Dollar Rallies After Word Congress Has Agreed On Fundamentals Of Bailout

The U.S. dollar was relatively strong through Thursday on speculation the U.S. Congress will approve a $700bn plan that will enable banks to clean up their balance sheets from leveraged investments in mortgage backed securities. Indeed, traders are betting that the measures proposed to the U.S. congress by the U.S. Treasury Secretary Henry Paulson and the Federal Reserve Chairman Ben Bernanke could lead to a world wide recovery in the appetite for risky assets like stocks and higher yielding currencies. To some extent, this explains why we saw the Dow Jones rallying more than 300 points on Thursday and the USD/JPY rising to as high as 107 yen per dollar from a low of 105.35 on Wednesday. In addition, a rapid weakening of economic growth in Europe continues to benefit the U.S. dollar against the sterling and the euro. At the time of this report the GBP/USD is being quoted at 1.8375 dollars per sterling from 1.8446 on Wednesday. Nonetheless, despite the recent wave of dollar strength, the U.S. economy could slow down faster than many investors expect. The U.S. Commerce Department said today in Washington that sales of new homes fell to a 17 year low. In fact, sales dropped 11.5 percent in August to the lowest annual rate since the 1991. The Federal Reserve has been taking a number of actions to increase liquidity and stabilize markets and the $700 billion dollar rescue plan, if approved, is likely to help the demand for housing in the form of lower mortgage rates. However, much more is needed since the U.S. economy will continue to slide until we see a much larger correction in the supply side of the housing sector in the form of lower prices. Currently, the average American can’t afford to pay for a mortgage and we are still far from reaching a bottom in the U.S. housing market.

Euro: Fundamentals Fade, Euro/Dollar Rally May Be Running Out Of Gas

A steady and deep selloff was in store for the euro Thursday as disappointing data put the currency in juxtaposition to the rebound in confidence behind the US dollar. The morning began with comments made by ECB Governing Council member Nout Wellink. Not sharing the same confidence that his colleague Bonello expressed yesterday, Wellink (who also happens to be the head of the Basel Committee on Banking Supervision) said he expected market uncertainty and volatility to last for ‘some time.’ While European policy board members are not mute on the severity of the recent financial crisis, there comments often deflect expectations for problems to intensify in the Euro Zone economy. While much of the crisis that has developed in the US has been generated by a panic, there were still fundamentals to support the fears. The ECB has been promoting stability through verbal reassurances and coordinated liquidity injections; but should conditions worsen, the weakened economy and ailing domestic financial sector could still deteriorate on its own (indeed, there is not likely to be any specific aid earmarked in the US bailout plan for the EU). From the economic docket, a few high profile indicators generated interest from the fundamental crowd. The GfK consumer confidence survey offered a surprise in an unexpected improvement – the first in five months. After investors and business leaders reported a pessimistic outlook on the deterioration in the financial sector, consumers were seemingly more concerned with the drop in energy costs. However, even officials at GfK found this unusual given the dour outlook for the economy and trouble in the credit market; and the group lowered its expectations for consumption this year. A little later, the M3 money supply report (a favored gauge of inflation) slowed to its slowest pace of growth since October of 2006 as bank lending and consumer spending cooled. As this was a reading for August, the next reading is likely to be even lower. Looking ahead, only the German import inflation indicator holds prominence, but the country’s preliminary September may also hit the wires before the end of the week. As ECB President Trichet holds adamantly to inflation, weaker numbers may finally encourage rate cuts.

British Pound Tumbles Despite Hawkish Commentary And Rebound In Risk Appetite

The UK has a significant stake in the outcome of the financial market rescue plan in the US. While the details are certainly not expected to help the European economy directly, the stability proffered to the global credit markets could quite possibly help avert a severe recession. Currently, the UK is on track for its first recession since the early 1990s; and a plunge in the housing market and contraction in consumer spending are leading the way. As long as financial turmoil freezes credit, rising default rates and expensive mortgages will prevent a recovery in the real estate market and British consumers (one of the most indebted peoples in the industrial world) will have to throttle back on spending. Therefore, as market-wide risk appetite responds to the details of the plan that makes it through Congress, the pound will respond as fundamental market participants weigh the ultimate impact on the ailing UK economy. Another direct concern for sterling traders during this period of financial uncertainty is the outlook for monetary policy. Overnight index swaps are pricing over 100 basis points of easing from the MPC through the coming year. However, the BoE has held firm on keeping rates at 5.00 percent. Adding to the hawkish front today, committee member Kate Barker expressed her concern over inflation at a decade high – though she did remark that a sharp drop in growth could lead the to inflation to undershoot the central bank’s target going forward. Despite Barker’s (and many others’) inflation warnings though, the market still sees cuts.

A Recession Raises The Probability Of Deep Rate Cuts For New Zealand

The slowing in global growth has claimed another casualty. Statistics New Zealand confirmed what many analysts and traders had expected today, that the economy had tipped into a recession through the first half of this year. While this second quarter contraction was more modest that what policy officials had expected, it was nonetheless the first official recession for the economy in 10 years. Looking at the details of the report, all of the sectors that RBNZ Governor Alan Bollard said were holding up inflation six months to a year ago are now solidly in the red. Construction activity dropped 3.8 percent through the period, consumer spending fell 1.9 percent and financial services contracted 0.7 percent. This certainly will put a damper on the broader carry trade as the 150 basis points of easing expected from New Zealand over the coming year could be dealt in quick order. With the return potential from the carry strategy dropping fast, a recovery could be delayed even if risk eases.

Antonio Sousa is a Currency Analyst for FXCM.