How the Fannie / Freddie Announcement Impacts Forex, M&A

This weekend, the US government announced that they have seized control of Fannie Mae (FNM) and Freddie Mac (FRE), also known as the Government Sponsored Enterprises [GSEs]. The sharp rally in the Asian and European stock markets as well as the move in Dow futures suggest that we will see similar strength in US stocks. There is no question that US Treasury Secretary Paulson’s announcement has carved out a bottom in equities, but for currency traders, it will be another reason to buy dollars.

Restoring Confidence Among Sovereign Wealth Funds

Risk aversion surged last week, sending the US dollar higher and carry trades lower. Even though the dollar has rallied more than 10 percent against the Euro and British pound since July, we have argued that the dollar’s strength is not over. With the government taking over Fannie Mae and Freddie Mac, it will shore up confidence amongst foreign investors and sovereign wealth funds in particular. Paulson took a look at China’s $4.6 billion reduction of exposure to Fannie and Freddie debt and realized that something needed to be done to prevent a further exodus of foreign investment.

Positive for Carry Trades and the US Dollar

For the past month and a half, the dollar has been rallying on slower growth outside of the US and the expectations for interest cuts abroad. None of those macro drivers that have been propelling the dollar higher have changed, and if anything, the GSE announcement restores confidence and helps to alleviate risk aversion. For the currency market, this means more dollar strength and a recovery in the Japanese Yen crosses. We are still looking for the EUR/USD to hit 1.40 and the GBP/USD to hit 1.75 over the next few weeks. There will be nothing to celebrate when it comes to Eurozone and UK data and because of that, the dollar will have a much better time holding onto its gains than the Yen crosses.

M&A Flow

The weakness in the US dollar has also brought on a new trend that is worth watching – dollar negative M&A flow. This morning, we have seen announcements of big deals of US corporations snapping up foreign firms. ConocoPhillips (COP) announced that they have agreed to pay up to $8B for a stake in Australia based Origin Energy Ltd. Two months ago, a deals like this would have cost as much as 15 percent more. Expect the dollar’s strength to bring more M&A flow.

Comments

[phdinsuntan...:]

so US$ 5000 billion of new US debt is good news for the dollar,
because China, EU and Japan funnie bonds are like cash and they can
buy more USTB, funding the US deficit and sell their stuff. Bailout foreign central banks instead of broken US investment banks is the new fashion...
insane, but may work for some time...

2008 Sep 08 02:42 PM

[gmiller:]

<There is no question that US Treasury Secretary Paulson’s announcement has carved out a bottom in equities>

Really? That's right up there with Bernanke's fairly recent statement that Fannie and Freddy had nothing to worrry about. Actually, he was right- they're Uncle Sam's problem now.

2008 Sep 08 05:22 PM

[Jackson Cash:]

I agree with other posters: ".. has carved out a bottom in equities" is garbage. Don't sell out forecasting such bull$hit.

2008 Sep 08 06:24 PM

[Msrpaul:]

They will buy dollars only because debts need to be paid. The dollar has been ruthlessly abused as a method for the government to confiscate savings and wealth from prudent people. Now the Fed kills foldm as deflation sets in. When everybody except the reckless IB's have been killed, in the name of "protecting the economy", which is code for maintaining the status quo, then the Fed will inflate. I have nothing but utter contempt for the privitisation of profits and socialising of losses. They created the bubbles to avoid reality. Now that people have been caught up in the bubbles seeking a return on their capital, they kill them. My loathing for them grows every day.
The dollar is worth nothing but bathroom functions.

2008 Sep 08 10:35 PM

[leegee:]

"Paulson took a look at China’s $4.6 billion reduction of exposure to Fannie and Freddie debt and realized that something needed to be done to prevent a further exodus of foreign investment...."

Kathy, in looking throughout the web at all of the other commentary by analysts this morning, you are the only one who seems to "have got it right." The actions of Paulson, et al, are only partially about the US housing/financial crisis.

Keep it up!

leegee

2008 Sep 09 11:21 AM

[ProHFAnalyst:]

This is the problem with Blogs. Anyone and everyone can write something, and it has a veneer of credibility becuase of the nice layout, etc.

2008 Sep 09 02:58 PM

[Chris B:]

Assets = Liabilities + Equity

so...

Government = Debt to foreign creditors + Taxpayer equity

As the national debt has increased Liabilities, it has reduced Equity, resulting in foreign creditors having a greater claim to the assets of government than taxpayers do. This is the same process that occurs when a company goes bankrupt. The remaining assets become controlled by the creditors, rather than equity holders. Additionally, in this case, the government is completely dependent on continued borrowing from foreign creditors for its daily operations. These borrowers could cut off funding tomorrow if they wanted to. The equity holders (taxpayers), on the other hand, do not have the option of refusing to pay taxes, so their interests are inherently at a comparative disadvantage.

For these reasons, the focus of government has shifted from benefiting taxpayers to benefiting the foreign creditors on which it depends. When the fed shifted the cost of trillions of dollars in dumb foreign investments from the creditors to the taxpayers, they were pursuing the interests of the liability owners at the expense of the equity owners. The alternative was to risk having foreign creditors clamp down on lending to the U.S, which would result in a currency crash and a government cash shortage - like Russia in the 90's, when the govt. couldn't even pay the salaries of its employees.

These factors will not change soon, and most people can't even figure out what is going on, so expect more of the same and invest accordingly.

2008 Sep 10 10:18 AM