US Dollar Ends Day Lower Despite House Approval Of Bailout Bill, Non-Farm Payrolls (NFPs) Disappoint

The US dollar started the day on a strong note amidst hopes that financial market stability was on its way. Indeed, Wells Fargo offered $15.1 billion for Wachovia, which would not require support from the FDIC, suggesting that the banking sector may be able to stand on its own two feet. The bid trumped Citigroup’s $2.2 billion offer for Wachovia’s banking operations, but the firm is unlikely to let Wells Fargo’s deal take place without a fight. The US dollar’s strength was all the more surprising as US economic data was extremely disappointing. US non-farm payrolls (NFPs) fell more than expected by 159k during the month of September, the worst reading since March 2003. Meanwhile, the unemployment rate held steady at a 5-year high of 6.1 percent. This marks the ninth consecutive month of job losses for the US, which is also the worst series of declines since the recession of the early 2000s. Oddly enough, the US dollar started to pull back during the afternoon as the House of Representatives approved the Treasury’s $700 billion rescue plan in a 263-171 vote. It appears that this approval was either already priced in to the US dollar beforehand, or the markets remain skeptical that this will be the magic bullet to alleviate the credit crisis.

Looking ahead to next week, there will be limited event risk on hand for the US dollar, leaving risk trends all the more likely to drive the markets. However, on Tuesday, the minutes from the Federal Open Market Committee’s September meeting will be released. It was somewhat surprising to see the markets completely brush off the disappointing non-farm payrolls numbers on Friday, as the risks for recession remain very high. However, bearish commentary by the FOMC members may enough to remain traders just how bad things are. Fed fund futures are fully pricing in a 50bp cut on October 29, and if the minutes suggest that the Committee may actually consider cutting rates, the US dollar could pull back sharply. My fundamental bias for the US dollar early next week: bearish.

Euro Weighed Down By Recession Fears - Chance For Recovery Next Week?

The euro remained weak against the US dollar on Friday, as traders shift focus away from the US economic slowdown/recession to the developing problems in the Euro-zone. On Thursday, the ECB left rates steady at 4.25 percent, but as usual, the key market-mover was commentary by ECB President Jean-Claude Trichet who said that the Governing Council had discussed actually cutting rates. While he went on to note that the Governing Council’s focus is on price stability only, since it is their primary mandate, there had been a reduction in upside risks. With the ECB recognizing that an economic slowdown is taking place, it is clear that indications of easing inflation pressures have allowed them to turn more dovish. This is why we see that Credit Suisse overnight index swaps are now pricing in over 100bps worth of rate cuts during the next 12 months. Looking ahead to next week, traders should watch for revisions to Euro-zone Q2 GDP on Wednesday and the ECB’s monthly report on Thursday. However, when it comes to EUR/USD, trading will likely be driven more by US dollar flows. My fundamental bias for next week: slightly bullish.

British Pound Ends Day Higher - Bank of England Expected To Cut Rates Next Week

The British pound plunged early in the day, but quickly recouped losses in the afternoon. However, this had little to do with UK fundamentals as the outlook for the UK remains bleak. In fact the Bank of England, which has been the most resistant central bank to helping banks during the credit crisis, actually said it would widen the range of collateral it accepts at three-month operations in an effort to boost liquidity. The BOE has said it will take asset-backed commercial paper with the highest short-term ratings along with top-rated securities tied to “some” corporate and consumer loans. This move, along with dismal UK economic data, has led the markets to widely expect a 25bp rate cut to 4.75 percent by the Bank of England next Thursday. While UK CPI remains well above the BOE’s 2 percent target and 3 percent ceiling at 4.7 percent, the Monetary Policy Committee is going to have a hard time ignoring the 5 consecutive months of contraction in the services and manufacturing sectors, along with the persistent decline in home prices. If the BOE does indeed cut rates, the news will likely weigh on the British pound. However, if the central bank shocks the market and leaves monetary policy unchanged, GBP/USD could easily surge higher.

Japanese Yen Mixed In Wild Day of Trading, Approval of Bailout Bill Fails to Boost Confidence

The Japanese yen gained versus the euro, Canadian dollar, and (barely) the US dollar as risk aversion remains in the driver’s seat. On the other hand, the low-yielder slumped against the New Zealand dollar, Swiss franc, and British pound. Indeed, there was so much volatility in the markets today that there were few discernable directional moves. Risky assets like USD/JPY and the DJIA started the NY trading session higher on the Wells Fargo/Wachovia deal and ahead of the House’s vote on the Treasury’s bailout bill. However, these assets pulled back during the afternoon as the approval of the bill failed to boost confidence. Nevertheless, with the credit crisis still hitting the world’s financial markets quite hard, true financial stability is not likely to come soon. This leaves traders 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.