Interactive Brokers FX Summary

Appetite for the greenback waned over the course of the past week as investors tried to understand the potential impact for the underlying economy from the $700 billion bailout package. Meanwhile lawmakers listened to Fed Chairman Bernanke and Treasury Secretary Paulson and gave them a cool response. The quote, "You can't handle the truth!" made famous by Jack Nicholson in A Few Good Men springs to mind. The duo on the Hill is trying desperately to persuade politicians that beyond a wrecked package lies some kind of economic Armageddon. The dollar has cheapened up and recent currency trading patterns are reflecting the heady implied options volatility noted in trading patterns last week. 

Currency option implied volatilities moved marginally ahead, save for that on the Aussie dollar, which had been running at elevated levels. With the exception of the British pound and Canadian dollar open interest in currency futures rose across the board. Given the fact that the pound at least has had a sharp pullback from its own abyss, it stands to reason that positions may have been stopped out leading to this lower reading of open interest. 

Option traders added most heavily to call positions and so nailed down the key currency movements this week. There was a sharp rise in option activity in the Swiss franc whose recent torpor has apparently been shaken off. 

The path for the dollar has been far from smooth over the course of the last couple of weeks in which traders seem to have shifted their perspective from leader of the pack to whipping boy. That's hardly surprising given the extremely fluid situation on Wall Street where fresh revelations appear to come out of the woodwork by the hour. Political response to the bailout plan is against the support of the financial infrastructure without some recourse to punish corporate executives who have allegedly driven business models into the ground while receiving monster pay packages. In a sensitive election year, politicians are also eager to witness the package provide respite for homeowners who fall foul of profligate mortgage lending practices. 

It has been the case that the ability of the Fed and the Treasury to tackle problems head-on has increased the appeal of the dollar. The argument had been that this aggressive dealing would help rejuvenate the U.S. economy and the prevalent regime of easy monetary policy would help prevent consumer-led recession. The dollar in that sense was at the head of the pack. Now, the fear is that the medicine is creating a new series of economic ailments and that's weighing heavily on the dollar. 

The rescue package will without a shadow of a doubt create a wall of treasury supply from one month t-bills right through to the 30 year bonds. One could argue that this fresh supply, which might take years to launch, will weigh on prices and send yields sharply higher. However, given the gravity of the economic situation and the need to bail out the street, one could argue that treasury note yields face a potential cap. Without the issuance, the economy won't mend itself, implying potentially easier monetary policy but certainly lower yields. 

The global appetite for this wave of issuance does augur a temporarily weaker dollar. For sovereign wealth funds and central banks to take on board the follies of the U.S. financial system, it makes sense that currency risk is reduced in terms of a weaker dollar to stimulate demand for fixed income. 

The incredible volatility apparent in the currency markets has put some analysts on guard for a statement from the forthcoming G7 meeting. That doesn't make too much sense to us. The previous bouts of currency market volatility were attributable to severe dollar weakness earlier this year and in 2007. Only two weeks ago the dollar was at its highest in a year at least. It's unlikely that the G7 will feel the need to act or even mention the dollar unless it plumbs the depths once again. 

The stimulus package faces a binary outcome. It will or it won't happen. If it doesn't, the Armageddon type fallout that Mr. Paulson seems to indicate will reach global proportions and growth will be severely strained. Counter to initial thoughts that dollar weakness might follow, it could be argued that the dollar would actually benefit as every competing currency faces domestic strife and the flight to safety creates a fresh new role for dollars. On the other hand, successful passage of the plan could put a floor under investor conviction and encourage risk appetite, which might be more supportive of other currencies. Under this scenario the dollar still has the benefit of being the leader of the pack and one could point to a possible win-win for the dollar on any outcome. One fact remains. The incredible current uncertainty is weighing against dollar sentiment for now. 

With the exception of the Australian and Swiss currencies, there was a greater flow of call volume swelling open interest this week. The put-call ratio, which measures the balance of bear against bull open interest declined to show the stronger appetite for calls over puts this week. On balance the currency option market still favors the downside for the Aussie and Swiss francs. 

But the reality has been a vicious bounce against the dollar on both accounts. In fact the 7.6% snapback in the Aussie unit is the largest of the week and is possibly supported by the current 5% yield cushion for the Aussie as well as the panic driven rally into gold last week. Gold's well-known status as safe haven saw it rescued from the otherwise disorderly exit from corn to crude oil as the dollar rallied lately. The side-by-side fears of deflation and inflation accompanied by those fears over priming of the monetary presses has caused the price of gold to rally like a phoenix from the ashes. Meanwhile the Swiss franc has stepped up to the plate after playing second fiddle to the yen recently. Its 3.7% rise on the week keeps it on par with the rally in the British pound. 

Bullish call option positions were made in the euro in the October contract where open interest built at strikes 1.45, 1.47, 1.48 and as high as both 1.52 and 1.55. These were counteracted by put positions built at the 1.43 and 1.45 strikes. In the November contract notable put open interest were established at 1.42, 1.4550 and 1.46 strikes. 

On the Japanese yen noteworthy put positions undermined the week's move higher in the unit as traders built on open interest between 89 through 94.50. In the Aussie unit put positions were established at 79 and 80 versus today's current 83.27 price.