The US’ $700B bailout plan will not do the trick – at least that’s how the currency market feels this morning. Deleveraging or the liquidation of risk is happening on a global scale as investors question if guaranteeing funds and bailing out banks are the right prescriptions for the credit crisis. Every single financial market from currencies to stocks, bond and commodities tells us that this is a crisis of confidence. Carry trades have sold off across the board, gold prices jumped $24, oil prices are trading below $90 a barrel while LIBOR rates continue to rise.
In response to the rise in risk aversion, the Treasury increased their auction sizes while the Fed will begin to pay interest on required and excess bank reserves. Unfortunately instead of boosting confidence like the US officials may have hoped, it is boosting risk aversion. No matter what government officials are doing, investors are not buying into it. This morning the German government moved to guarantee all deposits, but rather than buying Euros on the announcement, investors sold it as the destruction of balance sheets and slower global growth becomes everyone’s top concern. As central bank officials start running out of options, coordinated easing may be their only choice.
USD/JPY Headed for 100
For stock traders, it is time to get out your Dow 9000 hats and for currency traders, this means that it is time to think about 100 USD/JPY. The Dow Jones Industrial Average is now within a whisker of the 10,000 mark and I have long argued that Dow 10,000 would mean 100 in USD/JPY. When the Japanese government bailed out their local banks by buying up the bad debt in 1996, the Japanese Yen proceeded to fall 12 percent over the next 12 months. We first wrote about this in mid September, at which time we said we expected a 5 percent drop in USD/JPY – now we have another 2 percent drop to go.
How Much Further Can the Euro Fall?
The Euro on the other hand came under further selling pressure as the region’s own problems come to the forefront. There was a fundamental shift in the outlook for the EUR/USD last week after ECB President Trichet signaled to the markets that he is ready to cut interest rates. At this point, it is realistic to expect that the ECB to ease monetary policy in November if not sooner.
Now that the EUR/USD is more than 14 percent off its July highs, traders may be wondering how much further the currency pair can fall. Based upon purchasing power parity, the Euro does not hit fair value until approximately 1.15. Purchasing parity has its flaws because it only compares the price of a specific good or basket of goods and it does not take into consideration the quality of the goods. Nonetheless, understanding what the PPP value of the EUR/USD is allows us to understand possible value points for the Euro.