The eyes of everyone from investment managers to stock and currency traders were glued to testimony of the 3 biggest players in the latest financial crisis. US Treasury Secretary Paulson, Federal Reserve Chairman Ben Bernanke and SEC Chairman Cox urged the Senate Banking Committee to approve their request for $700B of taxpayer money. Instead of calming the markets, Paulson and Bernanke spent their time warning of the doomsday scenario should the Senators fail to approve their plan. As a result, stocks came under severe selling pressure. Volatility has been vicious in the financial markets today but the one thing that has remained relatively consistent is dollar strength. The greenback traded higher against every major currency. On Monday, the dollar’s weakness was triggered by the sharp rally in oil prices and today, the retracement is leading to a recovery in the US dollar. Since the beginning of the year, the EUR/USD has had a close 70 percent correlation with oil prices. Over the past 3 months, that correlation has become greater than 90 percent.
From Main Street to Washington, No One is Happy with Paulson’s Plan
Based upon the criticism by the Senators, the backlash from economists, commentators and average Americans, no one is happy with Paulson’s plan. The big question on Main Street is whether Paulson is putting the private interest ahead of the public. This is certainty a heavy debate and one that we will not take up in this column. Instead, we acknowledge the fact that no other viable solutions have been offered and instead Paulson has simply relented to more oversight. This lack of confidence or clarity in Paulson’s plan is a big reason why the US dollar could fall by another 5 percent. Like banks, investors from around the world are pulling their money out of high risk investments and hoarding their cash. According to The Independent, hedge funds are suffering mass redemptions. Foreign investors continue to lose confidence in dollar denominated investments, which is reflected in the sell-off in the stock market and rally in US Treasuries. For currency traders, this means that the US dollar is headed lower.
The Problem is Counterparty Risk
Paulson’s argument is that by freeing up capital for the banks, they can resume making loans for individuals and businesses. However the problem that lenders face is not necessarily a lack of cash, but the fear of couit’sitnterparty risk. The only encouraging thing that came out of the statement was a peculiar comment from Fed Chairman Ben Bernanke. Rather than stick to his prepared testimony, Bernanke spent his time talking about buying assets at their value if held to maturity over buying them at fire sale prices. If this is what they actually do, we could see banks revise up their write-downs. Unfortunately this is another band-aid that masks some of the troubles in the financial crisis and not a new solution aimed at boosting lending, reducing risk aversion or stimulating growth. Unless these problems are tackled head on, the US economy could be in for more trouble.
More Signs that Mr. Scrooge is Coming this Holiday Season
The Richmond Fed manufacturing Index and the report on house prices were both weaker than expected, but the big disappointment came from the National Retail Federation’s warning that spending this holiday season could be the slowest in 6 years. More consumers may be forced to think like Mr. Scrooge which will lead to weaker growth and slower hiring. Existing home sales are due for release on Wednesday. We expect sales to continue to slow because even if homeowners have money to buy, lenders are making it very difficult for them to take out a loan in excess of their down payment.
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