Lehman Spelling Trouble for the Dollar and Carry Trades

The US dollar dropped like a rock at the open of the Asian trading session on Sunday. It has been a long weekend for US government officials and the leaders of Wall Street banks.

Bank of America (BAC) and Barclays (BCS) pulled out talks to buy Lehman Brothers (LEH) as the government refused to provide sufficient funding. The events of this past weekend are the same as last Sunday - only the names have changed, with the GSEs swapped out for Lehman. It is very possible that Barclays and Bank of America wanted more government funding than JPMorgan (JPM) received for Bear Stearns, given their negotiating power and market risk. What is assured is volatility. Government bailouts can become a slippery slope and Paulson may not want to open the flood gates.

Dollar Collapses as Traders Prepare for Bankruptcy, Watch Out for Further Carry Trade Losses

The dollar collapsed against the Japanese Yen, Euro and British pound on Sunday evening as traders prepare for a possible Lehman bankruptcy. The ISDA (International Swaps and Derivatives Association) extended the hours of an emergency trading session between Wall Street dealers and Lehman Brothers so that they can net out or cancel transactions that offset each other with Lehman. No one knows what will happen with Lehman and what the credit quality of their assets are - all they know is that the right thing to do now is to reduce Lehman exposure. Counterparty risk is huge at this point for the currency market and that means carry trade weakness.

FOMC Statement Could be Dollar Bearish

The big event this week is the FOMC meeting. With the troubles in the financial sector, the last thing that the Federal Reserve wants to do is to talk about the possibly of raising interest rates. In fact, expect Lehman’s troubles to drive up expectations for a rate cut over the next 12 months. Economic data has taken a turn for the worse and the troubles in financial sector are growing. The Fed will keep interest rates unchanged at 2.00 percent but the FOMC statement could actually be dovish. Consumer confidence improved for the month of September but we are particularly worried about the sharp drop in retail sales and the softer PPI numbers.

Expect a dollar negative week.

Comments

[SW Richmond:]

The Fed's balance sheet is so impaired by this point that Bernanke is teetering on the brink of irrelevance. So long, Ben , we hardly knew ye.

2008 Sep 14 08:18 PM

[Smarty_Pants:]

The first domino finally teeters over as the gub'mint realizes that they can't bail out LEHMAN much less everyone else. More dominoes to follow.

Surprisingly the gold price jumps and the dollar falls, but it's only a confidence issue I'm sure. Like being confident that the FED will crank up the printing presses at some point.

What-ever will all those banks do now with the short positions they established to drive down the price of gold? Golly, I guess they'll just have to buy them back and help drive the price back up again.

Funny how you can only suppress things like widespread financial sector insolvency for so long. Eventually someone is left standing when the music stops.

Make sure you've got your bowl of popcorn and a drink. The big show is about to get under way.

2008 Sep 14 10:42 PM

[MarvinMBA:]

Offshore Investing has its own set of problems as the US banking system crisis will eventually turn overseas financials into shambles also.
There could be some profit opportunities by shorting dollars but be carefull of some swings that will take you out. Best to keep your bucks home away from any speculative actions for the next few weeks as we watch things play out...STAY AT HOME AND IN CASH/EQUIVALENTS....Ma... the Maven

2008 Sep 15 12:48 AM

[Fish Gone Bad:]

Smarty_Pants: My sentiments exactly. I have a big box of popcorn set aside just for this occasion.

Clark Jenkins
FishGoneBad.com

2008 Sep 15 02:15 AM

[User 30121:]

Unfortunately, I cannot consume popcorn, but it certainly is tempting. I will just get some doritos, I guess.

Those dollar-gurus (CLH, et al) you better watch out! Its starting to crumble (the pyramid scheme). You know, your govt, Fed buddies are starting to sweat. Its not very becoming,is it? HAHAHAHAHAHAHA

2008 Sep 15 03:50 PM