US Dollar Dives as the House Votes Down Bailout Bill - Black Monday Part 2?

The US dollar rocketed higher during the European trading session as European governments had to step in to rescue Belgium’s Fortis, the UK’s Bradford & Bingley, and Germany’s Hypo Real Estate Holding. However, nearly every factor worked against the US dollar during the New York trading session, but the House of Representatives’ defeat of the $700 billion bailout bill, or the Treasury Asset Relief Program (TARP), took the cake as the biggest driver in the financial markets. Indeed, the news sent the US dollar down and Treasuries soaring on flight-to-safety, while US stocks plunged with the DJIA losing a whopping 777.68 points, marking the worst point decline ever, while the S&P 500 fell 8.8 percent, the most since Black Monday (October 19, 1987). The TARP bill failed in a 228-205 vote in this highly politicized event, but a motion has reportedly been filed for reconsideration of the vote, while House Financial Services Committee Chairman Barney Frank (D-Mass.) has said that they will “assess the market reaction to determine the next step.” Well, the markets have made their preference loud and clear. As a result, the representatives that voted against the bill due to their constituents’ concerns - Democrats and Republicans alike - will need to re-evaluate what they want to do if there is another vote. My view? This bill is likely to pass eventually, though the majority that voted against the measure may demand a few changes first. Is this Black Monday Part 2? Not quite. On Black Monday, the DJIA and S&P 500 lost over 20 percent of their value in a single day, and today’s moves didn’t come close.

What does this mean for the US dollar? Nothing positive, that’s for sure. Until this US bailout plan is passed, risk aversion pressures will likely weigh heavily on the US dollar. However, given the fundamentals on the other side of the coin – such as emerging recessions in the UK, Euro-zone, Australia, New Zealand, and Japan - there is potential for the greenback to recover. However, with fed fund futures now fully pricing in a 25bp rate cut on October 29 and a 66 percent chance of a 50bp reduction, it will be difficult to see a rally to the degree we saw from mid-July through early September.

Euro Under Pressure as Credit Crisis Forces Bailouts of Belgium’s Fortis, Germany’s Hypo Real Estate

The euro fell nearly 200 points during the European trading session as Euro-zone economic data was disappointing by nearly all measures. Indeed, the Bloomberg Retail Purchasing Managers’ Index (PMI) for the Euro-zone slipped further to 46.2 in September from 47.7, marking the fourth consecutive month of contraction (a number below 50 signals contracting business activity). Furthermore, Euro-zone consumer, economic, industrial, and services confidence all turned increasingly pessimistic and looking at Credit Suisse overnight index swaps, the markets are pricing in nearly 100bps worth of rate cuts by the European Central Bank (ECB) over the next 12 months. However, a bigger driver of the drop in the euro and interest rate expectations was likely the indications of spreading financial problems. Belgium, the Netherlands and Luxembourg invested 11.2 billion euros in Belgium’s largest financial-services firm, Fortis, while Germany’s Hypo Real Estate, the country’s second-biggest commercial-property lender, received a 35 billion euro loan guarantee in order to provide liquidity. The news triggered massive losses in European stock markets as well, with most equity indexes ending the day down over 4 percent. Looking ahead to Tuesday, Euro-stat’s estimate for Euro-zone CPI is expected to slip to 3.6 percent in September from 3.8 percent. With the ECB announcing their next rate decision on Thursday, the news could trigger sharp moves as weaker-than-expected data likely to send the euro lower while strong figures could propel the currency higher.

British Pound Plunges 300 Points on Second UK Bank Nationalization

The credit crisis continues to hit the UK hard as the government was forced to nationalization yet another bank - Bradford & Bingley - marking the second seizure in the UK this year. As a result, the British pound fell approximately 300 points against the US dollar during the European trading session. The UK Treasury said in a statement it had tried to seek out private-sector solutions, but ultimately though nationalization was the best option for maintaining financial stability as the UK's Financial Services Authority said over the weekend that Bradford & Bingley no longer met the regulatory requirements for operating as a deposit taker. The news also sent the FTSE 100 down 5.3 percent by the market close, while UK Gilts rocketed higher amidst risk aversion. While the British pound did rack up some gains during the New York trading session, the currency remained weak toward the end of the day as the fundamentals remain wildly out of favor for the UK. In fact, Credit Suisse overnight index swaps are pricing in over 125bps worth of rate cuts by the Bank of England (BOE) during the next 12 months. While the BOE is not anticipated to reduce rates at their next meeting on October 9, the sentiment alone could weigh on GBP/USD. In the near-term, I think we’re likely to see the pair drop below 1.80 to the next level of support at 1.7900/16. However, if the final reading of UK Q2 GDP on Tuesday morning is revised down from current estimates of 1.4 percent (annualized), GBP/USD could easily drop toward 1.7725.

Japanese Yen Propelled Higher By Failure of US Bailout Bill

The Japanese yen was the key beneficiary of Monday’s market turmoil, as the low-yielder jumped 4.85 percent versus the high-yielding Australian dollar amidst a major carry trade sell-off. Indeed, anything associated with risk, be it stocks, forex carry trades, or commodities (except gold, a standard safe-haven instrument), fell significantly on news that the US House of Representatives voted down the Treasury’s $700 billion bailout bill. Without the passage of this measure, there will remain significant downside risks for the Japanese yen crosses. However, even if it does pass eventually, there will still bearish potential. Indeed, it has become clear that the credit crisis is hitting the world’s financial markets quite hard as evidence by the UK’s nationalization of Bradford & Bingley and the need for emergency liquidity by Belgium’s Fortis and Germany’s Hypo Real Estate. True financial stability is not likely to come soon, and as a result, traders are highly unlikely to pile back into the carry trade. My long-term fundamental bias for the Japanese yen: bullish.

Terri Belkas is a Currency Strategist at FXCM.