The U.S. Dollar traded lower versus most majors on Monday in reaction to the U.S. government's new plan to manage the toxic asset problem that is still plaguing banks. The new plan has the government offering to finance up to $100 billion to partner with the holders of toxic assets.
This program will not require new money, but will instead use the TARP funds from the $700 billion fiscal stimulus fund approved in October 2008. The government feels that this new plan is necessary to clean up banks in order to reestablish normal credit practices.
There is upside and downside to the new program. The upside is that this plan is expected to loosen up the credit markets for consumers and small business owners. The downside is that the plan may fail because banks and the government may not be able to decide how the assets will be valued. Unfortunately no one knows if the plan will work until specific action is taken.
The plan looks good on paper for the banks if the assets rise in value. If the assets go up then both the banks and the government will split the profits according to a pre-arranged percentage. If the assets lose value then the taxpayer is on the hook for the loss. What this plan amounts to is a call option for the banks €¦.. their loss is limited to their investment while they share in the upside potential.
The Swiss National Bank formed a toxic asset fund way back in October 2008. In its plan the SNB removed the toxic assets from the banks' balance sheets. This action put the toxic assets in control of the SNB and gave it a chance to liquidate these instruments in an orderly fashion. This action also gave the banks a chance to recapitalize.
The U.S. plan is a partnership between the Treasury and the bank with the bank standing to gain the most while the U.S. is faced with all the risk. The presentation of this plan clearly shows Treasury Secretary Geithner's allegiance to Wall Street and looks a little too risky for the taxpayer. I think the banks are going to stick the taxpayer with the worst of the worst and never give the taxpayers a chance to have their investments appreciate.
The strong rally in global equity markets overnight set the tone throughout the day in the Forex markets as aggressive investors renewed their interest in higher-risk, higher-yielding currencies. This put selling pressure on the U.S. Dollar from the start which continued throughout the New York trading session.
Bearish Dollar traders are giving the toxic bank plan the benefit of the doubt and selling Dollars to express their optimism that the plan will lead to a recovery in the U.S. financial system. For months traders had been buying Dollars for safety because they feared the banking system would collapse under the weight of the toxic assets on their books.
News that these bad assets would be eliminated triggered selling pressure in the Dollar on the hopes of a U.S. banking system recovery. This is making investors less risk averse and triggering demand for higher-yields.
Euros opened higher on greater demand for higher-yielding, higher-risk assets and accelerated throughout the trading session on comments from European Central Bank President Trichet about the future of interest rates and other plans to boost bank liquidity. Trichet does not want to see ECB interest rates at zero. It is now up to him to convince the other policymakers of his preference while the Euro is heading toward $1.40.
Most market participants know that the Euro Zone will lose exports if the Euro is allowed to continue to rise. If Trichet does not want to lower interest rates then he is going to have to come up with some other creative way to stimulate growth in the economy. This could mean an intervention or quantitative easing.
British Pounds opened higher and remained firm throughout the New York trading session. The firm stock market encouraged traders to seek a higher level of risk. Many traders feel the market's upside is limited because of the weak U.K. economy. Some traders believe the Bank of England will soon announce another phase of quantitative easing in an attempt to provide liquidity to the struggling economy. This action would likely weaken the Pound over the short-run.
U.K. CPI is due out tomorrow. Traders are looking for an increase in February of 0.3%. This would be the first increase in six months. The most important number tomorrow will be the annual rate of growth figure. The Bank of England wants to see it fall inside of its target zone of 1 to 3%. The market is pricing in a 2.6% number. If the CPI falls then the GBP USD will go down on expectations the BoE will have to take action again to revive the economy.
Strong equity and firm commodity markets helped support a rally in the Canadian Dollar. Traders have been buying the Canadian Dollar on optimism that the U.S. plans to finance toxic assets held at major banks will stimulate the U.S. economy. The bullish thought is that this action will help speed up the recovery in the U.S. economy which will spill over to the Canadian economy.
A recovery in the U.S. economy may also lead to an increase in demand for crude oil. Canada would likely benefit as its export market is driven by demand for energy. Strength in the U.S. economy may also spur renewed growth in the housing market which could lead to increased demand for Canadian wood products.
Those trading the news should note that the plan to buy toxic assets is still just a proposal and considerable negotiations between the banks and the U.S. government will have to take place regarding the price to be paid for these assets. Although the news is favorable today, the proposal is not a given and the market could continue to trade in both directions until a deal is worked out.
Gains have been limited lately in the Canadian Dollar because of the fear of an interest rate cut by the Bank of Canada. Watch the Canadian bond market yields to see if speculators begin to price in a change in the BoC policy. If yields trade steady or lower then this may be a sign that the current interest rate policy will not change. This will put selling pressure on the USD CAD.
The Japanese Yen was under pressure on Monday as speculators were buying the Dollar looking for more return on their investments. News that the U.S. is going to announce a plan to finance toxic assets held at major banks triggered a rally in equities which repelled traders away from low-yielding assets like the Yen.
Although nothing has been finalized, traders were more optimistic this morning that the U.S. economy will recover more quickly from its recession. This decreased trader aversion to risk and encouraged them to seek higher yielding assets. With an investment in the Yen yielding next to nothing, traders are favoring other currencies at this time.
The Japanese economy is still in shambles and traders do not expect to see a turn in the economy until Japan€™s trading partners in Europe and the U.S. begin an economic recovery. Some traders along with the Bank of Japan and the Japanese government favor a weaker Yen to spur export demand. This is also weakening the Yen as speculators are anticipating either an intervention or a round of quantitative easing to help drive the Yen lower.
Speculation that the U.S. economy may be on a path to recovery helped to drive speculators to higher yielding assets on Monday. Now that the U.S. banking system has stabilized and is anticipated to get better if the U.S. can find a way to finance toxic assets, Swiss investors in the Dollar are attempting to find better returns elsewhere. This is leading to greater demand for the Swiss Franc.
Traders should continue to monitor the activity from the Swiss National Bank since it may not be finished infiltrating the market. The SNB wants to see a lower Swiss Franc and will do what it has to do to weaken it. Although it is being tolerant at this time, one has to believe that it still has quantitative and intervention plans still in the works.
Strong equity global equity markets and greater demand for commodities helped buoy the AUD USD on Monday. Traders are optimistic that the U.S. is on its way to an economic recovery and want to get a better return on their investments. The high interest rates offered by Australia are a much better alternative to the low yields in the U.S.
Expectations are for the rally to continue as long as there is demand for commodity-driven currencies like the Australian Dollar, the New Zealand Dollar and the Canadian Dollar. Gains could be capped if government reports show inflation has fallen or production was down. This news will lead to renewed rumors of another rate cut by the Reserve Bank of Australia. Talk of lower rates could lead to profit-taking and an end to the current rally.
The New Zealand Dollar has been strong lately because of greater demand by investors for a higher return on their money. This trend could continue into March 26th when the New Zealand government announces the 4th quarter GDP number. Expectations are for the report to show a contraction of 1.1%. Any loss bigger than this figure will trigger a sharp break in the NZD USD as traders will begin pricing in another interest rate cut by the Reserve Bank of New Zealand or an intervention.
Speculators are leaning toward an intervention because of the language of the last RBNZ announcement. In its last announcement the RBNZ said it would slow down the rate of interest rate cuts and proposed the use of alternative means to stimulate the economy. At this time, traders are favoring an intervention because of its effectiveness and its efficiency at pushing interest rates down quickly.
The most bullish scenario will be more demand for higher risk assets and signs that the economy is on the road to recovery.
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