VIX Hits 3-Month High, Market Skeptical About Fed's Power

Includes: UDN, UUP
by: Kathy Lien

No US economic data was released Monday morning explaining the listless action in the US dollar. Traders are hesitant because they know that things could change dramatically with the 3 event risks Tuesday that could shake up in the US dollar.

The first is the retail sales report for the month of June. Despite a deteriorating labor market and rising food and energy prices, consumer spending should remain positive. Discounters like Wal-Mart (NYSE:WMT), Costco (NASDAQ:COST) and Target (NYSE:TGT) all reported stronger sales in the month of June, indicating that even though consumers may be trading down, they are continuing to spend their tax rebates. As long as consumer spending does not collapse, there may still be some hope for the US economy. Both the ICSC and SpendingPulse reports also support stronger spending numbers. Excluding autos, SpendingPulse reported that sales rose by the largest amount in 7 months.

A stronger retail sales report however may be eclipsed by Bernanke’s semiannual testimony on the economy and monetary policy. The Fed Chairman should remain hawkish on inflation, but he will be forced to address the latest problems in the financial sector. Expect Bernanke to come under significant pressure during the Question and Answer session for solutions to the latest financial market turmoil. It doesn’t help that going into the testimony, the Dow is trading near its 2 year lows. Unfortunately no one is convinced that the Fed’s offer for Fannie Mae and Freddie Mac to access the discount window or the Treasury’s attempt to seek Congressional Approval for an investment and larger credit line will be enough.

The VIX, which is the CBOE’s volatility index, hit a 3-month high Monday indicating that the market is still nervous and skeptical about the effectiveness of the US government’s latest announcements. They believe (perhaps rightfully so) that the Fed is running out of magic bullets. In order to avert another panic, the Fed needs to shock the markets, just as they did last year with aggressive easing. Gold prices also hit a 3-month high - confirming that traders are growing more risk-averse.

The failure of mortgage lender IndyMac (IMB) was also a big story Monday. With JPMorgan (NYSE:JPM), Merrill Lynch (MER) and Citigroup (NYSE:C) reporting earnings at the end of the week, the health of the financial sector should continue to dominate the headlines.

Finally, also keep an eye on producer prices since inflation is the primary reason why the US central bank has given up on cutting interest rates.