Trade Team Update - - 9/15/08

Looks like just another boring, routine day in the markets...

This I can say, I now know what it's like to trade the GBP/JPY... with the euro making a 400-point top to bottom move in addition to recovering about 200 points in the middle, once again we see unprecedented and historical volatility and it's only Monday.

I warned you last night there would be chaos today but I honestly never expected to see the depth of these price swings. For today's update I'm going to first cover the most important aspects of what's going on with Wall St. as it directly relates to trading and the EUR/USD. Then of course we'll hit the FOMC as there's no bigger event this week.

Wall St.

When the Dow closes down over 500 points, you know it probably wasn't a great day... overnight Lehman Brothers, one of the largest investment banks on earth went bankrupt. The Treasury basically forced another mega investment bank, Merrill Lynch, into finding a buyer. That buyer was Bank of America.

Meanwhile, Lehman's stock price dropped 95% today and is basically zeroed out. The other meltdown occured with AIG which I believe is the largest insurance house on the planet. I know they have assets of $1 trillion.

AIG is actually the most critical of them all because if they fail the affects would be catastrophic and on a global scale whereas the global-wide affects of Lehman and Merrill are not quite as much.

AIG begged the Treasury for $70 billion and was turned away. Now why did the Treasury turn away AIG yet rescue Bear Stearns? I think the Treasury's balance sheet is incapable of taking on AIG's risk. Plus, the Treasury knows there's more failures to come in the next few weeks. So, what Paulson is doing is using his powers to broker a deal between Goldman Sachs and JP Morgan to hook AIG up with $70-$75 billion.

Here's the problem. If AIG doesn't secure that funding by Wednesday their securities rating will get downgraded. That's a big problem because banks and institutions are holding billions worth of AIG bonds and if those bonds get downgraded it reduces their value and that value reduction will cause a nasty chain reaction across all markets. I think this story is to be continued...

Wall St. equities closed below some key levels and unless the Fed does something Wall St. wants, it could be another ugly day. Keep an eye on the Nikkei tonight to see how Asia is handling the Wall St. debacle. Expect more volatility with the yen pairs. I urge extreme risk management if you are trading the yen crosses under these chaotic conditions.

This I can tell you -- all of these solvency and liquidity and writedown issues are rooted in exactly one thing: housing. When the U.S. housing market was on fire due to loose lending standards and tons of easy money from the Fed, these banks got greedy and overleveraged themselves thinking the good times would keep on rolling...

When housing started to take a sharp turn in early 2007 I think the losses snowballed on the financial industry. Housing has fallen so sharply that it's only served to wipe-out these firms almost overnight. We are talking about investment houses that have been in existance for over a century getting wiped clean in a matter of months.

Wall St. will not heal until the housing market heals. These investment banks and commercial banks and financial institutions will remain at highly probable risk of complete failure as long as house prices continue to drop, inventories continue to go up, foreclosures continue to rise, and we get through the next round of ARM raises.

The housing market must find a bottom in order for the bear market on Wall St. to get off the ground and get back in the fight. I see no bottom in housing. I see no sustainable signs of a housing bottom forming, and as long as the jobs market continues to contract I do not see housing finding a bottom and making gains.

Crude and Gold:

The EUR/USD and commodities were very disjointed today. Gold had a total mind of its own. Overall gold had a strong afternoon which gave the euro quite a bit of support to test back over the 1.4300 level which has been rejected thus far.

Yesterday I gave a crude target of $95 which was hit. I am still targeting a move to the $88 level. I think at certain points today crude and the euro were correlated but it didn't last long. Crude also has a mind of its own and that market is totally wacked right now. I just do not see the sell-offs stopping because it's too easy to make the money shorting it.

Of course, the FOMC could easily cause extended moves in commodities tomorow, so be on the look out for this as well.

FOMC:

Tomorrow's FOMC is by far the most important and critical so far this year. The FOMC could massacre the markets based on their rate decision and rate statement. Tomorrow holds a risk level of 10 out of 10... the trading conditions will be extreme. And the price moves may not make a bit of sense.

The probabilities for tomorrow have changed in less than 24-hours. Just a few days ago there was almost no expectation for another Fed rate cut. In fact, the probabilities were showing a Fed rate hike as their next move.

As of this afternoon, Fed Funds Futures was running a 66% probability of a 50bps cut tomorrow. I'm shocked to even consider that. 66% is not a a high probability but high enough to make you think twice.

I forced myself to watch CNBC today and there was overwhelming support for a 50bps cut tomorrow from the various commentators and guests. I also heard 25bps and 100bps cuts. They all presented a compelling case. A few said there would be no cut.

I cannot call a rate cut for tomorrow. There are two dissenting rate cut voters on the FOMC. They voted for rate hikes at the last meeting. Unless Bernanke forces them to vote for a cut I do not see those hawks doing a 180.

A rate cut wouldn't exactly solve some of the issues plauging Wall St. and plauging the consumer. A cut in the Fed Funds Rate doesn't really make credit for consumers any cheaper or easier to access. It may help the business sector, but overall a rate cut won't solve issues.

I could see the Fed cutting the discount window rate by 50bps or more. That would make sense to me. I'm not ruling out a Fed Funds rate cut. I don't see it happening but that's great if it does happen.

If the Fed does cut I don't think it would be any less than 50bps. If they are going to use up more rate cut ammo they will probably want to make a statement to the markets.

Of course the only thing we need to worry about is how the rate cut will affect the EUR/USD. Well, in a normal and logical world, a rate cut would be a terrible thing for the USD and would send the EUR/USD up a minimum of 200 points and likely much more.

As you know, nothing has behaved normal and logical the past nine weeks. I could see the markets interpreting a rate cut as a good sign for the economy and for the U.S. financial sector and this would instill confidence in the USD. Or, the other explanation would be that a rate cut showed continued market strains and the "safe-haven" money flows continue into the USD.

This FOMC event will be huge and will likely cause strong volatility. Should the Fed do the right thing and hold rates, the other key will be the FOMC statement. If the Fed follows their current trends, they should stick to the hawkish rhetoric on inflation and remain dovish on economic conditions.

With these newest developments on Wall St., the Fed may not want to say anything to spook the markets. Bottomline, I'm ready to see the unexpected and illogical happen should the Fed cut. If the market decides to do the right thing and hammer the USD, that will be great too.

EUR/USD:

The price swings we saw today were unprecedented as far as I know. It was very interesting to watch but not very interesting to trade in. The price action is not behaving with much order and it's really not possible to even know to be a bear or bull.

The euro is still showing some bullish price action signs just like it did last night before it ran up to 1.4480. Overall my trade will be very conservative, especially as we get close to the FOMC decision. I don't want to see my trades getting bounced around from profit to negative every three seconds.

1.4188 is still a very key downside level as well as 1.4350 being a key upside level. Trying to establish any levels in between is pointless as there are so many improbable factors influencing the Forex market right now.

The best thing to remember is the extreme risk in the markets right now. I do not encourage any traders to add new entries right now unless you plan on managing them very tightly. Unless it's a hedge trade feeding you equity, take your money and run...

We could see some movement after Tokyo opens depending on what kind of volatility is happening on the Nikkei. Be smart with your trades and practice strict risk management the next 24-hours.