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.
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 (NYSE: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.