Forex Trading

The dollar gained a brief respite from the incessant selling seen in the latter half of the week as we heading into the New York close on Friday. Normal service resumed as Wall St stuttered after the Fed’s plan to rekindle consumer and corporate lending under its TALF plan fell short of expectations and the greenback was back in favour.

However, the retracement did not last long as attention shifted to the pending announcement from US Treasury Secretary Geithner on further details on the Obama administration’s plan to purge banks’ balance sheets of toxic assets. An interview in the WSJ with Geithner gave an early insight into what the content of the plan might entail. In the interview Geithner highlighted that the only way to resolve the financial crisis was to enroll the help of the private sector in the cleansing of troubled assets from banks’ balance sheets. The plan looks to embrace a three-pronged approach, with the creation of an entity, backed by the FDIC, to buy and hold loans. In addition, the Treasury is seeking to expand the Fed TALF facility to include older “legacy” assets and finally the government will initiate a public-private investment fund to soak up between $500 bln and $1 tln in troubled mortgage-backed and other assets. With recent public concerns over executive pay and bonuses linked to bailout recipient companies escalating, the markets are latching onto one condition in the report that says companies that participate in the scheme would not be subject to executive pay cap rules and taxation issues. Initial market reaction to this news has been favourable with S&P futures gaining over 1.5% and in turn dragging the Nikkei over 3% higher.

The weekend also saw ECB board members Weber and Trichet on the wires, both adopting a more dovish stance on EU interest rates, though Trichet in his usual manner was the more guarded of the two. Weber commented that “rates are at 1.5% in the EU and heading down” while also noting that EU rate cuts had not been inflationary so far. He was adamant in downplaying talk of a European region sovereign default, calling it “nonsense”. Trichet, in a WSJ interview, said it was possible the ECB could continue to take unconventional steps on bank financing but was strongly against pushing rates down to zero, warning that a ZIRP would offer a number of drawbacks and thus were not appropriate. He countered criticisms that the EU governments had not done enough in terms of stimulus, saying they were totally unjustified. The EUR saw a marginal knee-jerk reaction lower but was contained as players concentrated more on a weaker dollar from the positive vibes from the US toxic asset plan.

A key UK economic think-tank, the Ernst & Young Item Club has suggested that net government in the forthcoming tax year is likely to far exceed Chancellor Alistair Darling’s predictions, reaching some GBP180 bln and 12.6% of GDP, and has warned that public finances were deteriorating at an “alarming rate”. The Item club, which uses similar methodology as the Treasury forecasters, said that predictions made by Chancellor Darling in last November's pre-budget report had been overtaken by events. It forecast that total borrowing over the next five years would be £270bn higher than anticipated as falling tax revenues as a result of lower consumer spending and rising unemployment impacted. GBP wobbled at the start of trading in Asia but has still managed to hold up remarkably well.

While the dollar’s future direction at the start of the week will be dictated by the welcome tonight’s plan receives, later in the week it faces another hurdle with just under $100 bln worth of treasury auctions on the slate. $40 bln of 2-year notes on Weds, $34 bln of 5-year notes on Thurs and $24 bln of 7-year notes on Fri will be the first test of the depth of interest in holding US treasuries, and the Fed’s ability to maintain support, at a time when TICS data shows foreign appetite for long-term US treasuries is in retreat and China’s FX reserves have potential to dip for the first time since October 2008 (according to comments in the China Business News). A poor showing would likely see the dollar confined to the dustbin again.