The Dollar Index and the Financial Sector

Dollar Index: The Fed's plan seems to be fairly clear. Mr. Bernanke is expecting to see the economy slow in the second half of the year (and possibly into next year as well), so he wants to let the projected decrease in demand depress prices. It already looks as if Q3 GDP will be slower than what was seen in the first half of 2008. After the report on Durable Goods Orders showed that shipments of non defense capital goods increased 0.6%, economists put that together with inventories and made an early estimate of 1.5% for the third quarter. Whether a 1.5% GDP is sufficient enough to slow inflation is another story, but if this year's hurricane season does significant damage to production in the Gulf of Mexico, Mr. Bernanke may be faced with no choice but to indeed raise rates "sooner rather than later."

In the meantime, the dollar's inverse correlation to oil was well in evidence again on Wednesday, as traders bid up oil on speculation that Hurricane Gustav could potentially disrupt supplies from the Gulf of Mexico.

DXY has apparently tested 76.00 as support. The 450 tick range is large channel to trade, and breaking back below it may just send the dollar straight back down to where it just came.  The Usd is on over 90% of all currency tickets, it makes up the value of all synthetic cross pairs, so knowing where the Usd is trading, and what is driving it, is key to sustained success in reading and really understanding the nuances of Forex charts.

Overall: The index seemed to have made a test of support (also known as a continuation pattern) of the trend line extending from March 2006 and October 2006. This line was first broken on August 12. There is another trend line lies just above it, drawn from November 2005 through October 2006. If the index is to gain, this line will need to be successfully tested as resistance. On the day, the index fell 23 44 basis points to 77. The decline would have been worse except that the dollar gained on the pound during the day.

The Financial Sector was up 2% on the day, but there was more evidence that banks are having serious problems with mounting mortgage defaults. The Office of Thrift Supervision [OTS] said Wednesday the U.S. thrift industry posted a $5.4 billion loss in the second quarter, the second largest on record, after having lost $8.8 billion in the fourth quarter of 2007. The OTS said thrifts set aside a record $14 billion to cover loan losses during the quarter, the most ever. The agency said its list of "problem" thrifts grew over 16% to 17 in the second quarter, up from 12 as recently as March. Those 17 thrifts are included in the 117 "problem" banks the Federal Deposit Insurance Corporation reported on Tuesday.

After the 30% increase in the number of troubled banks reported yesterday, the WSJ said The FDIC may have to borrow money from the Treasury in order to handle the expected wave of bank failures. “We don’t think this credit cycle has bottomed out yet,” said FDIC Chairman Sheila Bair at a press conference Tuesday.  “I don’t like to make predictions, but I think it’s going to continue to be very challenging, and as I said I think the number of banks and assets on the troubled bank list will continue to go up.” 

Chris Whalen, managing director of Institutional Risk Analytics, said during an interview with CNBC that the FDIC needs a backstop of "about half a trillion dollars in borrowing authority, and they need a vehicle to own these banks while we triage them and sell them." Regarding the risk of seeing a large instituting fail, Mr. Whalen said it may depend on the loss rate "If we are way over 1990s levels, by say the third quarter, then I would tell you there’s going to be some institutions that may not be able to raise private capital and may need a bridge."

At the close of trade the XLF had gained 0.35 points (1.74%), closing on 20.52. The areas below here to hold are 18.00 and 16.00, and as the market recently have witnessed, the short targets are getting hit a lot quicker that the long prices. The volume was very light; just 88,788,392 ETF's changed hands against a daily volume average of 188,566,000.

Comments

[dieuwer:]

It seems that everyone is on the "FED will raise rates" bandwagon. The correct contrarian point would be to actually expect rates to decline.
If you look at the bond market, traders have been expecting lower rates since mid june of this year. The 10 year T yield dropped from 4.26% to 3.77% as of today. The 1 year T trading right now 2.16%. Very close, too close, to the FED yield. The yield curve is contracting since mid March.
My bet is that the FED will LOWER RATES before year end.

2008 Aug 27 07:26 PM

[Matt from Q...:]

As far as lowering borrowing costs are concerned, it's fairly evident that monetary policy by itself is not the answer to de-leveraging, therefore it's doubtful to see the Fed reduce rates further.

To paraphrase a wonderfully clear explanation by Paul McCulley from PIMCO, the paradox of de-leveraging is resulting in further asset-price declines, reinforcing the negative feedback loop. The root of all this is the decline in home prices, the asset upon which all this leveraging was built, so without a stabilization in home prices the de-leveraging process will continue.

Lowering borrowing costs further is not likely to mitigate this problem and therefore, it isn't likely to see another rate cut from the Fed.

2008 Aug 28 11:37 AM

[dieuwer:]

Bond market thinks otherwise

2008 Aug 28 04:16 PM

[BadHorse:]

Implicit in all the talk...(cycles, resistance and support levels, reserves, borrowing more money to pay off bad money, housing bottom, ...... is the absurd notion that financials will ride the same horse that took them up the mountain and down....back up the mountain again. In case it has escaped attention, that horse (READ BUSINESS MODEL) is dead and stinking to high heaven. Financials are only half way down the mountain. Right now they, and the dead horse, are on a cliff way
above the rocks and river below. Happy landings and happy trails.

2008 Sep 03 04:59 PM