Bailout Plan Fails to Impress, Traders Worried More About Dominoes Effect

The Congressional agreement of the $700 Billion bailout plan has proved to be anti-climatic for the stock and currency markets. There was a relief rally in the US dollar Sunday evening, but it lasted for no more than a blink of an eye as more problems came knocking on the door for financial institutions. Investors quickly moved onto the latest problems with a string of bank bailouts announced in Europe and the practical failure of Wachovia. Being sold at $1 a share is almost the same as filing for bankruptcy.

THE DOMINOES EFFECT

The US dollar has weakened against the Japanese Yen, but its strength against the Euro and British pound indicate that the concerns for those currency pairs now shift to the prospect of further bank failures in Europe. In the Eurozone, Fortis was bailed out by Belgium, the Netherlands and the Luxembourg governments while the Hypo Real Estate group was bailed out by the German government. In the UK, Bradford and Bingley was nationalized by the UK government. If the US banking sector is a good model, then we know that this is just the beginning of bank failures as the dominoes effect triggers more losses. With the ECB interest rate decision scheduled for Thursday, the problems in the banking sector could pressure the European Central Bank to consider easing monetary policy.

On the heels of the bailout plan, the Federal Reserve has injected a tremendous amount liquidity into the global money markets by increasing their swap lines. This is driving gold prices through the roof as inflation fears soar and money flocks out of US dollars and into gold as the safe haven play. Nonetheless, the Fed is trying to tell the market that they are serious about providing liquidity with the size of today’s liquidity injection – they more than doubled their swap limits from $290B to $620B.

US COMPANIES PLAYING DEFENSE COULD BOOST RECESSION RISKS

So far, the Treasury’s plan has failed to restore confidence in the financial markets. Not only are we expecting more layoffs across the board due to slower global growth but US banks and other financial institutions will also be looking to play defense over the next few months. This means tighter terms for home loans, car loans, and credit card loans which could strain the expansion efforts of US companies and the spending ability of US consumers. The Treasury’s plan has failed to reduce recessionary risks and that may be part of the reason why US stocks continue to fall and the US dollar is at risk of breaking 105 against the Japanese Yen.

MORE WEAKNESS FOR THE US DOLLAR

Looking ahead, I still expect the dollar to weaken against the Yen, but the troubles in Europe could lead to more erratic trading for the US dollar against the Euro and British pound.

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