Forex Investment and Currency Trading

European and Asian equities dropped 5%-6% and commodities slid across the board after the Big-3 bailout plan collapsed in the Senate. US futures signal a steep drop at the open and the dollar is softer. Senator majority leader Reid says they will hold a procedural vote on the Auto bailout bill tonight but does not expect it to pass as negotiations “failed to arrive at a conclusion.” The Treasury may relent and fund GM and Chrysler temporarily from the TARP.

Notably, this leg of dollar selling had taken hold even despite the poor news, weak data and lower equities that, until recently, spelled risk aversion flows benefiting USD. Indeed, the US international trade and jobless claims data gave no sign of the pace of deterioration letting up. The economic pain and damage is getting much worse than expected, so the monetary and fiscal policy responses also will have to be much more aggressive than markets had anticipated.

Against this backdrop, the markets may be transitioning to a weaker USD environment earlier than we had anticipated. Analysts believe the dollar could lose some of its allure for global investors as cross-border risk reduction flows dry up and as expectations of a Fed zero interest rate policy, quantitative easing and aggressive fiscal stimulus raise the prospect that the US will have to finance a large external deficit at unattractive yields. The risk is that weakness comes sooner rather than later, now that the market is becoming less fearful of a disorderly end-of-year squeeze in dollar funding.

On balance, US data  likely will do little to help the USD – the risk aversion trade seems to have faded in favor of worries about the Fed’s balance sheet (often misplaced) and the about the scale of the government deficit next year. Market currently expects a 50bps cut by the FOMC next week but a 100bp reduction should not be entirely ruled out.

The Canadian economy could take a major hit from the failure of an auto bailout. In addition to being a major producer of automobiles, Canada is also a significant supplier of auto parts to the US. Given that risk markets are selling off, and oil prices have slumped, CAD is underperforming this morning.