We're surprised that the dollar isn't higher than it is this morning or maybe we're misreading the tea-leaves. On Monday evening it was becoming apparent that the so-called bad-bank was being dropped. The fear is that the taxpayer will be left mopping up Wall Street's mess at great cost. But the overnight news is that Mr. Geithner has devised an alternative that draws on the Fed's balance sheet and used FDIC guarantees in a scheme that requires the seal of approval from private investors. Hedge fund and other private capital sources are said to be in favor of the implicit guarantees, which basically limit the amount of losses that might face should they overpay for what are currently hard-to-value and illiquid assets. On the other side of the coin those assets will be worth far more over time if the plan is a success. In other words, private equity is being offered a cheap call option with the up front premium being limited by the guarantee with all of the upside if the plan takes off.
This plan, if indeed the stories circulating are accurate will be unveiled at 11am ET today. Mr. Geithner will be interviewed on television shortly after. Until now investors had put stock in the view that the U.S. Treasury would backstop the economy but at an enormous cost that could fuel heavy selling of government debt that would increase the cost of borrowing. While the dollar has been the main safety valve for fear of financial calamity, many investors have raised their eyebrows at its prospects after the announcement of any resolution.
If the Geithner version of the bad bank gathers a head of steam it could save tax-payer money. At the least, it will make any further and likely stimulus packages all the more palatable. By convincing the private sector to buy-in to the plan the administration is achieving what the Senate is struggling to do, which is to find consensus as to how to deal with the issue. With confidence still shaky among investors and the public, the approval of private sector 'smart-money' could be a deal winner here.
As the plan gathers momentum we wonder how its shape and form might be adopted by foreign government. At the very best this plan might be provide a first mover's advantage to the U.S. dollar. Investors had thought that the key to the dollar's strength was purely based upon risk aversion and liquidity preference. However, the new guise of the bad-bank plan could create a floor under negative expectations and spark the view that there is a way out. While it might be too much to state that there is light at the end of the tunnel – because this is a very long and convoluted tunnel – it can be stated that at least there is a glimmer of hope.
Plan aside, President Obama's first television address Monday evening was one where he told it like it is, holding back no punches. Failure simply is not an option and he laid it on thick that the consequences of delay or inaction would be nothing short of catastrophic. We think that the negative tone to stock index futures overnight reflected his overtone, while the slight gain in the dollar is more reflective of potentially positive action due later today. It's also worth noting that President Obama again gave investors something of a wake-up call when he said that if the measures work the economy might start to feel the glow 'next year.' Those words should be served up cold to those getting too bullish on stocks following bad news.
The stimulus bill and the bad-bank plans are merely two stitches in what is an enormous tear in the patchwork quilt that is the tattered and torn U.S. economy. The rise in the price of gold overnight to $912.50 tells us that investor fear has not yet subsided. The stress-testing that the banks must undergo in order to qualify for newly-designed capital infusion will likely prove onerous on some and as we have seen recently, more banks may fail or at least face being absorbed by larger banks.
Guessing quite where the dollar will end the day is a hazardous game. For now, it's in demand and stands at $1.2980 and $1.4770 against the euro and pound respectively. It's also making headway against the commodity-sensitive currencies of Australia and Canada where the U.S. unit is stronger at 66.97 cents and $1.2212 respectively. Signs of strain continue in the euro/yen cross pair where the rise to ¥118.45 from ¥119.05 yesterday signals more risk aversion to come. Implied currency options volatility is a little higher this morning. It's going to be quite some day!