Lehman bankruptcy pressurizes USD in Forex!

Lehman finding a suitor was like finding ‘gold at the end of a rainbow’. With no ‘knight in shining armor’ appearing, the 158-year old company filed for chapter 11 this morning (listing $613b in debt), shattering consumer confidence, equities and the FI asset class. The Fed once again is under pressure, as the melt-down of ML and Lehman change the landscape and rules of Capital markets. The ‘domino effect will persist’. Will this change Bernanke and Co’s way of thinking for tomorrow’s FOMC?

The US$ is weaker in the O/N trading session. Currently it is lower against 10 of the 16 most actively traded currencies in another ‘volatile’ trading range.

On Friday, US retail sales fell by -0.3% m/m in Aug. from a downward revised -0.5% decline in July. The data highlights the effects of the tax rebates, which were supportive of sales in the early summer, and now have declined. Sales have been influenced by two opposing variables. First, the weaker variable, lower gas prices have led to a -2.5% drop in gas station sales. On the other hand, there was a +2% increase in auto-sales following a -4.6%% decline in July. Most of the other sub-components were generally softer (from technology to dept. store sales). Analysts believe this will continue to provide a drag on 3rd Q GDP. Despite the data being weaker than expected, the greenback continues to underperform against most of its major trading partners as US growth and further financial losses may influence the Fed’s O/N borrowing costs (2.00%). Expect capital markets to be focusing on tomorrow’s highly anticipated FOMC meeting statement and on ‘other cockroaches in the closet’! Consensus has stable rates to be a done deal, but, the wording of the announcement will be crucial in determining whether policymakers have changed their view on the risks to growth and inflation. With lower oil prices (-32% in 2-months), inflationary pressures have started to ease. On the other hand, other data (like retail sales) suggest that growth will be subdued in the 2nd-half of the year. One can expect Bernanke and Co. to express concerns about the ‘softening’ economy and further deterioration in the labor market (as per the Beige book). Do not be surprised to see a less ‘hawkish’ communiqué or dare I say a dovish tone!

The US$ currently is higher against the EUR -0.53%, GBP -0.44%, CHF -0.33% and lower against JPY +0.84%. The commodity currencies are weaker this morning, CAD –0.58% and AUD -0.89%. The loonie received support from a couple of sources on Friday. Despite printing yearly lows earlier in the week, the CAD dollar has roared back in fine form on the back of a ‘broad based US$ weakness’. A small rebound in commodities last week provided some support (with hurricane Ike missing most of the production platforms-elevated oil prices will not be sustainable). With persistent softer data being reported south of the border, interest rate differentials are beginning to take a grip on the greenback’s value. BOC governor Carney sees Canadian rates as being ‘appropriately accommodative’ while inflationary pressures ‘remain elevated’ (3.00%). The Fed meets tomorrow and analysts believe that policy makers will ease rates by 25bp in Oct. Expect traders to be better buyers of US$ on pull backs as Canadian economic data remains soft. On Friday, Canadian industrial production capacity fell to its lowest level in 16-years last quarter (78.9% vs. 79.6%), as demand from the US continues to wane. Commodities, which account for about 50% of Canada’s exports, continue to weaken with the slowdown in the global economy. The currency has lost 5.0% of its value since oil’s registered its highs 2-months ago. Politically and economically Canada will be pre-occupied with its general election slated for Oct 14th over the next few weeks.

The AUD and NZD traded under pressure, especially vs. the JPY as investors were willing to aggressively unwind recent carry trades and enter into ‘risk aversion’ deals. Traders are beginning to speculate that the Fed may need to cut o/n borrowing costs (2.00%) to provide some stability in the financial markets. Despite commodity prices advancing, expect stronger selling of the AUD on rallies for now (0.8128).

Crude is lower O/N ($98.00 down -318c). Hurricane Ike despite potentially racking up an estimated $18b (highest estimate) worth of insurance claims, is expected to have spared key areas in the Gulf of Mexico. Crude oil prices should remain under pressure. O/N, it fell to a 5-month low, while gas futures dropped on signs that refineries along the Gulf of Mexico will soon resume operations after shutting for both Ike and Gustav and escaping major damage. Analysts noted that Gulf operators had already evacuated personnel from 63% of production platforms. It’s estimated that 96% of Gulf oil production, and 73.1% of natural gas output, was shut (approximately +1.25m barrels a day and +5.4b cubic feet a day of gas) in anticipation for the recent hurricanes. This also prompted the DOE to release approximately +309k barrels from its strategic reserves. Electronic trading was allowed to open early yesterday in response to Ike. Lat week 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’. They intend to reduce a ‘huge oversupply’ of oil on the market, and at the same time psychologically provide an artificial floor for the black stuffs price ($80-$100). Global growth concerns will surely trump what some OPEC members are trying to achieve. Artificially trying to hold up prices will fail, as the Saudis (a strong ally to the US) are not planning to reduce its own oil production, they intend to supply whatever customers demand. Last weeks EIA report showed that fuel demand declined w/w and refinery production dropped after Hurricane Gustav shut plants along the Gulf Coast. Operating rates fell to 78.3% last week, the lowest levels in three years. Whilst crude stocks declined -5.8m barrels to 298m, it’s the crude production levels that will continue to weigh on prices. Gold has finally found some traction; ending nearly 2-week loosing streak ($782), as the greenback faltered vs. the EUR and investor’s coveted the ‘yellow’ metal as an alternative investment.

The Nikkei closed at 12,214 up +112. The DAX index in Europe was at 6,025 down -209; the FTSE (UK) currently is 5,233 down -183. The early call for the open of key US indices is lower. 10-year Treasury yields backed up 4bp on Friday (3.72%) and eased an astounding 24bp O/N (3.48%). Treasury prices have rallied especially in the front end of the US yield curve (bull steepener) and managed to print monthly low yields as Lehman Brothers filed for bankruptcy and traders predict that the Fed will have to cut interest rates, to shore up consumer confidence and provide support for the battered financial industry. Weaker than expected US retail sales number on Friday also provided support for FI. OIS traders continue to price in a Fed interest rate cut by year end (2.00%). Capital markets are concerned that Lehman’s failure to find a buyer will trigger further bank failures and credit-market losses.

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