Markets getting hammered as bailout plan unexpectedly rejected
Charis Charilaou
Chief Dealer
History usually repeats itself and after US lawmakers chose to reject the US Treasury’s $700 billion bail out plan, one more “Black Monday” was the inevitable outcome. Equities plunged across the globe and it's difficult to see what is going to break the sequence of selling of equities and JPY crosses.
Last week was another landmark for the financial world as the last two investment banks have decided to become banks. Goldman Sachs and Morgan Stanley have been approved as bank holding companies and are now regulated by the Fed. Goldman saw a USD5bn investment by Warren Buffet, and Japanese banks bought large stakes in both banks, Mitsubishi $9 billion into Morgan Stanley and Sumitomo into Goldman Sachs. The week started and ended with US Treasury secretary Hank Paulson stressing the need to pass legislation for a USD700bn plan to stabilize the economy. The plan known as TARP (Troubled Asset Relief Program) has been rejected on Monday by the US House of Representatives after a turbulent session. Other news included the acquisition of Washington Mutual deposits and some branches by JP Morgan, the partial nationalization of Fortis bank by the Benelux and the nationalization of Bradford and Bingley by the UK treasury. The FX market lacked clear direction as traders were split on the effect of the proposed bail out on the USD. Market risk aversion was on the rise by the end of the week due to the delay in passing the Treasury bail out package and the periodic seizing up of the credit markets. The rising risk-aversion took the AUD and NZD lower while supporting the safe-haven CHF and JPY. Gold was very volatile with no clear direction, while oil was plunging along with equities, trading as low as 95.50 on Tuesday.
LOOKING AHEAD
Although we think the focus will stay on Washington as Paulson is starting a new initiative there will also be some critical economic data coming out with the September payrolls the most important. We look for a 120k decline to confirm the overall trend and unemployment rate unchanged at 6.1% while average hourly earnings should rise 0.2% m/m. On Wednesday the ADP Employment report is forecast to show a 45k decline in private payrolls. Tuesday's data starts with the S&P Case Shiller index which should fall -16% from the previous -15.9%. Chicago PMI is also out on Tuesday with estimates for a fall to 54 from 57.9 and consumer confidence coming just after. On Wednesday we will also get the ISM manufacturing index which is set to come near the 50 level, while construction spending should come lower by -0.1% m/m. After Friday's NFP the ISM Non Manufacturing is also due and could increase to 50.8 from 50.6.
In Eurozone all eyes will be on Thursday's ECB meeting and press conference. In spite the growing evidence that the crisis is moving to Europe as well, with Eurozone HICP still running high at 3.8%, the clear and repeated Trichet message will probably stay the same- price stability is a prerequisite for financial stability. Tuesday's flash Eurozone September HICP is expected to move to 3.5% from 3.8%.
In UK the key will be the PMI data and the Bank of England Q3 credit conditions survey, both expected to come on the soft side. Tuesday will see the release of the September Gfk consumer confidence expected to show a new low at -41. Later in the week on Wednesday will get the manufacturing PMI survey expected to fall to 44.8 while on Thursday the PMI construction and the Nationwide house price index are likely to continue pointing towards recession.
STRATEGY
The EUR/USD traded up to 1.4865 last Monday when there was a broad view that the USD would broadly weaken whether or not the Treasury bailout package was passed. This was due to the markets view that the Fed would have to print a lot of money and US government debt would be less appealing to foreign investors and central banks, as the US fiscal deficit continued to blow out. In the course of last week and after the Fortis and Bradford & Bingley nationalizations, a view emerged that the US problems were not isolated and European and UK banks also faced challenges and didn't have the support framework to come up with a rescue as the US Treasury proposed. After Fridays strong rise, the EUR/USD proceeded to make slightly lower daily lows for the rest of the week. After the rejection of the bailout plan, the risk is concentrated on the JPY and CHF crosses as investors are looking for safe havens. However, there are hopes for a plan to be passed by the week end which it is likely to produce reversals once the markets digest all of the details of the plan and a lot will depend on whether or not the credit markets react positively to the plan. There is a lot of data out of Europe and the US next week with the main event being the US non-farm payroll data on Friday. The US economic data of lately have been weak and plan or no plan it is hard to make a strong case for a higher USD based on fundamentals. The key for the EUR/USD direction will be how investors view Europe, as there is a widely held view that the European economy will ultimately have a harder time overcoming the crisis than the US. On EUR/USD, the first obvious downside target is at 1.4250 which if broken would be looking at the September low at 1.3879. Despite the kneejerk reaction to breach 1.4550 after the result of the vote became known, we expect the pressure on JPY crosses combined with continued worries about European companies to be enough to keep the EUR/USD in a range for the short term. However, with the housing market still falling and both trade deficit and budget deficit going higher, we think the US will again concentrate on keeping interest rates and the dollar low. Having tested the most important EURUSD support at 1.3900 of the last EURUSD downmove, the market is still trading within the long term 2000-2008 trend and a test of the 61.8% Fibonacci retracement and double top break out at 1.5230-80 remains our preferred scenario for the medium term.
Disclaimer
This research report or summary has been prepared by TFI PCL from information believed to be reliable. Such information has not been independently verified and no guarantee, representation or warranty, express or implied, is made as to its accuracy, completeness or correctness. This report is provided for information purposes only. Nothing in this report should be considered to constitute investment advice. It is not intended, and should not be considered, as an offer, invitation, solicitation or recommendation to buy or sell any of the financial instruments described herein. TFI PCL accepts no liability whatsoever for any direct or consequential loss arising from the use of this document or its contents.
