Forex Blog - Forex News & Currency Analysis

The US Treasury was out announcing its bailout of the day yesterday, this time a package was aimed at going directly to the consumer with credit relief in the form of a special facility of $200 billion that would be backed by the Federal Reserve and the Treasury. The other large measure was the announcement that the Fed would be buying up to $600 billion of Government Sponsored Enterprises (GSE, i.e. Fannie Mae and Freddie Mac) mortgage debt. This latter news was a bit more of a surprise and brought down mortgage rates sharply, and that is likely what got risk appetite trying to make a comeback, though the outcome by the end of the day was less clear, since equities closed the day on a down trend.  The Fed and Treasury are throwing everything they can at the problem with seemingly no end in sight as the Fed is the lender of “sole resort” as one NY Times article put it. We continue to shake our heads at developments. These measures may look good in the short run for shoring up this or that market or credit spread, but they have terrible consequences down the road if we pause to consider the growing horror called the Fed’s balance sheet, which is now guaranteeing 50%+ of US GDP.

When the largest structural problem in the US economy is that all of its participants have engaged in too much borrowing, it is a surprise to see risk appetite rallying on a plan by the government to try to pump the economy with the ability to borrow even more - when what people need to do is save and pay down their debts. The essence of the problem is that the economy’s participants are finding their income streams shrinking after years of overindulgence during the heyday of credit expansion and now they are wading in a sea of red ink and imploding asset values. The only borrowing many are willing to take on in this environment is simply for the purpose of restructuring debt. The plans from the US government and Helicopter Ben (US Fed Chair, Bernanke) just keep getting bigger and bigger and scarier and scarier and it defies all logic that the market can find any shiver of a good vibe from all of this. Every new bailout scheme is designed to reward precisely those who were the most wasteful during the credit bubble at the expense of those who were prudent and conservative with their finances. When a society starts rewarding this kind of recklessness and decadence, it’s got a serious problem on its hands. That being said, the clear pattern is for the USD to do well when risk aversion is higher and we are a bit surprised to see it so much weaker. We’ve got our eyes out for a reversal, even if there is no evidence of such just yet.

The reaction in currency markets to the Fed/Treasury announcements was as one would expect when a jolt of risk appetite hits the markets, with the USD and JPY weakening sharply. But the JPY crosses failed to maintain altitude convincingly and AUD wasn’t exactly putting on fireworks either after an initial spasm of buying, and as the Asian session draws to a close this morning, it is looking like the market may have falsely got its hopes up once again. Support is still in place in EUR/USD in the 1.2950 area, but the action won’t look convincing if that level fails today. The JPY crosses look outright heavy - see more on USDJPY below.

We are particularly bearish on EUR. The same kinds of problems we are seeing in the US are brewing in Europe, they’re simply not as visible at the present time. Short EUR/JPY trades are probably the best way to express a bearish outlook on Europe and this pair could dive for the exits if this rally in equity hits the skids like all of the other recent ones have. Short term, we have to admit the possibility that the pair could test higher as it is technically neutral in a range, but the Euro situation is a ticking time bomb…especially as European Central Bank doesn’t have the mandate to operate like the US Fed with its ability to expand its balance sheet and the confusion of multilateral policy from the member nations of the EuroZone and potential for sniping over national interests could get ugly as the next wave of financial turmoil hits European shores.