Plosser and Paulson Profess a stronger USD$!

Temporary relief seems to have arrived for USD$ bulls, but market psychology continues to seek positives. They have been in short supply as weaker financial reporting coupled with slashing of dividends (Wachovia) could be the norm going forward for both Tier 1 and 11, as they shore up their capital base. Job and cost paring headlines are expected to undermine consumer confidence even further. Enter Plosser and Paulson, the tag team who profess a stronger dollar policy.

The USD$ is stronger in the O/N trading session. Currently it is higher against 14 of the 16 most actively traded currencies in a ‘volatile’ trading range.

Yesterday, the greenback started to strengthen ‘across the board’ on the back of policy members declaring their support for higher interest rates and a stronger USD$ policy. Paulson reiterated his stance, commenting that higher energy prices will only prolong global economic recovery and believes that core level of inflation is ‘quite manageable’. More importantly he indicated that any Fed lending to the GSE’s ‘will’ be backed by collateral. This, he is using as bait to persuade congress to approve his rescue plan. At stake is the US financial market’s stability, he is walking a thin line, trying to keep international investors confidence up, while at the same time not creating any panic in the domestic system. Day over day headlines continues to paint a bleak scenario for the US economy. On the other hand, Fed Plosser stated that inflation is too high and officials must back their words with action. He wants policy makers to raise rates sooner than later (2.00%). He indicated that the Fed must stay ahead of the curve, citing a loss in confidence in the Fed has boosted ‘price expectations’. The Fed must not be caught short again and wait for an economic turnaround to raise rates. Bernanke actions continue to be questioned from all sides while the administration deals with a number of snowballing economic and financial issues.

The US $ currently is stronger against the EUR -0.36%, GBP -0.00%, CHF -0.47% and JPY -0.44%. The commodity currencies are weaker this morning, CAD -0.31% and AUD -0.31%. The loonie after strengthening due to M&A activity earlier in the week has come under pressure from a few fronts. Yesterday’s Canadian retail sales came in lower than expected (+0.4% vs. +0.5%, m/m). It’s worth noting that the report still shows that Canadians are spending, albeit at a slower pace. While higher prices were the major impetus for this increase, volumes still rose +0.1%. One can expect this modest pace of growth to deteriorate over the coming months as the consumer continues to face higher borrowing costs, a weakening US economy, and a cooling housing market. Next up, commodity prices, it was only a matter of time before the strong correlation between that and the loonie would get back on track. With both oil and gold falling, in time, this will add further pressure on the CAD$. Hawkish rhetoric by Plosser and Paulson has given the ‘big dollar’ a lift both optically and on an interest rate perspective. A few investors have been caught short the USD$, expecting the loonie to appreciate above parity will be better buyers on any USD$ pull backs. This morning we have the BOC key inflation indicator to digest (CPI), a coin toss for the loonie.

The AUD$ remains under pressure (0.9652) and retreated from it 25-year high as traders pare positions because of falling commodity prices and the general bullish sentiment of the USD$. Last night Aussi CPI numbers (+1.5m vs. +1.3%, q/q accelerated in the 2nd Q, the fastest pace in 2-years, adding to pressure on the RBA to leave borrowing costs at a decade high (7.25%).

Crude is lower O/N ($125.95 down -250c). With ‘Dolly’ (a tropical storm in the Gulf of Mexico) predicted to miss oil fields and refineries, has weighed heavily on crude prices. Yesterday, traders were capable of printing new 6-week lows. In an eleven day span, that’s over a $20 fall from its highs of $147.27. Since the G8 meeting, global Cbank rhetoric has tried to talk the commodity price down. Slowing economic growth combined with lower consumption and surprising inventory reports have accelerated the declining pace of late. Geo-political issues had provided some support for the ‘black gold’ earlier in the week. ‘Dolly’ is heading towards the Gulf of Mexico/Texas and may turn into a hurricane, coupled with nuclear talks between Iran and UN representatives stalling will keep traders on edge. Iran has two weeks to conform to some of the suggestions that were put forward last weekend. It looks highly unlikely that a positive response is forthcoming as Iran is expected to continue its nuclear enrichment program. That will only leave the option of more sanctions to be imposed against the country. The bias sentiment of weaker prices remains in tact, especially with the USD$ gaining support vs. the EUR after Paulson strong dollar remarks yet again. Today, traders will take their cue from inventory reports. Last weeks EIA report showed that crude inventories surprisingly jumped, any other upward surprises will have speculators looking for the door. Gold was not immune to lower prices ($958) especially as crude declined and by default diminishing the yellow metal’s appeal as a hedge against inflation.

The Nikkei closed at 13,312 up +127. The DAX index in Europe was at 6,517 up +70; the FTSE (UK) currently is 5,438 up +74. The early call for the open of key US indices is higher. Yields of the US 10-year bond backed up 10bp yesterday (4.13%) and are little changed O/N. Treasury prices remain heavy as Fed member Plosser said that policy makers should hike interest rates ‘sooner rather than later’ (2.00%) and Sec Treasury Paulson hinted that US law makers will back a bill that will boost confidence even further in GSE’s (Freddie and Fannie). Traders are expected to keep the curve cheap as the FI market prepares for the sale of $58b in government debt this week.

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