Trade Team Update

As the debate in DC and the panic on Wall St. rages, all markets have basically come to a grinding halt today. Volumes on global exchanges are near non-existent and the liquidity within the FX market is at severely diminished levels.

Bailout:

Overall, I do not think today's testimony did much to comfort the legislators who are under pressure from their constituents to tell the Fed and Treasury to screw off while trying to manage the pressure Bernanke and Paulson are putting them under to get this bill passed ASAP.

This may just be political grand-standing, but I get the sense that DC lawmakers are not sold on the main facets of the plan and this is why almost every lawmaker asks the same questions:

1. Why does it have to be $700 billion?
2. Why does the Treasury have to buy toxic assets at prices higher than the true market value?
3. What exactly will happen if the Treasury doesn't get authorization to access all $700 billion?
4. How will the bailout fix the housing market?

Will the bill be passed into law by Friday? No, I don't think so but I believe DC and the Fed are eager to give the markets something they can hold on to and work with in the time being.

Bernanke:

Bernanke made some very interesting comments today... comments we need to consider as FX traders.

Bernanke's claim is that if this bill doesn't get passed that unemployment will rise rapidly, access to credit would completely dry up, growth would come to a standstill, the housing market would suffer, and Wall St. would take billion-dollar hits.

Excuse me Ben, but haven't those issues been happening for at least the past 16 months? I remember not too long ago the unemployment rate was comfortably under 5.0%... where are we at now?

Other idiotic comments included Bernanke saying this bailout plan would not cause any inflation and that inflation would continue to moderate over the medium-term. I almost fell out of my chair when I heard that. They must have stopped teaching at Princeton that creating debt and printing money, and adding currency to the money-supply is the true cause of inflation...

When questioned about how this creation of debt would affect fiscal issues and deficit issues, Bernanke threw Paulson under the bus... his response was that Paulson's Treasury was responsible for handling those deficit issues and it wasn't the Fed's concern.

Bernanke did say that the $700 billion bailout would, and I quote, "add difficulty to the economy and fiscal health". Great, so he admitted it after throwing Paulson under the bus and passing the buck his way.

What could end up hurting the euro is Bernanke's comments on rates... he basically said current interest rates are artificially low and that they would rise sooner than later... the dollar bulls enjoyed hearing that comment today.

Paulson:

Paulson failed once again at selling his plan. We did get an interesting confession from Paulson... he said, "A rescue plan was studied over a period of months, hoped it would not become necessary; did encompass small banks as well as larger institutions".

A period of months? Wait a minute... just a few short weeks ago Paulson was saying the fundamentals of the U.S. economy are sound and that our banking and financial sector was sound.

If that was the truth why would they have started this process months ago while telling the markets everything is A-OK? You can see what kind of crap we're dealing with here... lies, cover-ups, politics, glad-handing, and a whole bunch of BS.

The Solution:

Many traders have asked me what I would do in this situation and what the solution is. I don't have the brains, the arrogance, or the wisdom to answer that question.

But, traders are asking so I'll going to throw an idea out there anyway...

I hate to say this, but I do believe government involvement is required. But, only to get the process started and not any more involvement than putting the wheels in motion of handling the toxic assests and selling them back to the market.

I think it is wrong for the Treasury to basically write a multi-billion check to Wall St. in exchange for all of their near-worthless assets. Those assets aren't totally worthless and this is where I think the government can come in to act as an "auctioneer" of these assests.

Under the current plan, the Fed and Treasury price these assets at what they believe they're worth. This is price-fixing. Price-fixing is not going to solve the issue because these assets need to be valued by the market and not price-fixed by the government.

In order for the Treasury to eventually sell these assets back to the market, only the market can decide what they are worth and not the Treasury. The Treasury wants to use the free market to participate in solving the issue, but the free market can't do what free markets do if the assets are pre-priced by the government.

That is one of my biggest issues with this plan and why I think it's potentially disasterous to go about it that way. In my view, I think the Treasury can ease the equities and securities markets and comfort the credit markets by stepping in to orchestrate an auction type situation where the free market could value the mortgage-backed securities (MBS) and then the Treasury could facilitate the transaction between the seller and the buyer.

The Treasury could then set-up an escrow facility to minimize the risk and give comfort to the markets that the government is in control of the risk and that the free market is in control of deciding prices. The Treasury could collect a small transaction fee or maybe charge 1 point per transaction.

That's a very primitive and simple plan. I don't have an economics degree so that idea may not even be workable. But the bottomline is, the Fed and Treasury almost have to be involved, DC has to back the plan, and the taxpayer exposure and debt burden needs to be kept at the absolute rockbottom minimum.

If the Treasury creates billion of dollars worth of debt, it's going to hurt securities and both of those factors are USD-. If the Treasury does a bailout job and can do it significantly cheaper than $700 billion, both of those factors are USD+.

For every $12 dollars the Treasury gets in taxpayer money, $1 goes to paying debt holders back for buying our securities. Under the Treasury's plan, at least $700 billion worth of new debt will need to be created, the defecit level will be raised to over $11 trillion, and because of economic conditions taxes cannot be raised. Plus, fewer securities will be purchased by foreigners.

I think you can see the risks there...

Tomorrow:

Home sales fell 2.2% vs. an expected fall of 1.6%. Home sales are down 10.7% year-over-year. There's a 10.4 month supply of unsold homes which is an improvement but still at recessionary levels.

Median home sales are continuing to plunge, falling 9.3% year-over-year. This is the largest plunge in the data's recorded history. The dollar should be paying a price for this data. It didn't today but that doesn't mean it won't in the near future.

Tomorrow we get a ton of data... New Home Sales, Initial Claims, Durable Goods, and a bunch of Feds speaking all over the place. Fundamentally I have no real views for tomorrow. I can make an argument for the data to be USD+ or USD-. It may not even matter if the market's are focused on this bailout bill or we have big moves in commodities or a potential breakdown in Treasuries or a surprise event.

Basically, there's a crapload of stuff happening right now and these issues and potential events can change the market in the blink of an eye. The trends can change with every passing rumor that market manipulations want to throw out to the wolves.

EUR/USD:

The longer the euro stays in this range between 1.4600 and 1.4720, the closer we get to making a bigger and more exagerrated move. I'm still very cautious on buying the USD.

It's frustrating to see the euro running out of steam up at these levels and there's certainly room to correct more, but what I know about these issues on Wall St, with the USD fundamentals, and issues happening with Treasuries, I see risk on the dollar and I do not want to be caught should the market make a sharp move against the dollar.

The euro is not without its own risks. The pressure growing on Trichet to cut rates and the possibility of a large European bank failure make the euro a risky trade. Basically both currencies suck.

The euro is still showing bullish signs within the price action but the upside momentum is sporadic and is preventing it from holding onto gains. The lack of decent buying liquidity is also a factor weighing on the euro and no one can predict if and when this buying liquidity will return.

Today's low (ask) was on my downside key level of 1.4611 and so far that level is proving to be solid support after several tests at the close of NY and start of Asia.

This whole bailout plan is nothing but USD-. Why the market isn't burning the dollar at the stake doesn't make much sense to me but we have to play the hand we're dealt.

The 1.4611 level is still very key right now. A sustained break there shold send us down to test 1.4580 and then potentially to the key 1.4550 level. I still have longs at 1.4555 and will hold those open for now.

We need to make a sustained break of the 1.4730 and then the 1.4790 levels in order to even think about getting above the 1.4800 level at this point. Maybe now that the testimonies are over the markets can refocus on the the tasks at hand and we'll see more volatility. This is what I'm expecting.

As always, use strict risk management and do not overleverage.