House Kills the Bailout Plan and the US Dollar

TODAY'S BIGGEST PERCENTAGE MOVERS

• AUD/JPY (-375 pips or -4.28%)
• NZD/JPY (-270 pips or -3.70%)
• GBP/JPY (-695 pips or -3.59%)

THE STORIES IN THE CURRENCY MARKET

• USD: HOUSE KILLS THE BAILOUT PLAN AND THE US DOLLAR
• EUR: EUROZONE FINALLY GETS HIT BY THE DOMINOES EFFECT
• GBP: FALLS 340 PIPS AS UK GOVERNMENT NATIONALIZES ANOTHER BANK
• JPY: CARRY TRADES ARE BIGGEST LOSERS IN BAILOUT DRAMA
• CAD: OIL AT $95 A BARREL
• AUD: GOLD PRICES BACK ABOVE $900
• NZD: TRADE DEFICIT IMPROVES

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

HOUSE KILLS THE BAILOUT PLAN AND THE US DOLLAR

The rejection of the $700B bailout plan by the House of Representatives came completely out of the left field, driving a knife through both US equities and the US dollar. For the Bush Administration, it certainly feels like they are moving one step forward and taking two steps back but the severity of the financial crisis makes it absolutely necessary for Washington to put economics ahead of politics. Although traders were initially dissatisfied with Congress' approval of Paulson's plan, they were counting on a bailout. The combination of a huge liquidity injection by the Federal Reserve today and the hope that the bailout plan would move forward kept stocks from falling further. However those efforts and the sleepless weekend of debates turned out to be futile after the House rejected the bailout bill. For fairness, there was no was guarantee that Paulson's plan would have helped average Americans, but at least it could have brought some stability to the financial markets. Unfortunately it is now back to the drawing board for Paulson who has to meet with Bush, Bernanke and Congress to discuss their next steps. Volatility in the financial markets benefits no one especially as more than $1 Trillion in market value has been wiped out from US stocks today. The VIX, which measures equity market volatility shot to the highest level in 6 years while gold prices jumped 3.8 percent. LIBOR rates have also skyrocketed while the TED spread continued to widen indicating that as a result of the House's rejection of the bill, investors both domestically and internationally have become more risk averse. For those that are willing to part with their cash, they are demanding a high premium.

Dow 10,000 Could Mean 100 USD/JPY

The Dow Jones Industrial Average closed down more than 770 points while the S&P500 dropped more than 8 percent. This is the largest single day drop in the Dow ever and the largest percentage decline in the S&P500 in 20 years. We have long argued that if the Dow hit 10,000, USD/JPY could fall to 100. That correlation remains intact today as the plunge in US equities drags USD/JPY towards 104.00. In the September 19th edition of the Daily Currency Focus, we argued that the US dollar could fall by another 5 percent. At that time, USD/JPY was trading at 107.40 and to many people a 5 percent move lower, which is the equivalent of 530 pips seemed like a farfetched possibility. However since then the dollar has already fallen close more than 300 pips, making a move towards 102 within reach. With the US stock market plunging and the US government looking to raise the national debt, in addition to hammering out the bailout plan, the Bush Administration will have to work extra hard to reassure foreign investors.

Gold Becomes a Hedge for Inflation and the US Economy

Now more than ever, the US needs to rely on foreign funding. If Central Banks and Sovereign Wealth Funds around the world start to lose confidence in the US financial markets or the US government, we could be looking at a complete freeze in lending that expands beyond the banking sector. According to an article in the Wall Street Journal, central banks are already loading up on gold as European central banks cut their sales to the lowest level in almost 10 years. Gold prices are up more than $35 an ounce today as a hedge for inflation and a hedge for the US economy. Everyone is starting to realize that commodities are the only assets that have no counterparty or credit risk. Gold prices first jumped on inflation fears after the Federal Reserve's liquidity injections this morning. Having more than doubled their swap limits from $290B to $620B, the Fed is trying to tell the market that they are serious about providing liquidity and given today's sharp volatility, they will continue to do aggressively in the coming days.

TARP Drama Gets More Dramatic - Time to Play Defensive

For everyone from traders, investors, banks and the average American, the latest development in the TARP soap opera means one thing - which is that it is time to become more defensive. The Treasury has failed to restore confidence in the financial markets and it could be some time before there is stabilization. This is the new age of conservatism which means tighter terms for loans on credit cards, cars and homes as well as more penny pinching by US consumers. Expect this to lead to more layoffs and less expansion efforts by US companies. In fact, the longer the US government takes to agree on a plan, the greater the recessionary risks. Looking ahead, we still expect more weakness for the US dollar, particularly against the Japanese Yen. House prices, Consumer confidence and Chicago PMI are due for release on Tuesday.

EUROZONE FINALLY GETS HIT BY THE DOMINOES EFFECT

Banks in the Eurozone are no longer immune to the problems in the US financial sector. The dominoes effect has finally hit Europe with 4 bailouts in one weekend (2 in the Eurozone, 1 in the UK and 1 in Iceland). Fortis, Belgium's largest financial services company received a EUR11.2 billion rescue from the Belgium, Netherland and Luxembourg governments while the Hypo Real Estate group was bailed out by the German government. If the US banking sector is a good reference, then we know that this could just be the beginning of more bank failures. With the ECB interest rate decision scheduled for Thursday, the problems in the banking sector could pressure the central bank to move to a more dovish monetary policy bias. In addition to the problems in the financial sector, Eurozone economic data continues to weaken. Retail PMI fell deeper into contractionary territory while business and consumer confidence deteriorated. For the EUR/USD, the question of a recovery or further losses will be answered by the developments in the financial markets. If another bank fails in the Eurozone over the next few days, then the Euro could come under additional selling pressure. If all is quiet on the market's focus should shift to US developments. German unemployment is due for release tomorrow. Given the drop in the employment components of service and manufacturing ISM, we expect weaker numbers.

BRITISH POUND FALLS 340 PIPS AS UK GOVERNMENT NATIONALIZES ANOTHER BANK

The British pound came under aggressive selling pressure today as the UK government nationalized mortgage bank Bradford & Bingley. The crisis has hit Europe hard and it is particularly discomforting that one weekend has led to the forced rescue of so many banks. The UK housing market is in trouble and we doubt that Bradford & Bingley is the only ones feeling the pain. We have seen how widespread a financial crisis can get just by looking at the US financial sector. UK banks were just as leveraged as their American counterparts and their housing market is still in the process of unraveling. UK economic data was mixed with weaker than expected net lending on homes but stronger than expected mortgage approvals. The final figures for UK second quarter GDP are due for release on Tuesday along with the current account figures. If GDP is revised to negative levels, we could see further losses in the British pound.

CARRY TRADES - BIGGEST LOSERS IN BAILOUT DRAMA

The biggest losers in the bailout drama are carry trades. All of the Japanese Yen crosses are down more than 1 percent. AUD/JPY for example actually fell 4.5 percent, making it the day's single biggest market mover. USD/JPY fell 1.6 percent or 175 pips as risk aversion drives carry trades lower. The Yen crosses should continue to suffer as volatility remains high. The consequences of inaction, which is what we had today is severe and will most likely lead to more selling of carry trades in the Asian trading session. According to the Fed fund futures, traders are now pricing in a greater chance of a 50bp rate cut than a 25bp cut by the Fed before the end of the year. In order to restore stability and confidence, the Bush Administration needs to shock the markets and Fed fund futures suggest that this shock may come in the form of either interest rate cuts. Japanese banks have been far less leveraged than their Western counterparts, which is part of the reason why the Japanese Yen is outperforming the other major currencies.

OIL AT $95 A BARREL, RISK AVERSION DRIVES COMMODITY CURRENCIES LOWER

The Australian, New Zealand and Canadian dollars have come under aggressive selling pressure. This is tied to the market's risk appetite as high yielding currency pairs were sold across the board. Gold and oil prices have also moved in completely opposite directions. The price of gold has risen above $900 an ounce while the price of oil has fallen $11 to $95 a barrel. The drop in oil prices is tied to fears of an economic slowdown. Although the New Zealand trade deficit narrowed, the good news has failed to help the New Zealand dollar. Australia will be reporting retail sales and building approvals this evening - we expect weaker data.

EUR/JPY: CURRENCY PAIR IN PLAY OVER THE NEXT 24 HOURS

German employment numbers are due for release at 3:55am ET or 7:55 GMT. EUR/JPY will be the currency pair in play over the next 24 hours as the combination or risk appetite and German economic data impacts the currency pair.

Technically, EUR/JPY is in the "range trading zone," which we determine using Bollinger Bands. However it is at the brink of entering our "sell-zone." Should risk aversion dominate or we get some weak German economic data, we could see EUR/JPY fall into the sell zone which would happen on a break of 150. At that point, we could see selling exacerbate as support does not come in until 148.00. However should the data be good or risk appetite recovers and EUR/JPY rallies above 152.50, where we have a confluence of moving averages and Fibonacci resistance, a move back towards 156 becomes more likely.

Kathy Lien
http://www.gftforex.com

DISCLAIMER: GFT refers to Global Futures & Forex, Ltd. and all of its divisions, branches and subsidiaries, including Global Forex Trading and GFT Global Markets UK Limited. GFT Global Markets UK Limited is authorized and regulated by the United Kingdom Financial Services Authority. Each investment product is offered only to and from jurisdictions where solicitation and sale are lawful. Trading of foreign exchange contracts, contracts for differences, derivatives and other investment products which are leveraged, can carry a high level of risk, and may not be suitable for all investors. It is possible to lose more than the initial investment. In Australia, GFT means Global Futures & Forex, Ltd. ARBN 103 508 461, AFS Licence 226625. A Product Disclosure Statement (PDS) is available at www.gft.com.au. You should read and consider the PDS before making any decision to deal in GFT products. © 2008 Global Futures & Forex, Ltd. All rights reserved.