The U.S. Dollar is trading higher overnight against most
major Forex markets, buoyed by two major events: the inability of the European
Unionâ€™s rescue package to instill investor confidence in the Euro and the news
of the resignation of U.K. Prime Minister Gordon Brown. Both events are driving
traders out of risky investments, triggering an increase in demand for lower
After a one day reprieve following the announcement of the
European Unionâ€™s $1 trillion bailout package, the Euro is once again in a free
fall this morning, threatening to take out the recent bottom at 1.2518. The
historic announcement by the EU over the week-end failed to generate enough
investor confidence to support the Euro, but more importantly reaffirmed that
the destiny of the Euro is clearly in the hands of the hedge funds and large
The fact that the Euro is trading sharply lower ahead of the
session is a strong sign that the euphoria of the past 24-hours is over and
that reality has returned to the Forex markets. Simply stated, Mondayâ€™s trading
action demonstrated that traders accepted the fact that the EUâ€™s aid package
was a short-term fix and that over the long-term the economic problems in the
Euro Zone would continue to exist long after the new money was sucked into the
financial system. The post-bailout package sell-off in the Euro is also serving
as proof that the market doesnâ€™t believe that a country solves a debt crisis by
issuing more debt.
The rejection by the market of the rescue plan serves as
notice to the EU community that there is little doubt that the only way to
avoid the spread of contaminated debt in the Euro Zone is to implement further
austerity measures rather than pile debt upon debt. The overnight weakness in
the Euro is also a strong indication that the market is discounting the
inevitable that the debt of Greece,
Spain and Portugal is
getting very close to being declared â€śjunkâ€ť by the credit rating services.
Besides the fear of contagion over the short-run, Euro
investors are dealing with the real possibility that the bailout package will
be a drain on European economic growth. The implementation of the unprecedented
bailout package means that resources will be used to fill in â€śholesâ€ť in the
economy rather than sow the seeds for future prosperity. Flooding the market
with excess liquidity will force the European Central Bank to keep interest
rates low for a longer period of time. As other major central banks begin to
withdraw stimulus and hike interest rates, investors will shift investments out
of the Euro Zone and into these higher yielding currencies putting additional
pressure on the Euro.
While Euro investors deal with contagion issues, British
Pound investors are wondering what happened to the government. The decision by
U.K. Prime Minister Gordon Brown to quit has created disarray in the government
just 5 days after the recent election resulted in a hung parliament.
Speculators are selling the British Pound this morning while
the three main political parties haggle over how to structure the new
government. At this time the Labour Party and the Conservative Party are trying
to gain control of the hung parliament. The main objective of the process
taking place at this time is to convince the Liberal Democrat party to throw
its support to one of the two strongest parties.
British Pound traders are taking no chances at this time
that a solution will be reached soon. Instead they have decided to sell the
currency now and ask questions later. Even if a government is created today,
financial woes are not expected to disappear. There is still the main issue of
how to balance the budget and reduce the countryâ€™s debt load.
The longer it takes to form a government, the more impatient
traders will grow. This means that downside pressure is expected to continue
until the new government issue is settled. Furthermore, the delay in producing
a government could lead to a downgrade of the U.K.â€™s debt rating as the credit
rating services will interpret this to mean that a solution to its debt
problems may be difficult to attain in the short-run.
Today, traders should watch for a reversal of the action on
Monday. In other words, risk adverse traders are expected to sell higher risk
assets while seeking shelter in the lower yielding currencies. Look for
downside pressure on the commodity-linked currencies. Overnight, traders are
driving the Australian Dollar, Canadian Dollar and New Zealand Dollar lower. At
the same time, the lower yielding Japanese Yen is rising versus the U.S.
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