USD: Treasury’s GSE plan gives dollar respite
The dollar managed to halt its recent decline as news of the Treasury’s plans to support Fannie Mae and Freddie Mac were announced right at the Asia open. EURUSD traded back to 1.5899 from a high of 1.5972, while USDJPY traded in a range of 106.10-106.71. Stocks in Asia are largely flat and European equities look set to open today’s session on a firmer note. Nevertheless, risk sentiment is set to remain under pressure as the Treasury’s intervention on behalf of the beleaguered GSEs, in addition to the failure of IndyMac on Friday are signs that US financial markets may be entering a new period of stress. Despite record falls in housing prices, falling incomes and lack of credit availability are seriously hampering any recovery. Concerns of significant undercapitalisation amongst US commercial banks are weighing heavily on stock indices and despite ongoing inflationary concerns—oil topped $147/bbl during Friday’s session— prospects of a Fed hike are looking increasingly remote. The Treasury’s proposals for the GSEs fall short of outright nationalisation, but costs to the US taxpayer will be significant and the market will remain sceptical that the government won’t take full custodianship eventually. The extension of credit lines to both GSEs is the short-term priority. In addition to unconfirmed reports that the Fed is considering giving both companies access to its discount window, the Treasury plan will include a temporary increase in the GSEs’ Treasury credit lines, with conditions and amount to be drawn yet undetermined. The plan will also allow the Treasury to purchase equity in either of the two GSEs if needed, which may weigh on shares of both companies for fear of further dilution of existing shareholder equity. The US will want to full nationalisation because the consequent sudden increase in public debt would significantly affect the US’ credit ratings, but without doubt the Treasury is being forced to move in this direction. The Treasury’s latest announcements are unlikely to precipitate any mass selling of US agency or corporate debt by central banks in the short-term. However, the pipeline of new purchases is like to fall—weakening a key source of support for the dollar—as reserve managers are already facing valuation losses on their existing holdings. Ahead this week, Fed Chairman Bernanke is scheduled to deliver his semi-annual monetary policy testimony on Tuesday and Wednesday. We expect he will strike a fairly similar tone to that of the June 25 FOMC statement. Our US economists continue to call for two rate cuts by year-end in contrast to market expectations, and the latest developments are supportive of their views. There are no major events scheduled for the US session today.