AIG 1 Lehman O-as the FED takes control!

If it’s broke, let’s throw tax payers money at it! Cbanks are contributing cash to soothe money market concerns. Bernanke favors this over manipulating interest rates. Sorry Lehman, not sure what you did to receive the cold shoulder. But, AIG had the winning formula (selling 80% to the Fed for $85b bridging loan). Someone should have taped ML CEO and his two former Goldman Sachs colleagues who may get $200m for providing ‘the kiss of death’ within a year! This credit crisis fallout holds no punches. Alas, the Fed is doing its bit to keep investor confidence afloat.

The US$ is weaker in the O/N trading session. Currently it is lower against 11 of the 16 most actively traded currencies in another ‘whippy’ trading range.

FX Heatmap September 17th, 2008

Yesterdays US inflation numbers should eventually appease some of Bernankes concerns going forward. Inflation moderated as expected (-0.1% vs. +0.8%) last month, largely on the back of lower energy prices and the lack of evidence of a ‘price pass-through’ effect. Analysts believe that both Sept and Oct. CPI headline will fall even faster due to the same reasons. On the other hand core-CPI (ex-food and energy rose by only +0.2%) remains well contained. The evidence of ‘pass-through’ into the core numbers remains very weak. Analysts have argued that higher energy prices were initially a relative price shock and not something to have caused generalized inflation.

Recent capital market developments did not persuade the Fed to sway from its current monetary thinking. As expected by some, they left its O/N borrowing rate at 2%, ignoring calls by certain capital market participants to ease after Lehman Brothers Chapter 11 filing shook global markets. ‘The committee will monitor economic and financial developments carefully and they will act as needed to promote sustainable economic growth and price stability’. They continue to believe that downside risks to growth and the upside risk to inflation are both of significant concern. With the unanimous decision (the first in a year), they stated that they will ‘continue to address market turmoil with emergency lending (like their about face with AIG liquidity concerns). They believe that the substantial easing of monetary policy already combined with ongoing measures to foster market liquidity will help to promote moderate economic growth. The Fed have successfully performed another hand holding exercise, convincing Capital Markets to have faith and stay the course, together we will over come……or was it the possibility of throwing tax payers money towards AIG which propelled equity markets higher and provided a bid for the greenback after their rate decision yesterday?

The US$ currently is lower against the EUR +0.66%, GBP +0.06%, CHF +0.32% and JPY +0.07%. The commodity currencies are mixed this morning, CAD +0.26% and AUD –0.61%. The loonie continues to struggle as ‘risk aversion’ trading strategies dominate the FX market. Heightened investors concerns about global growth have had a negative effect on commodity currencies. Investors continue to sell commodities (especially crude and gold) as part of a move toward less ‘risky assets’. Since oil peaked 2-months ago (to date down -38%), the CAD$ has depreciated 6% vs. its largest trading partner south of the border. Global perception has analysts adjusting the loonies’ year end price vs. the greenback to 1.1000. Canada has become guilty by its ‘proximity and association’ with its southern neighbor. Yesterday’s data showed that Canada’s manufacturing sector continued to perform well into July, posting decent growth figures during the month on the back of broad based gains. Sales unexpectedly advanced +2.7%, m/m. But, it’s worth noting that energy shipments did not account for any of the gains as petroleum and coal shipments were unchanged from the previous month. The US remains Canada’s largest export market, over 75% of our exports head south and 50% of that is commodity based. With global growth issues a major concern, commodity prices will continue to soften. Expect traders to be better buyers of US$ on pull backs as Canadian economic data remains on the softer side. Politically and economically Canada will be pre-occupied with its general election slated for Oct 14th over the next few weeks.

The AUD and NZD continue to trade under pressure, especially vs. the JPY, as investors are willing to aggressively unwind recent carry trades and enter into ‘risk aversion’ deals. Yesterdays AIG rescue package initially provided support for both currencies, but created an opportunity to sell the currency once again. The high yielding assets of the Kiwi and AUD$ are considered a pair of the riskiest. Expect rallies to be sold for now (0.7963).

Crude is higher O/N ($93.42 up +233c). Both oil and gas prices renewed their downward spiral yesterday on concerns that the ongoing financial turmoil may weaken the global economy and reduce demand even further. With a potential rescue package for AIG in place, the market has taken back some of these losses. The black stuff managed to depreciate another 5% during yesterday’s trading session after AIG had its credit rating slashed and Lehman brothers filing for Chapter 11 earlier in the week. Investors fear that a further deterioration of the US financial system will spread to the real economy and affect demand for oil. Fundamentally commodity prices have the potential of falling much further. To date, oil has depreciated 38% from the highs printed 2-months ago. OPEC (who supply more than 40% of the world’s crude), have lowered their forecast for 2009 oil demand to 87m barrels a day because of the global economic slowdown. Analysts are now predicting that they will ‘step in’ and take action if price pressure push crude towards $80 a barrel. Market consensus has us believing that OPEC is content with $90-$100 a barrel. The market is currently doing battle with the pessimistic sentiment of the global economy. Once investors overcome this thought process, then the fundamentals of supply and demand be taking into account. Yesterday we have experienced our fourteenth straight day or price declines (and that includes two hurricanes). With the Gulf of Mexico successfully bypassing a direct hit from the storm last weekend, production facilities will be expected to be back on line sooner than anticipated. Last week, OPEC’s President Khelil called on members to stop producing more than the group’s set quota, a move that would reduce supplies and perhaps provide some crude price support. Initial reaction has had the opposite effect, they had hoped to reduce a ‘huge oversupply’ of oil on the market, and at the same time psychologically provide an artificial floor for the black stuffs prices. This morning’s EIA report may once again throw us another curve ball. Gold playing second fiddle to oil, regained some lost ground in the O/N session ($787). With the news of an AIG bailout the greenback coming under pressure, increased demand for the ‘yellow metal’.

The Nikkei closed at 11,749 up +140. The DAX index in Europe was at 5,992 up +27; the FTSE (UK) currently is 5,078 up +52. The early call for the open of key US indices is higher. 10-year Treasury yields backed up 14bp yesterday (3.48%) and are little changed O/N. Treasury prices fell aggressively, especially in the front end and flattened the US yield curve as traders hastily priced out the ‘easing premium’ in the FI markets after Lehman Brothers bankruptcy filing this week. With consumer confidence taking a battering, the flight to quality and surety remains as global equities trade under pressure. Today’s positive action about AIG rescue package may provide further relief for FI markets.

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Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments.
He has a deep understanding of market fundamentals and the impact of global events on capital markets.
He is respected among professional traders for his skilled analysis and career history as global head
of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean
has played an instrumental role in driving awareness of the forex market as an emerging asset class
for retail investors, as well as providing expert counsel to a number of internal teams on how to best
serve clients and industry stakeholders.
Dean Popplewell