Currency traders taking wait and see approach after Fed's loan to AIG

Posted Sep 17th 2008 1:30PM by Joseph Lazzaro
Filed under: International Markets, Forecasts, Federal Reserve, Recession

What will be impact of the Fed's takeover of AIG on the dollar?

Check back in a few days or even a week, according to currency traders.

"There are too many unknown variables to say with any authority right now where the dollar will head from here," currency Trader Andrew Resnick said Wendesday at mid-day. "We'll need at least a few days, maybe a week or so to sort out who the winners are and who the losers will be." Resnick added that he is presently flat (obviously), with no open currency trading positions.

At mid-day the dollar was slightly lower, down about 0.5% against the euro, British pound, and yen. But in the broader context of things, "the dollar's move so far has been small, and statistically insignificant and inconclusive," Resnick said.

"Right now, we're just reworking our statistical models. The problem is, the variables keep changing, so it makes the previous projections less accurate," Resnick said.

At mid-day the dollar was at $1.4136 versus the euro, $1.7921 versus the British pound and at 104.63 versus Japan's yen.

Two scenarios for dollar

With the above as a backdrop, Resnick said two almost diametrically opposed scenarios are possible.

Dollar lower: This model suggests the U.S.'s economic slowdown and low interest rates, combined with the additional U.S. government spending and borrowing required for the Fannie Mae (NYSE: FNM), Freddie Mac (NYSE: FRE) and now AIG (NYSE: AIG) takeovers will place many more dollars in supply, forcing the dollar lower in the immediate quarters ahead.

"A dollar-lower scenario would seem, logically, like a slam dunk. More dollars in supply, therefore each dollar is worth less," Resnick said, "But it's not a slam dunk."

Dollar higher: This model argues, if the global economy slows to a crawl, the 'flood of dollars' into the market will be offset by a 'flight to safety' -- investors seeking to preserve capital by piling money into the safest currency in the nation with the best record of protecting the value of money over time: the dollar, and the United States.

"Some investors may think this is goofy but there is a scenario in which the dollar does relatively OK despite all of the federal government's additional debt obligations," Resnick said. "In the first few months, institutional investors pour into [U.S.] Treasury notes in a flight to safety. Then, government actions in Fannie, Freddie and AIG stabilize the housing and credit markets, setting the stage for a resumption of U.S. growth, which would make the dollar more attractive."

Resnick said the upcoming U.S. election on November 4 is also weighing on the currency market. "Republicans are less likely than Democrats to back a tax increase to cut the [U.S.] budget deficit," he said. "So a big election win by the Republicans would be dollar-bearish because given the likelihood of increased government spending, the deficit will increase, unless some taxes are raised."

Resnick's diagnosis: "Stand aside for now. We'll need a week or so to gauge the impact of the Fed's AIG decision on the credit markets and on bank-to-bank lending."

Tags: AIG, bond market, British pound, credit crunch, credit markets, dollar, euro, Fannie Mae, Fed, financial crisis, FNM, FRE, Freddie Mac, interest rates, inthenews, LEH, Lehman Brothers, monetary policy, reserve currency, U.S. Federal Reserve, U.S. Treasury, yen

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Reader Comments (Page 1 of 1)

9-17-2008 @ 4:16PM

Chris K. said...

Long the Dollar; at least short term. Why? Because all those dollars the fed is pumping into these deals aren't actually making it into the market. Banks need capital, cash is king. Increased demand for greenbacks, reduced supply (on the market) = dollar higher.

9-17-2008 @ 7:43PM

gerald said...

Sell sell sell all your AIG stock. Get rid of all your AIG policies don't fall for the lie that they are any good. The maximum in the hand full of states that do back up insurance policies is only $300,000 on certain types of policies. If you have a $1 or $2 million dollar life insurance policy you will get hosed!!!! Besides if you are like me I have been waiting over a year to have my claim paid with AIG and now have to take them to court for three times the original amount owed plus attorney fees,this can't help their bottom line.