Paulson's Shift on TARP Exacerbates Global Unwind

Paulson’s Shift on TARP Exacerbates Global Unwind

The global unwind continues with currencies, equities and commodities taking another beating. Other than the Japanese Yen, all of the major currencies have weakened against the US dollar. The Dow Jones Industrial Average dropped 411 points while oil prices fell below $56 a barrel. The first round of selling was triggered by warnings from US corporations and the fear that other central banks would have to cut interest rates aggressively alongside the Bank of England. The liquidation exacerbated after Treasury Secretary Paulson held a press conference about the new provisions in the TARP. He has abandoned the government’s plan to buy troubled assets and instead plans on using the remainder of the $700B to help relieve pressure on Americans burdened with car loans, student loans, and credit cards.

Paulson Changes Course, Market Questions His Tactics

After creating a lot of hype around the need to laden the US balance sheet with troubled mortgage assets, the US Treasury Secretary has scrapped the plan, raising questions about the US government’s confidence in their own policies. Changing tactics at this stage of the game leads everyone to wonder if Paulson and his cohorts know what they are doing. He has openly admitted that the initial plan was not the most effective way to spend the $700B bailout package and instead will now use the money to ease consumer credit – a move that would be much easier to implement. The US government will continue to shore up banks by injecting capital. It remains to be seen if this move will have a meaningful impact on the credit markets by driving the yields on consumer loans lower. The first half of the TARP funds is quickly running out and it will be inevitable that Paulson or his successor will have to ask for the remainder from Congress. Support for the automakers is also increasing. Paulson touched on the need for the government to help the auto industry while Representative Frank suggested that the House could consider a new $25B loan. As we have previously mentioned, recent comments from the current administration and President-elect Barack Obama strongly suggests that no one is willing to let automakers like General Motors fail without trying to help.

Will the NBER Official Acknowledge the Recession?

It is earnings season and the reports that we have seen so far are a harsh reminder of the growing problems in the US economy. Retail sales are due for release on Friday and the warnings from retailers indicate that consumer spending has slowed materially. Best Buy cut its full year forecast today, DHL is shutting down its US operations and Circuit City became the 14th retail chain to go bankrupt, joining companies like Linen N Things and Steve and Barry. The declared bankruptcies do not tell half of the story. The biggest problem we are facing is that many retailers are destined to follow a similar path. With consumers keeping their wallets sealed shut, companies like Claire’s Stores, Borders, and Dillards (just to name a few) have been aggressively cutting earnings estimates as stock prices plummet. If Martin Feldstein, a member of the National Bureau of Economic Research is right about the unemployment rate surpassing 8 percent, then we could expect consumer spending to slow further, pushing more retail chains into bankruptcy. The NBER is the organization that officially determines whether the US economy has fallen into a recession. Although Feldstein is only one of its 8 members, we find it particularly interesting that he said the US recession is just beginning. The NBER has yet to officially recognize the recession and his comments are a step in that direction.

Oil and Trade

Oil prices dropped $3 today to a new 21 year low of $55.62 a barrel. Slowing Chinese growth is confirming fears that global demand for oil has slowed but we believe that the recent decline in oil prices is an overreaction. Nonetheless, the drop in oil will help to reduce gasoline prices and give US consumers some much needed relief. The national average of gas prices have already fallen to $2.182 a gallon, which is actually lower than the price for a gallon in 2006, the last time that crude prices were at currently levels. The US trade balance is due for release tomorrow. The sharp drop in the export component of manufacturing ISM suggests weaker trade numbers.


The big action in the currency market today was in the British pound. The currency broke 1.50 against the US dollar to hit a new 6 year low. Against the Euro, the move was even more historically significant, with the currency falling to a record low. The weakness was even felt in GBP/JPY, which is within a whisker of challenging its 1995 lows. The market is starting to believe that not only will UK interest rates fall below 2%, but they could be headed to Japanese levels. According to the November Inflation Report, the monetary policy committee believes that inflation will fall below their 2 percent target with the potential of hitting 1 percent. With price pressures expected to ease significantly, the Bank of England is sending a strong signal that interest rates will continue to come down. There is talk that the recessionary conditions in the UK economy could make the UK the next Japan. Another 200bp of easing by the end of the first quarter has been priced into the markets, which would take interest rates down to 1%. If the BoE chooses to overshoot monetary stimulus, UK interest rates could be at Japanese levels. Mervyn King has become quite a maverick and given his fear of deflation, we would not be surprised to see another large rate cut from the central bank. When the dust settles, the UK's aggressive monetary stimulus should turn their economy around faster than the Eurozone or the US, but in the meantime, more rate cuts mean more weakness for the British pound.


Compared to the 2 to 3 percent slide in the British pound, Japanese Yen, Canadian and Australian dollars, the 0.35 percent drop in the EUR/USD is nominal. The currency pair has held up pretty well in the face of massive risk aversion. Eurozone industrial production was slightly weaker than expected, but the decline was not significant enough to impact the Euro. The preliminary third quarter GDP report for Germany is due for release tomorrow – given the sharp decline in the trade balance and retail sales, the data should be Euro bearish. We continue to expect the EUR/USD to challenge its October lows, which were levels not seen since 2005. Eventually the European Central Bank will have to give up their stubborn stance on interest rates which could open the door for more losses.


The Canadian, Australian and New Zealand dollars continue to get pummeled. In the past week, we have seen USD/CAD soar from 1.15 to 1.2382 and the NZD/USD slide from 61 to 55 cents. For the 3 commodity producing countries, a weaker currency will boost foreign earnings. We have already seen currency fluctuations help Australian corporations like Qantas, Fosters and Billabong raise their earnings forecasts. This is part of the reason why the strength of the US dollar offers more problems than benefits for the US economy. To everyone’s surprise, interest rate cuts, cash handouts and steady employment numbers have helped to boost Australian consumer confidence. New Zealand retail sales on the other hand did not fare as well with consumer spending falling short of the market’s expectations. Retail sales rose 0.1 percent in September, which sales excluding autos dropped 0.5 percent. The Canadian merchandise trade balance is due for release tomorrow and we expect the numbers to be weak.


The more than 400 point drop in the Dow weighed heavily on all of the Japanese Yen crosses. The biggest movers were GBP/JPY and AUDJPY, which fell over 5 percent. For the past three days, we have seen investors fearful about the health of the global economy. Japanese consumer confidence fell to a record low. Even though this report does not usually provoke the same level of attention as those in other countries, it is still a leading indicator for consumer spending. With trade at a standstill, consumer spending is pivotal for the Japanese economy. Tomorrow, we will receive Industrial Production figures.

EUR/USD: Currency in Play for the Next 24 Hours

The EUR/USD will be our currency in play for the next 24 hours. Tomorrow, we expect German GDP at 2:00 am ET or 7:00 GMT, as well as French Current Account and CPI at 2:45 am ET or 7:45 GMT. The US will announce the Trade Balance at 8:30 am ET or 13:30 GMT.

EUR/USD has recently returned to the Bollinger band sell zone after a brief stint in range-bound territory. Referring back to Monday’s commentary, price action did break outside the triangle. According to how triangles are formed, you can make a price projection equal to the size of the base of the triangle. Such a projection could see prices heading toward 1.1800. However, there is an important support level at 1.2325, which is the October 28th low. Resistance is formed by a previous high and the 10-period moving average (orange line) at about 1.2800. Even though the price action was relatively subdued today, we can expect that the bevy of reports tomorrow will have an important implication on a potential trend extension.

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