Dollar Rallies on Quarter End Repatriation

It is the end of the third quarter, and demand for US dollars has been exceptionally strong. This is related to repatriation flows and profit taking following yesterday’s big moves. The stock market closed up 488 points, which is approximately 60 percent of Monday’s historic sell-off.

On the bailout front, since Congress is on recess for the Jewish holidays, there have been no significant developments. As a result, to credit today’s rally on the hope for a new bailout plan may be a bit of a stretch since the Senators haven’t even sat down to discuss potential changes. Therefore we still believe that yesterday’s sell-off is the market’s true sentiment towards the US dollar and US stocks and, so far, there aren’t any concrete reasons to believe otherwise.

How Higher LIBOR Rates Impact Average Americans

Despite today’s recovery, there is evidence that investors and banks are still nervous. The overnight LIBOR rate, which is the rate at which banks lend to each other, hit an all-time high of 6.88 percent intraday. The 3 month LIBOR rate is also above 4 percent, the highest level since January. For the average American, overnight lending rates or the 3 month LIBOR have little significance until they realize that many home equity loans, lines of credit, student loans, small business loans and credit card rates uses LIBOR as an index. Therefore the rise in borrowing costs will surely be felt on Main Street as lenders charge higher interest rates on loans. For the average American, this adds further strain to their ever-thinning pocketbooks.

Lending between banks is frozen as counterparty risk remains the number one problem in the financial markets. Volatility continues to remain high and we do not see any reason for that to change either. Yesterday, the S&P500 fell by the largest amount in 20 years and today, the index came close to rising by the most in 6 years. This schizophrenic behavior of the markets is sure to turn many investors gunshy.

Will An Interest Rate Cut Help?

In order to restore confidence at this stage of the game, the Bush Administration needs to shock the markets. One way of doing so could be through a rate cut by the Federal Reserve. As one of the most powerful psychological tools in the government’s arsenal, Bernanke may want to save it until there is evidence that the new bailout plan has failed to stabilize the markets. Fed fund futures have already priced in a quarter point rate cut between now and the October 29 monetary policy meeting.

However, the futures contracts have been wrong in the past, and should the new bailout package prove to be stronger than the one proposed on Monday, the futures contracts will price in a smaller chance of a rate cut. For the Federal Reserve, after pumping a huge amount of liquidity into the financial system, inflation has become a very big concern. Therefore Bernanke will not readily agree to cut interest rates unless he has no other choice. Furthermore, a measly 25bp rate cut from the Fed may not do the trick. Risk aversion is so severe that the only things that can stabilize the markets may be a 50bp one-shot rate cut or a coordinated easing by central banks around the world, but Bernanke will have a tough time convincing his Eurozone counterpart, Trichet.

Raising the FDIC Limit

In the latest development of the bailout drama, the most popular and likely proposal is to raise the FDIC insurance from $100,000 to $250,000. This bribe to Main Street offers a jolt of confidence and peace of mind. For the government no initial outlay is needed to increase the FDIC limit. The three big banks that are left on Wall Street – Bank of America (BAC), JPMorgan Chase (JPM) and Citigroup (C) will still be here when the dust settles. According to today’s WSJ, the Big 3 holds approximately 75 percent of all US deposits. Therefore even if other commercial banks fail, the FDIC only has to fork over a limited amount of money and even if they have to fork out more than that, it is the confidence booster that Americans need.

Consumer Confidence Improves but Still Near 16 Year Lows

Interestingly enough, despite the problems in the US financial markets, consumer confidence actually improved in the month of September from 58.5 to 59.8. However, the index still remains near its 16-year lows and is half of what it was a year ago. It is important to note that the survey was closed on September 23, which was before the 777-point slide in the Dow on Monday. The Chicago PMI index also beat expectations even though manufacturing activity in the Chicago region slowed this month. There were no silver linings in the house price report, which dropped 16.3 percent in the month of July, the fastest pace on record.

On Wednesday we are expecting our first leading indicators for Friday’s non-farm payrolls report. This includes the ADP employment change, the Challenger layoffs report, and manufacturing ISM. The numbers will shed more light on the weakness of the US labor market.

About Kathy Lien 236 Articles

Kathy Lien is an Internationally Published Author and Chief Strategist of, one of the world’s most popular online websites for currency research. Her trading books include the highly acclaimed, Day Trading the Currency Market: Technical and Fundamental Strategies to Profit form Market Swings (2005, Wiley); High Probability Trading Setups for the Currency Market E-Book (2006, Investopedia); and Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game (2007, Wiley). As Chief Currency Strategist at FXCM, Kathy is responsible for providing research and analysis for DailyFX, the research arm of FXCM. She also co-edits the BK Forex Advisor, an Premium Service with Boris Schlossberg – one of the few investment advisory letters focusing strictly on the 2 Trillion/day FX market.

Kathy is also one of the authors of Investopedia’s Forex Education section and has written for, the Asia Times Online, Stocks & Commodities Magazine, MarketWatch, ActiveTrader Magazine, Currency Trader, Futures Magazine and SFO. She is frequently quoted by Bloomberg, Reuters, the Wall street Journal, and the International Herald Tribune and has appeared on CNN, CNBC, CBS and Bloomberg Radio. She has also hosted trader chats on EliteTrader, eSignal and FXStreet, sharing her expertise in both technical and fundamental analysis.

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