Is the ‘big’ dollar exposed to further weakness?

Once again investors are forced into risk aversion trading (flight to FI) as US financial stocks come under the microscope. Is Lehman to follow Bear’s fate? Will Paulson and Co. show the same amount of leniency or favoritism? By already setting a precedent it will be difficult for both the Fed and Treasury not to have their finger in the pie!

The US$ is weaker in the O/N trading session. Currently it is lower against 12 of the 16 most actively traded currencies in a ‘whippy’ trading range.

Yesterday, US pending home re-sales declined more than anticipated (-3.2% vs. +5.3% from June to July). Fewer American’s signed contracts to purchase previously owned homes in the month of July. Thus providing stronger evidence that slower demand will keep adding to the ‘glut’ of already unsold properties. Tighter credit conditions have been the biggest hurdle for ‘newbie’ home owners. The US government seizure of the GSE’s over the weekend, in theory is supposed to loosen some of these restrictions. The Fed’s objective is to instill financial stability and consumer confidence. Paulson’s new mandate is to ensure that mortgage funds remain available and to ‘minimize further declines in the housing market’. Of course this objective will take some time to percolate throughout the economy. House prices in most regions have declined almost 16% y/y. The build up of unsold inventory will only pressurize prices even more. Analysts believe that the market needs to absorb ‘foreclosure stocks’ before any traction can be achieved.

Financial failure fears are dominating global equities and forexland. Lehman holdings once again have found fault with the market after talks about a capital infusion from Korea Development Bank (KBD) ended yesterday. Market perception has us believing that they will eventually go under because ‘they are wreck-able’. Capital markets question if Treasury will intervene again if they or some other financial firm falters? (Just like the Bear Stearns saga or the GSE’s over the weekend). It cannot be a ‘done’ deal; currently there is only a limited amount that Paulson and the Treasury can do. The market cannot always be relying on them as a natural back stop for their indiscretions. Saving Bear Stearns should be considered a precedent thus for now it is not a clear-cut ‘yes’.

The US$ currently is lower against the EUR +0.12%, GBP +0.22%, CHF +0.22% and higher against JPY -0.51%. The commodity currencies are higher this morning, CAD +0.42% and AUD +0.62%. Canadian housing starts surprised to the upside yesterday (+211k vs. +194k) and did very little to support the loonie. Despite mixed commodity prices the Canadian currency continues to flounder in ‘no mans’ land (only a matter of time). The currency has lost 5% of its value since oil ‘peaked’ 2-months ago. The loonie is trading within a very tight range despite the greenback outperforming against most of its major trading partners. Canada continues to be guilty by ‘association and proximity’ to its largest trading partner south of the border. The country exports over 70% of goods to its southern neighbor. The fundamentals of late remain weak and commodity prices seem to be artificially held up by ‘nature’ which does not bode well for its future value. Expect Canada to be pre-occupied with the snap election called for Oct 14th over the next few weeks.

The AUD found some technical support in the O/N session (0.8070), despite global equity losses convincing investors to pare holdings of higher-yielding assets. The market continues to digest and understand the seizing actions of the US government of the GSE over the weekend. Investors are concerned that the takeover of Fannie and Freddie will not end losses for financial institutions or avert a global slowdown, but for now the initial market reaction may have been over done.

Crude is higher O/N ($103.89 up +0.63c). OPEC comments pressurized oil prices again yesterday and managed to print new 5-month lows. According to Saudi Oil Minister Ali Al-Naimi speaking in Vienna, the oil market was ‘well- balanced’ and that inventories remained ‘healthy’, concluding that supplies were sufficient to meet global demand. This had the market convinced that OPEC will maintain their output pace. With the OPEC insurance premium been taken out of the equation (potentially cutting production) and Hurricane Ike deviating away from oil platforms in the Gulf (for now anyway), the market wanted to see a sub $100 a barrel, but, it seems that OPEC will try to prevent this. OPEC President Khelil called on members to stop producing more than the group’s set quota, a move that would reduce supplies by +520k barrels a day. They are not cutting ‘production’; they are cutting ‘over-production’. It will be interesting to see how the market reacts this morning, especially with the EIA headline. Hurricane Ike presently has weakened to a Category 1, but is expected to strengthen as it heads west into the Gulf of Mexico on a course that is expected to miss most of the oil installations. Oil companies continue to keep employees onshore (the ones who were moved out of the path of Hurricane Gustav last month). Analysts predict that 80% of the region’s oil output and 70% of its gas production continues to remain shut. So weather watching will remain the order of the day. Crude has lost 10% of its value over the past week. Expect an eye popping EIA headline this morning due to the weather conditions. Gold is finding it difficult to find any traction and dropped to a 10-month low ($778) as falling energy costs and a strengthening greenback has reduced the demand for the ‘yellow metal’ as a hedge against inflation.

The Nikkei closed at 12,346 down -54. The DAX index in Europe was at 6,206 down -26; the FTSE (UK) currently is 5,396 down -20. The early call for the open of key US indices is higher. 10-year Treasury yields eased 7bp yesterday (3.61%) and are little changed O/N. US duration is now more attractive for foreign official institutions, and speculators are looking for a bull flattener to occur pushing longer yields lower. Investors continue to believe that despite the US government seizing the GSE’s the economic slowdown will worsen. With global equities under pressure has traders seeking the safety of the FI market.

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