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US Dollar Consolidates as Traders Wonder if TARP = TRAP

Thu, Sep 25 2008, 08:18 GMT
by Kathy Lien

GFT

For the second day in a row, Federal Reserve Chairman Ben Bernanke and US Treasury Secretary Paulson pleaded to the power players of Washington to pass their request for $700 Billion to implement their Troubled Asset Relief Program (TARP). However if we move the letters around a bit, TARP becomes TRAP and that is exactly how many investment managers, economists, politicians and average Americans view the plan. They are afraid that this is a trap for US taxpayers because they may be paying for a bailout that benefits the private and not public sector. Bernanke argues that a failure of the private sector would have “grave” consequences for the public sector, which is true and Paulson has finally agreed to accept limits on executive pay under the bailout plan. Yet, today’s price action in US stocks and the US dollar suggest that some investors are holding out the hope that Paulson’s TARP does not become the trap that keeps Americans still paying for bailout many years to come.

LIBOR Rates Jump, TED Spread Widens

Other investors on the other hand are more skeptical. Three month LIBOR rates jumped 26 basis points to 3.47 percent, which is the highest level since January. The TED spread, which measures the difference between the interest rates of the 3 month LIBOR and the 3 month Treasury bill hit an intraday high of 311 basis points. Not only is this only the second time in 2 decades that the TED spread has gone above 300bp, but the premium is far above its pre-credit crunch levels of 20 to 30 basis points. The greater the TED spread, the greater the degree of risk aversion and the fear of default in the market. Therefore the jump in the LIBOR and the widening of the TED spread suggests that investors are still hoarding their cash and they are skeptical of whether the government’s efforts will actually restore stability in the financial markets and improve risk appetite.

Paulson’s Plan Could be a Lose-Lose for the US Dollar

Paulson’s plan is ultimately a lose-lose situation for the US dollar. If it is approved, it would cause a destruction of the US balance sheet by increasing the nation’s debt ceiling by 6.6 percent to $11.315 trillion. If it is not approved or if Paulson and Bernanke only get a trimmed down version of the plan, they would have to go back to the drawing board to come up with other solutions to unclog the mess. If we end up being between rescue plans, the uncertainty would weigh on the US dollar. Therefore I still believe that the US dollar could fall another 5 percent over the next few months.

Home Sales, Durable Goods and President Bush

Existing home sales dropped by 2.2 percent last month while mortgage applications plunged by 10.6 percent, the largest decline since July. The ongoing turmoil in the financial markets has made it increasingly difficult for even people with money to buy a home to secure loans. House prices continue to fall with the median price declining 9.5 percent from last August, causing more homeowners to pull their houses off market. The inventory of unsold homes dropped 7 percent, which was the largest decline since December 2006. In times of strong growth, a reduction of inventory may be good because it could suggest that demand is strong, but in times of weak growth, it suggests instead that homeowners are giving up on selling their homes now. Durable goods, jobless claims and new home sales are due for release Thursday morning. We continue to expect economic data to confirm that the US economy is weakening. President Bush will also be giving a nationally televised address on the financial crisis on tonight. Although we do not expect any groundbreaking announcements, his comments could nonetheless be somewhat market moving for the US dollar.

Published on  Thu, Sep 25 2008, 08:21 GMT