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Dollar sells off as traders question if bailout plan is the right prescription

Mon, Oct 6 2008, 08:18 GMT
by Kathy Lien

GFT

The wait is over - the House of Representatives have finally passed the $700B bailout plan but the markets remain unconvinced that this is the right prescription for the credit crunch. The goal of Congress was to find a way to bolster confidence and unfortunately the fact that the stock market went from being up more than 200 points to down more than 150 points by the end of day indicates that the crisis of confidence has not been resolved. Although USD/JPY has trailed the stock market lower, the greenback’s weakness against the Euro and British pound illustrates the market’s belief that the Federal Reserve is gearing up for an interest rate cut. We have previously said that if the bailout plan fails to do the trick of materially unfreezing the credit markets and so far it hasn’t, investors will be looking to Bernanke for help. With the big disappointment in non-farm payrolls and the lack of celebratory fireworks in reaction to the bailout plan, there is little doubt that the Federal Reserve will cut interest rates by the end of this month.

$10 Trillion in Debt and Counting

However for the time being, the problem of a weak economy still exists and it may be a while before the average American reaps any benefits from the bailout package. The national debt has exceeded $10 Trillion this week and this does even not include the costs of the bailout. The more liquidity initiatives that the Federal Reserve takes, the more destruction is done to the US balance sheet. The US government is bailing out Wall Street, but will foreign investors continue to bailout out the US government? Herein lies the critical question that will determine the fate of the US dollar. The weakness in the US economy and the global slowdown may cause foreign central banks and sovereign wealth funds to fold their arms when it comes to recapitalizing the US financial system. This is one of the main reasons why we believe that the US dollar will continue to weaken against the Japanese Yen. The second reason is the prospect of US interest rates falling to 1.50 percent by the end of the year.

Ninth Consecutive Month of Job Losses, Largest Decline in Payrolls Since March 2003

Non-farm payrolls dropped 159k last month, 50 percent more than the market expected. This marks the ninth consecutive month of job losses in the US economy and the largest decline in payrolls since March 2003. It is difficult to argue that the labor market is in anything but bad shape and we expect conditions to worsen. Unfortunately, there was no silver lining in the details of the employment report. The unemployment rate remained at a 5 year high of 6.1 percent while average hourly earnings and weekly hours slipped. This indicates that not only are Americans having difficulty finding jobs but they are making less as well. Although the job report was not bad enough to warrant a 50bp rate cut, it is still worrisome enough for the Fed to cut interest rates by 25bp at the end of this month.

Bailout Plan Has Less than 4 Weeks to Prove Itself

With the Federal Reserve’s interest rate decision scheduled for October 29, the bailout plan has less than 4 weeks to prove itself. Outside of the minutes from the most recent FOMC meeting, pending home sales and the trade balance, there are no significantly numbers on the US economic calendar next week. This means that traders will be focusing on digesting the implications of the drop in non-farm payrolls and the impact of the bailout plan on Wall Street and Main Street. These 2 factors should be the primary drivers of the dollar’s price action in the coming week.

Published on  Mon, Oct 6 2008, 08:26 GMT