAN EXPECTED

 

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

DOW RALLIES 936 POINTS, CURRENCIES REBOUND: GEARING UP FOR A US ANNOUNCEMENT

 

The case for a bounce in equities this week was strong following the Lehman CDS Auction and the possibility of new measures from the G7 and G20 nations in Washington this weekend. New guarantees and a host of other announcements have helped to stabilize the financial markets and ease the credit crisis, but is this the bottom or are we simply seeing a Columbus Day light volume rally in US equities?

Banks and money markets are closed today, which suggests that we may not be seeing the full reaction to this weekend’s announcements, but there is a good chance that the 936 point rally today marks a near term bottom that could lead to a move back above 9500 in the Dow. With equities at fire sale prices, investors are back in the markets. The return of risk appetite drove the EUR/USD, GBP/USD and carry trades higher while forcing the US dollar and Japanese Yen to give back its gains.

The unified response from the G7 nations and the measures taken by some of the largest economies in the world has helped to address many of the liquidity problems. The timing is also right because equities and carry trades have become so oversold leaving those investors with money itching to buy. Sentiment is extremely important these days and we have seen the market’s sentiment shift from skepticism to hope, which should lead to a reversal in the strength in the US dollar and the Japanese Yen. From the unlimited dollar funding to interbank loan guarantees, the efforts taken by governments around the world may finally be working.

Multi-prong Approach from the US Treasury

Equities have also rallied on the hope that the Troubled Asset Relief Program (TARP) and the Treasury’s plan to take equity stakes in banks will be implemented sooner than the market expected. The Treasury outlined the further details of the TARP plan this morning and said that asset managers will be selected over the next few days. The details for injecting capital directly into banks could come as early as Tuesday. Interim Assistant Secretary for Financial Stability Neel Kashkari is taking a multi-prong approach that could involve new measures to support the financial markets. If this is true, then we could see a continuation of the strongest one-day rally in the Dow ever. In addition to the details on the TARP, the US also announced that they will offer unlimited borrowing along with the BoE, ECB, SNB. There will be a fixed interest rate, taking away any uncertainty about the pricing. The size of the swap lines have also been increased to accommodate whatever dollar funding demand is needed. Basically the US Treasury is telling us that they are here to support the banks and will do all that takes to prevent another failure.

October 21 – The Hurdle to Overcome?

 

In order for this to be the long term bottom in equities, two important hurdles need to be overcome - the Oct 21 settlement of Lehman’s Credit Default Swaps and the Nov 7 settlement of WaMu’s CDS. As counterparty A forks up payment to counterparty B for the protection against a Lehman default, bankruptcies are a strong possibility as those who fall into the counterparty A group fail to come up with the money. If there are no major bankruptcies that force the US government to come up with another $100B to recapitalize an ailing financial institution, then the worst may be over.

This is the step in the right direction for all of the major world economies. If the optimism in the markets continues we could see a further correction in the US dollar and the Japanese Yen, and a recovery for the Euro and carry trades.

EUROPEAN LEADERS AGREE ON INDIVIDUAL SOLUTIONS

In a show of solidarity, European leaders have come up with a menu of measures to deal with the financial crisis. In principal, they have agreed to keep distressed lenders afloat and to guarantee new bank debt, but the menu is ala carte which means that individual governments can pick whatever they believe will work best for their individual nations. Even though, the EU leaders have sent a cohesive message to the markets, they are still using fractured responses but these fractured responses have nonetheless been powerful enough to send a wave of optimism through the Euro. Germany has set an example by providing additional liquidity for the banking system, as well as setting-aside funds to protect themselves in the event that a global depression becomes a reality. Germany’s package will total about E500 billion. France said that they will guarantee EUR320B in bank debt. As a whole, EU nations have committed EUR1.3 trillion to bank bailouts. In a slew of economic reports tomorrow, we are expecting Consumer Price numbers from both France and Italy, as well as the German ZEW Survey of Economic Sentiment. While inflation is likely to be tame, German confidence numbers could plummet to -50 from -41.1 last month. Such negative numbers express the sheer lack of confidence towards the German economy. An unexpected decline in sentiment may underscore German efforts at restoring such confidence.

BRITISH POUND SOARS AS UK INJECTS $64B INTO BANKS

The UK has announced that it will be spending more than $60 billion in an effort to avert any further bank meltdowns. Their plans include buying into and nationalizing some of the UK’s top banks. The Royal Bank of Scotland Group and HBOS will both be nationalized as the government takes a majority shareholding interest in both firms. Apparently, law makers were frightened when they learned how much trouble these firms were experiencing. In an effort that fundamentally changes the nature of banking in the UK, law makers hope that they are able to restore some strand of confidence in the UK economic system. In fact, many countries are creating similar policies that will mimic what the British government has done. This alone is a huge boost in UK credibility. After seeing the value of the pound make major declines, action was necessary to prevent the fleeing of more invested capital. Investors who were previously appalled at how long it took for the BoE to take action, are now pleased with the steps taken as GBP/USD rallies almost three-hundred points. Producer Prices came in about as expected this morning, as price levels have dropped -0.3%. Inflation will most likely be tame because commodity and oil prices have declined substantially. We expect another look into inflationary pressures in tomorrow’s Consumer Price Index, which is expected to show some decreases since last month. However, even a worse than expected report will be largely ignored since more troubling developments will be the primary focus of the BoE.

RALLY IN DOW LEADS TO CARRY TRADE RECOVERY

The more than 900 point rally in the Dow led to a major recovery in carry trades. Unsurprisingly, the biggest gainer was AUD/JPY which rose 9.8 percent on the day. In the past few weeks, AUD/JPY was the worst performing currency pair. As we indicated in Friday’s daily commentary, the JPY strengthens when volatility levels hits new highs, reflecting the inverse relationship between risk and carry-trades. As expected, VIX levels fell off more than 10% today, giving further evidence that the correlation will remain strong. A lack of important economic releases last week will be reversed this week. Later today, we expect the important Domestic Corporate Goods Price Index and tomorrow the Japanese trade numbers will be released, including the Trade Balance and Current Account. Although these numbers are important, they should only have a limited impact on the Japanese Yen.

AUSTRALIA AND NEW ZEALAND GUARANTEE BANK DEPOSITS

Like the other major countries, Australia and New Zealand have also taken steps to boost confidence and to stabilize to financial markets. Both countries have decided to guarantee all banking deposits for the period of three years. In addition Australia is tacking on bank lending guarantees and injecting almost $3 billion in order to improve liquidity. Unsurprisingly, these announcements have been positive for both the Australian and New Zealand dollars. Last night, New Zealand Retail Sales came in stronger than expected at 0.4%, compared to a -0.7% consensus. The prior interest rate cut has helped to support spending. Meanwhile the Canadian dollar has finally rebounded after falling 17 percent over the past 2 weeks. Even though no ground-breaking news has been reported, the US dollar is weaker and oil prices are lower.

GBP/USD: Currency Pair in Play Over the Next 24 Hours

 

The GBP/USD will be the currency in play for the next 24-hours. The Consumer Price Index is due for release tomorrow at 4:30 am ET or 8:30 GMT.

Referring to last week’s report on GBP/USD technical developments, the pair is still in the Bollinger band sell zone. Support is at Friday’s low of 1.6820. The resistance level we discussed last time is holding despite large gains in the pair. To find the resistance level we are using Fibonacci levels drawn from early-2001 lows to early-2007 highs. The most relevant resistance is located at the 50% retracement, or 1.7421. In addition, the one-standard deviation Bollinger Band is around this level. Through today’s price action, you could see how well this six-year retracement level has held. Highs earlier in the day respected the level as expected. Any further run-ups in GBP/USD must be led by a break of the 1.7421 level. If that happens, the downtrend should be over.

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 upon as a substitute for extensive independent research before making your investment decisions. Global Forex Trading is merely providing this column for your general information. This forum and its information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision based upon this forum or any information contained within. 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 such advice is sought, or other expert assistance is required, the services of a competent professional should be sought.

 

 

 

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