The Japanese yen and US dollar remain weak while US stock market futures have surged as the US Treasury, Federal Reserve, and FDIC have announced unprecedented plans to recapitalize banks via preferred share purchases, while guaranteeing the senior debt of all FDIC-insured institutions. Is this the answer the markets have been looking for?

The Plan

The US Treasury will proceed with a "voluntary capital purchase program" where the US government will buy up to $250 billion in preferred shares from financial institutions at "attractive rates" for the US taxpayer. Institutions that sell shares will have to agree to restrictions on executive compensation, such as the golden parachutes that many corporate CEO's have received despite the underperformance of their firms. US Treasury Secretary Henry Paulson said that nine large financial institutions had already agreed to the plan, including Bank of America, Citigroup, JP Morgan Chase and Morgan Stanley, Merrill Lynch, Goldman Sachs, Wells Fargo, Bank of New York Mellon and State Street. Thr news is likely to increase confidence in the US financial sector, and thus could lead US equities to surge today.

The FDIC will guarantee the senior debt of all FDIC-insured institutions and their holding companies for 3 years, along with deposits in non-interest bearing deposit transaction accounts (such as basic business payroll checking accounts, which were not protected before). The goal? To allow financial institutions easier access to liquidity by boosting confidence in these banks, which should convince investors that it is safe enough to buy their debt and hold their deposits with the banks.

The Federal Reserve also announced that its Commercial Paper Funding Facility (CPFF) program will fund purchases of commercial paper of 3 month maturity from high-quality issuers. The goal here is to allow the commercial paper markets, which have been frozen, to become functional once again.

The Market's Reaction

US stock markets have responded positively, as DJIA futures jumped, suggesting the index could open as much as 300 points higher. Meanwhile, the Japanese yen and US dollar have been falling back throughout the morning in anticipation of the news and both remain lower, though we have seen the declines slow a bit. Indeed, traders appear to be waiting for the US stock markets to open in order to gauge sentiment. If volatility continues to fall, as the CBOE's VIX Volatility Index plummeted from record highs of 76.94 on Friday to approximately 55 on Monday, this would work in favor of risky assets throughout the markets, including forex carry trades, equities, and commodities going forward.

US Dollar May Be At Risk as Fed Fund Futures Still Price In Rate Cuts

Despite the unprecedented actions taken by the Federal Reserve, Treasury, and FDIC this morning, fed fund futures continue to price in a 25bp rate cut to 1.25 percent on October 29. While the actions spurred optimism in the markets initially, they have failed to translate into larger moves throughout the day. Indeed, considering the probable negative impact of the financial crisis on economic growth in the US and signs of easing inflation pressures, the members of the Federal Reserve may find themselves cutting rates again before year-end, which leaves downside risks open for the US dollar.

John Kicklighter a Currency Strategist at FXCM.