The Dollar rallied late against the Euro as U.S. equity markets broke sharply lower when the S&P Corp. downgraded General Motors. Throughout the day the EUR USD traded higher as it looked as if the equity markets had calmed down enough to encourage profit taking in the treasuries. This led to some Dollar selling as foreign investors repatriated their funds previously parked in the treasuries during the flight-to-quality rally. If anything was learned from today it’s a stable stock market will most likely be supportive for the Euro.
Despite the global interest rate cuts on Wednesday, the credit market remained locked. This reflects the lack of confidence in the banking system. Banks simply do not trust each other and are bringing the system down with their decision not to loan. Traders still have not made up their minds as to whether the coordinated rate cuts were a goodwill gesture or a harbinger of worse events to come.
Continue to focus on global interest rates for clues as to whether tension in the credit markets is easing. The main indicator is the LIBOR rate followed by the TED Spread. A reduction in LIBOR could indicate the start of a major thaw in lending. Tightening the TED spread will indicate selling in treasuries which will mean traders are willing to take on a little risk. Movement by both markets could begin to instill confidence in the financial system.
The action the past two weeks made one thing clear: the market is starving for Dollars. If this is the case then the central banks should raid their safes and begin dumping surplus Dollars on the market. This will be looked at as drastic action on the part of the central banks because it will be inflationary, but the tightness in the credit market will likely be alleviated fairly quickly once the world’s banks see huge amounts of cash floating around. If a few central banks begin dumping Dollars on the market then the pressure will be on China to do the same. China is holding on to the largest supply of Dollars after the United States. Their economy relies on our economy doing well so it is in their best interest to stimulate the credit system. If there were more Dollars available, the credit markets would loosen up and business activity would return to normal fairly quickly.
Overall, more credit crisis turmoil is expected to be supportive for the Dollar, but a loosening of LIBOR rates and the flooding of the market with Dollars locked up in central banks could break the Dollar substantially.
The GBP USD continues to suffer from the threat of a recession and potential bank failures. Although it takes time for interest rate cuts to work their way through a financial system, there is usually some sort of knee jerk reaction to the upside indicating the market has accepted the change. Since the Bank of England cut rates 50 basis points on Wednesday, the British Pound has gone straight down to a new low for the year. This is an indication the market thinks the rate cut is too late, and the economy needs another cut as soon as possible. Watch the U.K. financial markets to see if another rate cut is being priced in. The Bank of England next meets in November which means traders should prepare for another emergency rate cut.
The USD JPY gave signs most of the day that traders were willing to accept more risk. Although the stock market was under pressure the majority of the day, it seemed that carry traders were aggressively buying the breaks. The Japanese Yen rallied late in the session when a downgrade of General Motors stock forced the stock indices sharply lower. This action may have blown out the confidence of the carry traders. Friday’s action will tell if this is the case. If the USD JPY comes back on Friday to post gains, then this will be a sign that the buying on Thursday was by strong hands. Continue to watch the stock market dictate the direction of the USD JPY.
The USD CHF weakened into the close on a heavy sell-off in U.S. equities. Traders supported the USD CHF most of the trading session in anticipation of a possible rally in the equities. Traders had committed to selling Swiss and buying Dollars in an effort to gain leverage in the stock market. Once the bad news about General Motors hit the market, the carry traders had no choice by to liquidate their positions. Any weakness in the stock indices on Friday is likely to bring selling pressure to the USD CHF as traders will seek the safety and liquidity of the Swiss. This pair is not likely to rally over the near term until traders increase their appetite for risk or unless there is renewed financial turmoil in the Euro Zone. Traders will continue to monitor Euro Zone banks to see if Swiss banks are at risk.
The USD CAD rallied sharply higher as crude oil broke hard. The U.S. Dollar has appreciated considerably against the Canadian Dollar because of the massive sell-off in the commodity markets. The Canadian economy relies heavily on its exports of gold, wheat and crude. The current credit crisis is slowing down the flow of exports and putting the Canadian economy at risk. Talk is circulating the Bank of Canada is getting ready to cut interest rates for the second time this month at its meeting on October 21. Look for the USD CAD to continue to strengthen as weakening commodity prices are likely to push the Canadian economy into a recession. Do not be surprised by another interest rate cut by the Bank of Canada later in the month.
The AUD USD rallied sharply higher following Wednesday’s massive sell-off. Some of the rally was due to short-covering because of oversold conditions. Some was due to an the increased appetite for risk as the U.S. stock market was holding steady, making higher yielding assets more attractive. Any rally is expected to be short-lived because the fundamental and technical trends are down. Look to sell rallies looking for a new low for the year.
The NZD USD rallied with the Australian Dollar. The rally was mostly short-covering as the main trend is decisively lower. The pressure is on the Reserve Bank of New Zealand to slash rates. Some traders are calling for as much as 150 basis points. This action is necessary because weakening commodity prices are dragging this market into a recession.