USD vs Treasuries Bailout Plan

The credit crisis triggered by the sub-prime meltdown has finally taken its toll on Bear Stearns, Lehman Brothers and Merrill Lynch, which were all top 5 investment banks in the USA. AIG, the insurance giant, has also been bailed out on the brink of its collapse by the Fed's US$80 billion. The collapses were triggered as banks and financial institutions are not willing to lend money to each other worrying their own survival and thus, corporate debt cannot be paid.

So, how does the US$700 billion bailout plan would work? Here's a rough rundown of Fed and Treasuries plan on how it is suppose to work out.

• The US$700 billion will come from issuing of debt to other countries in the form of treasuries debt/bonds. Issuing debt reduces the appeal of one currency and thus will depress the value of US Dollar in the short term. "Only short term?", you may ask, I will address that in the next few points.
  
• The money is intended to buy all the illiquid mortgage assets from banks or financial institutions. Buying all the illiquid assets at fire-sale/market prices gives market some confidence that will soon drive up the values of these assets. Note that the money is used for expenditure (unlike the usual Treasuries debt), but for investments on these mortgage assets with potential returns.
  
• As the illiquid assets are bought by fed/treasuries, banks will receive cash with which they can start lending again and therefore relieving the credit market conditions over time.
  
• When market has recovered, the securities are then sold again at a profit giving good return to Fed/Treasuries/taxpayers.
• The profit can then be used to reduce US Fed/Treasuries debt which mean strength for the USD.
  

Over the short-term (next 6 months - 1 year), it'll have negative impact on USD but good long-term outlook for the USD on these basis when the market recovers.

Note: of course there are a lot of other variables needs to be taken into account for the USD to strengthen. The view is based on current sentiment and market condition and should it stay unchanged over the interval mentioned.

USD against Other Currencies

USD has staged a come-back over the past 2 months. The USD bullishness is due to external more than internal reason and such rally may not last unless USA's internal fundamentals strengthens or external fundamentals worsen.

The statistics showed it:

• AUD per USD has dropped from 0.9400 at the beginning of August 2008 to close at 0.8560 at the end of the month. As of yesterday's closing, AUD stands at 0.8150 substantially lower than previous month's close. It has accumulated 17% losses since its high of 0.9840 on July 15th.
  
• Less damaging move seen in the EUR which has dropped from 1.5620 to 1.4570 in August alone. The Euro is quoted at 1.4260 as of yesterday's closing price. Since its high of 1.6030 on July 15th, it has staged 11% loss against the USD.
• The SGD has seen similar moves where the USD has gained to SG$1.4340 per USD from its low of SG$1.3440. The USD has profitted 6.69% since July 15th against this Asian currency.
  
• NZD is the worst of the lot discussed here staging a 18.6% loss against the USD since March 14th 2008 as it first enters a period of recession among the countries in the world. It closed at 0.6680 yesterday from its high of 0.8210 in March 14th.
  
• GBP/USD pair has dropped from its high of 2.1160 in November 9th 2007 to 1.7650 as of yesterday. It has seen 16.6% loss against the USD since then.

Those who watched CNBC and Bloomberg would certainly understand the reason behind those big moves against the USD currencies. To summarise, here's why:

• For the AUD, it's the dropping commodity prices. Its commodity-dominated exports will soon cause damage to the earnings for the Australians. This is affirmed with the RBA (Reserve Bank of Australia) to reduce rates from 7.25% to 7% on concern of declining economic growth (YES, not recessionary yet). Reducing rates will have negative impact on the currencies as it lowers yield for a particular currency.
• Recessionary risk in Europe is high on European Central Bank's mind. Recessions brings lower export earnings which lowers demand for a particular currency. With the USA seen already 'ahead' of Europe in recession and the first to come out of it, the European region and its corresponding EUR currency faces this pressure and thus the decline.
• The Singapore currency remains resilient to the USD strength due to the persistent growth in the Asian region while only managing 6.69% decline. However, it is showing signs of weakness that may follow once it hits this Asian region.
• The New Zealand is the first country in the world to go into recession and this is reason enough to see the most decline amongst other currencies.
  
• The United Kingdom saw a stagnation of 0% growth in GDP in the last quarter. With inflation running high, it is technically already in recession. Its housing market decline follows those of its US counterpart. Overall, the UK economy is not in good shape and showing potential signs of slipping into recession in the next quarter or two, and thus its currency is reflecting that.

So what's the potential moves for the currencies:

• The AUD has a strong support at region around 0.8000. This level has been the resistance hit at least 5 times in Feb 2004, Nov 2004, Feb 2005, Mar 2005 and Dec 2006 before finally broken in Mar 2007. Once broken, it has the potential to go down to 0.7400 and onto 0.7000, the bottom level where it started catapulting itself to a high of 0.9840. With such a decline seen over the past 2 months, it's just a matter of time before the upward correction comes and if it does, it will potentially trade between 0.8000-0.8750. Having said that, the fundamentals remain bearish for the AUD/USD pair and with more bad news, i.e. RBA cutting more rates/recessionary pressure, it may potentially break this 0.8000 barrier without any difficulty.
  
• On chart, the EUR has formed a double top in April and July. This usually signals the change of direction in the currency movement. As of now, the EUR has dropped to the shoulder zone of a head-and-shoulder formation. This signify a short-term consolidation zone where it may trade between 1.4300 - 1.5000 in the next 2 months. Breaking this, it will head towards the strong on the level around 1.3700 (which represents the peak in Nov 2005 and broken in 2 years later in Nov 2007). It may potentially hit 1.3700 by end of this year.
  
• Just like the Euro, USD/SGD pair has also entered a period of short consolidation of 2-3 months at range of 1.4370-1.4630. At the end of the year, we could see the pair head towards 1.5000.
• NZD has just hit the support level of 0.6630 level against the USD and may trade in the range of 0.6630 - 0.7120 in the next 2 months. Should the fundamentals in New Zealand remains bleak, it will break this and heads towards 0.5920 by end of the year. Looking at the chart, it has the potential to hit 0.5920 much sooner (in one/two month's time).
• The GBP/USD pair has NO clear support level between current level (1.7650) and 1.7000. The UK fundamentals allow 1.7000 level seems realistic towards end of this month (or next 2).

Conclusion:
Long USD against a basket of currencies (but this doesn't mean shorting other currencies).

Related blog links: Bullish USD Outlook

Note: Invest at your own risk.

Gustav and Its Impacts

So much focus on Gustav, the tropical storm-turn-hurricane category 5 when it hits the Gulf of Mexico. What does this mean to Ultra Oil&Gas ETF (DIG) ,Ultrashort Oil&Gas ETF (DUG) and the US Dollar currency?

Let's zoom into the ETF story first.

While this news may be bullish for the Crude Oil commodity itself, unfortunately, not for its refineries.

• So far in my articles, I have always assumed direct correlation between crude oil prices and its benefits to oil & gas companies. Higher energy prices translates to higher profits, and vice versa. So far, this direct correlation has been true due to the fundamentals of economics. The situation is direly different now.

• If you examine closely the components of DIG & DUG, both are either long/short the oil & gas companies, NOT the actual oil&gas commodities. As such, damages to oil&gas facilities which belongs to the refiners will adversely impact its production capacity and incur losses on the part of the companies.

• While the crude oil prices will surely rises in the case of reduced production capacity, the oil & gas companies are unable to profit from the rising oil prices due to the damages to their oil rigs which harvest the expensive oil (damage assessment during Katrina - similar category hurricane in 2005 - is huge and is available at this link)

• This is part of the reason why you've seen the DUG rises while crude oil price rises. Market is finally getting the sense of this sentiment.

• In short, Ultrashort Oil&Gas ETF has more potential upside and the reverse for its long counterpart.

What does this have to do with the US Dollar ?

• Precisely the point, NOTHING.

• The market has been so attached with the fact that rising crude oil is attributed to the weak dollar and the stronger USD will therefore cause prices of oil to go down. This correlation will be broken soon.

• USD fundamentals remain strong (more due to external factors than internal) and will continue to do so unless there are signs of reversal in ex-USA economies, especially the Euro-zone.

• Perhaps, this is a new environment where the strengthening of USD will go alongside the strengthening of crude oil price.

Crude Oil Bear Ended???

Crude Oil rises from $112 to $122 overnight. Is this a sign that the commodities bear is over?

In my opinion, NO. There are a couple of reasons which I think is in play:
1. Profit taking. Recent oil bear has been on a sharp drop over period of just a month (record high of $147 was on July 11th). So, a correction to the upside is normal and this is probably the period where the shorties (people who short oil) take profit as crude has been unable to break the $111-$112 support.
2. Reaction to the Russia-Georgia conflict is well overdue. When the news of Russia-Georgia conflict emerged, oil didn't spike up and this previous reason aggravate the correction.
3. Fundamentals for oil bear are still intact for the moment. UK re-affirms one such fundamental in its stagnant GDP reports growth for the past quarter. It is most likely to enter recession in the next quarter. With that news, USD will strengthen relatively against European currencies which causes USD-denominated commodities prices to drop. The story on worldwide demand destruction is also unchanged.
4. Warren Buffet's view on USD. He just appeared in CNBC (just at the point of writing) and said he has no bets AGAINST USD. His neutrality is a change of course over his previous bearish view on the USD and re-affirms the USD's upside potential.

Conclusion:
Shorties, stay on course.

Bullish USD Outlook

This sentiment is helped by the following factors:
1. Dropping commodities and gold as they are mostly priced in USD
2. The most important factor is: the shift of concerns from high inflation to slowing economic growth across the various central banks, i.e. ECB (European Central Bank), RBA (Reserve Bank of Australia), BOE (Bank of England)
3. The shift of concern causes those central banks to start holding interest rates for their currency with the strong possibility to cut rates soon (this is reflected in interest rate futures for AUD which is pointing to a 25 basis point cut in Oct 08 and another in Jan 09).

I have been monitoring the following 2 ETFs to understand the USD-buying interest:
1. PowerShares DB US Dollar Index Bullish Fund (AMEX:UUP) has market cap of ~USD 575 million (as of 12 August 2008), which represents 6x the interest in the bearish counterpart. As of the point of writing, the market cap has grown to ~USD697 million (a 20% increase in just 3 days*). Examining the chart of this ETF, this instrument had been consolidating for 4 months from mid-March till mid-July while testing low of ~USD22.30 at least 5 times. The resistance at USD23 and USD 23.30 has been broken to the upside. Future break out at ~USD 24 can test the next resistance at ~USD 25.
2. PowerShares DB US Dollar Index Bearish Fund (AMEX:UDN) has market cap of ~USD 95 million (as of 12 August 2008) and has dropped to ~USD 72 million (-24%) in just 3 days. Looking at the chart of this ETF, it has broken the support of ~USD 28.50 which is heading towards support of ~USD 27 and breaking this could test further support at the range of USD25.80 - 26.40.

One can argue that the increase/decrease in the market cap explained above is due to the changes in ETF prices. However, if we examine the absolute prices of the ETF in the same period as above, they're in the range of USD23.66 - USD24 (~1.4%) for the AMEX:UUP and USD27.00-28.09 (~4%). Clearly, the larger market cap movement represents new/lost substantial interest in respective ETFs.

However, there's still possibility that this sentiment can reverse, in my opinion:
1. Commodities stops dropping and starts rising again
2. Other central banks starts focusing on high inflation (due to point #1)

Conclusion:
Strong possibility of continued upside move of the USD against all major currencies.

PS: Invest at your own risk.

* I know that I need to monitor this over longer period of time. As I just started monitoring on 12th August 2008, only this information is available for me at the point of writing. This is intended to show the tremendous increase of the USD buying interest at this period.