Are Forex Markets waiting for a ‘vetoed’ plan to support the greenback again?

A day of reckoning by political pundits commences. The ‘naysayer’ will have to be convinced by delayed promises, to get their vote and push through the ‘toxic waste plan’. Capital markets can only sustain so much damage before ‘it’s declared broke’.

The US$ is weaker in the O/N trading session. Currently it is lower against 13 of the 16 most actively traded currencies, in another ‘whippy’ trading range.

A religious holiday prevented US lawmakers and political lobbyists from persuading the ‘naysayers’ to return a more positive response to Treasury Paulson $700b bank bail-out package. President Bush has urged the passage of the legislation, thus preventing ‘lasting damage’ to the economy. Global equity markets yesterday pared some of the record one day losses, on renewed hope that congress would come back today and try to get the amended plan through. Policy makers have a sole objective and that’s to restore confidence in the capital markets. This will reduce fear, and get banks back into the business of lending money. The contagion of the financial crisis continues to spread further afield. More European financial institutions seek the financial assurance from Euro governments. This week, the Irish government decided to underwrite ‘all the borrowing, loans and deposits’ of Irish-regulated banks. It was a necessary move, designed to ‘safeguard the Irish financial system’. Let’s see if both the senate and congress follow suit and perhaps raise FDIC’s limits!

The S&P/Case-Shiller Home Price index (2-month old data) continues to record falling house prices in 20-US cities yesterday. The data continues to record the fastest decline on record (-16.3 vs. -15.9, y/y). This is further proof that the worst housing recession in a couple of generations has yet to find a bottom. That is now 18-consecutative months of declines. The fact that house prices have quickened their slide before the worst point in credit markets hit last month, does not bode well for continued losses in household wealth. Falling demand is pushing down property values further and causing record foreclosures to mount. One can expect Banks to further curtail their lending practices over the coming months to limit losses. The heightened credit squeeze is forcing Banks to hoard cash at record speeds. This will result in the real estate market to speed up their contraction and consumer spending to continue to falter.

The US$ currently is lower against the EUR +0.38%, GBP +0.00%, CHF+0.43% and higher against JPY -0.06%. The commodity currencies are stronger this morning, CAD +0.77% and AUD +0.88%. Canadian July GDP surprised the market and beat all expectations (+0.7% vs. +0.1%). A July reading is nothing but, a historical footnote in these markets. It is bound to give way to the reality of a much weaker economy (already outlined last week by Governor Carney) once relevant data pushes into the current environment. The main positive drivers of energy, manufacturing and banking will not repeat themselves. The energy patch drove half of the gain via a one-off surge in production due to the combined effects of the completion of maintenance at some oil production facilities, and a surge in natural gas production. Manufacturing activity has also contributed (up +1.3% in July). But, with the US economy rapidly deteriorating, it does not bode well for future Canadian manufacturing exports. Other data yesterday revealed that raw materials prices declined faster than expected in Aug. (-7.7% vs. +1.6%), while industrial product prices declined at a slightly slower than expected pace (-0.2% vs. +0.6%). The loonie remained under pressure and declined the most in nearly a month as the greenback managed to appreciate against most of its major trading partners. Despite oil prices advancing, none of the strength spilled over into the currency market. The ongoing global credit squeeze has investors shying away from riskier growth currencies like the loonie. Capital market remains focused on the US financial aid package progress through both US houses before it becomes written in law. US law makers are going back to the drawing board and are looking to amend a ‘set of principles’ for a financial rescue plan to inject fresh capital into the paralyzed credit markets. Capital markets believe ‘a’ plan will stabilize the US economy, but weaker global fundamentals will dictate stagnant growth, which will surely hinder the performance of commodity currencies in the short term. The bulls will have to wait until the financial aid package is passed before the loonie has any short term hope of appreciating. Governor Carney last week indicated that any further slowdown in the US economy will affect areas that matter most to Canada. This should give Governor Carney the latitude to ease O/N borrowing costs (3.00%) by year end, as the downside risks for slower growth will intensify. Expect traders to be better sellers of the CAD$ on USD$ pull backs in the short term until proven wrong.

Despite the AUD dollar advancing in the O/N sessions on the back of higher commodity prices (0.8031), traders expect the currency to underperform vs. the greenback in the short term. Investors continue to speculate that the RBA will slash O/N borrowing costs (7.00%) this month by 50bp. This will encourage banks to boost lending amid a global credit freeze, rather than hoarding cash and to combat slowing economic growth down under. The currency trend is still to the downside with the greenback likely to strengthen, expect global growth concerns to take commodity prices lower.

Crude is higher O/N ($102 up +142c). Crude oil advanced yesterday, one day after it fell the most in 7-years (-9.9%), as US lawmakers said they intended to salvage the $700b bank-rescue package that may avert a deep economic slowdown. The US Senate will attempt to revive the bill later today. All technical and fundamentals have been discarded; future short term oil prices will be dictated by the passing or failure of ‘this financial package’. To date, prices have retreated 32% from their record high print back in July. Even if the financial aid package is vetoed, there is no guarantee that a global economic meltdown may be averted. Perhaps it may only be ‘the pace’ that can be adjusted. Organized covert operations by CBankers (orchestrated global rate cuts) may also be required to renew consumer confidence. Traders are betting that the Fed will cut O/N borrowing costs later this month, potentially supporting future fuel demand. Futures have priced in a 28% chance of a 50bp cut to 1.50%. This time last week, no rate change was priced in. The global economy remains very fragile, economic activity in Europe seems to be collapsing faster than in the US. The bail-out package does not guarantee that there will be no more bank runs or that the US economy will recover anytime soon. President Bush said the legislation ‘will help keep the crisis in the financial system from spreading throughout the whole economy’. Further Bank bailout yesterday in Europe (Dexia SA in Belgium) continues to pressurize the EUR and Sterling respectively. This mornings EIA report is expected to remain consistent with the 4-week moving average. Gas inventories are already at a 41-year low and are expected to decline further due to the disruption and temporary closure of platform operations in the Gulf of Mexico during hurricane season last month. Gold pared some of this weeks gain yesterday, as global equities rallied in tandem with the big dollars record gains vs. the EUR. This has persuaded investors to shy away from the ‘yellow metal’ as an alternative investment vehicle. Gold has advanced in this morning’s London session ($884) as the greenback trades under pressure.

The Nikkei closed at 11,368 up +108. The DAX index in Europe was at 5,824 down -7; the FTSE (UK) currently is 4,991 up +89. The early call for the open of key US indices is lower. 10-year Treasury yields backed up 17bp yesterday (3.83%) and managed to ease 8bp O/N (3.75%). Treasury prices plummeted a day after printing record gains as traders speculated that US lawmakers would be able to salvage the ‘toxic waste plan’, thus allowing liquidity to flow again within the credit markets. With Global equity markets paring 50% of this week’s loss had investors shying away from the safe heaven asset class. Capital markets believe that the financial aid package will be tabled again and vetoed. But, not everyone believes that the plan will help the US avoid a recession entirely. Hence, this has encouraged the appetite for higher yielding product.

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