We think the US Dollar might bounce up today

Foreign Exchange Currency Outlook : Not to sound like a broken record, but if the Fed and other central banks are intervening in the money markets to prop up liquidity, why are we not assuming they are also intervening in Foreign Exchange - or did intervene Sunday night but have now relaxed, and could come back to defend the dollar at a later time? We don’t have to assume intervention-the pattern of the dollar matches events pretty well-but let’s not assume the Fed and Treasury are taking an attitude of benign neglect. We assume the US dollar is firmly on their radar screen raising the question of where do they want it to go?

At a guess, they don’t have a level in mind but they must have a direction they prefer. If it’s up for the US dollar, that means confidence in the US is the top priority. If it’s down, that means the economy comes first (exports). It’s not even a toss-up this morning-confidence would surely be the winner.

More important is the issue of trust, which underlies all credit quality. You can’t force trust any more than you can legislate morality, and forcing trust is just what the central banks are now trying to do as they act as lenders of last resort.

In this matter, the US absolutely, positively has to win.

Any skepticism on the part of global investors would be a disaster for the US financial sector, including equities, as well as the US dollar exchange rate. Bloomberg reports that the tarnished image of the US from the need for bailouts can already be seen in the cost of insuring against US sovereign default, which rose to a record high yesterday.

“Benchmark 10-year credit-default swaps on Treasuries increased 4 basis points to 30, more than double those on government debt sold by Austria, Finland or Sweden, according to BNP Paribas SA.”

As we saw from the Treasury capital flow report, foreign investors were already withdrawing from the US in July. Today Bloomberg reports that “Sovereign-wealth funds invested just $900 million in new capital in U.S. and European financial institutions so far this quarter. That's down from $6.43 billion in the second quarter, $19.7 billion in the first and $28.5 billion in the final quarter of last year.” This data includes Europe, but the point in not invalidated since the US got the lion’s share.

It’s wrong to assume that the US can always issue its way out of trouble, and by "issue" we mean sell government paper at nice, low rates. We have always said that it’s over when the Treasury holds an auction and nobody comes. Right now risk aversion is so high that Treasuries are the safe haven of choice. But when the dust settles, it seems obvious that the newly increased risk of the US financial system (so many top firms needing to be rescued) means the US will soon have to pay a risk premium. In other words, yields must rise. Nobel winner Stiglitz, by the way, is noting the same thing we noted the other day about the Fed getting too much discretionary power—it’s not the rule of law applied to everyone when the Fed bails out AIG but declines to save Lehman. We understand it, but it’s still not the way things are supposed to work. Stiglitz thinks this adds to perception of higher sovereign risk in the US, and we agree.

Longer-run, the US system was not as robust as people thought, although we can’t fault the government for failing to be nimble, flexible and lightning fast. We may not like the form that the various rescues are taking, but problems are getting addressed and by credible, capable people. It took Japan ten years and it still hasn’t fully come out of its bank restructuring, but the US will do it faster and more thoroughly. The critics (like Buffett) were right-excess leverage was pure poison. Financial Markets are responding very fast, too, and at a guess, unless another shoe drops today, we could see things calm down. We keep mentioning a possible rise in equities because we imagine that will be the symbol of renewed risk appetite and exhaustion of panic. Panic is very hard to sustain, especially if fresh data comes that offers a glimmer of offset. Is the offset the swap lines?

Well, liquidity is everything today. And money leaving money market funds, which will almost certainly occur, probably means bank deposits, not the mattress or a hole in the back yard. Rising deposits at banks can’t be all bad—as long as another fund doesn’t fail.

Out of all this it’s hard to discover a US dollar forecast for any time horizon. We think the dollar might bounce up today, but don’t count on it. Longer-term forex outlook, like a week, we guess 1.4950 is not an unreasonable expectation.

Bye for Now

Barbara Rockefeller Forex Trading Reports

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