House Kills the Bailout Plan and the US Dollar

The rejection of the $700B bailout plan by the House of Representatives came completely out of the left field, driving a knife through both US equities and the US dollar. For the Bush Administration, it certainly feels like they are moving one step forward and taking two steps back but the severity of the financial crisis makes it absolutely necessary for Washington to put economics ahead of politics. Although traders were initially dissatisfied with Congress’ approval of Paulson’s plan, they were counting on a bailout. The combination of a huge liquidity injection by the Federal Reserve today and the hope that the bailout plan would move forward kept stocks from falling further. However those efforts and the sleepless weekend of debates turned out to be futile after the House rejected the bailout bill. For fairness, there was no was guarantee that Paulson’s plan would have helped average Americans, but at least it could have brought some stability to the financial markets. Unfortunately it is now back to the drawing board for Paulson who has to meet with Bush, Bernanke and Congress to discuss their next steps. Volatility in the financial markets benefits no one especially as more than $1 Trillion in market value has been wiped out from US stocks today. The VIX, which measures equity market volatility shot to the highest level in 6 years while gold prices jumped 3.8 percent. LIBOR rates have also skyrocketed while the TED spread continued to widen indicating that as a result of the House’s rejection of the bill, investors both domestically and internationally have become more risk averse. For those that are willing to part with their cash, they are demanding a high premium.

Dow 10,000 Could Mean 100 USD/JPY

dow092908 The Dow Jones Industrial Average closed down more than 770 points while the S&P500 dropped more than 8 percent. This is the largest single day drop in the Dow ever and the largest percentage decline in the S&P500 in 20 years. We have long argued that if the Dow hit 10,000, USD/JPY could fall to 100. That correlation remains intact today as the plunge in US equities drags USD/JPY towards 104.00. In the September 19th edition of the Daily Currency Focus, we argued that the US dollar could fall by another 5 percent. At that time, USD/JPY was trading at 107.40 and to many people a 5 percent move lower, which is the equivalent of 530 pips seemed like a farfetched possibility. However since then the dollar has already fallen close more than 300 pips, making a move towards 102 within reach. With the US stock market plunging and the US government looking to raise the national debt, in addition to hammering out the bailout plan, the Bush Administration will have to work extra hard to reassure foreign investors.

Gold Becomes a Hedge for Inflation and the US Economy

Now more than ever, the US needs to rely on foreign funding. If Central Banks and Sovereign Wealth Funds around the world start to lose confidence in the US financial markets or the US government, we could be looking at a complete freeze in lending that expands beyond the banking sector. According to an article in the Wall Street Journal, central banks are already loading up on gold as European central banks cut their sales to the lowest level in almost 10 years. Gold prices are up more than $35 an ounce today as a hedge for inflation and a hedge for the US economy. Everyone is starting to realize that commodities are the only assets that have no counterparty or credit risk. Gold prices first jumped on inflation fears after the Federal Reserve’s liquidity injections this morning. Having more than doubled their swap limits from $290B to $620B, the Fed is trying to tell the market that they are serious about providing liquidity and given today’s sharp volatility, they will continue to do aggressively in the coming days.

TARP Drama Gets More Dramatic – Time to Play Defensive

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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 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.

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Dow 10k Could Mean USD/JPY at 100

On Friday, the Dow hitting 10,000 still seemed to be a remote possibility, but today, that is starting to become a reality. We have warned on near daily basis about the danger of carry trades. Although the EUR/USD’s reaction to the systemic risk in the financial markets was not as clear, there was a clearly negative implication for USD/JPY. Not only did we talk about the 70 percent correlation between the S&P 500 and USD/JPY, but there is also a similarly tight correlation between USD/JPY and the VIX index, which measures the volatility of the stock market. This means that the weakness in stocks and the rise in volatility drove USD/JPY below 105. To put today’s move into perspective, the drop in US stocks today was the most since the September 11 attacks in 2001. Unless stability returns to the financial markets, all of the Japanese Yen crosses including USD/JPY will continue to suffer.


Since the beginning of the year, we have lost 3 of the largest investment banks on Wall Street and such unprecedented developments have called for unprecedented actions by US government and Wall Street officials. Since the announcement of Lehman Brothers filing for bankruptcy and Bank of America taking over Merrill Lynch, AIG has been given special permission by US authorities to tap into $20bln of its own capital to prevent a liquidity crisis and credit downgrades. The Federal Reserve is also holding a special meeting to discuss possible remedies to AIG’s problems. The ECB and the Bank of England have pumped more liquidity into the financial system while the Federal Reserve made an unusual intervention to drive Fed funds lower.


Why Did Fed Funds Soar to 6 Percent when Futures are Pricing in a Rate Cut?

Fed fund futures are pricing in an 80 percent chance of a 25bp rate cut tomorrow by the Federal Reserve. This is a big change from last week, when the only thing that the market was thinking about was a rate hike. However despite this sharp shift in expectations, Fed funds surged to a high of 6 percent, 400bp above the Fed’s target rate of 2 percent intraday. This jump in the overnight lending rate between banks indicates that no one wants to take on risk. Trust is a commodity these days as the move in Fed fund futures suggests that no one knows if their counterparty will be here to survive another day. Fund funds gave back all of its gains by the end of the US trading session, but that does not mean that risk appetite has returned – quite the contrary. AIG is in big trouble, Washington Mutual is still on our watch list with their bonds now cut to junk status by Moody’s and the worries now turn to Goldman Sachs and Morgan Stanley who will be releasing earnings this week. Large write downs could drive a nail in the coffin for the US stock market and USD/JPY. Of all the pairs in the currency major, USD/JPY and other carry trades will be hit the worst. Over the past 3 years, there has been a 68 percent correlation between the VIX and USD/JPY, so higher volatility means trouble for the currency pair. Although consolidation in the banking sector was something many people expected, no one thought that the consolidation would occur because of Chapter 11 filings.

Will a Fed Rate Cut be Enough to Shore Up Confidence and Trigger a Reversal in the US Dollar?
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Keeping Your Money Safe

After the collapse of IndyMac and Bear Stearns, everyone is wondering if their money is safe. I have been hearing alot of people warning their friends and family that they should keep no more than $100,000, the limit of FDIC insurance, at any one bank.

My colleague Boris Schlossberg shared this great article with me that I think everyone should read:

An easy way to beat the $100,000 FDIC limit without having accounts at 20 different banks may be to invest them in Certificate of Deposit Account Registry Service or CDARS, pronounced “cedars.”

According to, here is how it works:

“Sally Jones has $130,000 she wants put in CDs in bank A. Bank A gives her CDs worth $95,000 — leaving a little room for interest — and sends Sally’s remaining $35,000 to a company that knows bank B will issue Sally a CD for the remaining $35,000. In return, bank B buys $35,000 in CDs for its customers from bank A.

The company in the middle is Promontory Interfinancial Network. It acts as a sort of clearinghouse, matching deposits from one institution with another so funds that a bank places with CDARS essentially remain on the bank’s balance sheet.

“Prior to CDARS, if you wanted to insure more than $100,000, you had to do it through (different categories of legal ownership.) Now you can title it any way you want and we can cover it through the CDARS program,” says Russell Pemberton, vice president at Pulaski Bank.”

Make sure you read the entire article on (CDARS)!

**This is in no way an endorsement of CDARS. Make sure you do research on the products

Link to Certificate of Deposit Account Registry Service