Here are two interviews that I did with the Moneyshow last week about the volatility in the currency market and the Japanese Yen. Pretty basic stuff, but may be a good listen. Click on the image to access the video:
For the first time since March 2003, the Dow Jones Industrial Average broke 8000 at the open of the US markets. However just as quickly as stocks dropped 600 points, it recovered more than half of its losses in the first 15 minutes of trading and actually moved into positive territory 35 minutes into the trading session. The capitulation followed by the major short squeeze suggests that we may have seen a near term bottom. This type of volatility drove the VIX index to a record high of 70.
Currency Traders Waiting for the Buying Opportunity
Interestingly enough, we have not seen much of a reaction in the currency market. This suggests that the capitulation is only in stocks and traders are waiting for the bounce to get in. The day is early so many things can change and equities could sell off again, but for the time being, it appears that the buyers of EUR/USD, GBP/USD and USD/JPY are sitting on the sidelines waiting to get in. If stocks start bottoming out, carry trades could actually bounce today. No one will want to be short carry ahead of the G7 and G20 meeting this weekend – we expect a bounce.
Pessimism in Uncharted Territories
Pessimism in the market has hit uncharted territories with the TED spread reaching another record high. This indicates that liquidity remains a problem and unfortunately confidence in the markets is tied to liquidity. Lehman has a CDS auction today and the rumor in the markets is that governments could resort to temporarily shutting down equity trading. This seems nearly impossible by theory, but it is certainly becoming a growing possibility. There is nothing more coveted than cash right now and the continued hemorrhaging will force the G7 and G20 into action. It will be another long weekend for US Treasury Secretary Paulson and Federal Reserve Chairman Ben Bernanke. There is even talk that the US is considering a guarantee of bank debt.
G7 Meeting – Most Significant Since 1985 Plaza Accord
Finance Ministers have arrived in Washington for the G7 meeting while the G20 meeting is scheduled for the weekend. This will be the most significant G7 / G20 meeting since the 1985 Plaza Accord which marked a major turning point for the US dollar. The consequences of inaction are severe, so we expect a big announcement this weekend if not sooner.
We have been literally begging the Federal Reserve, the European Central Bank and the Bank of England to work together to stem the bleed in equities and they have finally done it (What is the Fed Waiting For? And Panic Selling in FX Begs Coordinated Easing). For the first time since Sept 2001, central banks around the world have delivered a coordinated interest rate cut. Coming 2 days before the G7 meeting and 1 day before the BoE interest rate decision, their move sends a strong message to market that the central banks are holding nothing back in their attempt to unlock the credit markets, stabilize the stock market and stimulate growth.
Given that the Bank of Japan stood aside, the move is bearish for USD/JPY. However the impact on the Euro and British pound is limited because the interest rate differentials between those currencies and the US dollar remain unchanged. Unprecedented is the buzz word in the financial markets these days and today’s rate cuts were nothing short of that.
Unfortunately despite an initial rally in stocks, equities have given back all of their gains as investors believe that the actions by the central banks are too little too late. This is undoubtedly the right move for the central banks, but the right time to have made the rate cuts was last Friday after the TARP approval. Stocks continue to sell off because this has not solved the funding issue. The LIBOR – OIS (Overnight Index Swap) rate hit a record high indicating that credit is still tight. The Reserve Bank of Australia’s full percentage point rate cut earlier this week has raised the bar.
Time for Halloween Treats – Next Stop Could be 1% for the Fed?
Given the market’s lack of a reaction to the rate cuts, the Federal Reserve may still give investors a Halloween treat by cutting interest rates 25bp at the end of the month and the next step after that could be a move to 1 percent.
It has been an extremely volatile day in the currency markets with big figures (100 pip) moves in USD/JPY happening in a blink of an eye. The more than 4 percent decline in USD/JPY is the largest single day percentage drop in close to 10 years. The degree of the moves that we have seen today in many currency pairs is normally something we would see in a quarter or even in some cases, a year. For example, the AUD/USD plunged as much as 9 percent today while NZD/JPY dropped more than 10 percent. Given that the dollar has collapsed against the Yen but soared against the Australian dollar, Euro and British pound indicates that the story today is deleveraging and liquidation. With the Dow accelerating its decline on the break of 10,000, the only thing that can stop the fall in equities and carry trades is coordinated easing by the G7.
Fractured Responses Not Working – Time for Coordinated Easing
As we have seen by the US’ Troubled Asset Relief Program (TARP) and the deposit guarantees announced across Europe, fractured responses are not working. There is no doubt that the problems have gone global and as result, a global response is necessary in order to stop the freefall that we are seeing in the financial markets. Over the past 20 years, shifts in the stance on currencies by the Group of Seven have triggered dramatic turns in the US dollar. Although the volatility in the US dollar has become a secondary story to the weakness in the US stock market, what the G7 meetings teach us is that a coordinated message by the major central banks around the world can put a stop to hemorrhaging. G7 Finance Ministers are meeting on Friday in Washington. At this stage of the game, there is no reason for central banks to not seriously consider coordinated action. The European Central Bank hinted that they are ready to cut interest rates, the Bank of England and the Reserve Bank of Australia are expected to do so this week and Fed fund futures are pricing in a greater chance of a 75bp versus 50bp rate cut by the end of the month. It is time for the Bernanke to step up to the plate and do all that he can to stabilize the financial markets. Increasing the size of the Treasury Auction Facility and paying interest on reserves is just not enough.
Expect a Dead Cat Bounce
For both carry trades and equities, the sell-off has been nothing short of brutal. However as we have on September 30th, the day after the Dow Jones Industrial Average closed down 777 points, a dead cat bounce of a few hundred points would be natural. We have been calling for the Dow to hit 10,000 and for USD/JPY to fall to 100 for a good number of months and now that those targets have been reached, there is a decent chance that could see a bounce. Wall Street and Main Street have been frightened by the monumental moves in the stock market and when fear is at its peak, the light may be just around the corner. This is not to say that we believe that rosier times are ahead, but the hemorrhaging may soon ease. The crisis in the financial markets has become so severe that a reaction that is more significant than what we have seen so far needs to come from government officials and once there is coordinated action, we may finally see stability. Growth will remain weak however, but for the US stock market we could enter a phase of contracting ranges. After Black Monday in 1987, the Dow Jones Industrial Average range traded for 14 months.
Zero Percent Interest Rates in the US?
Non-farm payrolls dropped by 159k last month, 50 percent more than the market expected. Even though there was a minor upward revision to the August data, the Fed will have no choice but to cut interest rates at the end of the month. Fed fund futures are pricing in a 50bp rate cut by the Oct 29 meeting but we believe that the number is not bad enough to cut by 50bp because the central bank will want save some ammo for the remainder of the year in case the bailout plan fails to stimulate the markets.
Traders Reluctant to Sell Dollars Ahead of House Vote
Interestingly enough, the US dollar initially fell against the Japanese Yen and Euro but quickly recuperated its gains. With the market is embroiled in uncertainty ahead of the House’s vote on the bailout plan, traders were reluctant to aggressively sell US dollars because the ugly NFP number nearly guarantees a passing of the plan. The reaction to the NFP number also tells us that the whisper number could have been somewhere around -200k.
NFP Could Fall by -200k Next Month
Given that this is the ninth consecutive month of job losses in the US economy, and the largest decline in payrolls since March 2003 no one can argue that the labor market is not in bad shape and we expect it to get worse. We haven’t seen the end of job losses and in fact, we expect to see a month of -200k NFPs before the labor market hits a bottom. 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. Not only are Americans having difficulty finding jobs but they are making less as well. These 2 ingredients spell more trouble for the US economy which is why it is time for the Fed to cut interest rates.
Big Question: Will the EESA Plan do the Trick?
The House is set to vote on the TARP/EESA plan around 12 to 12:30pm ET and we should see the results in the early afternoon. The approval of the bailout plan could lead to a relief rally in US stocks, but the question here is not whether the plan will be passed but whether it will do the trick of unfreezing the credit markets. House Speaker Pelosi said that she would not schedule a vote on the $700B bailout plan unless passage is certain. The bottom line is banks are not willing to lend to each other. The US economy remains very weak and the crisis of confidence that has frozen the credit markets may not be solved by a plan that focuses on recapitalizing banks and not creating jobs. This shared sentiment has put the Dow within an arm’s reach of 10,000 as a few hundred point swings have become the norm. Therefore we still expect the dollar to remain under pressure against the Japanese Yen and as for the Euro, today’s data is not bad enough to warrant a 50bp rate cut in the Fed funds rate which means that we may also see a relief rally in the EUR/USD.