Dollar's Fate Dependent Upon TARP Bailout Drama

TODAY'S BIGGEST PERCENTAGE MOVERS

• AUD/JPY (-110 pips or -1.23%)
• AUD/NZD (-147 pips or -1.20%)
• NZD/USD (+52 pips or +0.76%)

THE STORIES IN THE CURRENCY MARKET

• USD: FATE IS DEPENDENT UPON TARP BAILOUT DRAMA
• EUR: ECB NOT EXPECTED TO CUT RATES BUT WILL THEY HINT OF EASIER MONETARY POLICY?
• GBP: UK ECONOMY IS AT THE BRINK OF A RECESSION
• JPY: EXPECT A BIG MOVE IN USD/JPY ON BAILOUT PLAN
• CAD: LOOKING FOR WEAKER GDP
• AUD: RETAIL SALES IS THE BIG RELEASE NEXT WEEK
• NZD: NEW ZEALAND IS IN AN OFFICIAL RECESSION

EXPECTATIONS FOR UPCOMING FED MEETINGS

** PERCENTAGES MAY NOT ADD UP TO 100% BECAUSE OF THE PROBABILITY OF LARGER OR SMALLER MOVES BEYOND THOSE SHOWN ON THIS TABLE

DOLLAR'S FATE IS DEPENDENT UPON TARP BAILOUT DRAMA

It will be another long weekend for the US Treasury Secretary and the heavy hitters in Washington. September has certainly been a sleepless month for Paulson, as Fannie and Freddie was followed by Lehman Brothers and AIG and then the initial $700B proposal. This weekend, he will be in discussions with Congress to get a deal done by Monday. The $700 billion bailout plan has truly become a dramatic ordeal with Senators now denying that yesterday's tentative deal was ever in place to begin with. President Bush has promised that something will be done by Monday and the near term fate of the US dollar will be dependent upon whether that happens.

Deal or No Deal - Expect an Explosive Weekend for the Dollar

The clock is ticking and the rescue package is far from guaranteed which means that we could have a particularly volatile open on Sunday evening. If there is no deal, expect a massive selloff in the US stock market and the US dollar because it means that it is back to the drawing board for Treasury Secretary Paulson. If a deal is passed in its current version, it should help the dollar in short term since a deal was far from certain Friday afternoon. A relief rally should drive the dollar higher if everything moves forward as planned but over the long term, the cost of bailout is going to destroy the US balance sheet. It is still too heroic to be buying dollars because the effectiveness of the plan is unclear. Since Congress is going on recess at the end of next week and the consequences of inaction are severe, we will most likely see a plan before the markets open on Monday morning. The markets are currently pricing in a 100 percent chance of a rate cut by December.

J.P. Morgan Buys WaMu - Tradition of Bailouts Date Back to 1895

One of the biggest stories in the financial market today is the seizure and sale of Washington Mutual to J.P. Morgan. This is the largest failure in banking history and pages could be written about the severity of WaMu's demise, but what we find interesting is that in times of crisis, the true heroes emerge.

This year, J.P. Morgan has swept both Bear Stearns and Washington Mutual into their coffers. This illustrates the comparative strength of the bank and a tradition that has been more than 100 years in the making. John Pierport Morgan who established the original J.P. Morgan & Co in 1871 is widely credited for having rescued the US economy and the US government on 2 very prominent occasions - 1895 and 1907. A hundred years later, CEO Jamie Dimon is following in Morgan's footsteps with the credit crisis of 2008.

Non-Farm Payrolls Week

Over the past few weeks, we have seen macro factors overshadow micro ones. This morning, second quarter GDP was revised down from 3.3 to 2.8 percent due to weaker personal consumption, trade and business investment, but instead of falling, the US dollar actually gained strength on the hope that the bailout plan will be passed. Next week is non-farm payrolls week. Given the rise in jobless claims, we strongly believe that job losses could have topped 100k in the month of September. Depending upon how the week goes, even the NFP report may fall second to macro factors like the bailout plan or another bank failure. In addition to non-farm payrolls, the US will also be releasing personal income, personal spending, Chicago PMI, consumer confidence, service and manufacturing ISM numbers. Economic data should continue to be at depression like levels and it will certainly be another busy week in the currency market.

ECB NOT EXPECTED TO CUT RATES BUT WILL THEY HINT OF EASIER MONETARY POLICY?

Outside of the big rally in the EUR/USD on Monday, it has been a relatively quiet week for the currency pair despite the largest bank failure in US history and the proposal of a groundbreaking bailout plan. Throughout the course of the week, we have outlined many reasons why the EUR/USD should remain range-bound including higher oil prices, the possibility of a rate cut by the Federal Reserve and the counteracting power of hedging and repatriation. Although we think that no new high or low will be made in the Euro this year, the new week could deliver some volatility for the currency pair. There are a lot of economic releases on the Eurozone calendar including retail PMI, retail sales and employment for Germany as well as Eurozone PPI. The European Central Bank will also be making a monetary policy decision. As usual, they are not ready to cut interest rates, but Trichet will be delivering his press conference where he could signal any changes to his monetary policy bias. We expect Trichet to acknowledge the rising growth risks, but with oil prices back above $107 a barrel, he may not waver on the ECB's inflation focus, especially since recent comments from central bank officials have been hawkish. Nonetheless, it should just be a matter of time before Trichet buckles since Ireland is already in a recession and the European Commission believes that Germany and Spain are next.

UK ECONOMY IS AT THE BRINK OF A RECESSION

In the coming week, we will find out exactly how weak the UK economy really is. The final figures for second quarter GDP is due for release and given the drop in retail sales and the widening of the trade deficit, there is a strong chance that we could actually see a negative revision to GDP. For the second quarter in the row, growth has slowed and the preliminary release estimated stagnant or zero growth in the second quarter. In addition to GDP, we are also expecting the current account balance, manufacturing and service sector PMI. The UK economy is at the brink of a recession and with the layoffs in the financial sector, we expect the conditions to worsen. Adding to the tally of layoffs, this morning, HSBC announced that they are cutting 1100 jobs in their investment banking division. The British pound could be vulnerable to losses, especially if the tone of trading next week is dollar positive thanks to the approval of the bailout plan.

EXPECT A BIG MOVE IN USD/JPY ON BAILOUT PLAN

Of all the major currencies, the cleanest way to trade the bailout plan is through USD/JPY. The Euro and British pound has its own problems and economic data to contend with while USD/JPY is a simple measure of risk appetite and the market's sentiment towards US dollars. When we say that we expect the approval of the bailout plan to be short term dollar positive and long term dollar negative, we are referring to USD/JPY in particular. When the markets opened after the Fannie and Freddie bailout announcement at the beginning of the month, we saw sharp swings in USD/JPY and we expect similar price action time as well. To be more specific, USD/JPY gapped higher at the open of the Asian trading session by 100 pips and the rest of the Japanese Yen crosses followed suit.

NEW ZEALAND IS IN AN OFFICIAL RECESSION

For the second quarter in a row, New Zealand GDP contracted, which means that the country is in a technical recession for the first time in 10 years. The contraction was less than the market expected which is why the NZD/USD actually strengthened following the release. However, it is important to point out that of all the major currencies, the New Zealand dollar is the only one whose country is in an official recession. For the Reserve Bank of New Zealand, this gives them another reason to consider cutting interest rates. However, Finance Minister Cullen believes that the country will return to positive growth by the end of the year. Meanwhile the Australian and Canadian sold off against the greenback as commodity prices eased and the dollar trended higher. Next week, New Zealand has their trade balance due for release while Australia will be reporting retail sales and Canada will be releasing their GDP numbers.

USD/JPY: CURRENCY PAIR IN PLAY

With the announcement of whether there has been a deal or no deal on the bailout plan expected before the markets open on Monday, the currency pair that should see the cleanest and relatively significant reaction is USD/JPY.

Technically, the USD/JPY is in the "range trading zone," which we determine using Bollinger Bands. There is a lot of resistance above current levels and near 107. Not only is that level capped by the Thursday's high, the 100-day SMA and the 20-day SMA, but there is also the 38.2 percent Fibonacci retracement of the 124.15 (June 2007) and 95.76 (March 2008) bear wave. If that level is broken, it is all clear to 108.00. On the other hand if USD/JPY breaks 105, expect a move down to 104.

Kathy Lien
http://www.gftforex.com

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