Dollar Lacks Direction As Market Focuses On Testimony

[DailyFx]

The U.S. dollar had a mixed performance on Wednesday. The greenback was particularly strong against low yielding currencies like the Japanese yen but lost some ground against commodity currencies like the New Zealand dollar and Australian dollar.



Nonetheless, the currency market remains very volatile and the main focus has been on Capitol Hill where the Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson were giving their testimony. Indeed, many investors are waiting to see if the U.S. Congress will approve a $700bn plan that will enable banks to clean up their balance sheets from bad investments in mortgage backed securities. Yet, other investors are already making bets that those measures will not be enough to rescue the U.S. economy from a technical recession. In fact, regardless if the plan gets approved or not, the U.S. economy is likely to continue to face substantial challenges including further job losses, high energy prices and a rapid deleveraging in the financial sector. Moreover, some traders are concerned with the fiscal impact of the bailout plan which could cost almost 5 percent of GDP.

Just to put the size of the U.S. treasury bailout into perspective, one can look at the cost of the war in Iraq. Paulson's plan will cost $700bn or $30bn per month over the next two years. This is nearly three times more than the monthly cost of the war in Iraq which costs $10bn per month to the U.S. tax payer. Currently, the United States federal government runs a deficit of $438bn, or 3 per cent of gross domestic product and the bailout costs could push the fiscal deficit next year to $1 trillion or 7% of GDP. However, although no one can be sure that U.S. Treasury Secretary Henry Paulson’s plan to buy illiquid mortgage assets from several financial institutions is the best plan to deal with the current economic circumstances, it’s difficult to deny that the plan is not a good first step to restore confidence in the financial system. Indeed, the measures engineered by the U.S. Federal Reserve to clean the market from some toxic assets could be the beginnings of a more general recover in the appetite for risky assets like high yielding currencies. Looking ahead and despite the recent increase in volatility which makes it very difficult to make forecasts, I expect the U.S. dollar to rise further, particularly against the Japanese yen.

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