Euro Within 1 Penny of its Record Highs (page 1 of 2)

DailyFX Fundamentals 07-11-08

By Kathy Lien, Chief Strategist of DailyFX.com

Fannie and Freddie's troubles are a lose-lose for the US Dollar

Calling the financial markets active today is practically an understatement.

The combination of soaring oil prices and problems with Fannie Mae and Freddie Mac triggered sharp volatility in the equity and currency market.

At one point during the US trading session, the Dow jumped 200 points within minutes, driving EUR/JPY to a record high.

The market was initially very disappointed by US Treasury Secretary Paulson's reluctance to bailout Fannie Mae and Freddie Mac, but they were pleasantly surprised by Bernanke's offer to access the discount window (The ABCs of Fannie Mae and Freddie Mac's Problems).

However their optimism was short-lived as stocks resumed their slide.

The biggest question in the financial markets right now is whether or not Fannie and Freddie are too big to fail?

If the government stepped in to prevent the Bear Stearns meltdown from crushing the market, they will undoubtedly step in to prevent a collapse in Fannie Mae or Freddie Mac because if either GSE fails, Americans will have to shoulder the burden.

Fed Chairman Ben Bernanke has already announced that the GSEs can have access to the discount window, which would allow them to borrow money directly from the Federal Reserve rather than the markets.

If Fannie and Freddie's problems are not solved and they still have difficulties borrowing, this means that they will have difficulties lending, which is something that the US government cannot risk at this moment.

For the currency market, it is a lose-lose situation for the US dollar.

Further problems at Fannie and Freddie would push stocks lower once again, which would trigger another flight to safety out of US dollars.

A bailout would essentially double the public debt, risking a downgrade in the US credit rating.

Expect Friday's volatility to continue into the new trading week. We have a very busy US economic calendar that includes retail sales, producer prices, consumer prices, the Empire State and Philly Fed manufacturing surveys, industrial production, the Treasury International Capital flow report, housing starts and the minutes from the last FOMC meeting.

Meanwhile the trade balance was stronger than the market expected thanks to a rebound in exports. Consumer confidence also improved modestly but it still remains near a 30 year low.

Euro within one penny of record highs

The Euro traded within one penny of its record highs on fresh fears that another major financial crisis may be around the corner.

If it wasn't for the potential repeat of the Bear Stearns debacle in March, we would have a quiet summer.

However US stocks fell to a new 23 month low today triggering another flight to safety into anything but US dollars.

Whether the EUR/USD manages to hit a new record high will be less dependent on economic data and more dependent on how much better or worse the market feels about the health of Fannie Mae and Freddie Mac.

The latest rally in the Euro helps Eurozone nations deal with the rise in oil prices but it also raises the risk of sharply weaker growth for countries other than Spain and Ireland.

Like the US, there are a number of pieces of economic data on the Eurozone calendar that are worth watching.