The Fed’s future path still seems more bullish than the European Central Bank. If so, the yiel...
Waiting on the TARP Package
09/29/2008 12:00 am EST
"Don't worry about the mule being blind, just keep loading the wagon" seems to capture the market reaction as we await the fate of the "Troubled Asset Relief Program" (TARP). The analogy refers to the absence of a deal, which is seeing generally better risky asset performance. Congressional leaders are still negotiating the details of the government's proposal to un-freeze credit markets as this is written, but I remain confident that an agreement along the lines put forth by Treasury and modified by House and Senate leaders will be reached. The market's response so far has been to embrace the likelihood of a package as a signal to put risk back on. This was most evident in stock market gains on Thursday and USD strength going into the end of the week. The impasse that materialized on Friday temporarily saw risk assets falter, but as of late afternoon Friday, stocks were mostly up, JPY-crosses were mostly higher, and the USD was nearer to its highs for the week. Why am I optimistic on TARP passage? Simply put, the alternative is "You don't want to see what happens if it isn't passed." No one I know is pleased to be in this situation, but the alternatives are truly worse. With failure not an option, some form of the TARP will be passed.
Markets are slowly coming to the conclusion that the TARP will not result in a massive expansion of US debt and that the risk to US taxpayers will be substantially less than the headline figure of $700 billion. That removes a major negative for the USD outlook, though many others remain. The USD lost over 3% in trading this past Monday when the size of the program was first revealed, and this suggests the minimal scope for USD improvement as cooler heads prevail once a package is passed and enacted. To the extent that credit market conditions improve once a deal is in place, additional US economic slowing may be forestalled, and that is another reason to anticipate further recovery in the USD. This is especially so when one contrasts US efforts with the lack of governmental support being offered in other major economies. In the big picture, global growth is still slowing (the Baltic Dry Bulk Index, a measure of demand for container ships and a proxy for global trade, is at its lowest level in 2 years and down 65% since its May peak) and the latest series of events has likely reinforced that dynamic. Slower global growth will continue to see assets invested abroad repatriated home, providing the USD with further ongoing support. Slower global growth will also work to reduce commodity demand, which should see oil and other commodity price resume declines, bolstering the USD further.
Gold remains buoyant on remaining risk aversion, but I'll be watching for renewed declines as investor fears likely subside in coming days/weeks.
Finally, John Berry, a noted columnist for Bloomberg News, makes the argument that a successful TARP program could see US budget deficits reduced in coming years, as the US benefits from receiving high-yielding MBS interest payments (lending at high rates) while funding with low-yielding Treasuries (borrowing cheap), potentially reducing another major USD negative.
Near-Term Outlook for the Buck
While I am optimistic that a TARP package will represent a turning point in the credit/financial market crisis and that this will ultimately be good for the USD, the USD remains in correction mode at the moment. Next week sees month-end and quarter-end, which is likely to see liquidity reduced and volatility increased. Anticipating better USD conditions going forward, I look to be a buyer of USD on dips rather than a seller on rallies. In EUR/USD, a daily close below the 1.4500/30 area should signal the end of the correction and signal renewed USD strength. The 1.4800/50 area represents a likely significant selling opportunity. In GBP/USD, the 1.8250/8300 area is key support, below which sees a return to Sterling weakness, while 1.8600/50 represents the sell zone for me. USD/JPY is much more difficult to predict due to carry trade/risk aversion influences, but the 104.50-105.00 area looks attractive to get long, and strength over the 107.00/50 area likely signals an extension higher toward the 110.00/50 area.
While the market digests the details of the TARP plan, incoming data will drive short-term price action. US data is likely to remain on the soft-side in coming weeks, but it will not be alone, as discussed next. Such data-driven back-and-forths should provide traders ample opportunities to buy USD on dips and sell on rallies.
US Outlook Dims, but Others Fading Faster
This week provided more evidence that the US economy continues to grind lower and the risk that it enters (or is already in) a recession is now palpable. Housing weakened further with no bottom yet in sight, employment deteriorated to recessionary levels, and business spending is at risk of printing negative in 3Q. Existing home sales tumbled 2.2% while new home sales plunged 11.5% for the month of August. Meanwhile, inventories remain bloated in both segments at just over ten months worth of supply. Initial jobless claims this week also jumped to a whopping 493,000, which was the largest increase since 9/11, and means claims are now officially in recession terrain. The durable goods report provided the third piece of bad economic news, as it showed a decline of 4.5% in new orders for August. Indeed the core measure that feeds directly into GDP-non-defense capital goods excluding aircraft-plunged 2.0% on the month, and suggest business spending could actually be a drag on growth in 3Q.
This latest bunch of poor data does not, however, mean that the relative performance of the US economy versus others has deteriorated markedly. In fact, euro zone economies continue to show fresh weakness (as evidenced most recently by ugly PMI and IFO numbers) and the UK remains on the precipice of recession. Indeed, pressure is growing in the UK for the government to mount a bank rescue plan similar to what the US is considering, due to the plunging housing sector there. When one considers that the governments of these countries are less inclined to intervene in their frail financial systems, the near-term economic pain could be much more pronounced there than in the United States. As such, we continue to view the USD as better positioned to come out on top in this race to the bottom.
Key Data and Events to Watch Next Week
The US economic calendar is bustling next week and kicks off on Monday with the personal income/spending and core PCE prices data. Tuesday brings Case-Shiller home prices, the Chicago PMI index, and consumer confidence. Wednesday has ADP employment, ISM manufacturing, and construction spending on tap. Thursday brings the usual weekly jobless claims numbers along with factory orders data. Friday rounds out the week with a bang as we get the all-important employment report and the ISM non-manufacturing index. Fed speakers next week include Hoenig and Lockhart on Tuesday and Bullard and Hoenig (again) on Friday.
It is also pretty eventful in the euro zone. The main event will be on Thursday as the ECB meets on interest rates. While the bank will likely leave the rate unchanged at 4.25%, the press conference following the meeting will be closely watched. Otherwise, the EZ business climate indicator and consumer confidence start it off on Monday. Tuesday is busy with French PPI, French housing starts, German employment, EZ consumer price estimate, and German retail sales. The rest of the week is quiet with EZ employment on Wednesday and EZ retail sales on Friday.
The UK sees a modestly busy week. Monday has consumer credit, mortgage approvals, and GfK consumer confidence. Tuesday sees the final cut on 2Q GDP and the current account. Wednesday has PMI manufacturing and Thursday rounds out the week with nationwide home prices. Also watch for the Bank of England 3Q Credit Conditions Survey on Thursday.
Japan is pretty light next week and kicks off on Sunday evening with retail sales numbers. Tuesday sees the Nomura/JMMA manufacturing PMI, employment numbers, household spending, and industrial production. Wednesday closes out the week for data with small business confidence and the Tankan manufacturing indices.
Canada has a super light data calendar next week with only industrial production, raw materials prices, and GDP all due out on Tuesday.
Finally, it is pretty quiet down under as well. The New Zealand trade balance kicks it off on Sunday and NZ building permits are due on Monday. Tuesday has NZ business confidence, Australian private sector credit, Australian building approvals, and the AiG performance of manufacturers index. Last but not least, the Australian trade balance is on tap Thursday.
By Brian Dolan of Forex.com
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