Dollar Off Lows But Nervousness Persists - Will Oil Help?

Source: Daily FX

A relatively quiet night of consolidation in currency markets tonight as both Euro and Sterling spent most of the early European session basing about the 1.5900 and 2.0000 levels respectively. After making new record highs the EUR/USD dropped sharply in yesterday's North American trade mainly on the collapse in oil and better tone in equities as investors became more comfortable with the GSE rescue plan.

Nevertheless, nervousness persists in the FX market as traders worry about further systemic damage to US financial sector should any other major institutions fail in the near future. Analysts were quick to point out that the rescue of Indy Mac took more than 10% of FDIC capital leaving little room for error if other banks follow suit into insolvency as their mortgage assets depreciate.

The Dollar therefore remains in a precarious position as the markets adopt a state of siege mentality. The greatest fear amongst dollar bulls is that the massive snake lines that greeted the failure of Indy Mac will be repeated not only in California, but nationwide if more regional bank go under. The run on the bank dynamic is one of the most damaging developments for a country's currency as it demonstrates total lack of confidence in the system.

The market will get a glimpse of one measure of confidence today when the TICS data is released at 13:00 GMT. The TICS report is two months back so the data is relatively backward looking and does not reflect the current turmoil in the GSEs but it may still offer a clue as to the appetite of foreign investors for US capital assets. One of the key drivers behind the GSE rescue plan was the fact that Japan and China were major holders of those assets and any markdown in their value would curtail future foreign investment flows into the US which have been critical to the financing of the US trade deficit. Therefore any sharp drop off in the TICs figure could add fuel fire and push the greenback lower toady.

The one positive countervailing force for the dollar has been oil. Yesterday's collapse was one of the major reasons for the buck's recovery and should crude decline further today it may provide a much needed counterbalance to all of the negative news over the past 48 hours. Nevertheless the positive impact of lower crude may have a limited impact. Concern over systemic risk remains the dominant theme of trade in FX and could push the EUR/USD higher if angst over the state of the US economy reaches panic levels once again.